If a corporation undergoes a change in control, various income tax rules come into play. Most of these rules are restrictive in nature, and are generally meant to prevent the takeover of a corporation for the purpose of accessing its existing tax losses and credits that it has been unable to use because it is not profitable, and effectively transferring those losses to another business.
For these purposes, a change in control normally means the acquisition of more than 50% of the voting shares in the corporation. There are some exceptions – for example, if X purchases the shares of Yco from a person related to X who already controls Yco, there will not be a change in control.
A change in control also includes the acquisition of more than 75% of the shares of the corporation on a fair market value basis, regardless of the number of votes. Again, there are some exceptions – for example, there is no change in control if X acquires more than 75% of the shares of Yco but X already controlled Yco.
Some of the more significant change-in-control rules are summarized below.
Deemed taxation year-end and new year
A change in control results in a deemed year-end for the corporation immediately before the change in control, and a new year beginning at the time of the change of control. Since the deemed year end will typically result in a shortened taxation year, the tax filing dates and balance-due dates for that year will be pushed up accordingly. (The filing date is six months after the year end; the balance-due date is 2 months after year-end, 3 months for certain CCPCs).
The year-end also uses up a year for purposes of the carryforward of various unused losses and credits that can be carried forward for a specific number of years. (However, as noted below, certain losses and credits cannot be used at all.)
The shortened taxation year will require a pro-rating of certain deductions. For example, capital cost allowance (tax depreciation) will have to be pro-rated, based on the number of days in the short year relative to a 365-day year.
Net capital losses
Normally, net capital losses (allowable capital losses [half of actual capital losses] in excess of taxable capital gains for a year [half of actual capital gains]) can be carried back three years or forward indefinitely. However, they cannot be carried over from pre-change of control years to post-change of control years, or vice versa.
In other words, there is a specific restriction that says net capital losses cannot be carried forward beyond a change of control or back before the change of control.
Write-down of unrealized capital losses
Immediately before the change of control, the corporation’s capital properties with accrued losses – that is, where the fair market value is less than the adjusted cost base of the property – are subject to a deemed disposition and re-acquisition at fair market value. This results in the triggering of all accrued capital losses in the year ending before the change of control. Because of the rule discussed above, these losses cannot be carried forward to future years beyond the change of control.
However, the corporation can elect to trigger its accrued capital gains on other properties, in which case the cost of those properties is bumped up accordingly. The triggered gains can be offset by the accrued capital losses as noted above. Basically, this rule allows the corporation to elect on a property-by-property basis, a deemed disposition and deemed re-acquisition at any amount between the adjusted cost base of the property and its fair market value.
There is a change in control of Xco. Before the change of control, Xco owned a capital property with a $100,000 adjusted cost base and a $70,000 fair market value. This property is automatically written down to $70,000, leading to a $30,000 capital loss and $15,000 allowable capital loss in the year that is deemed to end before the change in control.
The corporation also owns another capital property with a $50,000 adjusted cost base and a $90,000 fair market value. The corporation can elect a deemed disposition and re-acquisition at $80,000, resulting in a capital gain of $30,000 and taxable capital gain of $15,000. This taxable capital gain can be offset entirely by the allowable capital loss. Meanwhile, the adjusted cost base of this property is bumped up to $80,000.
Normally, non-capital losses (most unused business and property losses in a year, other than net capital losses) can be carried back three years or forward 20 years. On a change in control, the carryovers are somewhat restricted.
Non-capital losses from a business before the change of control may be carried forward to years after the change of control, generally only to offset income from the same or similar business carried on after the change of control with a reasonable expectation of profit. Similarly, non-capital losses after the change of control from a business can be carried back to years before the change of control if the same or similar business was carried on with a reasonable expectation of profit. Otherwise, non-capital losses cannot be carried forward or back beyond the change of control.