Theo Yameogo: Welcome, Eric. Thank you for joining me. I'm looking forward to hearing your experience about transaction tax.
Eric Xiao: Thanks for having me, Theo. I look forward to our discussion.
Theo Yameogo: Let's get right into it, Eric. As the national leader for Mining and Metals Transaction Tax, what are the key trends that you're seeing in the market?
Eric Xiao: Great question, Theo. I've been working with clients on their M&A tax strategy for the last 20 years. What I'm seeing now is that the M&A activity has stabilized, but clients continue to be cautious. The macroeconomic environment is still top of mind. This includes higher interest rates, concern of possible economic slowdowns, global trade and high inflation. Having said that, there are still a lot of transactions in the mining sector., This includes financing transaction involving metals streaming contracts, spin-out transactions where a company will spin out a project to a new company or consolidation transactions involving mergers and acquisitions.
Another thing that's important to point out is the global and Canadian tax reform that's currently unfolding. This includes a global minimum tax, limitation on interest deductions, transfer pricing reform, just to name a few.
Some of these changes will become effective starting in 2024, and I expect they will have a significant impact on the after-tax return of transactions.
Theo Yameogo: That's very interesting, Eric. On the consolidation transactions side, can you elaborate on what you've seen in the space and what are the key tax issues?
Eric Xiao: Sure, Theo. There's a wide variety of consolidated transactions where a company undertakes to expand their operations or increase their reserves. This includes for example, private deals, joint ventures or mergers of public companies. There are several tax issues to be considered in order to maximize the after-tax return of a transaction. This includes, for example, whether the transaction would trigger taxes payable to the shareholder and also what are the tax implications to the merged entity.
A good example is a recent merger of two Canadian public companies. It’s a share-for-share exchange transaction where the target shareholder sold their shares to the purchaser in exchange for purchaser shares. It is structured to be a rollover for tax purposes. For a US taxable resident, for example, the circular indicates that the transaction is intended to be a tax-free reorganization for US tax purposes.
For Canadian shareholders, they actually have three options. First, it can be an automatic rollover because it’s a share for share exchange transaction. Second, the shareholder can also choose to report the transaction on a fully taxable basis. And number three, the shareholder can also choose to report a portion of the capital gain by requesting the purchaser to file a joint Section 85 election.
So, there's lots of flexibility here.
Theo Yameogo: That's fascinating, Eric how the tax implications can work in consolidation transaction. What other interesting transactions have you seen recently that you want to share with us.
Eric Xiao: Sure, Theo. I think another interesting type of transaction is joint acquisition or joint bidding, where two or more parties would team up to buy a target company. Sometimes the joint bidder will continue to own the target as a joint venture partner. In some other cases, they would divide up the target, so each one of them would own a piece of the target assets. A joint bidding or joint acquisition transaction are typically more complex from a tax perspective.
The issue, as I said, is whether the separation of the target assets to multiple purchasers could result in the target being subject to tax at a corporate level and whether or not they are planning ideas that will minimize the target's taxes payable, for example, by making use of the target's tax attributes or through some sort of a so-called step-up transaction planning.
Theo Yameogo: Eric, let's take a different angle on this transaction discussion. Recently, there's been a lot of carveouts and spinouts. Can you give us some sense of what are the M&A tax implications behind these ones?
Eric Xiao: Sure, Theo. I've seen a number of spinout transactions where a mining company will spin out a project into a new company so that the new company can focus on that project, including raising financing, etc. Some of the spinout transactions are being done on a taxable basis, but some are being done on a tax-free basis. One of the tax-free spinout transactions is the so-called butterfly transactions.
If certain conditions are met, a butterfly can be done so that the spinout transaction is tax free for the shareholders, but also for the company. Now, butterfly transactions tend to be complex, so some mining companies would choose to obtain a binding tax ruling from the tax authority. A ruling would really provide certainty to the tax treatment of the spinout transaction so the company can be guaranteed on these tax results.
Theo Yameogo: Eric, on tax reforms and tax policy changes, can you give us a key example that clients should be focusing on?
Eric Xiao: Absolutely, Theo. As you know, there's so many Canadian tax policy changes recently. One of the examples is the introduction of a new tax regime that will limit the deduction of interest expenses. Under the new regimes, a Canadian company cannot deduct interest expenses in excess of 30% of its adjusted tax EBIDTA. This could have a significant issue for Canadian company that's highly leveraged.
For example, borrow to acquire foreign subsidiary and cannot push down the interest expenses into the foreign company. Now, if a portion of the interest expenses is not deductible, this will increase taxes payable and reduce the after-tax return on the investment. The new regime is called the EIFEL rules. EIFEL stands for excessive interest and financing expense limitation. The new EIFEL rules will become effective for most companies starting 2024.
I expect it could have a significant impact on transactions.
Theo Yameogo: It seems like these are super complex situations, Eric. How does a client go about addressing all of these when they are in an M&A transaction?
Eric Xiao: You're absolutely right, Theo. It is complex when it comes to taxation involving Canada and other countries. I think one of the best practices is to have a single point of contact so that the client can call one person within an advisor’s organization. And that person, acting as a single point of contact, can then reach out to their vast global network to find the right specialist to resolve whatever issue they can.
Theo Yameogo: Thanks Eric, for joining me today and sharing the knowledge and the insights.
Eric Xiao: Thanks so much for having me, Theo. I truly enjoyed our conversation.
