Photo of Matthew ClarkBy Matthew ClarkMay 11 2017
Tax Law

Private Companies & Hybrid Transactions

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property (ECP) regime have been exaggerated. Vendors and arm’s length purchasers can continue to receive favourable tax treatment from hybrid sales, provided the vendor has sufficient cash or basis in the assets being sold.

The Asset/Share Sale Structure

When a vendor is selling his or her business, the vendor will often prefer a share sale, to make use of his or her capital gains exemption. Purchasers, on the other hand, often prefer asset sales, to reduce exposure to historical creditors and to increase the tax basis in the purchased assets. This gap can be a hotly-negotiated issue in many business sales.

The Hybrid sale was created to bridge the gap between asset and share sales. A properly-constructed hybrid sale allows the vendor to obtain the capital gains exemption through a share sale while providing the purchaser with security from the vendor’s historical creditors and providing the benefit of future tax deductions in respect of assets.

We have written a more detailed analysis on how small businesses/private corporations can continue to take advantage of a hybrid sale for the Canadian Tax Foundation, which includes a description of common transaction steps and a numerical example comparing after-tax effects of the new and old regimes (first published by the Canadian Tax Foundation in (2017) 25:4 Canadian Tax Highlights).

The Problem – More tax, less cash

Effective January 1, 2017, the ECP regime was replaced with a new capital cost allowance class that altered the tax treatment of gains on former-ECP (such as goodwill, trademarks, customer lists, and patents). These gains are now taxed at a higher “investment income” tax rate (50.67% vs. 27% in Alberta), which includes an additional refundable tax payable by the vendor.

The refundable tax can only be recovered if the vendor pays sufficient taxable dividends to its shareholders. Due to the structure of common hybrid sales, only a portion of the purchase price is received in cash by the vendor.

This creates a problem if the vendor does not have sufficient funds to pay the required amount of dividends necessary to recover the refundable tax. In this case, the vendor is effectively leaving cash (in the form of refundable tax not recovered) on the table, reducing the comparative benefits of a hybrid sale over a straight asset sale.

Solution – One Size Still Fits Many

At first glance, this issue has led some to believe that the hybrid sale has become an unattractive tax-planning option. We disagree. If the vendor has enough cash already available, or if the transaction includes high-basis assets, the refundable tax can be recovered and the full benefit of the hybrid sale is realized.

While the deferral opportunity provided by the former ECP regime is no longer available since the refundable tax is not refunded until the funds leave the corporate solution, hybrid sales can remain an attractive option for CCPCs under the right circumstances.

Handle With Care

The hybrid sale requires more attention to detail than in prior years. Tax advisors should continue to consider this tool in the war chest, but must take due care in its use. As discussed in our Canadian Tax Foundation article, used correctly, a hybrid sale can allow for the use of a capital gains exemption, reduce overall taxes to vendors, bridge the gap between purchasers and vendors, and enable a quick post-closing CDA strip. To ensure this positive result, taxpayers and advisors must now be more attentive to the vendor’s tax attributes than in prior years.

Invitation for Discussion:

If you would like to discuss this article in greater detail, or any other tax or business law matter, please do not hesitate to contact one of the lawyers in the tax law group at Nerland Lindsey LLP.


Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.

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