Canada: Canada Releases Revised Equity Repurchase Tax Proposals

In August 2023, the Canadian federal government released a draft legislation package (August Proposals) with explanatory notes (Explanatory Notes) which includes, among other things, revised proposals to amend the Income Tax Act (Tax Act) to introduce a new equity repurchase tax. Under these proposals, many publicly traded entities will be subject to a 2% tax on the "net value" of certain equity repurchases that occur on or after January 1, 2024.

What you need to know

• Entities subject to the equity repurchase tax include a broad group of publicly traded entities, including Canadian-resident corporations (excluding mutual fund corporations) and certain trusts and partnerships (Covered Entities).
• The equity repurchase tax will be calculated on an annual basis using a netting rule and will generally be equal to 2% of the total value of equity that is redeemed, acquired or cancelled (a Repurchase) by a Covered Entity in a taxation year, less the total value of equity issued by the Covered Entity from treasury in the year, and:
  • equity for purposes of the tax calculation will not include equity having debt-like characteristics;
  • subject to limited exceptions, acquisitions of equity by certain affiliates of a Covered Entity will be deemed to be a Repurchase of equity by the Covered Entity and will be factored into the netting rule;
  • subject to limited exceptions for certain types of corporate reorganizations and acquisitions, all Repurchases of equity by a Covered Entity will be factored into the netting rule, including Repurchases in the context of normal course issuer bids, substantial issuer bids and certain other reorganizations; and
  • generally, the only issuances of equity that will be factored into the netting rule will be issuances of equity for cash consideration, to employees in the course of their employment and on an exchange of a debt instrument that was issued solely for cash consideration.
• The tax will not apply to a Covered Entity that Repurchases less than $1 million of equity in a taxation year, as determined on a gross basis.
• The tax applies to Repurchases and issuances of equity that occur on or after January 1, 2024.

Background

In the 2022 Fall Economic Statement, the Canadian federal government announced its intention to introduce a corporate-level 2% tax on the net value of all types of share buybacks by Canadian public corporations, effective January 1, 2024. As stated in the 2022 Fall Economic Statement, this tax is similar to the 1% share buyback tax that was enacted in the United States under the Inflation Reduction Act of 2022.

Further to this announcement, in Budget 2023, the government released detailed legislative proposals to introduce the new equity repurchase tax and notably expanded the types of entities subject to this tax to also include certain publicly traded trusts and partnerships. Budget 2023 clarified that normal course issuer bids and substantial issuer bids would constitute Repurchases of equity for purposes of the new tax.

This bulletin discusses the August Proposals and related Explanatory Notes, which further refine the details of the new equity repurchase tax.

To whom the tax applies

A Covered Entity means any of the following entities if any of their equity is listed on a designated stock exchange:

• a Canadian-resident corporation, other than a mutual fund corporation;
• a mutual fund trust that:
  • is a real estate investment trust;
  • is a specified investment flow-through (SIFT) trust; or
  • would be a SIFT trust if its assets were located in Canada; and
• a partnership that:
  • is a SIFT partnership; or
  • would be a SIFT partnership if its assets were located in Canada.

Calculation of the tax

The tax is calculated using a netting rule and is generally equal to 2% of the "net value" of certain equity Repurchases, determined by the following formula:

0.02 x (A - B)

where

Variable A = the total fair market value of equity that is Repurchased by the Covered Entity, or deemed to be Repurchased by the Covered Entity, in the taxation year

Variable B = the total fair market value of equity that is issued by the Covered Entity in the taxation year

This netting rule will apply on an annual basis, corresponding to the Covered Entity's taxation year, and will generally be applicable to Repurchases and issuances that occur after January 1, 2024. The August Proposals do not include any grandfathering rules that would exclude equity that is outstanding prior to this coming into force date, and which may be Repurchased after 2023, or for obligations to effect Repurchases that have been entered into prior to 2024 for transactions that are to occur after 2023. In addition, in the event that the amount in Variable A exceeds the amount in Variable B, the Covered Entity will be subject to the tax; however, in the event that the amount in Variable B exceeds the amount in Variable A, the August Proposals do not include any carryover rules that would permit a Covered Entity to use this excess to offset Repurchases included in Variable A in other years.

Further details of the amounts included in Variable A and Variable B are discussed below, including an anti-avoidance rule.

Equity for purposes of the tax calculation

As noted above, the calculation of the equity repurchase tax generally factors in Repurchases and issuances of equity by a Covered Entity. The term "equity" is generally defined for purposes of these rules to mean shares of a corporation and interests in a trust or partnership. However, each of Variable A and Variable B of the tax calculation will exclude equity that constitutes "substantive debt", which the Explanatory Notes describe as equity of a Covered Entity that possesses debt-like characteristics. More specifically, equity will constitute substantive debt if in accordance with its terms the equity:

• is not convertible or exchangeable other than for:
  • equity that if issued would be substantive debt of the same Covered Entity;
  • a bond, debenture or note of the Covered Entity, the fair market value of which does not exceed the total of the fair market value of consideration for which the equity was issued, any unpaid distributions or dividends, and any premiums payable solely due to the early redemption, cancellation or acquisition of the equity; or
  • equity that would be issued only after the occurrence of a trigger event pursuant to a non-viability contingent capital provision to satisfy regulatory capital requirements applicable to the Covered Entity;
• is non-voting;
• has a periodic rate of dividend or other distribution payable, if any, expressed as a percentage of an amount equal to the fair market value of the consideration for which the equity was issued if the percentage is fixed or determined by reference to a market interest rate plus a fixed amount, if any; and
• entitles any holder of the equity to receive, on the redemption, cancellation or acquisition of the equity by the Covered Entity (or by a person or partnership with whom the Covered Entity does not deal at arm's length or is affiliated), an amount that does not exceed the total of the fair market value of the consideration for which the equity was issued, any unpaid distributions or dividends, and any premiums payable solely due to the early redemption, cancellation or acquisition of the equity.

Many preferred shares may not meet the definition of substantive debt. For example, preferred shares that are convertible in accordance with their terms for common shares, as well as preferred shares that are voting, will not constitute substantive debt. Since the August Proposals do not include grandfathering rules, Covered Entities that currently have issued and outstanding preferred shares that may be Repurchased after 2023 may want to consider if their shares qualify as substantive debt for purposes of these rules.

Variable A: inclusions

Variable A of the tax calculation includes the fair market value of equity (other than substantive debt) that is Repurchased (i.e., redeemed, acquired or cancelled) by the Covered Entity in a taxation year, subject to the exceptions discussed below.

In addition, certain equity acquisitions by a "specified affiliate" of a Covered Entity will be deemed to be a Repurchase by the Covered Entity, with the result that the fair market value of the equity acquired by the specified affiliate will also be included in Variable A. This deeming rule will not apply to an acquisition of equity by a specified affiliate if the affiliate is:

• a registered securities dealer that acquires the equity as agent for customers in the ordinary course of business and disposes of the equity to the customer within a reasonable period of time; or
• a trust that is an employee benefit plan (and meeting certain other conditions) or which is governed by an employee or deferred profit-sharing plan.

However, to avoid double counting, Variable A excludes equity that is Repurchased by a Covered Entity from a specified affiliate, where the equity acquired by the specified affiliate was deemed to be acquired by the Covered Entity and previously included in Variable A.

A "specified affiliate" at any time of a Covered Entity is defined to mean a corporation, trust or partnership if, at that time, the Covered Entity: (i) controls the corporation, trust or partnership; or (ii) owns, directly or indirectly, equity of the corporation, trust or partnership having a fair market value equal to or more than 50% of the fair market value of the total equity of the corporation, trust or partnership.

Pursuant to an anti-avoidance rule, a person or partnership will be deemed to be a specified affiliate where it is reasonable to consider that one of the main purposes of a transaction or series of transactions is to cause the person or partnership to acquire equity of a Covered Entity to avoid the equity repurchase tax that would otherwise be payable.

Variable A: exceptions

Variable A of the tax calculation excludes the value of equity that is Repurchased on or as part of certain reorganization or acquisition transactions, with the result that these Repurchases will not be subject to the new equity repurchase tax.

The first kind of reorganization transaction that will be excepted from Variable A will be a Repurchase on an exchange of equity by a holder for no consideration other than equity (that does not include any substantive debt) that is equity of:

• the Covered Entity;
• another entity that is related to the Covered Entity immediately before the exchange and is a Covered Entity immediately after the exchange; or
• another Covered Entity that controls the Covered Entity (or an amalgamated successor entity of the Covered Entity) immediately after the exchange.

The Explanatory Notes include several examples of reorganization or acquisition transactions that meet the above-noted conditions, including a Repurchase on a share-for-share exchange under section 86 of the Tax Act where the only consideration includes shares (that are not substantive debt) of the Covered Entity or of a subsidiary of the Covered Entity which are then listed on a designated stock exchange and a Repurchase from a selling shareholder who receives equity consideration (that is not substantive debt) on an acquisition transaction structured as a triangular amalgamation.

Other Repurchases of equity by a Covered Entity that will be excluded from Variable A include Repurchases:

• on a winding-up of the Covered Entity during which all or substantially all of the property owned by the entity is distributed to its equity holders;
• on a tax-deferred amalgamation of the Covered Entity and one or more other predecessor corporations if each shareholder of the Covered Entity receives no consideration for the disposition of their shares of the Covered Entity on the amalgamation, other than shares (that do not constitute substantive debt) of the new amalgamated corporation;
• in the course of a tax-deferred internal reorganization or butterfly transaction to which paragraph 55(3)(a) or (b) of the Tax Act applies;
• on certain dispositions of property by an individual (including a trust) to a trust that does not result in any change in the beneficial ownership of the property; and
• on a qualifying exchange that occurs as part of a tax-deferred merger of two mutual fund trusts or a mutual fund corporation and a mutual fund trust.

Variable B

As noted above, the fair market value of equity (other than substantive debt) issued by a Covered Entity is included in Variable B and is netted against the amount of Variable A in computing the tax payable in the year. However, not all equity issuances are included in Variable B. In particular, Variable B excludes issuances of equity unless the equity is issued:

• solely for cash consideration paid to the Covered Entity;
• to an employee of the Covered Entity (or an entity related to the Covered Entity) in the course of the employee's employment; or
• in exchange for a bond, debenture or note of the Covered Entity that was issued solely for cash consideration, the terms of which confer on the holder the right to make the exchange.

By virtue of these exclusions, the only equity issued by a Covered Entity that will be included in Variable B—and thus reduce the net amount that is subject to the equity repurchase tax—will be shares issued solely for cash, shares issued to employees, and shares issued on the conversion of convertible debt.

Anti-avoidance rule

The Repurchases included in Variable A and the equity issuance included in Variable B are subject to an anti-avoidance rule. More specifically, equity that is Repurchased or issued as part of a transaction or series of transactions will be deemed to be a Repurchase of equity included in Variable A, or an issuance of equity excluded from Variable B, as the case may be, where it is reasonable to consider that the primary purpose of the transaction or series is to cause a decrease in the total value of equity Repurchased, or increase in the total value of equity issued.

De minimis threshold

The August Proposals include a de minimis threshold of $1 million, such that the tax will not apply if the amount of Variable A in the tax calculation is less than $1 million in a taxation year (the amount is prorated for short taxation years). The de minimis threshold is calculated on a gross basis, that is, without regard to the netting rule and the value of equity issuances included in Variable B.

Filing and payment obligations

Covered Entities that Repurchase equity in a taxation year will be required to file a return in prescribed form, and if applicable, pay any equity repurchase tax. The filing and payment deadlines are as follows:

• if the Covered Entity is a corporation, the return must be filed on or before the day the corporation is required to file its return of income under Part I of the Tax Act for the year and payment of the tax is due on or before the balance-due day for the taxation year;
• if the Covered Entity is a trust, the return must be filed within 90 days from the end of the trust's taxation year and payment of the tax is due on or before the balance-due day for the taxation year; and
• if the Covered Entity is a partnership, the return must be filed before the earlier of 5 months after the end of the taxation year and March 31 immediately following the calendar year in which the taxation year ended, and payment of the tax is due on or before the day that the partnership is required to file a return.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.