Canadian M&A in 2013

January 31, 2013

In the first of a two-part series looking at the state of M&A law in Canada, members of Stikeman Elliott’s national M&A group discuss 2013’s top issues and trends from a variety of perspectives. Part One begins with an overview of the market by John Ciardullo, head of the Capital Markets/Public M&A Group in the Toronto office of Stikeman Elliott, and also includes discussions of developments in the areas of antitrust/competition and tax law by Michael Kilby and John Lorito, respectively.

(To go directly to Part II of this article, click here.)


John Ciardullo, Toronto ([email protected])

In our M&A Outlook for 2012, we posed the question of whether the proverbial glass was half empty or half full. A year later, the future of Canadian M&A remains uncertain, as 2012 was another mixed year and the prognosis for 2013 seems equally murky. Nevertheless, Canada remains a very stable place to do business and we anticipate continued interest in Canadian M&A opportunities. As Mark Carney, the Governor of the Bank of Canada and soon-to-be Governor of the Bank of England recently said, “[i]n this uncertain world … Canada is rightly viewed as an attractive investment destination”.

Reflecting back upon 2012, overall deal volumes were less than robust as a result of lingering global macro-economic and political issues, volatile commodity prices and other negative factors. However, some sectors performed relatively well and there were a number of high-value transactions that challenged the notion that market participants are reluctant to pursue large transactions in a risky environment.

Looking forward to 2013, we expect the cautious stance concerning M&A activity to continue. However, there is mounting tension between the protracted uncertainty overhanging the market and the abundance of capital available for M&A activity, and we expect some to yield to this liquidity pressure in 2013. Industry sectors we expect to be active include real estate and infrastructure, given the on-going desire for yield producing assets. We further expect to see continued activity in the energy and natural resource sector, although here the picture is a little more complex. We have little doubt that the interest in the sector will persist due to its global strategic importance, the on-going need for significant investment in Canada and the desire of many to tap into our surplus of natural gas as a less expensive source of supply or to benefit from the price differential between North America and Asia.

Nevertheless, the picture will be complicated by our federal government’s recent policy pronouncements in the wake of the Investment Canada decisions in CNOOC/Nexen and Petronas/Progress Energy, debates surrounding pipelines and related matters, volatile commodity prices and other factors. In the short term, our new foreign investment framework is expected to curtail outright acquisitions of control of Canadian companies in the oil sands by state-owned entities (SOEs) and lead to more of the types of minority investments and joint-ventures that we’ve seen in the past. An open question will be the extent to which the new framework and lingering uncertainty tied to the rejection by the Ministry of Industry of BHP Billiton’s attempt to acquire Potash Corp. in 2010 will result in a broader “chilling effect”, or conversely whether the federal government’s policy stance will eventually soften as North America heads towards energy self-sufficiency and the need for oil sands and heavy oil perhaps doesn’t arise as quickly or profoundly as currently anticipated.

As always, we expect a good portion of M&A activity to be cross-border in nature as a result of the continuing appetite of foreign companies and private equity funds for Canadian assets and the on-going trend towards our banks and pension funds investing outside of Canada. However, in many ways, 2012 was a year where political, regulatory and legal issues dominated the M&A landscape. The unsettled state of play in our foreign investment, anti-trust and securities regulatory regimes, as well as the anti-takeover developments we witnessed in Quebec, leads us to expect that foreign investors looking to Canada will be very sensitive to regulatory, political and other potential pitfalls, and will engage in very careful and thoughtful planning to address perceived execution risk.

Competition and Foreign Investment Regulation

Michael Kilby, Toronto ([email protected])

Investment Canada – The Year of the State-Owned Enterprise

2012 proved to be a highly eventful year for foreign investment law in Canada. Although numerous foreign investments by SOEs in the Canadian energy sector had received foreign investment approvals in recent years1, the summer of 2012 saw the announcement of two multi-billion dollar energy transactions involving SOEs that collectively posed an unprecedented test for the Investment Canada Act and for Canadian policymakers. In June, Petronas (the Malaysian state-owned oil company) announced its $6 billion acquisition of Progress Energy. At the time, this was the largest-ever proposed acquisition of a Canadian company by a state-owned enterprise. But that record did not stand for long: just a month later, in July, CNOOC Limited (a majority Chinese state-owned oil company) announced its $15 billion acquisition of Nexen.

These proposed acquisitions became the subject of intense scrutiny in the national media throughout the summer and fall, and indeed attracted attention in the business press globally, particularly in Asia. With few exceptions, large-scale M&A activity in the Canadian oil patch ground to a halt in the fall of 2012 as market participants stood still and held their collective breath pending the outcome of the government reviews of these proposed foreign investments. Tension was only heightened in October when the Minister of Industry rejected the Petronas transaction on a preliminary basis, immediately recalling the rejection of BHP Billiton’s hostile bid for Potash Corporation of Saskatchewan less than two years earlier.

The review process concluded on December 7, 2012, when the federal government announced its approval of both the Progress and Nexen transactions. But at the same time it detailed a new approach and revised guidelines applicable to investments by state-owned enterprises, particularly in the oil sands. As a consequence, continued acquisitions by SOEs of controlling interests in the oil sands industry have been largely constrained and, going forward, will be found to pass the critical “net benefit to Canada” test only on an exceptional basis. However, the acquisition by SOEs of non-controlling interests, including by means of joint ventures, will continue to be welcome (indeed, acquisitions of non-controlling interests are, generally speaking, not subject to the Investment Canada Act). While the “exceptional basis” test does not apply to sectors other than the oil sands, the government has noted that it will continue to monitor investment by SOEs throughout the Canadian economy, and in this regard has adopted a somewhat more measured tone in relation to investment by such entities, across all industries.

We further expect to see long-awaited regulations that would alter the primary review threshold under the Investment Canada Act from a C$330 million “book value” test (indexed to inflation) to a C$600 million “enterprise value” test implemented in 2013, which threshold will then be increased to C$1 billion over a four-year period. However, the government has stated that, for state-owned enterprises, the review threshold will remain C$330 million in book value (indexed to inflation).

Competition Act – The Changing of the Guard

With respect to competition matters, 2012 saw the departure of Canada’s Commissioner of Competition, who had established herself as an active and assertive competition law enforcer bringing cases against Air Canada (since settled), VISA/MasterCard (ongoing), the real estate brokerage industry (ongoing), Rogers (ongoing), Bell (settled) and the retail gasoline industry (numerous convictions obtained). The most prominent developments in 2012 were likely the clearance issued in respect of the Maple Group/ TMX transaction (following a very lengthy review), the settling of litigation in respect of certain cooperation arrangements between Air Canada and United Continental, and the Commissioner’s victory in successfully challenging a completed, non-notifiable transaction in the industrial waste industry, which serves as a cautionary reminder that the Commissioner has the jurisdiction to review and obtain divestitures in respect of closed transactions, even where such transactions fall below the mandatory reporting thresholds. Vigorous merger reviews are expected to continue under the new Acting Commissioner, John Pecman [ed. note: Mr. Pecman’s appointment has subsequently been made permanent].

Telecom – Controversial Domestic Decision but Opening the Doors to Foreign Investment

In 2012, Canada’s federal communications regulator, the Canadian Radio-television and Telecommunications Commission (CRTC), surprised many when it rejected the $3.38 billion bid by BCE Inc. to acquire Astral Media Inc. amid concerns that impact a combined Bell Media-Astral would have on domestic competition and Canadian consumers. In doing so, it was alleged that the CRTC went against its own thresholds for approving mergers that had been previously set in a 2008 decision. The deal has subsequently been re-packaged in an effort to overcome regulatory opposition.

Another important development in 2012 were amendments to the Telecommunications Act that provide that foreign ownership rules will no longer apply to a telecommunications common carrier if the carrier and all its affiliates have total annual telecommunications revenues representing less than 10% of total Canadian telecommunications revenues, as determined by the CRTC. Based on total reported revenues for 2010, the threshold below which Canadian ownership rules no longer apply is approximately $4.2 billion, and likely growing. All but the largest wireline and wireless carriers will fall below this threshold, including new wireless entrants, non-dominant carriers, and even several incumbent carriers. It will therefore be interesting to see the extent to which major international telecom firms endeavour to enter into Canada by way of acquisition, an option not previously available to them. Indeed, the key foreign shareholder in Globalive/Wind Mobile (one of the new wireless entrants) has already increased its voting shareholding from a minority level to a majority level. Current rules limit foreign ownership in telecommunications carriers to an effective maximum of 46.7%, reflecting combined maximum allowable interests at the operating and holding company levels. These rules remain in place for larger carriers and similar rules also continue to apply to broadcasting undertakings licensed under the Broadcasting Act.

Tax Trends

John Lorito, Toronto ([email protected])

In our M&A Outlook for 2012, we discussed the emergence, in 2011, of foreign asset income trusts and noted that we expected the trend to continue in 2012 with offerings providing Canadian yield-seeking investors with exposure to foreign-based real estate assets. In fact, in 2012, a number of offerings were brought to market providing Canadian investors with exposure to various classes of real estate assets from multi-unit residential to industrial. With the search for yield still very prominent, look for more of such offerings in 2013.

Structures used by non-residents of Canada for acquiring shares of Canadian corporations and Canadian assets will likely see some revisions in 2013. Currently, the Canadian tax system provides a competitive advantage to non-resident bidders for shares of Canadian corporations and other Canadian based assets over their Canadian resident counterparts. Generally, non-residents are able to use internal leverage to reduce the future taxes payable by the Canadian target corporation or in respect of income from the Canadian based assets. The interest deductions created through the internal leverage reduce Canadian corporate income taxes at rates approximating 25% in exchange for Canadian withholding tax at a rate that in many cases is reduced to 10% under an applicable tax treaty. For U.S. investors, the advantage is even greater as the Canada-U.S. Income Tax Convention provides for a nil withholding rate on all interest paid by a Canadian resident to a non-resident, including related party interest. In addition, it is generally possible to structure instruments that are treated as debt for Canadian purposes but equity for U.S. purposes. As a result, while the Canadian payor receives a deduction for the interest paid, the U.S. recipient does not have a corresponding income inclusion.

Two tax changes enacted in 2012 will lessen this advantage:

  • The first is the reduction in the acceptable thin capitalization ratio from 2:1 to 1:5:1. As a result, foreign acquirers will be allowed to use less internal leverage to fund their Canadian acquisitions thereby reducing the amount of interest deductions that will be available to shelter future income.
  • The other important tax change is the introduction of the “foreign affiliate dumping rules”. These rules generally apply to an investment in a foreign subsidiary made by a Canadian corporation that is controlled by a non-resident corporation. Under these rules, the investment may result in the Canadian corporation being deemed to have paid a dividend to its non-resident parent in the amount of the investment made in the foreign subsidiary. The deemed dividend is subject to Canadian dividend withholding tax. Alternatively, the rules may apply to reduce the paid-up capital of the shares of the Canadian corporation which reduces the amount of internal debt that may be used to fund the Canadian corporation under the Canadian thin capitalization rules.

The rules also apply to a Canadian corporation controlled by a non-resident corporation that acquires, or makes an investment in, the shares of another Canadian corporation that derives more than 75% of its value from foreign subsidiaries. Accordingly, in the case of the acquisition of such Canadian corporations, it may no longer be advantageous to use a Canadian acquisition corporation. Typically, Canadian acquisition corporations have been used by non-residents to make acquisitions of Canadian corporations in order to maximize paid-up capital (which acts as a pipeline to distribute profits to the foreign shareholder without Canadian withholding tax) and internal leverage.

Finally, a growing trend for structuring Canadian acquisitions is the use of the hybrid asset/share purchase. While not necessarily a new structure, current Canadian corporate tax rates and individual tax rates on dividends and capital gains often make it advantageous for both sellers and buyers to use a hybrid purchase structure. In very general terms, the hybrid structure involves the purchase of the assets of a Canadian corporation followed by the distribution of some of the after-tax proceeds from the asset sale and then the sale of the shares of the corporation. This structure provides the purchaser with a step-up in the cost base of the assets for Canadian tax purposes while still providing sellers with the favourable tax treatment they would receive from a straight share sale. The hybrid structure adds complexity to the transaction but the tax savings for sellers and purchasers can be significant so look for this trend to continue.

[ed. — For an update on tax developments in 2013, have a look at our 2013 Federal Budget Commentary.]

To continue to Part II of this article, click here.

DISCLAIMER: This publication is intended to convey general information about legal issues and developments as of the indicated date. It does not constitute legal advice and must not be treated or relied on as such. Please read our full disclaimer at

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