ADVERSE CONSEQUENCES of a NON-QUALIFIED AMALGAMATION
Amalgamation - Section 87 Tax Deferral - Long-Form Amalgamation - Vertical Short-Form Amalgamation - Horizontal Short-Form Amalgamation
Contact Neufeld Legal at 403-400-4092 / 905-616-8864 or Chris@NeufeldLegal.com
An amalgamation is a legal process where two or more corporations merge to form a single, new corporation, or where one of the merging corporations continues while the others are absorbed. In a tax context, a qualified amalgamation is a specific type of merger that satisfies all the criteria outlined in the Income Tax Act (Canada). When an amalgamation is "qualified," it is treated in a specific, beneficial manner for tax purposes, most notably, it allows for the tax-deferred rollover of assets and liabilities from the predecessor corporations to the new amalgamated corporation (Amalco). This typically means that the merger itself does not trigger immediate capital gains or losses, providing essential flexibility for corporate restructuring. The failure to meet even one of the prescribed statutory requirements, however, causes the transaction to be deemed a non-qualified amalgamation, which results in the loss of these crucial tax-deferred rollover benefits and can lead to significant, immediate tax liabilities for the predecessor corporations and their shareholders.
The most direct cause for an amalgamation to be non-qualified is the failure to strictly adhere to the specific requirements of the governing tax statute. In the context of the Income Tax Act (specifically subsection 87(1)), a key condition is that all of the property of the predecessor corporations must become the property of the new amalgamated corporation (Amalco), and all of the liabilities of the predecessors must become the liabilities of Amalco, by virtue of the merger itself. Furthermore, all of the shareholders (except for the common parent corporation, if applicable) of the predecessor corporations must receive shares of Amalco. If, for instance, a predecessor corporation attempts to "carve out" or dispose of certain assets or settle specific liabilities immediately before the legal amalgamation, or if some shareholders receive non-share consideration (like cash) for their shares in the process, the "all or substantially all" condition is violated. Any structural deviation from a true statutory merger where everything seamlessly rolls over will likely result in the amalgamation being non-qualified.
Another critical area that often causes an amalgamation to fail qualification relates to the consideration received by the shareholders and the subsequent continuity of their interests. The tax provisions are generally designed to ensure that the amalgamation is a reorganization of the existing corporate structure, not a sale of the business. Therefore, shareholders of the predecessor corporations must receive shares of the new Amalco in exchange for their old shares. A common pitfall is the introduction of non-share consideration, known as "boot," into the exchange. If a shareholder receives a significant amount of cash, a note, or any property other than shares of Amalco for their interest, the transaction may be considered an immediate disposition of their shares for tax purposes, thereby disqualifying the amalgamation from the tax-deferred treatment at both the corporate and shareholder levels. The goal is a mere change in corporate form, not a change in economic substance or ownership.
Beyond the fundamental tax requirements, an amalgamation can also be deemed non-qualified if it fails to satisfy the relevant corporate law criteria under the governing statute. While the corporate law merger creates the legal entity, the tax law looks at the substance of how that legal entity was formed. Moreover, tax legislation often contains specific exclusions that can immediately disqualify a merger, regardless of whether the other conditions are met. For example, tax rules typically exclude certain types of mergers from the definition of a qualified amalgamation, such as a vertical amalgamation between a parent corporation and a wholly-owned subsidiary, or "twinning" or "triangular" amalgamations where a third party is introduced to the exchange. While some of these excluded transactions may be dealt with under other specific tax rollover provisions, they do not qualify under the general amalgamation rule, making the overall transaction susceptible to adverse tax consequences if the wrong provision is relied upon.
The primary risk and consequence of an amalgamation being classified as non-qualified is the immediate realization of tax liabilities. Instead of the smooth, tax-deferred rollover of assets at their historical tax cost, a non-qualified amalgamation is treated as if the predecessor corporations disposed of all their assets at their fair market value just prior to the merger. This deemed disposition can trigger substantial capital gains or recapture of depreciation (recapture) at the corporate level, which are then carried forward to the new Amalco. Concurrently, the shareholders of the predecessor corporations are deemed to have disposed of their shares for proceeds equal to the fair market value of the Amalco shares (and any other consideration) they received, which can trigger significant capital gains for them as well. Ultimately, a non-qualified amalgamation converts a strategic corporate restructuring designed to be tax-neutral into an immediate, costly tax event, often resulting in tax liabilities that erode the financial benefits of the merger.
For knowledgeable and experienced legal representation when undertaking an amalgamation or other corporate restructuring, contact corporate business lawyer Christopher Neufeld at Chris@NeufeldLegal.com or 403-400-4092 / 905-616-8864.
