Application of substituted property rules where consideration paid to target (Kodiak) shareholders was over 10% of shares of U.S. acquiror (Whiting) (p. 15:7)
[T]he consideration provided to Kodiak shareholders consisted of shares of a U.S. corporation, which do not qualify as specified property under paragraph 88(1)(c.4) for the purposes of the substituted property rules in paragraph 88(1)(c.3). Kodiak represented more than 10 percent of the value of the combined entity, meaning that more than 10 percent of the value of the Whiting shares issued to the Kodiak shareholders was attributable to the Kodiak shares. Accordingly, the Whiting shares were attributable property for the purposes of subparagraph 88(1)(c.3)(i). Thus, under the plan of arrangement, all of the the Kodiak shareholders acquired substituted property for the purposes of the bump rules, and the conditions in paragraph 88(1)(c) for the bump were not satisfied.
Summary description for acquisition of Yukon target with mostly U.S. assets (“Kodiak”) by U.S. public corp (“Whiting”) (pp. 15:5-6)
[W]hiting established a taxable Canadian corporation as a subsidiary to effect the transaction ("Whiting Bidco"). …
2) [A]t the same time,
a) In consideration for shares in the capital of Whiting (the "consideration") delivered to the Kodiak shareholders by Whiting on behalf of Whiting Bidco, Whiting Bidco issued shares to Whiting with a fair market value equal to the value of the consideration; and
b) Whiting Bidco purchased the outstanding Kodiak shares in exchange for the consideration, to be issued directly by Whiting to Kodiak shareholders on behalf of Whiting Bidco….
5) Whiting Bidco and Kodiak amalgamated (to form "Kodiak Amalco") "with the same effect as if they were amalgamated under...the BCBCA", "except that the separate legal existence of [Kodiak] will not cease and [Kodiak] will survive the Amalgamation".
Need to avoid Whiting shares being issued to Whiting Bidco (p. 15:8)
The transaction also presented a potential pitfall under the FAD rules. Had Whiting issued its shares to Whiting Bidco for delivery by Whiting Bidco to the Kodiak shareholders, there could have been two investments in FAs by a CRIC. Had Whiting issued shares to Whiting Bidco, immediately afterwards Whiting would have been an FA of Whiting Bidco, because the shares would have represented more than 10 percent of Whiting's total issued common share capital. In evaluating whether the FAD rules apply, it is necessary to evaluate whether a corporation in which a CRIC makes an investment is an FA of the CRIC immediately after the investment. There is no "at the end of the series of transactions" requirement or purpose test, suggesting that even momentary FA status could be sufficient to trigger the application of the FAD rules.
As discussed above, the acquisition of shares of Kodiak by Whiting Bidco was a deemed investment in an FA by a CRIC. Accordingly, had the transaction proceeded with Whiting issuing its shares to Whiting Bidco, the FAD rules could have applied in respect of two FA investments and would have had the potential to create a deemed dividend under subsection 212.3(2) in respect of each such investment. The PUC created by the issuance of Whiting Bidco shares to Whiting would have been sufficient to offset one of the FA investments (as it did), but there would have been no further PUC available to offset the other FA investment, meaning that a dividend equal to the value of the transaction could have been deemed to have been paid by Whiting Bidco to Whiting, and could have been subject to withholding tax at a 5 percent rate (under the Canada-U.S. tax convention.). Having Whiting deliver the shares directly to the Kodiak shareholders on behalf of Whiting Bidco, but without Whiting Bidco acquiring the Whiting shares, was intended to avoid this possible pitfall. [fn 18: This approach also is taken to avoid so-called "corporate incest"…]
Potential advantages of a direct acquisition not available where no significant Canadian operations (p. 15:8-9)
Had Whiting purchased the shares of Kodiak directly, paragraph 212.3(10)(f) would not have applied. In order for the acquisition of shares of a Canadian corporation to trigger the FAD rules, the shares must be acquired by another Canadian corporation (the CRIC). This would not have been the case. In this context, Whiting would have acquired the Kodiak shares with their historical PUC, but that PUC would not have been suppressed under the FAD rules, and would have been available for a broader range of purposes -- supporting thin capital computations for shareholder debt, making other distributions from Canada, avoiding FAD rule consequences in respect of future investments in FAs, etc. While it is easy to conceive of situations where this might be valuable to a purchaser, it is unlikely that the Whiting-Kodiak transaction would have benefitted meaningfully from such an approach. The fact that Kodiak's assets were all foreign meant that there would be little direct benefit from introducing debt into Canada, and that there was little likelihood that the suppressed PUC would not be available for any distribution that Kodiak Amalco might wish to make….
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