Grant Thornton recently released its 20th annual International Business Report on M&A in which it suggests the market for M&A looks strong both globally and in Canada, as businesses look to invest cash resources built up over a period
New reporting obligation for transactions affecting tax basis of securities
As a result of new US reporting rules that came into effect on January 1, 2011, Canadian public and private issuers may be subject to a significant information reporting obligation when undertaking one of a wide range of transactions. The new rules are intended to increase compliance in reporting capital gains and losses for US tax purposes.
The rules require issuers of “specified securities” to complete an information return for any “organizational action” that affects the US tax basis of those securities. Specified securities currently include shares of a corporation or a Regulated Investment Company.
On January 1, 2013, or at a later date if determined by the IRS, specified securities will include notes, bonds, debentures, other debt, and certain commodities, contracts or derivatives with respect to commodities, or financial instruments.
Organizational actions that trigger the reporting requirement may include transactions such as mergers, acquisitions, stock splits, stock redemptions, distributions in excess of US earnings and profits, and similar transactions and events.
Expense escrow funds are a good idea
Although expense escrow funds have become increasingly popular south of the border, they still remain relatively uncommon in Canada. An expense escrow account is a separate fund created to pay the legal fees or other expenses of the former shareholders that may arise in defending against claims post-closing. Expense escrows benefit sellers, shareholders and buyers as follows:
- Sellers – by discouraging buyers from bringing a weak or frivolous claim, with the aim of tying-up funds in escrow indefinitely, knowing that the former shareholders will not have the means to fight it;
- Large shareholders – by providing funds to represent the selling shareholders without forcing large shareholders to contribute more than their pro-rata portion of expenses; and
- Buyers – by providing access to funds in the event that the terms of the merger obligate the parties to split costs for items such as audits and arbitration.
Shareholder Representative Services (SRS), a United States based shareholder representative company, recommends a minimum escrow expense fund of $100,000, increasing depending on the size, complexity and earn-out potential of the transaction. According to the 2011 SRS M&A Deal Terms Study, available at the SRS website, the average size of an expense fund for deals with and without earn-out provisions was 0.51% and 0.4%, respectively, in 2011.