Tax Strategies to Save You Cash

Episode 14 transcript:

Dean: Welcome to Strategy Talks with Dean and Helen, part of the PricewaterhouseCoopers Managing in a Downturn podcast series. I'm Dean Mullett, co-head of our Restructuring and Distress Strategy Group, and a member of our Credit Crisis Task Force.

Helen: And I'm Helen Mallovy Hicks, a Partner in the Advisory Practice of PricewaterhouseCoopers in the Dispute Analysis & Valuations group.

Dean: The current state of the economy is understandably of great concern for most Canadian businesses. This series of audio podcast discussions with a variety of subject matter and industry guests are designed to help your business weather the storm by exploring some of today's hottest issues related to the economic crisis.

Helen: In today's episode we will be talking about some ways to ride out the recession by reducing your tax costs. We are joined by Doug Frost, PwC partner in mergers and acquisitions tax services national leader and Janice Russel, a partner in the MNA tax services group as well as a member of our Canadian National Tax Services group. Welcome Doug and welcome Janice. Janice, what about in the case where a company needs to sell a division? Can you talk to us about tax strategies there?

Janice: The number one objective is minimizing the amount of tax that's paid on any income or gains that's going to result from the sale of the division and so it's important to think about the tax structure early and consider things like whether the transaction should be structured as an asset sale or a share sale. You should think about where the assets that you want to sell if that's the situation where they are located in your corporate group. It might make sense to transfer them into another entity that has losses or expenses that might offset some of the income that could be realized and that would be done before you do your deal with a third party. And you should also look very closely at the amount of tax costs you have in your existing assets because sometimes transactions internal reorganizations can occur where you can really get the full benefit of that tax cost in terms of figuring of where exactly you're going to sell.

Dean: Janice, if you're looking at an internal reorganization as you're getting prepared to sell a division, how much time and effort does it really take? Because when a company wants to sell a division they want to do it fast. Obviously they want to keep as much cash as possible and at the same time they don't want to wait a couple of months to start trying to sell a business. Is this something that you do concurrently in having your end objective with the structure is going to look like so they can go to market with that and all the busy work happens after the strategy is agreed on?

Janice: The amount of time and complexity depends on every situation. It is certainly important upfront as early as possible to think about the tax issues. Everything doesn't need to be settled immediately by any means so it's important though when you are structuring your deal and when you draft your term sheet that you include enough flexibility in the terms so you have that ability to continually review the tax structure and introduce steps to get you where you need to be.

Doug: Many companies have no idea really how much they're paying monthly in tax. They may know they're paying tax installments but have they reduced installments to take into account reduced levels of taxable income? So that's probably an easy thing to look at first of all. But then when you move away from there is a lot of taxes in the sales tax area, you know GST is recoverable and a lot of provincial sales tax isn't. Customs duties aren't recoverable, so have they looked at whether they're paying the correct amount? Whether a different interpretation could result in a recovery of tax? And then income tax itself, we have a new service we call direct tax recover, where people are reviewing past income tax filings and are looking for alternative filing positions or even picking up errors and claiming refunds for the government. So it's probably a really good time to have a look at those kinds of things.

Helen: So are you finding things in this review? So what are your chances of finding these things?

Doug: Absolutely, it's amazing. In large organizations where information is produced by large computer systems, screw ups happen and when you start to drill down into the numbers and have a closer look at them you sometimes find some positives and some negatives. I guess the other areas are tax credits. The tax system provides in investment tax credits for research and development spending and many companies haven't adequately looked at what they do and whether it qualifies and that's the first thing. Even though you may not be a real high tech company there may be certain improvements that go on with your processes and we can have engineers come out and look at what you're doing and see if it qualifies and capture the cost and claim the tax credit and that's cash from the government.

Helen: Janice, what about another scenario, what if a company is in significant trouble and needs to restructure its bank debt, is there tax planning that can be done there to minimize taxes or to get some benefit?

Janice: There's lots of tax planning often. I mean if we're talking about a situation where a company, for example is in CCAA, then there could be a tremendous amount of tax planning that goes into reorganizing the company overall to minimize tax that arises when emerges. There is also tax planning just in more simple situations where you have to restructure your debt. The key focus is a lot of tax planning is that the rule that we have in debt forgiveness that can apply where you repay debt or settle debt for less than the original principal amount, can grind your existing losses and reduce the tax costs of your assets. When you have injured company debt these rules can also apply and so sometimes transactions are undertaken to eliminate through amalgamation for example the amount of internal debt that could be subject to these rules.

Helen: So in fact, in a debt restructuring situation it's not necessarily taxes that will result but if not planned properly you could then you can cause some issues with different tax costs spaces.

Janice: That's right, you could loose your tax attributes and if you completely grind them then the rules provide for an income inclusion so you can generate income in situations where the debt forgiveness rules apply. The other thing is and this certainly comes up with larger groups, including multinational groups, sometimes when you are reorganizing debt not just in Canada but also outside of the country in terms of your foreign subsidiaries you have to think about our foreign affiliate rules in particular what we call FAP which can impute income if you do certain transactions outside of Canada that result in this income.

Dean: Do you find that companies actually go down a path of either selling off divisions, maybe less so with that because it's probably more common then debt restructuring but actually don't think of the tax consequences or realize that they'd better think through them up front. Then, all of the sudden bang! - At the end there's a different picture then what they were expecting.

Janice: Yes, again it always varies but certainly there are some situations where in hindsight, I think, where companies wish they had focused on the tax issues earlier. As I think I mentioned earlier, it's always more important to have at least acknowledge the need to incorporate tax planning to any of your structuring.

Doug: The thing about debt parking is the rules are inherently arbitrary. You think that the logical thing would be if you borrow money to buy a building, if you subsequently restructure that debt and there is a reduction or a forgiveness of the debt, the forgiven amount of would reduce the tax basis of the building, it would be a matching. No such thing, there is an arbitrary ordering, if there is debt forgiveness it applies first of all to your tax losses and reduces the tax basis of your depreciable, reduces tax basis of other assets called capital assets, there's ordering. But if you have arbitrary ordering it also implies that you should be able to plan. When you have debt forgiveness in a company, make sure the company owns the assets that you want grown down.

You don't want the assets that have fast right off rates or you don't want a lot of tax losses in a company where there is going to be debt forgiveness. So if you can control the timing of the debt forgiveness and restructure and move assets around within your group, you can usually manipulate things so that the debt forgiveness applies in a way it harms you the least.

Helen: Doug, what are issues that are particularly relevant in multinational companies? What are you seeing in today in managing through a downturn tax issues with multinationals? What are they dealing with?

Doug: Most multinationals face fairly complex international structures, lots of intercompany lending, lots of movement of profits, cash between the various parts of the organizations. So they may find that first certain parts of the organizations aren't as profitable as they had been in the past. So that may imply that there is a need to move cash in places that hadn't been required. So they have to take into account the tax issues around the movement of the cash. Are they paying more withholding taxes? Less withholding taxes? Or how do they manage that? Are their transfer pricing arrangements appropriate? Because suddenly the levels of profits aren't in the places that you thought they'd be, so what can you do to change those to better manage the global profits and global taxes? Foreign exchange fluctuations, you may have hedge everything or you may not have and if you haven't there have been some pretty rapid changes in affect rates and that could sometimes give rise to significant gains in taxable locations and problems in moving cash around. So it's a particular challenge for them.

Helen: So are you finding that they are adequately planning and acting ahead or running?

Doug: Some are, although it takes time, significant time, to turn the ship. Many of these complex international financier arrangements and transfer pricing structures don't just change overnight. You do have to go through updating transfer studies and you want to make changes that are only long term changes, you don't want to change something that is very a short term anomaly.

Dean: Just to back on the debt restructuring for a second and leading up to the current recession there was a pretty boom, there was lot of M&A activity and private equity money going into the market place. Now you have a bunch of private equity companies that have these investments that they've made and obviously their objective is to create as much value and appreciation as possible, the world is a little different then when they first got into their investment. So some of those strategies that they are deploying have big tax consequences to it. We talked about the debt restructuring and there are other elements to it. Maybe you can share some of the things you're seeing proactive investors doing with their investment portfolios?

Doug: I've been seeing some companies or some of the private equity funds certainly going out and buying up debt at discounts at the market. We've also said the so called vulture funds, many of them are taking advantage of low priced public debt and that's fine. There is no immediate impact on the borrowing company if someone is buying their debt on the market at a discount. However, in some case the purchaser of the debt is just an initial step and it's leading to the private equity company also buy up the shares and they may eventually come a significant share holder someone over 25 percent. The moment that happens it kicks up a rule we call the debt parking rules. When a shareholder acquires debt of a company at a discount, that discount can become deemed debt forgiveness, so then the borrowing company then has to figure out the impact whether it even knows it's happening is an issue. So that's a problem we've seen people stepping into. We've seen companies out in the market buying back their own debt, so again, they should be aware that they've got a deal with the debt forgiveness rules or if some of them get clever try and set up a company that decides to buy back the debt, the debt parking rule still applies to them.

Helen: Doug and Janice, many companies are well placed to take advantage of acquisition opportunities and there are also some great acquisitions opportunities out there for those companies who do have the funds to partake, what are the tax issues if the target is in financial difficulty?

Janice: Well the debt forgiveness issues what we've talked about and the debt parking is front and center that needs to be taken into account. Understanding the extent to which the company may have losses and thinking about after the acquisition how those could be used, baring in mind the rules we have about acquisitions of companies that can restrict the availability of losses and eliminate certain types of losses when there is an acquisition of control, that's very important. Those rules kick in if you've had more than 50 percent of the voting power or voting rights to control the company, so they have to be taken into account and dealt with in the structuring.

Doug: You have exposures with historic companies; a company that's in trouble probably has a few skeletons in the closet. And the fundamental decision you need to make is it worth buying this company? There may be some tax losses and some nice tax numbers in there that might make this deal more attractive as a share deal, but maybe you're better buy the assets. You eliminate the commercial risk and you also end up acquiring the assets a tax basis equal to the price you paid, which may be the easiest and cleanest deal for all.

Dean: Assuming that the seller is open to an asset deal and that's not always an option correct?

Doug: Right and it's usually when we're dealing with private companies that the asset deal is a possibility. Certainly in the public company contexts in almost all cases it's going to be a share deal in a take over bit.

Helen: You mentioned tax losses, are you seeing a change in the market for tax losses?

Doug: The market for tax losses is interesting because the rules in Canada do restrict the ability of a buyer to effectively use losses after an acquisition of control The exception to that is where the business that gave rise to the losses continues to be carried on for a reasonable expectation of profit and you can use the losses against income from that business or income from a business that produces similar products and services. So people over the years have always looked to acquire that may operate in a similar business to their own and that has been attractive for some and perhaps there are more opportunities now then there had been otherwise.

Dean: We are just about out of time here, so with our few remaining moments I was wondering if each of you could give us one piece of advice that if our audience took away just one thing you said today what would that be? Doug maybe we'll start with you.

Doug: Just the number of issues that worry can conserve cash, look at all the areas where the company is paying tax and get a handle of that. Either avoid or defer the payment of tax.

Janice: I think similarly where you are trying to maximize your profitability try to make taxes work for you and gain the benefits you can in terms of restructuring, planning ahead and maximizing your ability to recover taxes and be very proactive in dealing with your tax situation.

Dean: Well it's been great having you both of you here today. For more information on tax issues and opportunities during a financial crisis please visit our managing in a downturn webpage at http://www.pwc.com/ca/managinginadownturn.

Dean: This concludes this episode of Strategy Talks, part of the PricewaterhouseCoopers Managing in a Downturn podcast series. I'm Dean Mullett, thank you for listening.

Helen: And I'm Helen Mallovy Hicks. We hope you'll join us again soon for another episode. To download or to subscribe to this podcast series or to find more information on this topic, please visit our Managing in a Downturn website at pwc.com/ca/managinginadownturn.

The information in this podcast is provided with the understanding that the authors and publishes are not herein engaged in rendering legal accounting, tax or other professional advice or services. The audience should discuss with professional advisors how the information may apply to their specific situation. Copyright 2009, PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or as the context requires, the PricewaterhouseCoopers global network or other member firms of the network. Each of which is a separate and independent legal entity.

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