Control of a corporation is a complicated concept which has numerous tax implications. Control is most frequently determined based on who has the voting power to elect the board of directors, known as de jure control. However, control can also be determined based on various other factors when de jure control does not exist, known as de facto control.
By default, control of a corporation is deemed to change in the morning of the acquisition date even if the acquisition occurs later in the day. The corporation can elect out of this requirement to have the acquisition of control occur immediately prior to the actual acquisition. In certain situations, an acquisition of control can also occur prior to closing such as when a letter of intent is signed. Determining the timing of the acquisition is an important first step when assessing the tax implications.
There is a deemed year-end immediately before an acquisition of control and a new taxation year begins at the time of the acquisition. Therefore, the regular fiscal year will be split into two taxation years and a separate tax return must be filed for each. Corporate income tax returns are due six months after year-end, and you must ensure that each return is filed in a timely manner. Certain deductions, such as capital cost allowance claims, must be pro-rated for the short taxation years. Each short year will count as a full tax year for items that rely on the number of years, such as the expiry of loss carry forwards. As a result, these losses will expire one year sooner.
An acquisition of control has additional consequences for loss carry forwards. Net capital losses (losses arising due to the disposition of capital property) cannot be carried forward to years after the acquisition date. These losses will expire if not utilized during the short taxation year ending immediately before the acquisition. Similarly, losses incurred after the acquisition cannot be carried back to years before the acquisition. Any capital property that has unrealized losses at the time of the acquisition must also be written down to fair market value which will increase the balance of net capital losses. An election is available to trigger a deemed disposition of capital properties that have accrued gains. This election allows for the utilization of the net capital losses prior to expiry.
Non-capital losses (generally, losses arising from property or business) can be carried forward to future taxation years subject to the typical twenty year carry forward period. However, these losses can only be utilized against income from the same or similar business. For example, if you purchase a corporation which operates a restaurant and you continue to operate the same restaurant, or a new restaurant, you would be able to utilize any loss carry forwards from prior to the acquisition. However, if you converted the restaurant to a retail store or a rental building, the non-capital losses cannot be utilized against future profits. The same or similar business rule also applies to carrying losses back from after the acquisition to years before the acquisition.
Similar rules also apply to the carry forward or carry back of investment tax credits. The most common way to earn investment tax credits is from incurring scientific research and development expenses. Investment tax credits can only be carried forward or back to offset taxes from a same or similar business.
Acquisition of control rules are in place to ensure that acquisitions take place for business purposes rather than tax reasons. Proper planning is required to ensure that losses and credits are utilized, and all elections and returns are timely filed.
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