With the release of the 2022 Fall Economic Statement, the Federal Government proposed a new tax on repurchases of equity by certain entities (the “Buyback Tax”). The draft legislative proposals and explanatory notes published by the Department of Finance on August 4, 2023 shed additional light on the Buyback Tax. If enacted in its current form, the legislation would apply to transactions that occur on or after January 1, 2024.
The Buyback Tax is forecasted to generate $2.5 billion in additional tax revenue over five years. It is part of the federal government’s plan to impose additional tax on public corporations paying out record profits to shareholders through relatively efficient means like buybacks of shares. Although the tax has been presented as an encouragement to businesses to reinvest profits into the business, the focus of the tax may be less altruistic.
What is the Buyback Tax?
The Buyback Tax is a new 2% tax on the net value of equity repurchased by a “covered entity” during the year. The net value is determined using a formula in the draft legislation, and is generally the fair market value of the equity (other than “substantive debt”) redeemed, acquired or cancelled by the covered entity in the year, less the fair market value of equity (other than “substantive debt”) of the covered entity issued in the year.
The Buyback Tax only applies if the entity repurchasing the equity is a “covered entity.” Generally speaking, a covered entity includes a Canadian public corporation, certain partnerships, and certain mutual fund trusts.
What are the exceptions?
The Buyback Tax does not apply on repurchases of “substantive debt,” which is described in the explanatory notes as equity that possesses “debt-like characteristics.” There are several defined terms in the draft legislation and a detailed explanation of such terms is beyond the scope of this article.
The draft legislative proposals also contain a de minimis exception, which provides that the Buyback Tax will not apply if the fair market value of equity redeemed, acquired or cancelled by a covered entity in a year is less than $1,000,000 (pro-rated for short taxation years).
In addition, the Buyback Tax will not apply where the equity is redeemed, acquired or cancelled through a “reorganization or acquisition transaction.” Generally, a “reorganization or acquisition transaction” includes (provided certain specific conditions are met), among other things:
- an issuance of equity by a covered entity unless cash is the only consideration paid for the issuance, the issuance is made to an employee in the course of the employee’s employment, or the issuance is in exchange for a bond, debenture or note of the covered entity that was issued solely for cash; and
- a redemption, acquisition or cancellation of equity by a covered entity on certain exchanges of equity, on a winding-up of a covered entity, on an amalgamation of the covered entity, and on a butterfly reorganization.
The explanatory notes contain several examples of transactions that qualify as a “reorganization or acquisition transaction.” For example, consider a share exchange under section 86 of the Income Tax Act (Canada) whereby a public corporation reorganizes its share capital by exchanging all of its issued and outstanding Class A Shares for new Class B Shares. This would constitute a “reorganization or acquisition transaction” because it is a redemption, acquisition or cancellation of equity by a covered entity on an exchange of equity by a holder for no consideration other than equity of the covered entity.
Impact of the Rules
The impact of the Buyback Tax remains unclear. Companies that choose to pay dividends will continue to do so without being significantly impacted by this tax (and arguably, this tax is not directed towards traditional dividend payers). The recipients of such dividends will also continue to be taxed at a higher rate than they would be on a capital gain from a sale of shares or return of capital. However, companies that traditionally do not pay dividends may be expected to reduce buybacks in favour of internal reinvestment. Such reinvestment will arguably increase the value of the shares traditionally subject to the buybacks, and likely the gain on the sale of such shares by shareholders (even if the ultimate result will not be as instantaneous as a buyback). Therefore, the Buyback Tax (while a possible deterrent on buybacks or the number of shares subject to buybacks) is not expected to increase dividend payments by companies that would be subject to the tax.
If you have any questions about the Buyback Tax, please contact a member of the Miller Thomson LLP Corporate Tax group.
