The anti-Morris Trust rules do not operate in Canada. That’s the bottom line of a recent court ruling involving a complex reorganization transaction that eventually garnered favorable tax treatment for the parent company.
In the United States, the anti-Morris Trust rules, which can be found in Section 355(e) of the Internal Revenue Code, govern parent-company spin-off transactions with regard to tax treatment. In general, the rules state that an otherwise tax-free stock distribution by a parent company of a controlled subsidiary is taxable at the parent-company level if the distribution is part of a plan (or series of related transactions) in which the following is true: one or more persons acquires stock representing a 50% or greater interest in either the distributing corporation, the controlled subsidiary, or any successor company.
The rules are a bit different in Canada, however, where if the transaction is classified as an amalgamation, it may qualify for tax-free treatment. The example case laid out below is based on the finding in Husky Oil Ltd. v. Her Majesty The Queen, 2010 FCA 125 (FCA 2010). Since the case is complicated, the steps are broken down into bullet points.
• MuCorp owns all the stock of Lambda Corp. MuCorp’s ownership structure is as follows: Mr. Sigma owns 42% of the company, the public owns 35%, and Beta Corp. owns 23%. All of the companies are taxable Canadian corporations.
• H Corp., also a taxable Canadian corporation, expresses an interest in acquiring the stock of MuCorp, but does not want to acquire Lambda.
• However, Beta is interested in acquiring Lambda, and both goals are accomplished through a complicated series of transactions that are ruled to be tax-free to MuCorp.
• The fundamental transaction went as follows. The shares of MuCorp owned by Beta had a value of $20,693,436. The Lambda stock owned by MuCorp was valued at $15,500,000. Through a series of transactions, Beta’s stock in MuCorp was, in effect, “redeemed” for the balance — $5,193,436 in cash — plus all the shares of Lambda owned by MuCorp.
• H Corp. initiated a tender offer for all of the MuCorp stock owned by shareholders other than Beta. The tender offer was successful, and H Corp. acquired direct control of MuCorp. Accordingly, each member of the H Corp. group became related to each member of the MuCorp group.
• Beta then “sold” all of its MuCorp shares to H Corp. for cash, a note, and common shares of H Corp.
• MuCorp and Beta entered into an agreement for amalgamation, while Lambda and a subsidiary of Beta, 347 Corp., were amalgamated in a transaction that was subject to the Canadian Income Tax Act’s subsection 87(4). The resulting corporation was named LA.
• Before the amalgamation, Beta owned all the stock of 347, and MuCorp owned all the stock of Lambda. After the amalgamation, Beta owned one common share of LA, and MuCorp owned 15,500,000 shares of LA’s preferred stock.