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Canadian implications for U.S. private equity


Governments around the world have responded to the COVID-19 pandemic in a myriad of ways—depending on their domestic politics, finances, and culture.

Even within North America, programs to support business have varied. Local knowledge is paramount for U.S. private equity (PE) funds with Canadian portfolio investments. When supporting their Canadian portfolio companies, the Coronavirus Aid, Relief, and Economic Security (CARES) Act may matter far less than local country legislative developments.

Tax law also differs substantively from one side of the border to the other, and the economic recovery could develop differently across jurisdictions.

As U.S. PE funds assess their Canadian portfolio investments amid the COVID-19 economic downturn, they need to consider all factors—from cross-border tax integration to the specifics of Canadian tax law to Canadian government programs.

This article covers only government programs most relevant to U.S. private equity firms.

Canada Emergency Wage Subsidy

The Canada Emergency Wage Subsidy (CEWS) program covers 75% of wages for the first $58,700 of an employee's salary. This cap per employee works out to $847 per week. There is no cap on the total amount an employer may claim.

Portfolio companies are eligible to access they subsidy if they experience a set drop in revenue.

On first review, some companies may think they are not eligible for CEWS. However, portfolio companies may be able to make elections and increase their chances of eligibility.

Depending on the fund structure and ownership of the Canadian portfolio company, certain nuances in the legislation would require careful consideration to confirm eligibility for the program.

Get more details on the Canada Emergency Wage Subsidy—including how to apply

Canada Emergency Commercial Rent Assistance Program

The Canada Emergency Commercial Rent Assistance Program (CECRA) provides forgivable loans to commercial property owners whose tenants are impacted by the COVID-19 economic downturn. While the property owners themselves receive funding from the government, the program is designed to also help tenants.

U.S. PE funds that have invested in Canadian portfolio companies with retail operations will find this program particularly noteworthy. Depending on the size of the retail operations, some work will be required to determine eligibility. CECRA currently applies only for landlords of small businesses.

However, COVID-19 government programs are subject to change.

The Canada Mortgage and Housing Corporation will administer and deliver CECRA. It is expected that the program will go live in the second half of May.

Find out whether your portfolio companies can benefit from CECRA.

Restructuring debt in Canadian companies

Companies that restructure their debt in response to current economic conditions will need to consider the impact of the Canadian debt forgiveness rules. Depending on how the debt restructuring occurs, it may result in a taxable income inclusion that is equal to the forgiven amount determined under the debt forgiveness rules. This income inclusion could require payment of tax.

The debt forgiveness rules may apply if a commercial obligation is settled or extinguished during a taxation year without payment of the full principal amount. Even if there are no debt repayments, modification of debt terms may result in a settlement or novation of the debt. Moreover, additional complexities can arise in the context of related party transactions.

To limit the amount included in income when debt is forgiven, a business can follow these three steps:

  1. Forgiven amount is applied automatically to reduce the debtor's loss carryforwards.
  2. If a forgiven amount still remains, the debtor can apply the debt forgiveness on an elective basis to reduce tax basis of depreciable assets or other pools.
  3. If tax pools are exhausted, the forgiven amount can be applied to reduce the adjusted cost base of certain capital property or reduce current year capital losses.

If a forgiven amount remains after elective amounts are applied, 50% of the remaining forgiven amount is included in income, with some exceptions and relief for insolvent corporations, or claiming a reserve, to defer the immediate impact of the rules.

Restructuring of debt obligation could also trigger non-resident withholding tax on accrued interest balances.

Tax issues roundup

COVID-19 has had a profound impact on the global economy and led to considerable disruption in existing business models. For U.S. PE funds with Canadian portfolio investments, it will be important to evaluate how recent events impact cash flow, liquidity, and the operating structure.

They also need to consider the impact on the overall fund. Legislative developments in the U.S. must be considered, together with any tax planning implemented in Canada.

Canadian portfolio companies should consider these steps to respond:

Understand cash positions in Canada and the best ways to minimize tax leakage when repatriating funds in a cost-effective manner to the PE sponsor. If capital is required in Canada, analyze how best to deploy it.

Are there stranded tax attributes, or can planning be implemented on how to monetize losses or other tax attributes? Consider the global effective tax rate and what planning can be undertaken by paying intercompany charges or revisiting existing transfer pricing models in order reduce the combined tax burden.

Are there opportunities to purchase add-on investments in a cost-effective manner through either a stock purchase or asset purchase? If yes, evaluate how to structure these deals to integrate with existing Canadian portfolio companies. As part of this assessment, evaluate how the transaction would be treated from a U.S. income tax perspective.

Negotiations to update the North American Free Trade Agreement (NAFTA) began long before the COVID-19 outbreak. They will reach fruition this summer when the new agreement takes effect on July 1. Called the Canada-United States-Mexico Agreement (CUSMA), or USMCA in the U.S., the agreement challenges importers to prepare quickly. The lead time to implementation is unusually short for CUSMA—its effective date was confirmed only in late April.

Portfolio companies understandably have focused in recent months on their COVID-19 response. They now need to find time for the new trade agreement—ensuring they confirm their customs certificates and instruct their customs broker on next steps. Importers that do not prepare could find their goods detained at the border or their companies overpaying duties.

The U.S. and Canada: Covering both sides of the border

For PE funds based in the U.S., their Canadian portfolio companies raise issues that are specifically Canadian. Yet perhaps it's more accurate to say their treatment is specifically Canadian. These issues also arise in the U.S., from debt restructuring to making the most of government stimulus programs to helping a company's brain trust manage expenses in the wake of the COVID-19 pandemic. Additionally, some issues call for a cross-border approach.

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