The top-10 tax issues in international mining M&A

If you’re connected to a mining company that is considering a corporate merger or acquisition in 2015, keep in mind that current and future tax consequences can sour what could otherwise be a sweet deal. 

A company should make tax planning part of its M&A arrangements from the start to help take advantage of any opportunities to reduce its tax burden and avoid surprise tax liabilities that can arise from complex transactions like international mergers and acquisitions.

 Though 2014 saw many mining companies make operational changes aimed at reducing costs in a low-price commodities environment, we anticipate that the focus in 2015 will shift to the pursuit of economies of scale by increased M&A activity. 

To prepare and plan for the tax consequences of any M&A activity, a company should consider our following picks as the top-10 U.S., Canadian and global tax issues and opportunities facing mining companies carrying out M&A transactions in 2015.

1. Reduced tax attribute carryovers — Changes in ownership often significantly limit future utilization of an acquired corporation’s global “tax attribute carryovers” such as loss carry forwards. When a change in ownership is triggered for U.S. tax purposes, it limits the amount of tax attribute carryovers available to offset annually against income to a factor of the corporation’s fair value at acquisition date. Comparable limitations in Canada arising on an acquisition of control cause capital losses to expire and limit future use of non-capital loss carry forwards. The loss of these tax attributes may be so costly that an entire transaction becomes unappealing. However, changes in ownership can be defined differently for different jurisdictions. For instance, a change in ownership for U.S. tax purposes may not be an acquisition of control for Canadian tax purposes. 

2. Tax consequences of investment in foreign real property — Many, if not most, jurisdictions around the world have special provisions dealing with foreign investment in real property. For example, in our article “Don’t overlook U.S. tax consequences of cross-border mining investments” (T.N.M., June 6–12, 2011), we discussed how non-U.S. companies’ transactions or reorganizations could have tax consequences for their U.S. real property interests and U.S. subsidiaries that own substantial real property interests. For instance, two amalgamating Canadian corporations that own U.S. Real Property Interests or subsidiaries that qualify as U.S. Real Property Holding Companies could inadvertently be subject to U.S. taxation because a deemed disposition of the U.S. real property can be triggered on amalgamation under the U.S. Foreign Investment in Real Property Tax Act (FIRPTA). Structuring the transaction in ways other than as an amalgamation for Canadian tax purposes is one option that may help to limit exposure to FIPRTA.

3. Post-acquisition restructuring for tax efficiency — When two mining companies combine, the new corporate structure may no longer allow a tax-efficient flow of cash through the chain of companies or may not allow certain beneficial tax filings for tax purposes. Accordingly, management should consider a post-acquisition restructuring shortly after the acquisition in order to eliminate redundant entities and better align the remaining entities. This restructuring can help the merged company avoid additional withholding and income taxes by redirecting the movements of cash and by facilitating future consolidated corporate tax filings that may allow group members to use each other’s tax attributes, including carryover attributes.

4. Due diligence to identify tax liabilities — When mining companies combine, the parties need to consider the possible liabilities for numerous different types of taxes (e.g., income, excise, property, etc.) in the various jurisdictions (e.g., federal, provincial, state, municipal, etc.) in which they do business. Complex, specialized tax provisions that often apply to mining companies must be considered during the due diligence phase in order to ensure that all possible tax liabilities are accounted for. Given the size and complexity of the tax environment for mining companies, it is not surprising to discover previously unidentified tax liabilities during the due diligence stage of a merger or acquisition. Since audited financial statements typically act as a starting point for company valuation, it is important for an acquirer to assess the completeness of financial statements for tax liabilities prior to establishing an appropriate purchase price. Thorough due diligence should always consider all relevant jurisdictions and types of taxation so that all significant tax liabilities are known before completing the transaction.  

5. Potential alternative minimum tax liability — Many tax jurisdictions provide significant tax benefits to the mining industry. Sometimes these tax benefits are so significant that mining companies could potentially avoid most, if not all, of the otherwise assessable regular income tax. Accordingly, some of these jurisdictions have also created tax provisions that require payment of a minimum level of income taxation. These alternative minimum tax (AMT) provisions often accelerate the amount of taxes payable by U.S. corporations taking advantage of preferential deductions including some that are mining-specific, such as exploration and development deductions and percentage depletion. Mining companies that become liable for AMT may be able to make retroactive AMT-related tax elections to help reduce the amount of tax payable in the short term by increasing balances of tax attributes available for deduction in future years. 

6. Tax impact of treasury management — Opportunities to generate free cash flow and benefit from new economies of scale will motivate many mining M&A transactions in 2015. Management should carefully consider the tax implications of accessing this cash. While it may be convenient to access the money on an as-needed basis through a bank account in return for a note or as part of a cash pooling arrangement, such actions could generate undesired tax consequences when not recorded, documented and managed properly. Deemed dividends, imputed interest, tax withholding, interest and penalties are only a few of the provisions available in many jurisdictions that tax authorities could potentially use to tax mining companies’ transactions. 

7. Tax implications of employee compensation — Parties involved in any transaction must understand the potential tax effects on various elements of their employees’ compensation, including how each jurisdiction taxes employees and provides corporate deductions to employers for employee compensation. For example, the U.S. often allows corporate deductions when income from stock options is treated as ordinary income to the employee shareholder. However, some types of payments may significantly increase transaction costs, give rise to additional amounts of tax and penalties and may lead to the loss of certain favourable tax treatment at the executive level. For example, change in control payments and gross-up provisions for payments characterized as excess parachute payments for U.S. tax purposes can triple costs to the company.  In particular, costs may increase if the payments fail to meet the U.S. nonqualified deferred compensation rules that can trigger additional penalties.

8. Implications of changing a company’s tax jurisdiction — Some cash-starved U.S. mining companies have reincorporated in Canada to gain a TSX listing and attract capital to help them grow their mining business. Unfortunatel
y, these reincorporation’s often fall within the U.S. tax inversion provisions. Generally speaking, these inversion rules can cause a foreign corporation that acquires a U.S. subsidiary to be classified as a U.S. corporation for U.S. tax purposes and therefore be taxed on its worldwide income. These rules can apply to transactions involving share consideration, where a certain percentage of the foreign acquirer’s new shareholders post-acquisition were original shareholders of the U.S. target company. 

9. Tax effect on shareholders of mining companies — Tax consequences for shareholders should also be considered in a mining company transaction. A particularly punitive result can arise if the passive foreign investment company (PFIC) rules for U.S. shareholders of foreign companies apply because PFIC shares are taxed at a substantially higher rate than non-PFIC shares. (We also discussed these rules in our June 2011 article.) A PFIC is a corporation where passive income represents more than 75% of total gross income, or where 50% or more of its assets produce passive income during any given year. As a result of decreasing gross margins, many mining corporations that generate some passive income may be caught by the PFIC rules due to decreasing gross income from operations. In any merger or acquisition involving U.S. shareholders, companies should seek advice on determining their PFIC status and how to appropriately alert U.S. shareholders of any changes in this status. Companies should also consider communicating certain information regarding taxpayer elections that shareholders can make to reduce their overall tax burden. Further, tax-free reorganizations may not benefit PFIC shareholders. 

10. Opportunities for tax savings in structuring intercompany transactions — M&A transactions often require management to reconsider where corporate functions (e.g., head office, purchasing, selling and engineering) should be located and how the cost of these services should be charged throughout the affiliated group of corporations. Tax issues and opportunities should be considered when analyzing how these functions should be structured. In addition, certain tax planning relating to intercompany financing, IP-holding companies and centralized purchasing and sales structures may provide enhanced tax and operational savings.  

Conclusion

Making tax part of your merger and acquisition strategy can provide both immediate and future tax savings and eliminate headaches down the road. These top-10 issues and opportunities are just a few of the many tax matters your company may need to consider as part of a merger or acquisition, especially if you’re operating in more than one country. Your tax advisers can help you determine the best course of action for your company’s particular facts and circumstances. 

— All of the authors are with accounting firm KPMG and specialize in different areas associated with mining taxation: Ron Maiorano, U.S. corporate tax; Robert A. Davis, transfer pricing; Penny Woolford, Canadian international tax; Ana-Luiza Georgescu, international executive services; Sebastien Tremblay, U.S. corporate tax; Michael Long, Canadian tax; Nathan Heinrichs, transfer pricing; and Martin Miasko, U.S. corporate tax. Visit www.kpmg.com for more information.