U.S. President Joe Biden speaks during an appearance at the White House on Jan. 25, 2021.KEVIN LAMARQUE/Reuters
U.S. President Joe Biden’s proposed hikes to corporate and capital-gains taxes could compel family-owned U.S. companies to sell their businesses, creating opportunities for Canadian companies to make cross-border acquisitions.
The Biden plan would reverse the 2017 Tax Cuts and Jobs Act, which slashed the top U.S. corporate income tax rate to 21 per cent from 35 per cent. Mr. Biden’s plan proposes raising the rate back to 28 per cent and boosting the levy on long-term capital gains to 39.6 per cent for taxpayers with more than US$1-million in income, up from the current 20 per cent.
Family-owned enterprises may be especially motivated to cash out before a version of the Biden tax plan is implemented. In addition to a spike in corporate taxes and the capital-gains tax, the plan also proposes raising the income tax rate to 39.6 per cent from 37 per cent for individuals with an annual taxable income of more than US$400,000.
Patricia Olasker, a partner at Davies Ward Phillips & Vineberg LLP in Toronto, expects companies to try to close deals before a new U.S. tax regime would come into effect at the beginning of 2022.
“I think in the short term the threat of these changes will act as a bit of an accelerant on this already hot M&A fire,” she said. “We’re already in a period of incredible activity on both sides of the border.”
One example is Superior Plus, a Canadian propane distributor and supplier, which has acquired six U.S. companies since the beginning of 2020. It most recently bought Freeman Gas, a family-owned propane distributor, for US$170-million.
In the long run, Ms. Olasker expects higher U.S. taxes to reduce deal flow to an extent, but sees other factors that could neutralize the negative effects – including pent-up demand for takeovers in a postpandemic world and substantial amounts of “dry powder” that companies and private-equity funds can deploy.
“I think those things might offset this wet blanket that’s been thrown over by the Biden tax bill,” she said.
Michael Horwitz, a partner at Torys LLP, says he believes the proposed increase in capital-gains taxes may have greater implications for an M&A slowdown than an increase in corporate tax rates.
“If higher capital-gains rates become effective [next year], it would increase pressure on family-owned businesses to complete anticipated or pending deals in 2021 ahead of the increase,” he said.
Ms. Olasker said family-owned companies would seek higher valuations under a Biden tax regime to offset the tax on capital gains.
“If companies become more expensive to buy, one would expect to see fewer deals,” she said.
In calculating valuations, Michael Amm, a partner and co-head of the M&A practice at Torys, said most acquirers have already priced in the impact of the Biden tax plan, which Mr. Biden introduced in 2020 as a presidential candidate.
“When acquirers would do a [discounted cash-flow] evaluation, yes, that DCF will be lower by definition ... but I think anybody who’s trying to do a significant strategic transaction is probably not going to worry about that too much,” he said. Mr. Amm added that a reduction in free cash flow could be a disincentive for debt-backed deals, since the lower returns could slow down payments on credit facilities.
Industry observers say the most severe effects of Mr. Biden’s economic plan on M&A could be its nationalistic elements, which support a “Buy America” movement, meant to incentivize U.S. job creation, especially in manufacturing.
“We have Canadian clients who are looking to expand into the U.S. in industries that are heavily subject to [Buy America] requirements,” Mr. Amm said. “For a Canadian company that’s participating in that to say, ‘I’m going to get bigger in my Montreal manufacturing plants and just ship everything down to the U.S.’ won’t work because you won’t meet Buy America requirements.”
Another Biden proposal would double the minimum tax on foreign subsidiaries of U.S. companies to 21 per cent from 10.5 per cent.
“The Buy America requirements are really onerous, and they’ve been increasing steadily through administrations,” Mr. Amm said.
Ms. Olasker said a higher U.S. tax rate would have presented opportunities for inversion acquisitions, in which a non-U.S. company with a lower tax rate buys a U.S. firm, and the merged company then gets taxed at the non-U.S. rate. However, the Biden tax plan would make it more difficult to take advantage of that arbitrage.
Currently, if a Canadian company acquires a U.S. corporation and at least 80 per cent of the combined entity’s shares are U.S.-owned, the company would be subject to U.S. tax rules. The Biden plan suggests lowering that threshold to 50 per cent.
“That’s not an uncommon threshold to hit in a merger of equals, Ms. Olasker said. “That would be one of the ways in which they would make unattractive the inversion transaction.”
As U.S. lawmakers deliberate the Biden plan, Treasury Secretary Janet Yellen recently called for a global corporate minimum tax that would end a global “race to the bottom” on corporate taxes.
“There are a lot of countries [where] a fair amount of their economy is based on being a low-tax jurisdiction and serving as a headquarters space or a holding-company space,” said Peter Keenan, a partner at Torys, citing countries such as Ireland, Singapore and Luxembourg.
“I don’t know if it’s going to happen overnight.”
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