Canada will allow deductions for foreign acquisitions

OTTAWA — A funny thing happened on the way to a “hollowed out” corporate Canada. Instead of foreigners’ taking over Canadian companies and moving top jobs and decision making offshore (InvestmentNews, March 26), Canadian companies are acquiring foreign companies in record numbers. And in an about-face that supports the trend, Finance Minister Jim Flaherty said May 24 that he will allow the deductibility of interest expenses in connection with foreign investment. When he submitted a budget in March, the finance minister roundly was criticized by Canadian business leaders for proposing to eliminate tax deductibility on foreign investments. Although now in favor of the deduction, Mr. Flaherty said, he will not allow companies to use foreign tax havens to claim a second deduction, which now is possible in certain circumstances. The new rules will not be implemented for five years. Currently, the number of Canadian foreign acquisitions exceeds the number of foreign acquisitions of Canadian companies by a ratio of 2.9-to-1, according to the Crosbie Mergers & Acquisitions, a joint venture between Toronto-based Crosbie & Co. Inc. and The Financial Post newspaper, which is owned by Winnipeg, Manitoba-based CanWest Interactive. The research firm also found that cross-border deals, which generally involve large transactions, account for 37% of M&A activity and 56% of announced deal value. That confirmed analysis by KPMG LLP of M&A deals in 2006 and 2005, which reveals that Canadian companies have been on a two-year buying spree. “Despite the perception that Canada is up for sale, there is significant deal flow going both ways,” Peter Hatges, a partner in Toronto-based KPMG Corporate Finance Inc., wrote in a May 9 press release. New York-based KPMG LLP is affiliated with KPMG International, a global cooperative. The KPMG study, based on figures supplied by New York-based Thomson Financial Investment Banking/Capital Markets, said that there were more outbound deals than inbound ones in 2005 and 2006. Canada had 348 outbound deals in 2005 and 442 in 2006. In contrast, there were only 277 inbound deals in 2005 and 383 in 2006. “We’re not surprised by the statistics,” Mr. Hatges wrote. “As Canadian companies mature to the point where they are world-class players, they are getting world-class attention, and typically, the most appropriate suitor will be a foreign buyer. Furthermore, growing and emerging Canadian companies are being very active in cross-border transactions. Despite the fact that the overall outbound deal values are smaller, the outbound deal activity is 20% greater than inbound deal activity.” Canadian-dollar frenzy Helping acquisition-minded Canadian companies is the Canadian dollar, which has gained approximately 7.7% against the U.S. dollar this year and is hitting highs not seen in almost three decades. That is good for Canadian companies on the hunt for U.S. companies but not so good for Canadian investors in U.S. stocks. The strong Canadian dollar perhaps explains why the average Canadian portfolio has only an 18% foreign weighting, according to the Toronto-based Investment Funds Institute of Canada. Without hedging, Canadian investors in U.S. stocks have been losing market gains to the weakening American dollar. For instance, Toronto-Dominion Bank offers investors a TD U.S. Index Fund, which is similar to the widely followed Standard & Poor’s 500 stock index. The version of the fund that is not hedged lost 3.3% in the three-month period through April 30, while the currency-neutral version gained 2.8%. Canadian shareholders added $2.9 billion worth of foreign shares to their portfolios in March, all in U.S. shares, reported Statistics Canada, an Ottawa-based federal agency. It was the sixth consecutive month of “robust” purchases, which totaled $14 billion, the agency said, noting that more than half of the March investment in U.S. shares was due to foreign takeovers of Canadian companies and the resulting new issues of U.S. equities to Canadian shareholders.