Fording Tax Avoidance Deal: Lots of Unanswered Questions

The C$13 billion “Fording trade” settled the other day, which was one of the rare positive events for Bay Street dealers over the past few months. Positive, that is, if you are in the fee business, but not so for the Canadian taxpayer.

Canada’s banking system had the Teck Cominco (TCK) acquisition of Fording Canadian Coal Trust (FDG) tied up six ways from Sunday, which begs the question: if you are so hard up for capital, where did the $9.8 billion in loan capacity come from? To my pleasant surprise, CIBC (CM), Royal Bank (RY) and Bank of Montreal (BMO) are each providing 13.3% of Teck’s $9.8 billion bridge and term loan facility. Then there was the C$2.3 billion that Scotiabank (BNS) had handy in October to help Teck with some nifty tax “planning.”

It was just the other day that we all were hearing about the capital relief needed to keep the Canadian banks sailing in the right direction. The federal government stepped up to the plate with a C$25 billion program via the Canadian Mortgage and Housing Corp. [CMHC], along with some expansive new collateral posting rules at the Bank of Canada. In addition, the Canadian Bankers Association was understandably grateful:

Today’s [Thursday] announcement by the Minister is an important measure in making credit more available in the consumer marketplace. This is a safe, efficient and economic way of facilitating credit markets.

For some of us, this was a market-distorting event (see prior post “Political expediency trumps free market” November 3-08). However, as Wednesday's Globe and Mail reported, according to at least one bank, it wasn’t nearly enough:

"The rest of the world is putting hundreds and hundreds of billions of dollars into their systems,” a top executive at one of the big banks said yesterday [Tuesday].

Finance Minister Jim Flaherty announced a new program on Oct. 10 that allows Ottawa to buy C$25-billion of mortgages from banks in order to free up new lending capacity. That program is a step in the right direction, but needs to be dramatically ramped up, bankers argue.

"They could have done $100-billion by now at very low spreads and put a lot of attractive term financing into the Canadian marketplace, which we’re badly in need of and [which] every other country in the world has access to,” the executive said.

The irony of this complaint must be clear to the unnamed bank executive. The federal government is being asked to ramp up the backdoor subsidized financing program represented by the C$25 billion CMHC facility. However, according to media reports, these very same Canadian banks helped Teck “maneuver” to avoid a C$4 billion tax bill. All right there in plain sight for Canadian taxpayers and CRA to see. When the federal government announced the C$25 billion CMHC facility on October 10, (ostensibly needed to keep the economy rolling in new SME loan capital), do you think officials advised Finance Minister Jim Flaherty that one of the first demonstrations of the success of this bank subsidization program would be Scotiabank’s C$2.3 billion Fording Unit hotel strategy?

Yes, Minister, we are providing the very capital to Canada’s banking system that they are in turn using to help Teck avoid a C$4 billion tax bill.

On Thursday, when the Prime Minister met with Canada’s bank leadership and heard their tales of woe, one can only hope that someone in his delegation asked the obvious question:

You want us to give you access to more cheap capital, just so that you can help the next Teck that comes along with a $4 billion tax bill they want to avoid?

It wasn’t that long ago that Tyco’s (TYC) HQ fled the United States for Bermuda, just to reduce its corporate tax rate (36% became 23%). Then Stanley Works tried to follow in 2002. One day, a brave U.S. official said, and I paraphrase: “you are doing that just to avoid paying tax and we won’t allow it”. The U.S. Congress held hearings, and tax-dodging CEOs were accused of being “unpatriotic” by their public leadership.

Here at home, the story is quite different, indeed.

Disclosure: We own BMO and BNS in our household.

Comments

[searcher:]

Self serving comments from the bankers always sounds so much better than from other executives. God bless 'em.

2008 Nov 07 12:44 PM

[ariesl:]

Does anyone understand why those of us who still held shares of FDG until the actual buy out day were hit with a 15% withholding tax ON THE ENTIRE AMOUNT. NOT JUST CAPITAL GAINS, BUT COST BASIS AS WELL. This makes no sense to me. The shares, by the way, were held in a US Roth IRA. If I was younger, and it was a regular IRA, I would have to pay a 10% penalty for early withdrawal (the taxed amount was withfrawn from my account and dispersed to the Canadian Gov. 5 days after the distribution from TCK).Even worse, I'd then have to claim the dispersement as income and pay tax on that. Luckily, I sold almost all my shares ahead of the completion of the merger. I'm still mad about on principle. If anyone is sure my brokerage screwed up, and can think of a solution, please post it here. I'm sure I'm sure I'm not the only one concerned.

2008 Nov 07 02:09 PM

[ginsy:]

i came to the same conclusion! how can a distribution of capital b a dividend. how can the unit holders of fdg get together to sue the trustees of fdg for breaching their fiduciary responsibility? does anyone know a competent canadian tax lawyer who will take this case on a contingency basis and make a class action of it? he'll clean up. OR bring an action on behalf of any one unitholder to protest the wht on the grounds that the transaction was a tax avoidance scheme and the results shd b recast by the canadian tax service to reflect the realities of the transaction. every unitholder who wasn't "forced" to sell his units at a discount to the merger price [and i'm one of them; i waited too long] would be happy to join such a class.
i'm a computer nerd, so how will i get your ideas

2008 Nov 07 04:35 PM

[toomuchgas:]

I don't understand what the McQueen is complaining about but the15% withholding is no problem because you can take it as a credit toward your U.S. taxes (unless it is a retirement account). No one has anything to complain about because they got a huge premium over what FDG was trading at prior to the offer and more than it is really worth.

2008 Nov 07 06:40 PM

[mdimillo:]

If you read the full disclosure on the transaction for FDG, you would have noticed the unique aspect of the deal. It was considered as an asset purchase for tax purposes, which is treated the same as a dividend in terms of withholding. They even highlighted that US holders should consult their tax professionals for advice. Once I did this and discovered what would happen, I sold ahead of the closing. In a way you were lucky because the gain was in your Roth IRA. I had it my regular account and would have lost the long term capital gain rate on the sale and would have had to pay as if it were regular income. I gave up the last $3 cash payment to avoid paying regular taxes on a 300+% gain. In the future, I would suggest consulting a tax guy or doing more homework when the deal is this complicated.

2008 Nov 10 04:37 PM

[ginsy:]

mycomment is shown above. how does someone contact me? thru another comment? how do i return to the site? thanks

2008 Nov 11 10:36 PM

[bill63:]

If you look at the bottom of page 102 in the pamphlet Fording sent share holders concerning the sale under U.S. Federal Tax Consequences it states "any such gain or loss generally should be capital gain or loss, which would be long term...Prefential tax rates apply...

On Nov 10 04:37 PM mdimillo wrote:

> If you read the full disclosure on the transaction for FDG, you would
> have noticed the unique aspect of the deal. It was considered as
> an asset purchase for tax purposes, which is treated the same as
> a dividend in terms of withholding. They even highlighted that US
> holders should consult their tax professionals for advice. Once I
> did this and discovered what would happen, I sold ahead of the closing.
> In a way you were lucky because the gain was in your Roth IRA. I
> had it my regular account and would have lost the long term capital
> gain rate on the sale and would have had to pay as if it were regular
> income. I gave up the last $3 cash payment to avoid paying regular
> taxes on a 300+% gain. In the future, I would suggest consulting
> a tax guy or doing more homework when the deal is this complicated.

2008 Nov 24 02:53 PM

[Directoy:]

That A big Questions. whay dont they dot it?

2008 Dec 31 02:53 PM

[babli:]

I had 100 FDG shares in regular US account and got $8200 and $1230 tax deducted by canadian govt. As I have a actual capital gain of $4600. Do I have to pay US tax on $4600 also and then take foreign tax deduction of $1230?

Jan 04 09:42 AM