NA Issuer Bid: Premia on NA.PR.N, NA.PR.O, NA.PR.P are Deemed Dividends

The National Bank issuer bid for NA.PR.N, NA.PR.O and NA.PR.P, announced in February is very rich and holders are urged to take advantage – the prices equate to yields of 1.98% and there are better things to hold!

However, it should be noted that the Issuer Bid Circular, published on SEDAR dated March 4, 2011, has the following information:

A Shareholder that is an individual (including a trust) (“Individual Resident Shareholder”) and who sells a Preferred Share to the Bank pursuant to the Offers will be deemed to receive a taxable dividend (on a deemed separate class of shares comprised of shares of a series of the Preferred Shares so sold by all Shareholders) equal to the excess of the amount paid by the Bank for the Preferred Share over its paid-up capital for purposes of the Tax Act. The Bank estimates that on the Expiration Time and Date the paid-up capital per Preferred Share Series 21 will be equal to approximately $25, per Preferred Share Series 24 will be equal to approximately $25, and per Preferred Share Series 26 will be equal to approximately $25 for purposes of the Tax Act. The deemed dividend will be included in computing an Individual Shareholder’s income, and will generally be subject to the gross-up and dividend tax credit rules normally applicable to taxable dividends received by individual shareholders from a taxable Canadian corporation, including the enhanced gross-up and dividend tax credit if the dividend is properly designated by the Bank as an “eligible dividend”. The Bank shall designate any deemed dividends arising as a result of the sale of Preferred Shares to the Bank pursuant to the Offers as an “eligible dividend” for these purposes.

The difference between the amount paid by the Bank for a particular Preferred Share and the amount deemed to be received by an Individual Shareholder as a dividend in respect of the Preferred Share will be treated as proceeds of disposition of the Preferred Share for purposes of computing any capital gain or capital loss arising on the disposition of the Preferred Share.

Thus, those accepting the offer will compute their capital gain as the difference between their Adjusted Cost Base and $25, and include the premia paid over $25 in their dividend income.

This will have major consequence for some individuals.

Market prices do not fully reflect the bid: at the close last night, NA.PR.N was trading to yield 2.27% while the other two were in the 2.40%-2.50% range. It would appear that either the market is applying a rather large discount due to the tax treatment, or that it is not fully accounting for the dividend that will be earned by holders at the close of business April 5.

Trades executed on the ex-Dividend date of April 6 will settle on April 11, allowing purchasers on April 6 to tender to the offer (although I speak only of institutions; individuals should very definitely check this out with their brokers because the back-office will decide what timing they want). I believe that the most likely scenario is that on April 6 the prices for the issues will adjust to reflect the Issuer Bid price, less enough of a discount to make it worth-while for institutions to make a little money buying and tendering.

Thus, I suggest that individuals for whom the Deemed Dividend is an important tax consideration to be avoided should carefully consider planning to sell on April 6 … while remembering that I have no crystal ball and cannot guarantee that this will be an optimal strategy.

Update: Assiduous Reader AB writes in and says:

Was reading your post below and not sure what you mean by “This will have major consequence for some individuals.” and “would appear that either the market is applying a rather large discount due to the tax treatment”.

I own quite a bit of all the NBC Preferreds they have offered to buy (in a corporation) and am trying to decide what to do. Not sure what you mean by major consequences. We bought at the issue price of $25.

OK, first the “major consequences”. Let’s take NA.PR.P as an example – the issuer bid is at a price of 28.03. If you tender at this price, you will not declare a capital gain on your 2011 taxes: the entire premium of 28.03 – 25.00 (your ACB) = 3.03 wil be considered a dividend.

On the other hand, say you sell on the market at 28.03. In this case, you will declare a 3.03 capital gain, and none of the premium will be taxable as dividends.

Depending on your individual tax circumstances, one way may be much better than the other. Say, for instance, you have enormous capital losses available (incurred during the Credit Crunch, perhaps). You can use these capital losses to offset capital gains, but you can’t use them to offset dividends (deemed or regular). If you have a large amount of losses accumulated, then the difference between the two pathways will be about $0.60/share in 2011 taxes, based on a capital gains marginal rate of 20%. That’s quite substantial!

Other considerations apply if, for instance, you are subject to the OAS clawback. The 100% inclusion rate of dividend income, with the dividend gross-up added on top of that, could make tendering the shares to the bid – and taking your winnings as a deemed dividend – quite costly in terms of tax effects.

And since you hold these things in a corporation … that will have other effects and could be quite complex!

I will note that I am not a tax expert, have no wish to be, and don’t know your personal circumstances, or those of your corporation. I will say, as above, that there could be a big difference in what is best for you, so you should consult your personal tax advisor.

As for the other part of your question “would appear that either the market is applying a rather large discount due to the tax treatment”.

Well, let’s look at NA.PR.P again. If you hold the issue now and tender to the issuer bid, you will earn the dividend of $0.4125 that goes ex on April 6. So your total cash receipt per share will be $28.03 + 0.4125 = 28.4425.

The closing quote today was $28.25-26. That’s a difference of nearly $0.20! It would seem to me that a LOT of people are deciding to sell into the market to avoid the deemed dividend, and there are not enough arbitrageurs, as yet, competing to take the business and reduce the premium to a more reasonable nickel or dime.

It is my guess (and note well the word “guess”!) that on April 6 you will have earned the dividend and the market price will only be be five to ten cents less than the issuer bid price of 28.03 … but as noted, there are no guarantees … the market price could be forty cents less than the issuer bid price, leaving you worse off than if you sold now. If it was my money we were discussing, I’d take the risk … but it’s not my money!

Update, 2011-3-16: Assiduous Reader AB writes in again and says:

When you talk about the difference between the two pathways being $.60 a share in 2011 taxes, I think you are not actually calculating the difference. 20% capital gains on $3 is 60 cents but you would pay about $1 of dividend tax on the $3 deemed dividend if selling to NBC (at a rate of 33%), so the difference is 40 cents, correct? You then also have to take into the cost per share for commission.

Well, what I was really thinking was the case in which the taxpayer has otherwise useless capital losses carried forward. If he sells on the market, taking the capital gain, he will be able to use these capital losses to offset it and thereby pay no tax on this transaction.

This will leave him with fewer capital losses going forward, of course, but as far as this transaction is concerned, taxes are zero. This is compared to a rate of about 20% if you take the dividend, or $0.60 per share.

Note that I am using a marginal rate of 20% on dividends for illustrative purposes – your figure of 33% seems very high to me (see the E&Y 2011 Tax Calculator) but again, I don’t know your personal circumstances.

And yes, I am ignoring commission in this discussion. If you hold “quite a bit” of stock through a discount brokerage, you can generally trade for $10 a trade, which is basically negligible. Naturally, if you are trading through a full service broker, costs will not be quite so neglible.

Update 2011-3-19: Assiduous Reader DJ writes in and says:

Can you comment on the situation where someone bought the shares for more than the issue price of 25$ (In my case NA.PR.P bought in 2009 at 28$). I would really appreciate your thoughts with respect to this situation to help me decide whether to tender my shares

In that case, tendering the shares will result in:

  • Capital Loss of $3 (the deemed sale price of $25 less the adjusted cost base of $28)
  • Dividend of $3.03 (the total consideration of $28.03 less the deemed sale price of $25)

I suggest that you if you decide against tendering these shares you should sell them on the market, since the issuer bid yield of 1.98% is very low; there are plenty of alternatives with both better credit quality and higher yield … unless your commission expense is unbelievably exhorbitant!

If you sell on the market, you will declare at capital gain or loss based on your actual sale price – there is no “deemed dividend” nonsense (although you will, of course. be taxed on the dividends you actually receive).

One Response to “NA Issuer Bid: Premia on NA.PR.N, NA.PR.O, NA.PR.P are Deemed Dividends”

  1. […] that holders tender their shares or sell on the market. It will be remembered that tendering has important tax implications as the premium paid above par is a deemed dividend for tax […]

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