Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: In the given fact situation, whether expenditures incurred by corporations mainly to obtain professional advice (financial, legal and accounting) in deciding whether to combine their respective business to another, XXXXXXXXXX , in making representations to XXXXXXXXXX and in amalgamating are of a current or of a capital nature?
Position: The merger costs are expenditures or outlays of a capital nature that satisfy the definition of ECE. Subsection 20(1), except for paragraph 20(1)(b), does not apply to allow the deduction for any of the fees incurred.
Reasons: The disputed merger costs incurred from the time each corporation decided to commit to combining its business to another are of a capital nature because, regardless of the form of the business combination, the related costs (i) would result in either adding to the corporations as an entity, structure or organization, or, in acquiring or creating a business entity, structure or organization, for the earning of profit or (ii) are incurred once and for all, with a view to bringing into existence an asset or advantage for the enduring benefit of the trade of the corporations.
Le 10 mai 2004
XXXXXXXXXX , Direction générale de la politique
Chef d'équipe, Section des services et de la planification
techniques, XXXXXXXXXX Direction des décisions en impôt
Bureau des services fiscaux de XXXXXXXXXX Marc LeBlond
Division de la vérification (613) 946-3261
2003-005362
XXXXXXXXXX Frais relatifs à la fusion
La présente est en réponse à votre note de service du 16 décembre 2003 et à nos conversations téléphoniques (XXXXXXXXXX/LeBlond). Vous nous demandez si les frais relatifs à la fusion de XXXXXXXXXX. sont des dépenses courantes ou en capital dans la situation décrite ci-dessous.
Tel que vous nous l'avez demandé (XXXXXXXXXX/LeBlond), le reste de notre réponse à votre demande est en anglais.
Unless otherwise stated, all references to a statute are to the Income Tax Act R.S.C. 1985 (5th Supp.), c.1, as amended.
We concur with you that the disputed merger costs consists of expenditures or outlays of a capital nature that meet the definition of ECE, and, that subsection 20(1) (except for paragraph 20(1)(b)) does not apply to any of these costs. Furthermore, we agree that the CRA should not accede to Amalco's adjustment request in respect of its federal income tax return for XXXXXXXXXX because, among other reasons, Amalco's request does not satisfy one of CRA's five conditions to accept a refund request in paragraph 4. of IC 75-7R3 i.e. Amalco's assessment for that year as it relates to the disputed merger costs is not wrong. The basis for our conclusion is in part D. below.
XXXXXXXXXX.
XXXXXXXXXX.
Definitions and Abbreviations
In this letter, the following terms have the meanings specified:
"Amalco" means: XXXXXXXXXX;
"Accountant" means: XXXXXXXXXX;
"merger costs" means: The total of all expenditures made or incurred related to the business combination of "Predco1" and "Predco2";
"Board(s)" means: Board(s) of Directors;
"CRA" means: Canada Revenue Agency;
"CBCA" means:Canada Business Corporations Act;
"ECE" means: "Eligible Capital Expenditures" as defined under subsection 14(5);
"XXXXXXXXXX" means: XXXXXXXXXX;
"XXXXXXXXXX" means: XXXXXXXXXX;
"XXXXXXXXXX" means: XXXXXXXXXX;
"XXXXXXXXXX" means: XXXXXXXXXX;
"XXXXXXXXXX" means: XXXXXXXXXX;
"XXXXXXXXXX" means: XXXXXXXXXX;
"XXXXXXXXXX" means: XXXXXXXXXX;
"XXXXXXXXXX" means: XXXXXXXXXX;
"Predco1" means: XXXXXXXXXX;
"Predco2" means: XXXXXXXXXX;
"Taxpayer(s)" means: Individually (jointly) "Amalco", "Predco1" and "Predco2".
A. - Facts
Our understanding of the facts, as submitted in the auditor's memorandum (December 4, 2003) attached to your request, is as follows.
1. Amalco was formed on XXXXXXXXXX by the amalgamation of Predco1 and Predco2 pursuant to the provisions of the CBCA. Predco1 and Predco2 were incorporated under the CBCA.
2. Predeco1, Predco2 and Amalco are XXXXXXXXXX "taxable corporations", as defined under subsection 89(1).
3. XXXXXXXXXX.
4. Predco1's and Predco2's "fiscal period", as defined under subsection 249.1(1), ended on XXXXXXXXXX . Amalco's first "fiscal period" ended XXXXXXXXXX.
5. The merger costs were XXXXXXXXXX.
6. XXXXXXXXXX.
7. On XXXXXXXXXX, the Board of Predco1 retained the services of a financial/investment advisor, XXXXXXXXXX, to obtain advice in connection with the proposed Business Combination with Predco2, XXXXXXXXXX.
8. XXXXXXXXXX.
9. XXXXXXXXXX.
10. XXXXXXXXXX.
11. On XXXXXXXXXX, Predco1 retained the services of a law firm, XXXXXXXXXX, to obtain legal advice in connection with the proposed Business Combination with Predco2, XXXXXXXXXX.
12. On XXXXXXXXXX, the Board of Predco2 retained the services of a financial/investment advisor, XXXXXXXXXX to obtain advice and assistance XXXXXXXXXX.
13. XXXXXXXXXX.
14. XXXXXXXXXX.
15. XXXXXXXXXX.
16. XXXXXXXXXX.
17. XXXXXXXXXX.
18. On XXXXXXXXXX, Predco2 retained the services of a law firm, XXXXXXXXXX, to obtain legal advice in connection with the proposed Business Combination with Predco1, XXXXXXXXXX.
19. XXXXXXXXXX.
20. Sometime between XXXXXXXXXX, after reviewing their short, medium and long-term options, it was proposed by both Predco1 and Predco2 Boards' to combine their businesses.
21. XXXXXXXXXX.
22. XXXXXXXXXX.
23. XXXXXXXXXX.
24. XXXXXXXXXX.
25. XXXXXXXXXX.
26. XXXXXXXXXX.
27. XXXXXXXXXX.
28. XXXXXXXXXX.
29. XXXXXXXXXX.
30. XXXXXXXXXX.
31. XXXXXXXXXX.
32. XXXXXXXXXX.
33. XXXXXXXXXX.
34. XXXXXXXXXX.
35. XXXXXXXXXX.
36. XXXXXXXXXX.
37. Predco1 and Predco2 retained the services of the same chartered accountancy firm, Accountant, to obtain advice in connection with the proposed Business Combination between Predco1 and Predco2, XXXXXXXXXX.
38. XXXXXXXXXX.
39. XXXXXXXXXX.
40. XXXXXXXXXX.
41. XXXXXXXXXX.
42. XXXXXXXXXX.
43. XXXXXXXXXX.
44. XXXXXXXXXX.
45. On XXXXXXXXXX, the date Predco1 and Predco2 were officially amalgamated, each outstanding Predco1 common share was converted into XXXXXXXXXX Amalco XXXXXXXXXX and each outstanding Predco2 common share was converted into XXXXXXXXXX Amalco XXXXXXXXXX.
46. XXXXXXXXXX.
47 Predco1 and Predco2 each nominated XXXXXXXXXX members of the Board of Amalco.
48. XXXXXXXXXX.
49. XXXXXXXXXX.
50. The amalgamation of Predco1 and Predco2 to form Amalco is governed by section 87. In its original federal income tax return (T2) for XXXXXXXXXX, Amalco considered the merger costs as ECE.
51. XXXXXXXXXX.
52. On XXXXXXXXXX, Amalco filed with the TSO a waiver in prescribed form in respect of its taxation year XXXXXXXXXX.
53. On XXXXXXXXXX, during the course of the on-going tax audit of Amalco's T2 - XXXXXXXXXX , Amalco requested that this return be reassessed to allow an amount of XXXXXXXXXX (herein after the "disputed merger costs") as deductible in computing its income for the taxation year XXXXXXXXXX instead of as an ECE.
B. - XXXXXXXXXX TSO's Question, Position and Analysis
B.1. - TSO's Question
You request our comments as to the proper tax treatment of the disputed merger costs. We understand that our comments are requested in order to respond to Amalco's adjustment request described under paragraph 53. above.
Unless otherwise stated, all page references are to the auditor's memorandum attached to the TSO's opinion request.
XXXXXXXXXX
C. - Taxpayers' Positions, Analysis and Arguments
The detail of the taxpayers' positions, analysis and arguments are set out in pages 21 to 39 and are not repeated here.
C.1. - Taxpayers' Positions
The taxpayers summarized their positions on page 21 as follows:
In summary, the position of the taxpayers is that all of the costs incurred as a result of the combination of Predco1 with Predco2 are deductible under one of the following basis:
1. Based on the Boulangerie St-Augustin and Colin Energy cases, such expenditures were of a current nature, deductible in the computation of income from a business pursuant to section 9. Additionally, neither paragraph 18(l)(a) nor paragraph 18(l)(b) apply to change this result.
2. In the course of the combination of Predco1 with Predco2 to form Amalco, certain representations had to be made to various governmental bodies and authorities by its legal counsel. The fees associated with such representations are deductible pursuant to paragraph 20(l)(cc).
3. Only that portion of the professional fees that can be associated with the actual amalgamation of Predco1 with Predco2 can be considered an ECE. For pragmatic reasons, the taxpayer has estimated such costs as being equal to the last statement of fees received from the respective legal advisors of Predco1 and Predco2 and the filing fees [XXXXXXXXXX (on page 45)]. In this regard, the amount that has been used is likely greater than the actual costs that could reasonably be considered as an ECE.
4. XXXXXXXXXX.
Lastly, we would note that the position taken by the taxpayer is fully supported by the CRA's administrative guidance prepared following the Boulangerie St-Augustin case.
[Added]
C.2. - Taxpayers' Analysis and Arguments
C.2.1. - Subsection 9(1)
The taxpayers' analysis and arguments on the current deductibility of the disputed merger costs under subsection 9(1) and the non-applicability of paragraph 18(1)(a) can be summarized as follows.
It is the taxpayers' view, that the decision in the cases The Queen v. Boulangerie St-Augustin Inc., 97 DTC 5012 (FCA) and International Colin Energy Corp. v. The Queen, 2002 DTC 2185 (TCC), support the current deductibility of the disputed merger costs under subsection 9(1) and the non-applicability of 18(1)(a) and (b).
The Boards of amalgamating corporations are required by law to inform their shareholders of a proposed amalgamation XXXXXXXXXX. This obligation is created by subsection 122(1) of the CBCA XXXXXXXXXX:
122. (1) Every director and officer of a corporation in exercising their powers and discharging their duties shall:
(a) act honestly and in good faith with a view to the best interests of the corporation; and
(b) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.
XXXXXXXXXX
XXXXXXXXXX
C.2.2. - Non-application of Paragraph 18(1)(b)
We reproduce below, in its entirety, the taxpayers' representative's view on the non-application of paragraph 18(1)(b) from page 33.
Paragraph 18(1)(b) denies a deduction for expenses or outlays that are on account of capital. In general, a capital outlay is an expenditure that is not only made once and for all, but is incurred with a view to bringing into existence an asset or advantage for the enduring benefit of trade. For a particular expenditure to be categorized on account of capital would depend upon the facts of the situation.
XXXXXXXXXX
To be competitive, all business must prepare strategic plans on a regular basis. Board of directors has the duty to do what is best for its corporation and, therefore be involved in such planning.
XXXXXXXXXX
C.2.3. - Paragraph 20(1)(cc)
The taxpayers' view is that a portion of the disputed merger costs relating to assistance by some of Predco1's and Predco2's advisors in making various representations to government bodies and authorities in the course of the combination of Predco1 with Predco2 to form Amalco, are deductible currently pursuant to paragraph 20(l)(cc).
XXXXXXXXXX
D.1. - Amalco's Requested Adjustment to a Prior Year (XXXXXXXXXX)
Return of Income (T2)
In our opinion, the CRA cannot accept Amalco's request that its T2 - XXXXXXXXXX be reassessed. Our conclusion is based on the following observations.
D.1.1. - Legislation
152(4) Assessment and reassessment - The Minister may at any time make an assessment, reassessment or additional assessment of tax for a taxation year, interest or penalties, if any, payable under this Part by a taxpayer or notify in writing any person by whom a return of income for a taxation year has been filed that no tax is payable for the year, except that an assessment, reassessment or additional assessment may be made after the taxpayer's normal reassessment period in respect of the year only if
(a) the taxpayer or person filing the return
[...], or
(ii) has filed with the Minister a waiver in prescribed form within the normal reassessment period for the taxpayer in respect of the year; or
[...]
164. (1) Refunds - If the return of a taxpayer's income for a taxation year has been made within 3 years from the end of the year, the Minister
(a) may,
[...]
(iii) on or after mailing the notice of assessment for the year, refund any overpayment for the year, to the extent that the overpayment was not refunded pursuant to subparagraph (i) or (ii); and
(b) shall, with all due dispatch, make the refund referred to in subparagraph (a)(iii) after mailing the notice of assessment if application for it is made in writing by the taxpayer within the period within which the Minister would be allowed under subsection 152(4) to assess tax payable under this Part by the taxpayer for the year if that subsection were read without reference to paragraph 152(4)(a).
D.1.2. - CRA's Position on the Reassessment of a Prior Year Return of Income
D.1.2.1. - General
Information Circular 75-7R3 (July 9, 1984) on Reassessment of a Return of Income provides that:
Reassessment to Reduce Tax Payable
4. A reassessment to create a refund ordinarily will be made upon receipt of a written request by the taxpayer, even if a notice of objection has not been filed within the prescribed time, provided that
(a) the taxpayer has, within the four year filing period required by subsection 164(1), filed the return of income;
(b) the Department is satisfied that the previous assessment or reassessment was wrong;
(c) the reassessment can be made within the four year period or the seven-year period, as the case may be, referred to in paragraph 1 above or, if that is not possible, the taxpayer has filed a waiver in prescribed form;
(d) the requested decrease in taxable income assessed is not based solely on an increased claim for capital cost allowances or other permissive deductions, where the taxpayer originally claimed less than the maximum allowable; and
(e) the application for a refund is not based solely upon a successful appeal to the Courts by a taxpayer.
D.1.2.2. - Federal Court of Appeal decision in Boulangerie St-Augustin Inc.
The Tax Appeals Directorate Decision Number: 95-13R (February 11, 1997) on the Federal Court of Appeal decision of November 28, 1996, Boulangerie St-Augustin Inc., 1995 DTC 56, provides that:
The Department did not seek leave to appeal this adverse decision to the Supreme Court of Canada.
[...]
The Department is of the opinion that the scope of this judgment is limited to cases in which there is more than one takeover offer and the offer accepted ensures the continuation of the business. In all other cases, our position remains the same, when:
The facts are similar to those found in B.C. Power. In B.C. Power, just part of the issue costs was allowed; the professional fees were still disallowed;
The amounts disbursed were for the exclusive benefit of the shareholders and not the company.
All objections and appeals being held in abeyance may be processed accordingly.
The Audit Directorate COMMUNIQUÉ - AD-00-02 (February 8, 2000) on Take-over Bid Costs provides that:
APPLICATION
This policy is applicable to reassessments/audits completed on or after October 15, 1998. The Department will not accept requests for adjustments on or after October 15, 1998 where the period for filing a notice of objection has expired. Accordingly, if a reassessment has been completed prior to October 15,1998 and the period for filing a notice of objection has not expired, the taxpayer will still not be entitled to amend their return for this issue as this policy was not applicable prior to this date.
D.1.3. - Application of paragraph 4. of IC 75-7R3 to Amalco's Adjustment Request in respect of its T2 - XXXXXXXXXX
D.1.3.1. - General
The authority provided to the Minister under subsection 152(4), among others, to reassess tax for a taxation year, payable by a taxpayer, is discretionary because of the use of the word "may". The CRA's long standing position on how it administers the discretionary powers provided under subsection 152(4) is set out in Information Circular (IC) 75-7R3.
In Amalco's case, paragraph 4. of IC 75-7R3 is relevant as the requested adjustment, if acceded to, would require reassessing Amalco's T2 - XXXXXXXXXX to reduce tax payable and generate a refund of an "overpayment" for the year, as defined under subsection 164(7).
The underlying intent of the rules in paragraph 4. of IC 75-7R3 is to apply the Income Tax Act in a just and equitable manner to all taxpayers and to protect the Crown's tax revenues. In order to achieve these objectives the CRA, for instance, satisfies itself that the previous assessment or reassessment in respect of a particular taxation year was wrong based on its interpretation of the law as it was in the particular taxation year (condition (b) of paragraph 4.) and by applying the decisions of the Courts, it accepts, only prospectively (condition (e) of paragraph 4.).
D.1.3.2. - Application of condition (e) of paragraph 4. of IC 75-7R3
In Amalco's case, even though Amalco's refund request is based solely upon Boulangerie St-Augustin Inc.'s successful appeal to the FCA, condition (e) of paragraph 4. is not an impediment to Almalco`s requested reassessment because the situation in Amalco is not similar to Boulangerie St-Augustin Inc.'s.
The dispute in Boulangerie St-Augustin Inc. was in respect of fees incurred for professional advice required by its Board to respond to take-over bids. In Amalco's case, the disputed merger costs are not connected to take-over bids to acquire the legal control of Predco1 or of Predco2 but related to a friendly business combination (XXXXXXXXXX) where each Predco1 and Predco2 was committed to combine its business to another and where both decided that their businesses would be best served by amalgamating together.
Note that, even if Predco1's and Predco2's businesses had been merged by take-over like in Boulangerie St-Augustin Inc., the CRA would have rejected a request similar to Amalco's by either Predco1 or Predco2, in respect of their T2 - XXXXXXXXXX, because, in XXXXXXXXXX, CRA's position (XXXXXXXXXX) was to follow the FCA decision in Boulangerie St-Augustin Inc. only in cases involving multiple take-over bids.
The CRA would have rejected, also, a request similar to Amalco's by either Predco1 or Predco2, in respect of their T2 - XXXXXXXXXX , even if their businesses had been merged by take-over, if the request had been made relying on the CRA's revised position on take-over bid costs of February 8, 2000 (Audit Communiqué AD-00-02).
Generally, the CRA applies its positions prospectively. Exceptionally, the CRA decided that the revised position on take-over bid costs would apply retroactively to reassessments/audits completed on or after October 15, 1998. However, the Communiqué limits its application by not accepting " ... requests for adjustments on or after October 15, 1998 where the period for filing a notice of objection has expired." Note that the reference to "the period for filing a notice of objection" is in respect of the last assessment or reassessment for the year to be adjusted that was made before the requested adjustment.
In this case, a request similar to Amalco's by either Predco1 or Predco2 would not have satisfied the criteria to apply the CRA's revised position on take-over bid costs because on the date on which Amalco (Predco1 or Predco2) made the adjustment request (XXXXXXXXXX) each Predco1's and Predco2's period for filing a notice of objection to the last assessment or reassessment of its T2 - XXXXXXXXXX had already expired.
D.1.3.3. - Application of condition (b) of paragraph 4. of IC 75-7R3
The CRA should not reassess Amalco's T2 - XXXXXXXXXX to allow, as it requested, the deduction of the disputed merger costs in computing it's income for XXXXXXXXXX because the last assessment or reassessment of Amalco's T2 - XXXXXXXXXX as it relates to the disputed merger costs is not wrong.
In effect, the disputed merger costs cannot be deducted in computing Amalco's income for XXXXXXXXXX since Amalco did not make or incur these costs. The facts clearly indicate that it is Predco1 and Predco2 that made or incurred the disputed merger costs.
Furthermore, the CRA would not agree to reassess Predco1's and Predco2's respective T2 - XXXXXXXXXX , if Predco1 and Predco2 made the same adjustment request as Amalco today or if they had made it prior to the expiry of the normal reassessment period in respect of their taxation year XXXXXXXXXX because the tax treatment of the outlays as ECE is not wrong. Our conclusion is based on the observations in D.2. below.
D.1.4. - Other Consideration
If the CRA could accept Amalco's adjustment request, the CRA could not refund to Amalco its overpayment for the year XXXXXXXXXX because of paragraph 164(1)(b).
Paragraph 164(1)(b) provides that the Minister shall make a refund provided that the " ... application for it is made in writing by the taxpayer within the period within which the Minister would be allowed under subsection 152(4) to assess tax payable under this Part by the taxpayer for year if that subsection were read without reference to paragraph 152(4)(a)."
The CRA could not make the refund to Amalco because Amalco made its adjustment/refund request on XXXXXXXXXX, which is after the "normal reassessment period" for Amalco, as defined under subsection 152(3.1), in respect of XXXXXXXXXX, since this period ended on XXXXXXXXXX.
D.2. - Predco1's and Predco2's Disputed Merger costs
The disputed merger costs consist of expenditures or outlays of a capital nature, that meet the definition of ECE, none of which are currently deductible under subsection 20(1) (except as provided under paragraph 20(1)(b)). Our conclusion is based on the following observations.
The most recent court decisions involving the tax treatment of business combination related costs are Boulangerie St. Augustin Inc. (in November 1996), Colin Energy (in November 2002), BJ Services Company (The successor to Nowsco Well Service Ltd) v. HMQ, 2003 TCC 900 (in January 2004) and Rona Inc. v. The Queen, 2003 DTC 979 (in March 2003).
In the first three cases mentioned above, the dispute involved fees incurred by the taxpayer for professional advice required by its Board to respond to take-over bids. The specific fees under dispute in Boulangerie St-Augustin were those related to the preparation of directors' circulars in reaction to take-over bids. For the most part, in Colin Energy, the disputed fees were for developing strategic financial alternatives to a take-over bid, finding, evaluating and recommending third parties interested in merging, negotiating a merger, and preparing a directors' circular, including the provision of a fairness opinion. In the latest case, BJ Services, the litigation involved fees similar to those in Colin Energy as well as "hello" and "break" fees that were paid in the course of responding to a hostile take-over.
In these three cases, the court decided that the expenditures at issue were incurred for the purpose of gaining or producing income from a business and were not capital in nature. In BJ Services, Campbell's, T.C.J., decision on this issue is as follows, at page 2043:
[38] [...]
Shareholders provided Nowsco the funding and if this was lost or withdrawn, customers would be lost, staff laid off and eventually, taken to the extreme, Nowsco operations would shut down. It is simple logic that maximizing shareholder value must be inextricably tied to the bare bones of gaining or producing income on a daily basis in any corporate environment. How can it be anything but? Given the circumstances, the expenses were part of the general overall costs, a corporation must incur to earn income, even though these expenses have no direct link to revenue generating activities but are related to shareholder interests. It is good and wise corporate behavior to attend to shareholder interests and expenses incurred in doing so are simply part of the cost of doing business in the corporate marketplace.
[Emphasis Added]
In the trilogy of cases mentioned above, the taxpayer was the target of take-over bids (the BJ Services case involved hostile take-over bids) and the disputed fees were incurred by the target to respond to attempts to acquire its control by purchasing sufficient issued and outstanding shares of it's capital-stock. The Predco1 and Predco2 situation does not involve take-over bid costs incurred by a target corporation but the merger costs of two corporations committed to combine their business to another, that decided that their businesses would be best served by combining them by amalgamating together.
In Rona Inc. the issue was whether fees paid to outside professionals (including lawyers, accountants and financial consultants) for services rendered in respect of the acquisition of competitors' shares, interests in joint ventures and the acquisition of other assets were on current account or were capital in nature. The services rendered in Rona Inc. included performing due diligence checks, developing an acquisition strategy, writing take-over bid circulars and preparing a request for an advance ruling certificate from the Competition Bureau. Archambault, T.C.J. started his analysis of the issue by summarizing the principles and tests developed by the courts to distinguish between income expenses and capital outlays. Archambault, T.C.J. quoted, among others, President Jackett of the Exchequer Court (as he then was), in Canada Starch Co. Ltd. v. M.N.R., 68 DTC 5320, in which he made the following distinction between expenditures on revenue account and expenditures on capital account, at page 986:
For the purpose of the particular problem raised by this appeal, I find it helpful to refer to the comment on the "distinction between expenditure and outgoings on revenue account and on capital account" made by Dixon J. in Sun Newspapers Ltd. and al. v. Fed. Com. of Taxation [(1938) 61 C.L.R. 337] at page 359, where he said:
The distinction between expenditure and outgoings on revenue account and on capital account corresponds with the distinction between the business entity, structure, or organization set up or established for the earning of profit and the process by which such an organization operates to obtain regular returns by means of regular outlay, the difference between the outlay and returns representing profit or loss.
In other words, as I understand it, generally speaking,
(a) on the one hand, an expenditure for the acquisition or creation of a business entity, structure or organization, for the earning of profit, or for an addition to such an entity, structure or organization, is an expenditure on account of capital, and
(b) on the other hand, an expenditure in the process of operation of a profit-making entity, structure or organization is an expenditure on revenue account.
[Emphasis Added]
D.2.2. - Merger costs on Capital Account
D.2.2.1. - Nature of the Underlying Transaction and of the Merger Costs
It is our view that Predco1's and Predco2's disputed merger costs are outlays made on capital account as the nature of the underlying transaction is of a capital nature. Our conclusion is based on the following observations.
Paragraph 10. of Interpretation Bulletin IT-99R5 (dated December 11, 1998/ consolidated December 2000), on Legal and Accounting Fees, indicates that:
the deductibility of transaction costs, including:
- fees of legal, accounting and other consultants relating to the structuring of the transactions;
- the cost of negotiating contracts; and
- the cost of obtaining letters patent, supplementary letters patent, amendments to them, etc.;
is dependent on the nature of the underlying transactions (as income or capital) and the applicability of the provisions of paragraphs 18(1)(a), 18(1)(b), 20(1)(e), or 20(1)(cc), or the definition of "eligible capital expenditure" in subsection 14(5), as the case may be.
[Emphasis Added]
XXXXXXXXXX
In Predco1's and Predco2's case, the disputed merger costs are comprised mainly of professional advisory fees for services provided by financial advisors (XXXXXXXXXX), by law firms (XXXXXXXXXX) and by an accounting firm XXXXXXXXXX.
The taxpayers argue, essentially, that the disputed merger costs are expenditures on income account because they were incidental to their business income producing process as it is accepted business practice XXXXXXXXXX to prepare and review strategic plans on a regular basis. Furthermore, that this practice calls for obtaining third party professional advice in order to meet the corporate law requirement that directors and officers exercise their duties with care, diligence and skill.
While we agree that expenditures related to the regular review of a company's strategic (business) plan may generally be currently deductible, we believe, however, that the disputed merger costs are not connected to the regular review of Predco1's and Predco2's strategic (business). In our opinion, the facts indicate that the merger costs were all incurred after each Predco1 and Predco2 had committed itself to combine its business with another and were directly linked to their efforts to do so.
The CRA position in paragraph 5. of Interpretation Bulletin IT-475 (March 31, 1981), reproduced below, applies in this situation such that Predco1's and Predco2's merger costs are to be considered as a whole for the purposes of section 9, paragraphs 18(1)(a) and (b), subsection 20(1) and of the definition of ECE.
Paragraph 5. of Interpretation Bulletin IT-475
Expenditures made as part of a taxpayer's ordinary business operations in respect of research to determine whether a capital asset should be created or acquired, but which themselves are not directly linked to the creation or acquisition of a capital asset, are current operating expenses which are deductible in the year incurred. However, once the commitment is made to proceed with the particular project all expenditures which are directly linked to the creation or acquisition of a capital asset form part of the capital cost of that asset unless that asset is not, in fact, created or acquired. [...]
[Emphasis Added]
A view similar to the one above was adopted by Archambault, T.C.J., in Rona Inc., at page 989:
[45] Thus far, the analysis has dealt almost exclusively with the direct acquisition costs of stores and competitors and little has been said about the fees. The reason for this situation is quite simple. The nature of the fees depends on the purpose of the services that were rendered. If the professional fees involve current transactions, they are income expenditures. If the fees involve the expansion of the business structure, they are capital outlays. For example, if fees are paid for negotiations with respect to a marketing campaign, they are income expenses. However, if fees are paid in order to acquire a competitor, they are capital outlays. What needed to be determined first is the nature of the transactions conducted by Rona in order to characterize the nature of the professional services required for these. Here, the professional services were retained for transactions in which franchised stores, or "corporate" stores to be constructed or already owned by competitors were to be acquired. The purpose of these services was to confer on Rona an advantage [Translation] "for the lasting benefit of [its] business". Therefore, the fees for those services are capital outlays, and the parties agree that those fees must be included in the costs of the assets acquired by Rona.
[Emphasis Added]
We are of the view that the disputed merger costs consist of outlays on account of capital, based on the principle stated in Canada Starch Co. Ltd, as they were for "the acquisition or creation of a business entity, structure or organization, for the earning of profit, or for an addition to such an entity, structure or organization".
In effect, whether Predco1 and Predco2 combined their respective business with another by acquiring assets, by acquiring shares of another corporation or by amalgamating with other corporations, the connected combination expenditures incurred from the time each Predco1 and Predco2 became committed to merge with another would result, in either adding to itself as an entity, structure or organization or, in acquiring or creating a business entity, structure or organization, for the earning of profit.
Predco1 and Predco2 ultimately decided to combine their respective business by amalgamating together. Hence, the disputed merger costs were expended arguably to create a business entity, structure or organization as Chief Justice Dickson, as he then was, said in The Queen v. Black and Decker, [1975] S.C.R. 411 at 420-21, as quoted by Justice Jerome in Pan Ocean Oil Ltd, at page 5335, when corporations amalgamate "...the end result is to coalesce to create a homogeneous whole."
We also believe that the disputed merger costs are outlays of a capital nature because it is arguable that these were expended on the structure within which the profits were to be earned as oppose to the money-earning process. In effect, whether each Predco1 and Predco2 combined its business with another by acquiring assets or shares of another corporation or by amalgamating with another corporation, the merger costs would be expended on the structure within which the profits would be earned by Predco1 and Predco2, in the first two cases, and by Amalco, in the latter case, not on their money-earning process.
Lastly, we also believe that the disputed merger costs consist of outlays on account of capital on the basis that these expenditures were incurred once and for all, with a view to bringing into existence an asset or advantage for the enduring benefit of the trade of Predco1 and Predco2.
The Supreme Court of Canada confirmed, in British Columbia Power Corporation Ltd v. The Queen, 67 DTC 5258, the classic test first developed by the British Courts for determining whether an expense is capital or current, at pages 5260 and 5261:
They also held that the expense was a capital expense, incurred "once and for all" and for the purpose of procuring "the advantage of an enduring benefit" within the sense of the language of Lord Cave in British Insulated and Helsby Cables Ltd. v. Atherton, [1926] A.C. 205 at 213. That well-known statement is as follows:
But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.
[Emphasis Added]
Whether the consolidation (business combination/merger) sought by Predco1 and Predco2 was carried out by acquiring a competitor's assets or the shares of a competitor or by amalgamating together, the connected costs are arguably incurred once and for all, with a view to bringing into existence an asset or advantage for the enduring benefit of the trade.
D.2.3. - Subsection 20(1)
We are of the view that none of Predco1's and Predco2's specific expenditures or outlays included in the merger costs are currently deductible under subsection 20(1) (except as provided under paragraph 20(1)(b)).
In our opinion, all expenses incurred in connection with a merger, from the time the taxpayer is committed to combine its business to another, which are directly linked to the creation of a business entity, structure or organization, form part of the cost of creating it.
D.2.4. - ECE
The disputed merger costs are ECE. This conclusion is based on the following observations.
Subsection 14(5) defines ECE as follows:
ECE of a taxpayer in respect of a business means the portion of any outlay or expense made or incurred by the taxpayer, as a result of a transaction occurring after 1971, on account of capital for the purpose of gaining or producing income from the business, other than any such outlay or expense
(a) in respect of which any amount is or would be, but for any provision of this Act limiting the quantum of any deduction, deductible (otherwise than under paragraph 20(1)(b)) in computing the taxpayer's income from the business, or in respect of which any amount is, by virtue of any provision of this Act other than paragraph 18(1)(b), not deductible in computing that income,
[Emphasis Added]
Paragraph 2. of Interpretation Bulletin IT-143R3 (August 29, 2002), on the Meaning of eligible capital expenditure, provides that an ECE, may broadly be defined as an outlay or expense incurred by a taxpayer:
- in respect of a business;
- as a result of a transaction occurring after 1971;
- on account of capital; and
- for the purpose of gaining or producing income from the business.
Paragraph 59. of Interpretation Bulletin IT-474R (March 14, 1986) - Amalgamations of Canadian Corporations provides that:
Expenses of Amalgamation
59. Reference is made to paragraphs 13 and 14 of IT-143R2. The position is the same where expenses are incurred in regard to a proposed amalgamation which is not completed.
Paragraph 14. of IT-143R3 (same as in IT-143R2), the CRA states that:
The CCRA considers that incorporation expenses and similar expenses incurred in the setting up of a new corporation or in connection with an amalgamation of two or more corporations, as well as expenses incurred in connection with the reorganization of the affairs of a corporation (including the costs of supplementary letters patent), are "eligible capital expenditures" if they meet the requirements of that definition in subsection 14(5) as explained in paragraph 2.
[Emphasis Added]
According to paragraph 13. of IT-143R3 (same as in IT-143R2), incorporation expenses referred to in paragraph 14. include all the expenses necessarily incurred by the incorporators to bring a corporation into existence, such as:
(a) fees required by the appropriate government agency (federal or provincial);
(b) cost of affidavits;
(c) advertising expenses in those jurisdictions where applicants are required to give notice of their intention to apply for a charter;
(d) legal fees;
(e) costs of preparation of articles of incorporation and of bylaws;
(f) expenses incurred by applicants in attending preliminary meetings; and
(g) accountant's fees associated with the incorporation.
[Emphasis Added]
We are of the view that the merger costs (XXXXXXXXXX) satisfy the criteria of ECE in paragraph 2. of IT-143R3. These expenses were made or incurred by Predco1 and Predco2, as a result of a transaction occurring after 1971, on account of capital costs for the purpose of gaining or producing income from a business.
Therefore, each Predco1 and Predco2 should have added three-quarters of the merger costs to their "cumulative eligible capital", as defined under subsection 14(5), which in turn are transferred to Amalco at the time of the amalgamation, pursuant to paragraph 87(2)(f).
In fact, this appears to be the position that Predco1 and Predco2 adopted in Amalco's pro forma consolidated financial statements as at XXXXXXXXXX and that Amalco adopted in filing its T2 - XXXXXXXXXX .
D.3. - Conclusion
We concur with you that the CRA should not accede to Amalco's adjustment request in respect of its T2 - XXXXXXXXXX because Amalco's request does not satisfy one of CRA's five conditions to accept a refund request in paragraph 4. of IC 75-7R3 i.e. Amalco's assessment for that year as it relates to the disputed merger costs is not wrong. Furthermore, we also agree that the disputed merger costs consist of expenditures or outlays of a capital nature that meet the definition of ECE and that none of the disputed merger costs are currently deductible under subsection 20(1) (except as provided under paragraph 20(1)(b)).
We trust that our comments will be of assistance. For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the CRA's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Maurice Bisson, CGA
for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Planning Branch
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