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: 1. Is the application of paragraph 20(1)(e) of the Income Tax Act restricted when a corporation is under CCAA protection?
2. What are the factors that determine whether the expenses related to restructuring may be an eligible capital expenditure?
3. Are costs related to acquisition of shares, in the course of reorganization, considered to be within the provisions of paragraph 20(1)(e) of the Act?
Position: 1. No
2. Question of fact
3. No
Reasons: 1. Application of paragraph 20(1)(e) of the Act does not depend on whether a taxpayer is under bankruptcy proceedings or under CCAA protection.
2. It is a question of fact.
3. The purpose of paragraph 20(1)(e) is to allow the deduction of financing expenses only.
August 12, 2010
XXXXXXXXXX TSO Headquarters
XXXXXXXXXX V. Srikanth
Attention: XXXXXXXXXX 2009-032867
Deduction pursuant to paragraph 20(1)(e)
We are writing in response to your e-mails dated June 22, 2009 and July 3, 2009, wherein you requested our views on the application of paragraph 20(1)(e) of the Income Tax Act (the "Act"). Specifically, you wanted our opinion on the following issues:
1. the application of paragraph 20(1)(e) of the Act when a corporation is under the protection of the Companies' Creditors Arrangement Act ("CCAA");
2. what determines whether certain fees paid during the course of reorganization would be considered as eligible capital expenditures; and,
3. are costs related to the acquisition of shares, in the course of reorganization, considered eligible for deduction pursuant to the provisions of paragraph 20(1)(e) of the Act?
The relevant facts can generally be summarized as follows:
- In XXXXXXXXXX , XXXXXXXXXX and its subsidiaries ("XXXXXXXXXX ") applied for and received protection under the CCAA.
- In XXXXXXXXXX , XXXXXXXXXX filed a Consolidated Plan of Arrangement and Reorganization (the "Plan") to the Court.
- In XXXXXXXXXX , XXXXXXXXXX implemented the Plan and emerged from protection under the CCAA.
- Significant legal and consulting fees related to the CCAA restructuring were incurred by XXXXXXXXXX prior to, and during, the CCAA restructuring.
- The CCAA restructuring involved, inter alia, debt restructuring.
Application of paragraph 20(1)(e) of the Act
The purpose of the CCAA is to permit a corporation to remain in business notwithstanding that it is insolvent. It preserves the insolvent company as a viable operation and enables it to reorganize its affairs to the benefit of the debtor and the creditors. Accordingly, a company under CCAA protection is allowed to stay in business. Therefore, provided that the expenses are otherwise eligible for deduction and there is no court order to the contrary, deduction under the provisions of the Act will be allowed notwithstanding the fact that the corporation is under CCAA protection.
Accordingly, in our view, in the given submission, legal and consulting fees that satisfy the requirements for deductibility under paragraph 20(1)(e) of the Act would be deductible regardless that such expenses were incurred during a period when the corporation was under CCAA protection.
However, with respect to the expenses incurred prior to CCAA filing and outstanding as at that date, these debts are generally settled for amounts less than 100 cents to a dollar at the time when the corporation comes out of CCAA protection. Hence, at that time, the debt forgiveness rules under the provisions of section 80 of the Act could apply in respect of the amount of debt that was compromised. Until such time, expenses incurred prior to the CCAA protection will be deductible, as long as they were otherwise eligible for deduction under that provision.
Eligible Capital Expenditure ("ECE")
Your second concern is whether certain fees, or a portion of such fees, incurred prior to or in anticipation of, and during, the debt restructuring period should be considered an ECE.
If expenses are incurred in the course of a qualifying purpose under paragraph 20(1)(e) (or paragraph 20(1)(e.1)) and partly for some other purpose, only the part of the expenses that may reasonably be considered applicable to the qualifying purpose under paragraph 20(1)(e) (or (e.1)) is deductible thereunder. In such a situation, those expenses that do not qualify for deduction under paragraph 20(1)(e) (or (e.1)), may be deductible pursuant to paragraph 20(1)(b) of the Act as an ECE.
In order for the payment to be deductible pursuant to paragraph 20(1)(b) of the Act as an eligible capital amount, the purpose test in the definition of "eligible capital expenditure" must be satisfied. Paragraph 14 of IT-143R3, entitled "Meaning of Eligible Capital Expenditure" states 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)..."
Thus, if the expenses incurred during a CCAA restructuring process are considered not to be eligible for deduction pursuant to paragraph 20(1)(e) (or (e.1)) of the Act, they may be deductible as an ECE pursuant to paragraph 20(1)(b) of the Act.
Deduction pursuant to subparagraph 20(1)(e)(v) and paragraph 20(1)(e.1) of the Act
Your third concern is where expenses incurred during the restructuring process were such that the indebtedness with respect to a specific creditor was terminated as a result of such restructuring process, whether such expenses can be considered to relate 'solely to the year' and, therefore, be eligible for deduction pursuant to paragraph 20(1)(e.1) of the Act.
Where borrowings, the expenses in respect of which are eligible for deduction pursuant to paragraph 20(1)(e), are settled in a particular year, subparagraph 20(1)(e)(v) allows the balance of the expenses that were not deductible in previous taxation years, as a result of the five-year apportionment rule, to be deductible in that particular year, provided:
- the expenses do not relate to transactions made as a part of a series of borrowings or other transactions and repayments, and
- the consideration for settlement does not include any unit, interest, share or debt obligation of the taxpayer or any person with whom the taxpayer does not deal at arm's length or any partnership or trust of which the taxpayer or any person with whom the taxpayer does not deal at arm's length is a member or beneficiary.
Thus, generally, expenses that relate to debts which have been completely extinguished may be eligible for deduction pursuant to subparagraph 20(1)(e)(v) of the Act. However, in a particular situation where consideration for the settlement of debt includes a share of the taxpayer or any person with whom the taxpayer does not deal at arm's length, subparagraph 20(1)(e)(v) will not apply.
Paragraph 20(1)(e.1) of the Act provides that, notwithstanding paragraph 20(1)(e), certain financing expenses that relate only to the year they are incurred are deductible in that year. The fees deductible under paragraph 20(1)(e.1) include standby charges, guarantee fees, registrar fees, transfer agent fees, filing fees, service fees, or any similar fees, provided such fees are not:
- contingent or dependent upon the use or production from property;
- computed by reference to revenue, profit, cash flow, commodity price, or any other similar criterion; or
- computed by reference to dividends paid or payable to shareholders of any class of shares of the capital stock of a corporation.
If the expenses listed in your submission fulfill the above-mentioned conditions, they may be eligible for deduction under paragraph 20(1)(e.1) of the Act. However, it is a question of fact whether a particular fee is reasonably considered to relate solely to the year.
You have indicated that the CCAA restructuring plan involved incorporation of a new corporation and issuance of shares. Legal fees were incurred for this process. Your concern is whether such expenses will be eligible for deduction pursuant to subparagraph 20(1)(e)(i) which allows for the deduction of expenses incurred, inter alia, in the course of an issuance of shares of the capital stock of the corporation.
In our view, the purpose of paragraph 20(1)(e) is to allow the deduction of financing expenses. Subparagraph 20(1)(e)(ii) permits the deduction of expenses incurred in the course of a borrowing of money. Subparagraph 20(1)(e)(ii.1) allows for the deduction of expenses incurred in the course of becoming indebted by reason of an amount having become payable by the taxpayer for property acquired to earn income. Finally, subparagraph 20(1)(e)(ii.2) allows for the deduction of expenses incurred in the course of a rescheduling or restructuring of a debt obligation or an assumption of a debt obligation.
Based on the above, and considering the scope of subparagraphs 20(1)(e)(ii), (ii.1) and (ii.2), it can be argued that subparagraph 20(1)(e)(i) should be interpreted as allowing a deduction in respect of expenses incurred in the course of an issuance or sale of shares, only if such issuance of shares results in the raising of money for the corporation. In the absence of any indication of financing, no deduction may be permitted under subparagraph 20(1)(e)(i).
Further, as explained in paragraph 10 of the Interpretation Bulletin IT- 341R4, entitled "Expenses of Issuing or Selling Shares, Units in a Trust, Interests in a Partnership or Syndicate, and Expenses of Borrowing Money", the deduction permitted by paragraph 20(1)(e) or (e.1) is restricted to the taxpayer who enters into a transaction described within these paragraphs. For instance, a taxpayer can deduct expenses incurred in the course of: an issuance of shares of the taxpayer by the taxpayer; a borrowing of money used by the taxpayer for the purpose of earning income from a business or non-exempt income from property; an assumption of a debt obligation by the taxpayer in respect of such a borrowing; etc. Accordingly, if expenses are paid by a parent company on behalf of its subsidiary in connection with the issuance of shares by its subsidiary, they are not deductible by the parent company under paragraph 20(1)(e). However, if such expenses are reimbursed by the subsidiary to the parent, and are reasonable in the circumstances, they should be deductible by the subsidiary.
It should be noted that in any particular situation it would need to be determined whether we are dealing with the issuance of a share, such that the provisions of subparagraph 20(1)(e)(i) are applicable, or whether we are dealing with a restructuring or rescheduling of a debt obligation, which had originally been issued in the course of a borrowing noted under subparagraph 20(1)(e)(ii) or incurring indebtedness noted under subparagraph 20(1)(e)(ii.1), and such restructuring or rescheduling involves the conversion or substitution of the debt obligation to or with a share, such that the provisions of subparagraph 20(1)(e)(ii.2) are applicable.
Allocation of expense
In the submission, one of the requests was that we suggest an allocation method where any portion of a fee may be subject to the application of more than one tax provision. Unfortunately, we are unable to comment on the various allocation methods that you have indicated in your submission other than to comment that allocation of the expenses should be done on a reasonable basis.
Finally, you wanted our views on whether certain legal and professional expenses incurred in respect of a study carried out, prior to the corporation coming under CCAA protection, to determine if a past transaction involving the acquisition of additional shares of XXXXXXXXXX from public investors, by XXXXXXXXXX , could be treated as current expenses, since they were incurred to study the ability of XXXXXXXXXX to function as a going concern as a result of the acquisition.
The Courts have generally found that costs incurred for the creation of a business entity, structure or organization, or for the modification of such entity, structure or organization are capital in nature. For example, in Canada Starch Co. Ltd. v. M.N.R., 68 D.T.C. 5320 ((Exchequer Court), Jackett P. stated:
"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."
The following comments were made by Archambault, T.C.C.J. in Rona Inc. v. The Queen, 2003 DTC 979 (TCC), when dealing with the issue of whether the appellant was eligible to deduct certain legal and accounting fees in respect of the acquisition of a competitor's shares and an interest in a joint venture:
[45] "...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...
[51]...In my opinion, the purpose of this takeover bid was to preserve Rona's business structure, and the related expense is therefore a capital outlay. I consider it appropriate to apply the reasoning followed in M.N.R. v. Dominion Natural Gas (1940), 1 DTC 499-133, and Her Majesty the Queen v. Jager Homes Ltd., F.C.A., No. A-792-83, January 28, 1988 (88 DTC 6119). In this last decision, Urie J., writing for the Federal Court of Appeal, states as follows...:
... To use the words of Dixon J. in the Sun Newspapers case, supra, "The expenditure in question is a large non-recurrent unusual expenditure made for the purpose of obtaining an advantage for the enduring benefit of the appellants' trade ..." In other words, the payments for legal fees were made to preserve the business entity, structure or organization not as the kinds of expenditures which are made to earn profits from the operation of such business entities."
In the given situation, since the legal and professional expenses were not related to a source of business income at the time they were incurred, but rather to a capital restructuring transaction, in our view, they are considered capital outlays. Further, it is a question of fact if such expenses are eligible for deduction as an ECE pursuant to paragraph 20(1)(b) of the Act.
R.A. Albert, CA
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch
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