31 March 2011 Internal T.I. 2011-0391701I7 - Tax treatment of transaction costs

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: A. Whether the costs incurred by XXXXXXXXXX in respect of the proposed acquisition of XXXXXXXXXX , the combination with XXXXXXXXXX and the unsolicited takeover bids by XXXXXXXXXX and XXXXXXXXXX are deductible under subsection 9(1) or eligible capital expenditures. XXXXXXXXXX .

Position: A costs incurred by XXXXXXXXXX with respect to the attempted takeover of XXXXXXXXXX and the stock option buyout costs incurred by XXXXXXXXXX are on capital account, while the other transaction costs are deductible in computing income under subsection 9(1) XXXXXXXXXX

Reasons: A. The attempted acquisition of XXXXXXXXXX shares and the stock option buyout were capital transactions, while case law has held that other transaction costs, which cannot be linked to a capital transaction, are current expenses XXXXXXXXXX

						March 31, 2011

XXXXXXXXXX 					Resources Industry Section
XXXXXXXXXX Tax Services Office 	T. Harris
						(613) 957-8284

						2011-039170

XXXXXXXXXX
Treatment of Takeover Transaction Costs

We are writing in response to your memoranda of December 24, 2010 and February 11, 2011 wherein you requested our opinion with respect to the income tax treatment of the following disbursements relating to the merger and acquisition transactions that occurred in the XXXXXXXXXX taxation year of XXXXXXXXXX :

1) Expenses incurred by XXXXXXXXXX in respect of an unsuccessful bid made by XXXXXXXXXX to acquire all of the outstanding common shares of XXXXXXXXXX ; and

2) Expenses incurred by XXXXXXXXXX in respect of the proposed combination with XXXXXXXXXX and the unsolicited takeover bids from XXXXXXXXXX .

XXXXXXXXXX

Our Comments

Deduction of Transaction Costs

In general terms, an expenditure may be deductible in the year it was incurred to the extent that it is deductible in computing a taxpayer's profit from a business or property under subsection 9(1). In addition, paragraph 18(1)(a) provides that a deduction may only be claimed for an expenditure incurred for the purpose of gaining or producing income from the business or property. Where these conditions are satisfied, an expenditure will generally be deductible in the taxation years in which it is incurred, unless the expenditure was incurred on capital account and paragraph 18(1)(b) would apply to deny the deduction.

XXXXXXXXXX Acquisition Costs

It is our view that the attempted acquisition of the shares of XXXXXXXXXX by XXXXXXXXXX and the subsequent combination of the business operations would have resulted in the acquisition of capital property, being the shares of XXXXXXXXXX , by XXXXXXXXXX such that this transaction would be a capital transaction. Consequently, it is our opinion that the costs incurred by XXXXXXXXXX with respect to this attempted takeover would be on capital account and would not be deductible on a current basis by virtue of paragraph 18(1)(b). We believe that our position is consistent with the case law, including the following statement made by MacGuigan J. in D. Morgan Firestone v. The Queen, 87 D.T.C. 5237 (F.C.A.):

Despite this climate of uncertainty as to the exact test, there has nevertheless been general agreement that an expenditure for the acquisition or creation of a business entity is on capital account.

It is also the CRA's long-standing position that expenditures incurred in an unsuccessful transaction will be accorded the same treatment as if the transaction had been successfully completed. This position is supported by the decisions in Firestone, Brooke Bond Foods Ltd. v. The Queen, 84 D.T.C. 6144 (F.C.T.D.), Graham Construction Engineering (1985) Limited v. The Queen, 97 D.T.C. 342 (T.C.C.) and Rona Inc. v. The Queen, 2003 D.T.C. 264 (T.C.C.).

Consequently, XXXXXXXXXX would only be entitled to a deduction with respect to the XXXXXXXXXX acquisition costs to the extent permitted by paragraph 20(1)(b) which requires that these costs qualify as an eligible capital expenditure within the meaning of subsection 14(5). As described in paragraph 2 of Interpretation Bulletin IT-143R3 "Meaning of Eligible Capital Expenditure" August 29, 2002, it is the CRA's position that an expenditure will constitute an ECE if it was made or incurred by a taxpayer:

(a) in respect of a business;

(b) as a result of a transaction occurring after 1971;

(c) on account of capital; and

(d) for the purpose of gaining or producing income from the business (whether or not income from the business was actually produced by such outlay or expense).

Paragraph 23 of Interpretation Bulletin IT-143R3 includes the following comments with respect to whether certain fees incurred in an unsuccessful attempt to acquire shares of a corporation:

'Since an outlay or expense is an eligible capital expenditure only if it is incurred for the purpose of gaining or producing income from a business, legal and accounting fees incurred in an abortive attempt to acquire shares of a corporation would normally not qualify. Where, however, the taxpayer can demonstrate that he or she proposed to make the business of the corporation part of a similar business which the taxpayer already operated, the fees may qualify as eligible capital expenditures.'

While it is not clear that these comments were intended to apply to large public corporations, it is our view that the factors XXXXXXXXXX suggest that XXXXXXXXXX intended to combine the business of XXXXXXXXXX with those of its own. Furthermore, as stated in paragraph 36 of its decision in BJ Services the Tax Court stated "It is a basic common sense approach to view maximizing share price as inextricably interwoven with the business of any company, whether that be public or otherwise." Therefore, we believe that a court would not support the position that these costs were not incurred for the purpose of earning income from XXXXXXXXXX 's business and that the XXXXXXXXXX acquisition costs should be considered to represent eligible capital expenditures.

XXXXXXXXXX Transaction Costs

XXXXXXXXXX

XXXXXXXXXX , the proposed XXXXXXXXXX combination would appear to have been negotiated in circumstances that are very similar to those considered by the Tax Court in BJ Services, which found that the costs were deductible in computing income under subsection 9(1). While we believe that an argument could be made that these transaction costs were on account of capital as the proposed combination represented a capital transaction relating to the structure in which XXXXXXXXXX 's business would be carried on, such an argument is contrary to the decisions in BJ Services and International Colin Energy.

XXXXXXXXXX Takeover Costs

Based on established case law, including the decisions in British Columbia Power Corp. Ltd. v. MNR 67 DTC 5258 (SCC) and Boulangerie St-Augustin Inc. v. The Queen 95 DTC 164 (TCC); affirmed by 97 DTC 5012 (FCA), the costs incurred by XXXXXXXXXX with respect to obtaining professional advice and communicating with its shareholders concerning the XXXXXXXXXX and XXXXXXXXXX offers would be deductible as current expenses in computing XXXXXXXXXX 's income under subsection 9(1).

The XXXXXXXXXX takeover costs incurred by XXXXXXXXXX also include XXXXXXXXXX payments made to its employees for surrendering vested stock options for cancellation. We agree XXXXXXXXXX that the decisions in Imperial Tobacco Canada Limited v The Queen, 2010 DTC 648 (TCC) and The Queen v Kaiser Petroleum Ltd., 90 DTC 1990 (FCA), indicate that these stock option buyout costs incurred by XXXXXXXXXX were on capital account and, therefore, not deductible by virtue of paragraph 18(1)(b). XXXXXXXXXX similar to the situation considered in Imperial Tobacco, the amendment of the XXXXXXXXXX was coincident with the recommendation by XXXXXXXXXX 's Board of Directors that XXXXXXXXXX 's shareholders accept the XXXXXXXXXX Offer. As in Imperial Tobacco, XXXXXXXXXX took steps to amend the XXXXXXXXXX to permit key employee's who held stock options with the right to surrender to XXXXXXXXXX for cancellation any option that was then exercisable for common shares in return for payment by XXXXXXXXXX of an amount equal to the difference between the exercise price and the market value of the shares. In our view, the rationale of Bowie, J. in Imperial Tobacco should also apply to XXXXXXXXXX 's situation.

XXXXXXXXXX

For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency'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 the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be made by you to Mrs. Celine Charbonneau at (613) 957-2137. In such cases, a copy will be sent to you for delivery to the taxpayer.

We trust that these comments will be of assistance.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch