Share investments potentially a business (pp. 5:10-15)
[C]onsolidated Mogul's chief task in the relevant years was the development and management of properties owned by other companies in which it had acquired various shareholdings….
Not only was the investment in shares a business activity, it was part of the corporation's mining business….The mere fact that the corporation's assets consisted largely of shares and that its income consisted largely of dividends did not make the corporation's business any less a mining business [[1969] S.C.R. 54].
[I]n Firestone [87 DTC 5237], the appellant set out to create his own venture capital business By acquiring financially distressed manufacturing businesses and making them profitable through supervision and direction….
MacGuigan J (for the court) observed that shares are no different from other business assets of a capital nature….However, MacGuigan J also found that the supervision costs were fully deductible under section 9 because they were operating costs in the venture capital business, incurred for the purpose of earning profits in the form of dividend income….
In short shares held by a parent corporation on capital account can easily form part and parcel of the parent's business, whether this business be called an investment business, a venture capital business, a capital management business, a group stewardship business, a capital financing business, or even a mining or some other industry business….
Furthermore, as a general principle under sections 3 and 9, dividends paid on shares held in such business constitute income from business (not income from property).
Potential carry-forward of losses of an investment business (pp. 5-17-18)
Losses from property do not carry over under subsection 111(5)…
The line separating the passive owner from the parent that holds shares in group companies as part of its business is easily crossed. For the parent that has crossed this line, losses from this source—including interest expense deductible under paragraph 20(l)(c)—are considered losses from business, not from property.
…The loss business might not change in the parent, as a factual matter, following the acquisition… . [T]he loss business might be described in various ways depending on the facts—as an investment business, a venture capital business, a capital management business, a capital financing business, or even a mining (or some other industry) business….
Income and profit from the loss business, under the streaming rules, can easily include dividend income. Dividends constitute income under section 9, notwithstanding that an amount equal to such dividends is deductible in computing the corporation's taxable income under subsection 112(1). This may have the indirect effect of allowing the streamed business losses to be used against other taxable income….
Break fees referable to pre-acquisition agreement (pp.5:23-24)
Break fees arise in the public corporation marketplace. They are routinely negotiated as part of a pre-acquisition (or support) agreement,…
The contractual rights secured by a bidder under a pre-acquisition agreement are not simply "general and non-exclusive rights." They represent exclusive proprietary rights as against the target corporation, and, as such, constitute property. Furthermore,-termination of these rights should constitute a disposition of property. [fn 110: … Bache, 2011 FCA 104, at… 22 and 41.]…
Break fees as capital receipts (p. 5:25)
[E]arlier decisions made in the context of option agreements are helpful and persuasive. The courts have looked to the nature of the property underlying the contract to determine whether the option itself was capital property. In other words, the question whether amounts realized on the disposition of the option contract were of a capital nature turned on whether the property underlying the option would have been capital property in the option holder's hands if the option had instead been exercised (and the underlying property acquired). [fn 113: Hill-Clark-Francis Ltd. v. MNR, [1961] Ex. CR 110; David Miller v. MNR, 62 DTC 1303 (Ex. Ct); MNR v. Aldershot Shopping Plaza Ltd., 65 DTC 5018 (Ex. Ct.); Morris Schnek…, 1984 Conference Report (…Canadian Tax Foundation…at 710-11… .]
…[T]he rights secured under a pre-acquisition agreement are analogous to rights secured under an option agreement….Accordingly, if the shares would be capital property in the hands of the bidder (if successfully acquired), the rights under the pre-acquisition agreement should likewise be capital property.
[F]rom there, it seems a short step to conclude that the amount received on the disposition (the break fee) is a capital receipt.
Break fees as proceeds of capital property or eligible capital amounts (p. 5:26)
If the transaction occurred before the 2006 amendments were made to the mirror-image rule in section 14, the amount is likely to be a capital gain….
lf the break fee were received after the 2006 amendments to the mirror-image rule, the result is surprisingly unclear. Following these amendments, the text of the rules in sections 14 and 39 can be seen to result in perfect circularity….
[E]arlier decisions made in the context of option agreements are helpful and persuasive. The courts have looked to the nature of the property underlying the contract to determine whether the option itself was capital property. In other words, the question whether amounts realized on the disposition of the option contract were of a capital nature turned on whether the property underlying the option would have been capital property in the option holder's hands if the option had instead been exercised (and the underlying property acquired). [fn 113: Hill-Clark-Francis Ltd. v. MNR, [1961] Ex. CR 110; David Miller v. MNR, 62 DTC 1303 (Ex. Ct); MNR v. Aldershot Shopping Plaza Ltd., 65 DTC 5018 (Ex. Ct.); Morris Schnek…, 1984 Conference Report (…Canadian Tax Foundation…at 710-11… .]
CFA holding company can hold shares of CFA subs as an investment business (p. 5:19)
[A] top-tier holding affiliate in a foreign country may have activities similar to that of a parent corporation of a Canadian corporate group: that is, it may hold shares in other foreign affiliates as part of its overall business of equity and debt financing, strategic oversight, capital management, and technical services provided to and in respect of the other group companies….the holding affiliate should be considered to have a business. Furthermore, if the revenues of that business are principally interest and dividends, the holding affiliate should also be considered to have an investment business as its source of income in the first instance.
Back-to-back application of s. 95(2)(a)(ii)(B)(I) (p. 5:20)
[A]ssume that FA 1…is a parent affiliate of the kind described above….
Assume, for a particular year, that the only revenue actually received by FA 1 in its investment business consists of interest on loans (of money) used by FA 2 for the purpose of earning income in its active business. Further assume that this interest payable is deductible in computing FA 2's prescribed earnings from its active business under paragraph (a) of the definition of "earnings" in regulation 5907(1). FA l's net income from its investment business for the year is certainly "derived from" amounts deductible in computing FA 2's prescribed earnings from its active business. This should be sufficient to recharacterize what would otherwise be FA l's net income from its investment business (income from property) into income from an active business under subclause 95(2)(a)(ii)(B)(I).
Furthermore, if FA 1 has itself obtained financing in connection with its investment business from another foreign affiliate (FA 3), the foregoing could affect the tax treatment of interest income earned by FA 3. This is so whether the financing relates to shares held in the investment business or to loans held in the investment business. For instance, assume that FA 3 financed FA l's acquisition of shares held in FA l's investment business. In computing FA l's net income from this one source, FA 1 deducts interest payable to FA 3. Interest payable to FA 3 should represent an amount deducted by FA 1 in computing its net amount that is required to be recharacterized as active business income under subclause 95(2)(a)(ii)(B)(I). This, in turn, should mean that the interest income received by FA 3 is also recharacterized as active business income under subclause 95(2)(a)(ii)(B)(I), because the interest payable by FA 1 to FA 3 is deductible by FA 1 in computing its prescribed earnings from an active business under paragraph (b) of the definition of "earnings" in regulation 5907(1).
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