Date:
20121121
Docket: A-92-12
Citation: 2012 FCA 306
CORAM: EVANS
J.A.
SHARLOW
J.A.
STRATAS
J.A.
BETWEEN:
MORGUARD CORPORATION
Appellant
and
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
SHARLOW J.A.
[1]
This
is an appeal of a judgment of the Tax Court of Canada in which Justice Boyle
dismissed Morguard Corporation’s appeal of a reassessment under the Income
Tax Act, R.S.C. 1985, c. 1 (5th Supp.) for the 2000 taxation
year (2012 TCC 55).
[2]
The
facts are well and fully stated in Justice Boyle’s reasons for judgment. For
the purposes of this appeal, only a summary is necessary here.
[3]
In
1997, Morguard adopted a business strategy of acquiring controlling interests
in real estate companies. It entered into a number of transactions in pursuing
that strategy. One was the acquisition in 1998 of a 19.2% interest in Acanthus
Real Estate Corporation. Another was Morguard’s takeover bid in June of 2000,
in which it sought to acquire all of the Acanthus shares it did not already
own. The bid was preceded by negotiations with the directors of Acanthus which
led to a preacquisition agreement in which the directors agreed to support a
Morguard bid at $8.25 per share, and to pay Morguard a break fee of $4.7
million if an unsolicited competing bid was made and the directors of Acanthus
withdrew their support of the Morguard bid.
[4]
A
competing bid was made at $8.50 per share. The directors of Acanthus withdrew
their support of the Morguard bid and paid the $4.7 million break fee. Morguard
increased its bid to $9.00 per share, and the preacquisition agreement was
amended to increase the break fee to $7.7 million. However, the competing bid
was increased to $9.30 per share and then, following negotiations with
Morguard, to $9.40 per share. Morguard declined to increase its bid further.
[5]
The
directors of Acanthus supported the $9.40 competing bid. At that point Acanthus
became obliged to pay Morguard the additional $3 million break fee, which was
paid in July of 2000. Morguard, which by then held 19.9% of the shares of
Acanthus, accepted the competing bid and realized a capital gain of
approximately $4.8 million on the sale of its Acanthus shares.
[6]
Morguard
has never sold any of its interest in real estate companies, except for its
shares of Acanthus. Up to the date of the Tax Court hearing, it had never
received another break fee.
[7]
In
filing its income tax return for the 2000 taxation year, Morguard reported its
taxable capital gain on the sale of its Acanthus shares. It also reported the
break fee of $7.7 million, net of bid expenses of approximately $1.8 million,
as a capital gain. The reported taxable capital gain (2/3 of the gain) was
approximately $4 million.
[8]
In
this Court, counsel for Morguard conceded, correctly in my view, that the break
fee was not received as the proceeds of disposition of capital property.
Therefore, for income tax purposes it is either income or a non-taxable capital
receipt. I note parenthetically that the 2006 amendments to the definition of
“cumulative eligible capital” in subsection 14(5) of the Income Tax Act
may bring within its scope any amounts received on account of capital in
respect of a business. However, that amendment was not in effect in 2000 when
Morguard received the break fee in issue in this case.
[9]
In
2005, the Minister reassessed Morguard to remove the taxable capital gain
related to the $7.7 million break fee, replacing it with an income inclusion of
$7.7 million less the reported bid expenses. The net increase to Morguard’s
income was approximately $1.9 million. Morguard appealed unsuccessfully to the
Tax Court, and now appeals to this Court.
[10]
Justice
Boyle found as a fact that the break fee was paid pursuant to an agreement
negotiated by Morguard in connection with its potential acquisition of
Acanthus, that Morguard pursued the acquisition in accordance with its
established business strategy and in the ordinary course of its normal business
operations, and that the receipt of the break fee was a normal and expected
incident of its business activities. These factual conclusions were reasonably
open to Justice Boyle on the evidence presented. Indeed, as findings of fact
they were not challenged by Morguard in this appeal.
[11]
Morguard’s
appeal is based primarily on the statements from Justice Boyle’s reasons to the
effect that Morguard was “essentially in the business of doing acquisitions and
take-overs” (paragraph 45). Morguard argues that this statement is wrong in law
because it is not consistent with Neonex International Ltd. v. Canada
(1978), 22 N.R. 284, [1978] C.T.C. 485, 89 D.T.C. 6339 (F.C.A.). Morguard
argues that Neonex is authority for the proposition that the acquisition
of capital properties does not and cannot, as a matter of law, be a business in
itself.
[12]
Neonex
was a corporation that carried on an electric sign and advertising business. It
also, over a relatively short period of time, acquired the shares of over 60
corporations to which it provided management services and financing in the form
of loans. Neonex incurred legal expenses in the course of an unsuccessful
attempt to acquire a particular corporation. This Court held that the legal
expenses were not deductible because they were outlays on account of capital.
Morguard relies particularly on the following passage from Neonex
dealing with this issue (at page 6346, D.T.C.) (my emphasis):
|
In
his Memorandum of Fact and Law counsel [for Neonex] put his case on this
issue as follows:
In the course of carrying out
those business activities [of acquiring target companies, Neonex] incurred
expenses in respect of staff, travel and legal and accounting advice, all
with a view to being able to earn income from its business and property.
Throughout, as a conglomerate [Neonex] constantly entertained the necessary
and incidental risk of having its pursuits fall apart either because the
target companies which it investigated were unsuitable for its purposes, unavailable
on terms acceptable to vendor and purchaser, or unavailable because [Neonex]
and others involved in the transactions were unable, for whatever reason to
perform and carry out the arrangements agreed upon. A necessary and
incidental risk, although an infrequent reality was the possibility of being
engaged in legal disputes about rights and obligations assumed or acquired in
the course of its business. Expenses incurred in those circumstances were
necessary and incidental to the conduct of [Neonex]'s business and are
deductible in computing income […].
A
similar argument was made before the learned Trial Judge who found it
difficult to accept that the buying of shares with a view to retaining them
can itself be said to be a business. Rather, he held, [Neonex] was
in the business of making and selling signs and, as well, in the business of
supplying management expertise, services and funds to the companies, the
control of which it had acquired by the purchase of shares. The
acquisition of the shares was, in his view, not in itself a business but was,
in each case, an investment made with a view to earning income, a fact that,
as will be seen from the above quotation from [Neonex]'s Memorandum of Fact
and Law, was admitted by [Neonex].
I
wholly agree with this finding. I also agree with the Trial Judge that the legal
expenses at issue herein -- those incurred in an effort to complete the
takeover and those incurred in seeking compensation in lieu of shares -- were
outlays associated with an investment transaction and thus were made on
capital account.
|
[13]
As
I read Neonex, this Court accepted the finding of the trial judge that
Neonex was not carrying on a business consisting of the acquisition of income
producing assets. I do not understand the Court to be establishing a rule of
law that the acquisition of income producing assets can never be a business in
itself.
[14]
Morguard
also relies on Firestone v. Canada, [1987] 3 F.C. 200 (F.C.A.). In that
case, this Court held that the costs incurred by Mr. Firestone in investigating
50 business opportunities with a view to acquiring medium sized manufacturing
companies in financial difficulty and turning them to profitable account were
not deductible. Most of the companies investigated were not acquired. The facts
were found to be indistinguishable from the facts in Neonex, and
accordingly the investigation expenses were held not to be deductible because
they were outlays on account of capital. I do not read Firestone as
authority for a legal principle to the effect that the acquisition of income
producing assets can never be a business in itself.
[15]
The
conclusion that Morguard received the break fee on income account is consistent
with the principles stated by the Supreme Court of Canada in Ikea Ltd. v.
Canada, [1998] 1 S.C.R. 196, which is the main case upon which Justice
Boyle relied. I agree with Justice Boyle that it is now the leading case on the
characterization of extraordinary or unusual receipts in the business context
(see his reasons, at paragraph 40).
[16]
Morguard
argues that Justice Boyle misapplied the principles in Ikea, because the
result in Ikea was based on a factual conclusion that the payment in
issue was a reimbursement of rent (an expense on income account), and in this
case there is no analogous finding. I do not read Ikea as being based
solely the conclusion that, in commercial terms, the receipt of a tenant
inducement payment may be associated with a higher rent. The test actually
applied in Ikea involved consideration of a number of factors, including
the commercial purpose of the payment and its relationship to the business
operations of the recipient.
[17]
The
issue in Ikea was whether a tenant inducement payment received in
respect of a long term lease of store premises was on income or capital account.
It was held to be an income receipt because, on the facts as found by the trial
judge, it was received as part of the ordinary business operations of Ikea and
was inextricably linked to such operations, even though it was received as a
result of negotiations for a long term lease which would be a capital property.
[18]
I
see no error of law in Justice Boyle’s understanding or application of Ikea.
Specifically, he made no error in applying the linkage test set out in Ikea.
Given the facts as he found them, it was open to him to conclude that Morguard
received the break fee on income account.
[19]
For
these reasons, I would dismiss the appeal with costs.
“K.
Sharlow”
“I
agree
John
M. Evans J.A.”
“I
agree
David
Stratas”
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