Citation: 2011 TCC 213
Date: 20110420
Dockets: 2005-1631(IT)G
2005-1760(IT)G
BETWEEN:
POTASH CORPORATION OF SASKATCHEWAN INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hershfield J.
Background
[1] In 1997 and 1998
the Appellant (“PCS”) incurred legal and accounting fees totalling $157,695.39
and $1,753,654.88 respectively (the “consulting fees” or “subject expenses”).
[2] The consulting fees
were incurred by PCS in order to plan and implement a reorganization of a group
of companies, none of which was PCS itself, the purpose of which was to reduce
foreign withholding taxes on funds repatriated from a U.S. subsidiary.
[3] PCS deducted the
full amount of the consulting fees in the year incurred on the basis that they
were not precluded from being so treated by either paragraphs 18(1)(a)
or (b) of the Income Tax Act (the “Act”). The deductions
so claimed were denied on the basis that such paragraphs did preclude them and
PCS was assessed accordingly in respect of each of its 1997 and 1998 years. PCS
has appealed both assessments. The appeals were heard on common evidence.
[4] Essentially, all of
the relevant facts relating to these appeals are set out in the Partial Agreed
Statement of Facts (the “Agreed Facts”) appended to these Reasons as Schedule
A. One area of controversy relating to the amount of the consulting fees was
agreed to at trial. The sole issue to be decided in these appeals then is the
extent to which the consulting fees are deductible, if at all. It is understood
that if the subject expenses were not incurred for the purpose of gaining or
producing income from a business or property no deduction will be allowed
pursuant to paragraph 18(1)(a). It is also understood that although no
deduction will be allowed pursuant to paragraph 18(1)(b) if the subject
expenses are capital in nature, a deduction would be allowed if they are found
to be eligible capital expenditures as defined in subsection 14(5) of the Act.
That is how the issue in these appeals has been approached by the parties. The
overall purpose of incurring the subject expenses was not disputed and neither
party was open to my attempting to make an allocation of the subject expenses amongst
the distinct steps of the reorganization. While the steps were entirely tax
motivated, there is no suggestion of improper tax avoidance.
Factual Summary
[5] In 1995 PCS had a
direct (80%) equity interest in each of a U.S. holding company and a U.S. limited liability
finance company (“Finance LLC”). It held the remaining (20%) equity interest in
both these U.S. companies indirectly
through a wholly owned Canadian subsidiary. The U.S. holding company was the top
company in a chain of U.S. companies all wholly owned by the company above it and
included eight operating companies at the bottom of the chain. In 1995, Finance
LLC was financed by PCS to the tune of US$730,000,000 by proportionate
investments from PCS and its Canadian subsidiary. Finance LLC in turn financed a
wholly owned U.S. subsidiary (“Phosphate Co”) of the U.S. holding company, by way of
interest bearing loans.
The advances were used by Phosphate Co to fund acquisitions of certain
operating entities. In 1997 Finance LLC financed a wholly owned U.S. subsidiary of Phosphate
Co (“Nitrogen Co”), to the tune of US$950,000,000 by way of interest bearing
loans. The advances were used by Nitrogen Co to fund certain acquisitions. The total loan amounts (referred to as the
“Loans”) were evidenced by Phosphate Co notes and Nitrogen Co notes (referred
to together as the “Notes”) and were funded by proportionate equity investments
in Finance
LLC made by PCS and its
Canadian subsidiary.
[6] Interest payments
on the Loans were distributed through Finance LLC back to Canada subject only to a 10% U.S. withholding tax. PCS’s
Canadian subsidiary’s share was in turn distributed to PCS.
[7] In 1996 and 1997
Finance LLC made total distributions up the line to PCS and its Canadian
subsidiary of some US$440,000,000. The distributions included both returns on
investment which were subject to 10% U.S. withholding and returns of capital. The returns on
investment were reported by PCS as dividend income received from Finance LLC
and its Canadian subsidiary in the total amounts of Can.$182,000,000 and Can.$134,000,000 in each of
1996 and 1997, respectively. These amounts are not net of the 10% U.S. withholding tax. Such dividends were exempt surplus in Canada under the Act so
no further tax was incurred to repatriate this income.
[8] In August of 1997,
it was announced that the Canada-U.S. tax treaty benefit on the flow through
income of LLC to a non-resident was to be denied by an amendment to the Internal
Revenue Code. The U.S. withholding rate on distributions from Finance LLC was
increased from 10% to 30%. Since the repatriation of income to Canada was exempt surplus, the
increase would substantially reduce the after tax return on PCS’s U.S. investment.
[9] The reorganization
steps taken in 1997 and 1998 are detailed in paragraphs 37-39 of the Agreed
Facts. The steps taken over a period of months were elaborate, involving
several foreign countries whose various tax rules and treaty provisions created
a network through which corporate interests and the Notes were transferred. Ultimately,
the Notes were transferred to an Irish branch of a Luxemburg entity the shares
of which were owned by PCS and its Canadian subsidiary in the same proportions
they held their interests in Finance LLC. That is, the Luxemburg entity
replaced Finance LLC as the company entitled to the Loan interest, subject to a
5% income tax in Luxemburg. The interest payments made on the Loans were not
subject to U.S. withholding tax. The
funds could be repatriated to Canada from Luxemburg at a withholding rate of 5%
under its treaty with Canada.
This replaced, eliminated, the 30% U.S. withholding tax.
[10] The consulting fees
were incurred by PCS to accomplish this result. That is the essence of the
Agreed Facts.
[11] However, I note here
that as early as April 1996 changes to the U.S.-Luxemburg tax treaty were
announced that would subject the interest payments from the U.S. entities to the
Luxemburg entity to a 30% U.S. withholding tax. That change although known to the
Appellant when first announced, did not affect the decision to proceed as the
change was not given effect or implemented until January 2001.
[12] The Luxemburg entity
was wound-up in 2001. Its reported earnings from inception to its demise were
as set out in paragraph 44 of the Agreed Facts.
[13] Throughout this
period it paid no dividends to its two Canadian shareholders. Instead, very
substantial loans were made from the Luxemburg entity to PCS as set out in
paragraph 45 of the Agreed Facts. The Luxemburg entity reported no income from
these loans to PCS and PCS reported no interest expense in respect of them.
[14] While this is, to
say the least, a recitation of the facts in a proverbial “nutshell”, it is
sufficient, at this point, to put the evidence of the Appellant’s witness in
context.
The Appellant’s Witness
[15] The current vice-president
of internal audit of PCS, Ms. Arnason, testified at the hearing. At the time of
the reorganization she was the director of taxation of the company and I am
satisfied that she was a well-informed witness who gave her testimony in a
forthright manner.
[16] She testified that
by 1994 PCS had become the world’s largest potash producer by capacity with
limited growth potential beyond that point. It had explored and exploited the
most desirable potash opportunities on a global basis. Its focus in the years
1995 through 1997 moved to expanding beyond potash, seeking opportunities to
exploit other fertilizer nutrients, namely phosphate and nitrogen. Its first
purchase in 1995 was of a phosphate mining operation in North Carolina for some $800 million.
Its second purchase, also in 1995, was another phosphate operation in Florida for another $280
million. These acquisitions were financed by Finance LLC and gave rise to the
Phosphate Co note. The nitrogen operation was acquired by way of a merger in
1997. Finance LLC lent Nitrogen Co $950 million to allow it to make further
acquisitions in 1997. This gave rise to the Nitrogen Co note and gave PCS, via
subsidiaries, a significant number of nitrogen plants in both the U.S. and Trinidad. These acquisitions
made it the world’s largest integrated fertilizer operation by capacity. It was
a player in all three of the main fertilizer elements. The acquisitions were
believed to have an added value of approximately $1.6 billion off-set by the
Notes on a consolidated basis.
[17] To achieve the
acquisitions a decision was made not to raise additional share capital. The
strength of PCS’s balance sheet made debt financing a good option. That debt,
incurred in Canada by PCS, needed to be serviced. The holding structure relating to the
acquisitions needed to best accommodate a cashflow to Canada to meet that requirement.
[18] The use of Finance
LLC was an ideal structural approach to maximize this cashflow. The U.S. tax rules did not tax
the interest income it earned from the downstream debtor companies (Phosphate
Co and Nitrogen Co) although they were allowed the interest deduction. Finance
LLC was treated as a flow-through entity subject to withholding tax only on
payments up-stream to PCS and the Canadian subsidiary. As noted above, the
distributions were treated in Canada as tax free returns of capital and dividends. The
dividends were eligible for exempt surplus treatment under the foreign
affiliate provisions of the Act and not subject to tax in Canada. Under the tax rules of
the two jurisdictions then, the 10% U.S. withholding was the only cost of repatriating the funds
necessary to pay the debt service on the Canadian borrowings. Ms. Arnason
testified that it was intended that the interest income earned by Finance LLC
was to be passed up to PCS in this way, including the portion going through the
Canadian subsidiary.
[19] With a 10% U.S. withholding tax, this
structure met PCS’s cashflow requirements. On the other hand, a 30% U.S. withholding rate was
significantly more than had been built into PCS’s analysis and its debt
servicing needs. PCS also had what Ms. Arnason referred to as robust operations
in Canada that were also in need
of the cashflow from its new acquisitions being flowed through Finance LLC.
[20] To avoid this
increased U.S. withholding rate, PCS sought a new structure with preferential
treaty arrangements both between the U.S. and the new host country and that country and Canada. That involved, as
well, finding a host country whose security laws, tax laws, business practises
and language all gave PCS a high comfort level without imposing an onerous
administrative burden on the corporate group. The host country chosen was
Luxemburg. That is, the entity to hold the Notes originally held by Finance LLC
was to be a Luxemburg entity. The process to get there involved certain
intermediary steps being taken. For example, a direct transfer of the Notes to
Luxemburg was not as efficient as routing them for a short period through an
Irish company and then having the Luxemburg entity hold them in a branch in Ireland. The terms of the Notes
also had to be amended to minimize a capital tax in Ireland. The shares that PCS and its
Canadian subsidiary held in Finance LLC had to be transferred for a short
period to a British Virgin Islands company and then, for a short time as well,
to an Irish company. Still, at the end of the day, the Luxemburg entity owned
the Notes and PCS and its Canadian subsidiary owned the equity interests in the
Luxemburg entity in the same proportions that they had held interests in
Finance LLC.
[21] In addition to
ensuring that the foreign tax consequences were as planned in respect of the
movement of the Notes monitored, all the steps in the series of transactions
were being planned by PCS’s advisers to ensure that the transfers of the
interests that PCS and its Canadian subsidiary had in Finance LLC, and the share
transfers triggered by the liquidation of the short lived entities in which
they would have held interests, were not subject to a tax in Canada in the
course of creating the final result. Such tax, if inadvertently triggered in Canada, would be borne by PCS
and its Canadian subsidiary. For example, attention had to be paid to the
rollover provisions in subsection 85.1(3) of the Act applicable on the
disposition of shares in a foreign affiliate.
[22] The details of the
reorganization are not important. However, I do note that the cross-examination
of Ms. Arnason focused on the purpose of each step and the fact that each Board
of each company acted independently to approve the steps taken in respect of
their respective separate entities. Ms. Arnason acknowledged this but
maintained that it was all about achieving the end result, namely to replace
Finance LLC with the Luxemburg entity to avoid the negative impact that the increased
U.S. withholding tax would have had on PCS. The end result sought was achieved
without any inadvertent consequences along the way. The Notes that Finance LLC
acquired in the course of financing the down-stream acquisitions ended up in
the Luxemburg entity and the interest payments on those Notes left the U.S.
without any withholding tax, subject to only a 5% income tax in Luxemburg and a
5% withholding tax on repatriation to Canada.
[23] As well, the
cross-examination of Ms. Arnason confirmed that PCS’s business activities were
the production, processing and sale of potash and that its strategy, to head a
group that was to become a global leader in the integrated fertilizer arena,
was growth oriented. That is, it was an investment strategy, not part of a
trading activity. As well, she confirmed that a functional analysis of PCS’s
custodial costs entered in evidence confirmed that in addition to the potash
business, PCS performed certain services for its subsidiaries (the costs for
which were allocated to its subsidiaries on a time spent basis) and had a
custodial function to maintain and monitor its investments. Ms. Arnason agreed
that the consulting fees did not relate to these functions.
[24] In the miscellaneous
category, I add the following which was brought out on Ms. Arnason’s
examination. PCS was not in jeopardy of defaulting on its bank loans during the
relevant times. PCS incurred legal fees for consulting services on the 1995-97
acquisitions which were capitalized as part of the acquisition costs of those
operations. Costs relating to replacing Finance LLC were not regarded as
acquisition costs and were not capitalized. The acquisitions may have had a
positive effect on PCS’s share values. There was no legal requirement on
Finance LLC to make distributions to its two Canadian shareholders. Distribution
decisions were made by the board of the entity making them. A read-in from an
examination of discovery also confirmed that decisions of each of the companies
involved in the reorganization that replaced Finance LLC with the Luxemburg
entity, including the decisions of the Luxemburg entity, were made by the
respective boards of those companies.
[25] Ms. Arnason made it
clear, and I accept her testimony on this as I have for all her testimony, that
the actual implementation fees respecting each step in the series of
transactions that constituted the overall reorganization were not part of the
consulting fees. Each entity paid its own transactional costs. I have accepted her
view that the purpose for incurring the subject expenses was for the benefit of
PCS, not the downstream related companies. That input and advice from Canada may have assisted and
influenced foreign entities that bore their own professional costs, does not
mean that they did not act independently, in a legal sense. Their raison d’être
did not inherently put them in a conflict of interest with PCS. Their interest, for example, in saving taxes on any
assets acquired, held or disposed of, would not conflict with the interest of a
shareholder no matter how far up the corporate chain.
[26] In any event, Ms.
Arnason made it clear that the entire reorganization was undertaken, and the
consulting fees were incurred, by PCS for one reason, namely, to replace
Finance LLC with something better than what was being imposed by the new 30% U.S. withholding tax. The
final structure ensured that there was no U.S withholding tax on the payments
leaving the U.S.
The Appellant’s Submissions
[27] In oral argument,
Appellant’s counsel likened the reorganization to a repair of a broken
structure that needed fixing. The structure was the channel or pipeline through
which income from property flowed and expenses incurred to repair it were
incurred, in the normal course as in the case of maintaining a pipeline, with
the view to maintain and enhance the receipt. In his written submission he
highlighted the purpose for incurring the subject expenses as follows:
25.
Put plainly, the
purpose of incurring the Consulting Fees was to implement the Reorganization to
address the increase in U.S. withholding tax and to maximize PCS’s
income from property net of foreign withholding taxes.
[28] I acknowledge that
the point of the reorganization was to relocate the Notes so as to avoid the
increase in the U.S.
withholding tax on repatriation of the funds to Canada. I accept, as Appellant’s counsel
argued, that but for that increase, the structure utilizing Finance LLC would
have been maintained. I acknowledge as well, as Appellant’s counsel argued,
that there was a reasonable expectation of continued significant income from
the downstream entities. He argues that the future availability of such
significant amounts, as would thereby be available for distribution to PCS, is
a relevant factor supporting the purpose of incurring the subject expenses.
[29] It is argued that
that meets the requirement in paragraph 18(1)(a) of an expense incurred
“for the purpose of gaining -- income from -- property”. It is argued that it
is the intention at the time the expense is incurred that is relevant and
whether or not dividends were paid from the Luxemburg entity should not, does
not, impact the determination of the requisite purpose once identified.
Appellant’s counsel cites authorities for this latter proposition including
ones that deal more broadly with the application of the purpose test and its
subjective and objective elements.
[30] That it is the
intention at the time the expense is incurred that governs is supported by the
decisions in 722540 Ontario Inc. v. R. (sub nom. Novopharm Limited v.
R.) and
Ludmer et al v. R. (sub nom. Ludco Enterprises Ltd. et al v. The
Queen). The
Appellant cites the following passage from the decision of the Supreme Court of
Canada in Ludco in support of its position:
54 Having determined that an
ancillary purpose to earn income can provide the requisite purpose for interest
deductibility, the question still remains as to how courts should go about
identifying whether the requisite purpose of earning income is present. What
standard should be applied? In the interpretation of the Act, as in other areas
of law, where purpose or intention behind actions is to be ascertained, courts
should objectively determine the nature of the purpose, guided by both subjective
and objective manifestations of purpose: see Symes,
supra, at p. 736; Continental Bank
of Canada, supra, at para.45; Backman,
supra, at para. 25; Spire Freezers Ltd., supra, at para.
27. In the result, the requisite test to determine the purpose for interest
deductibility under s. 20(1)(c)(i) is whether, considering all the
circumstances, the taxpayer had a reasonable expectation of income at the time
the investment is made.
55 Reasonable expectation accords
with the language of purpose in the section and provides an objective
standard, apart from the taxpayer's subjective intention, which by itself is
relevant but not conclusive. It also avoids many of the pitfalls of the
other tests advanced and furthers the policy objective of the interest
deductibility provision aimed at capital accumulation and investment, as
discussed in the next section of these reasons. (Emphasis added by the Appellant.)
[31] These highlighted
passages make the Appellant’s point quite clearly on the basis that the same
reasoning applies to paragraph 18(1)(a) and subparagraph 20(1)(c)(i).
Even if the reorganization failed (which it did not) or dividends were never
paid, the purpose test would still be met provided what was sought to be gained
by incurring the expenditure was income at the time the expense was incurred.
[32] In what I believe
was a response to a question I asked during argument dealing with whether or
not PCS’s “income” was affected at all by the U.S. withholding tax, Appellant’s
counsel made the following argument:
45. In addressing this
point, relevant background is provided by the FCA in Novopharm, in which
it applied the “income” test under 18(1)(a) of the Act based on the test
applied to 20(1)(c) by the SCC in the Ludco decision. Paragraphs 19 and
20 of Novopharm read as follows:
19 However,
more recent decisions of the Supreme Court of Canada indicate that, at least
with respect to subparagraph 20(1)(c)(i), income is not equivalent to profit or
net income. At paragraph 59 of Ludco, Iacobucci J. states:
Because it is left undefined in the Act, this Court must
apply the principles of statutory interpretation to discern what is meant by "income"
in the context of s. 20(1)(c)(i). The plain meaning of s. 20(1)(c)(i) does not
support the interpretation of "income" as the equivalent of
"profit" or "net income". Nowhere in the language of the
provision is a quantitative test suggested. Nor is there any support in the
text of the Act for an interpretation of "income" that involves a
judicial assessment of sufficiency of income. Such an approach would be too
subjective and certainty is to be preferred in the area of tax law. Therefore,
absent a sham or window dressing or similar vitiating circumstances, courts
should not be concerned with the sufficiency of the income expected or
received.
Although
his determination is with respect to the definition of income in subparagraph
20(1)(c)(i), the relevant words are so close to those in paragraph 18(1)(a)
that it would be difficult to justify a different interpretation with respect
to paragraph 18(1)(a).
20 The
Minister submits that paragraph 18(1)(a) is generally aimed at deductions of
outlays which are not profit motivated. However, I think the rationale outlined
by Iacobucci J. in Ludco, as to why income in subparagraph 20(1)(c)(i)
is not equivalent to profit or net income, is equally applicable to paragraph
18(1)(a). Nowhere in the language of paragraph 18(1)(a) is a quantitative
test suggested. Nor is there any support in the words of paragraph 18(1)(a)
that suggests a judicial assessment of the sufficiency of income. And, as
with subparagraph 20(1)(c)(i), such an assessment would be too subjective where
certainty is to be preferred. For these reasons, I am of the opinion that the
view of Pigeon J. in Lipson, supra, to the extent that it may have been
applied to paragraph 18(1)(a), must now be considered to have been superseded
by the rationale in Ludco. (Emphasis added by
the Appellant.)
[33] The argument then is
that incurring expenses to increase income net of foreign withholding taxes
meets the income test under paragraphs 18(1)(a) and 21(1)(c) of
the Act. The Appellant equates additional cashflow with additional
income. To further support the Appellant’s position the following paragraph in Ludco
is also cited:
61 I
agree. Indeed, when one looks at the immediate context in which the term
"income" appears in s. 20(1)(c)(i), it is significant that within the
provision itself the concept of "income" is used in contradistinction
from the concept of tax-exempt income. Viewed in this context, the term
"income" in s. 20(1)(c)(i) does not refer to net income, but to
income subject to tax. In this light, it is clear that "income" in s.
20(1)(c)(i) refers to income generally, that is an amount that would come into
income for taxation purposes, not just net income. (Emphasis added by the Appellant.)
[34] The Appellant’s
argument goes on to assert that the consulting fees were also incurred for the
purpose of earning income from the business of PCS. The reorganization was
designed to increase cash available for distribution to PCS for use in its
business.
[35] The Appellant
submits that the decision in BJ Services Co. Canada v. R. stands for the proposition that
expenses that are not directly related to income earning activities can
nevertheless be deductible if they meet a business need of the corporation.
Paragraph 18(1)(a) cannot apply to limit their deduction in such
circumstances. In that case, professional fees were incurred to make changes to
the corporation’s capital structure to fend off an unsolicited takeover bid.
[36] In BJ Services,
this Court, referring to the Symes decision of the Supreme Court of
Canada (cited thereunder) held as follows:
29 (…) [T]he Supreme Court, in Symes
v. R. (1993), [1994] 1
C.T.C. 40 (S.C.C.), is clear that if the expenses are business in
nature, instead of personal, the test for deductibility may be met by showing
the expense satisfied a need of the company. Expenses incurred by a
business, which are ancillary to its primary functions and activities, are
not immediately excluded from being deductible. As a result this renders
the paragraph 18(1)(a) restriction porous and allows the Nowsco expenses to
pass through the excluding provisions, as long as they are business in nature
and not personal. There need not be a direct link between expenses and
revenue. Expenses may be deductible, provided they are not personal and
meet some business need of the taxpayer.
30 The expenses here were certainly
ancillary expenses. However the hello and break fees, as well as the other
expenses, must be viewed in the larger context of the commercial operations
of Nowsco. (…) (Emphasis added by the Appellant.)
[37] While the consulting fees
may not have been directly related to PCS’s business of mining, processing and
selling potash, in the larger context of its commercial operations, it was
argued that PCS needed the subject cashflow in both its operations and to
service its external debt. I acknowledge that there was a business need for the cashflows expected from Finance
LLC. The activities of PCS in Canada were, as Ms. Arnason testified, robust and like any
thriving enterprise, PCS might well rely on strong cashflows from downstream
sources.
[38] Appellant’s
counsel also referred me to International Colin Energy Corp. v. R. and Boulangerie St-Augustine Inc. v. Canada. In International Colin,
consulting fees paid by a failing corporation to find a suitable merger
candidate was held to have been incurred for the purpose of improving its
ability to earn income and deductible on that basis. The Appellant argues that this test of
satisfying some business need is not restricted to dire circumstances such as
needing cash to the point where one would otherwise be in a default position.
[39] In Boulangerie St-Augustine it was held that professional
fees incurred in relation to preparing a circular for shareholders concerning a
takeover bid were deductible. Justice Archambault found that adopting a more
generous interpretation of the requirement in paragraph 18(1)(a) that
the expense be incurred for the purpose of earning income from a business was
required. It was not necessary that the expense relate directly to the business
operation.
[40] The Appellant’s counsel’s
submissions also deal with paragraph 18(1)(b) of the Act. He maintains
that the deduction of the consulting fees is not precluded by that paragraph.
[41] It is noted, as a starting
point, that the consulting fees are said not to represent the cost of acquiring
a specific asset but rather represent the cost to plan and watch over the
implementation of the reorganization. It is submitted that the acquisition cost
of the shares in the Luxemburg entity must be limited to the direct cost of
their acquisition. There was a subscription price in relation to that
acquisition and it was paid separate and apart from the consulting fees.
Further, the consulting fees continued to be incurred after the subscription
for the shares in the Luxemburg entity.
[42] It is further submitted
that the consulting fees were not incurred with a view to bringing into existence
an advantage for the enduring benefit of PCS.
[43] Appellant’s counsel argued
that a tax benefit (which is the advantage sought by the reorganization) is not
by its very nature an enduring benefit. Both the change in the U.S. withholding
rate imposed by the U.S. on payments from Finance LLC
and the later changes in the withholding rates on payments from the U.S. to Luxemburg, evidence the
stroke of a pen absence of any enduring benefit that might be attributed to a
tax benefit.
[44] Further, Appellant’s
counsel cites the minority opinion of Locke J. in British Columbia Electric
Railway Company Limited v. The Minister of National Revenue:
72. Furthermore,
in the minority opinion of Locke, J. in BC Electric Railway
(concurring however in the result with the majority opinion written by Abbott,
J.) the SCC referred to another decision in Anglo- Persian Oil,
which suggests that an “enduring benefit” is not one that, for some time,
relieves you of an income payment:
20 In Anglo-Persian Oil
Company v. Dale (1931), 16 T.C. 253, Rowlatt J., referring to the word
"enduring" in the passage from Lord Cave's judgment, said (p. 262) that
quite clearly he was speaking of a benefit which endures in the way that fixed
capital endures, not a benefit that endures in the sense that for a good number
of years it relieves you of a revenue payment. (…) (Emphasis added by the Appellant.)
[45] Another reason that
it cannot be found, as a matter of fact, that there was an enduring benefit to
the reorganization is that it was known that any tax benefit from the Luxemburg
structure would be temporary at best. In such circumstances, it is argued that
it cannot be found that the subject expenses were incurred with a view of
bringing into existence an advantage for the enduring benefit of PCS.
[46] In the alternative,
the Appellant argues that if I find that the consulting fees were incurred on
account of capital, then they are eligible capital expenditures of PCS.
[47] The definition of
“eligible capital expenditures” at subsection 14(5) of the Act requires:
a)
an
amount incurred, in respect of a business, for the purpose of gaining or
producing income from the business;
b)
that
the amount be incurred on account of capital; and
c)
that
none of the exclusions in that definition apply to the amount.
[48] The Appellant
submits that the first requirement is met based on this Court’s decision in BJ
Services. The second requirement would be met on the basis of my making
that finding. Lastly, it is submitted that none of the exclusions to the
definition of eligible capital expenditures apply to the consulting fees.
The Respondent’s Submissions
[49] Counsel for the
Respondent asserted, in effect, that I should look at the planning steps
separately and the multi-faceted objectives they each sought to implement. The
subject expenses should be seen as having been incurred to facilitate these
distinct objectives. On that basis, none of the individual transactions in the
series can be found to be for the purpose of gaining or producing income for
PCS.
[50] It is submitted that
only the acquisition of shares of the Luxemburg entity was a transaction
entered into for the purpose of producing dividend income for PCS. However, it
is argued that it should be clear that most of the steps and transactions
undertaken by PCS’s foreign subsidiaries, if viewed independently, were not
undertaken to acquire shares of the Luxemburg entity. Accordingly, the
consulting fees cannot be found to have been incurred to earn income from these
shares. They were incurred for other purposes inherent in each of those
separate transactions.
[51] The Respondent
asserts then that the purpose test must be applied in respect of each of the
transactions even though the overall purpose of the series of transactions was
to maximize the cashflow, through the group, back to PCS. For example, some
expenses were incurred to ensure that the entity that received the interest
payments on the Notes would only be subject to a minimal local income tax.
Other expenses were incurred to minimize capital taxes in both Ireland and Luxemburg. It would
not be helpful, in my view, to go through each step of the reorganization, as
did Respondent’s counsel, and reiterate counsel’s position that the particular
purpose of that particular step was this or that, as opposed to being for the
purpose of producing income for PCS. His point is made without going through
that exercise.
[52] Reliance is placed
on Singleton v. M.N.R.
where Major J. of the Supreme Court of Canada noted at paragraph 34 as follows:
… it is an error to treat this as one simultaneous
transaction. In order to give effect to the legal relationships, the
transactions must be viewed independently. When viewed that way, on either
version of the facts (i.e. regardless of the sequence), what the respondent did
in this case was use the borrowed funds for the purpose of refinancing his
partnership capital account with debt. This is the legal transaction to which
the Court must give effect. (Emphasis added by the Respondent.)
[53] Relying, as did the
Appellant, on the almost identical language in paragraph 20(1)(c) to
that in paragraph 18(1)(a), Respondent’s counsel also referred to an
observation of Rothstein J.A. writing for the Federal Court of Appeal in Singleton
as follows:
In the context of the Income Tax Act in
which the phrase “series of transactions” appears 41 times, its absence from
paragraph 20(1)(c) implies that there is no legislative intent to import
the series test into that paragraph or, in other words, to link a series of
individual transactions as if they were one transaction …
[54] Similarly, reliance
is placed on Rothstein J.A.’s finding in Novopharm where he again
confirmed at paragraph 12 that these provisions do not contemplate treating
individual transactions as part of a series but rather each must be viewed
independently.
[55] Since the consulting
fees were incurred for different immediate purposes in respect of each of the
steps taken, their deductibility must be governed accordingly.
[56] Considering the
paragraph 18(1)(a) requirement in the context of the subject expenses
being incurred to earn income from a business, the Respondent relies more on
the construction of the provision that would match the expenditure to income
from a particular business. Benefits, even cashflow benefits, that arise from
expenditures unrelated to the particular business of PCS cannot be said to have
been incurred for the purpose of earning income from that particular business.
Respondent’s counsel cites Royal Trust Co. v. Minister of National Revenue at paragraph 33 as follows:
The essential
limitation in the exception expressed in [Section 18(1)(a)] is that the outlay
or expense should have been made by the taxpayer "for the purpose"
of gaining or producing income "from the business". It is the
purpose of the outlay or expense that is emphasized but the purpose must be
that of gaining or producing income "from the business" in
which the taxpayer is engaged. … (Emphasis added by the Respondent.)
[57] Based on admitted facts
and the evidence presented at the hearing, it is asserted that the business of
PCS during its 1997 and 1998 taxation years was solely the mining, processing
and sale of potash. The consulting fees did not relate in any way to these
businesses and, accordingly, do not meet the “from the business” test in
paragraph 18(1)(a).
[58] It is further argued
that seeking to deduct on income account expenses associated with all the
various steps involved in the reorganization ignores the separate legal
existence of the various foreign subsidiaries. It is submitted that if the
separate corporate existence of PCS and its foreign subsidiaries are respected,
then the consulting fees incurred by PCS to enable its foreign subsidiaries to
move the Notes from the U.S. to Luxemburg are expenses of the respective
foreign subsidiaries because it was each foreign subsidiary that actually
implemented each successive step for its own account. On this basis, it is
submitted that the consulting fees that affected the relocation of the Notes,
even though incurred by PCS are, nonetheless, expenses of the foreign
subsidiaries whose existence PCS chose to have the benefit of in the course of
the Notes being relocated. As to the principal benefactor of that relocation,
it is asserted that it could be the Luxemburg entity. The subject transactions
did, after all, create an income earning capacity for the Luxemburg entity.
From that perspective the consulting fees can be said to have been incurred for
the purpose of enabling the Luxemburg entity to earn income, not PCS. In R.
v. MerBan Capital Corp. the
Court noted that “A payment made to allow a subsidiary to earn income is a
payment made in respect of another taxpayer’s business” and as such does not meet the
requirements of paragraph 18(1)(a), at least with respect to the gaining
or producing income from the business requirement.
[59] Having created the
Luxemburg entity to earn the interest income, PCS’s benefit is indirect, at
best. That is, it is argued that even if the business of PCS benefited from the
reorganization, it was an indirect benefit in respect of which costs to achieve
it, would not be deductible. Respondent’s counsel relied on Canada Safeway
Ltd. v. Minister of National Revenue
where the Supreme Court of Canada denied the claim to an interest deduction
of a parent company to finance the acquisition of its subsidiary. The parent
company, a retail grocer, argued the acquisition of the shares of the
subsidiary enabled it to control the business of the subsidiary and do so in a
manner that would benefit the parent in terms of increasing the parent’s
business income.
[60] In that case, Rand
J. warned of a slippery slope that would be created if a parent company, like
PCS, is allowed to deduct an expense simply because there is an indirect
benefit to the business income-earning capacity of the parent company through
share ownership. Rand J. noted:
What the
contention comes to is that the subsidiary becomes a mere agent or alter ego of
the [parent] company; that its acts are those of the [parent] company; and that
by acting as shareholder or director the [parent] company is acting in its own
immediate right in matters of which the agency subsidiary performs the motions.
But the two corporate bodies are assumed to be totally disparate in themselves
and their activities, with the [parent] company exercising its voting power not
in the course of its own business but as a shareholder only. That distinction
in capacity cannot be obliterated by a vague sense of exercise of power by the
[parent] company through its stock ownership as an instrument immediately used
in its business. If the subsidiary is not merely an agent, the exercise of
voting power must, on the argument made, be taken to be in the course of the
[parent] company's business; but that exercise is as a shareholder or director
of the subsidiary and I cannot view it as an act in the [parent] company's
business. In the circumstances before us, the interposition of a new and
distinct capacity as shareholder breaks the continuity of the company's act as
being in its own business; the act of voting is in respect of an act relating
to the business of the subsidiary. No doubt there is in fact a causal
connection between the purchase of the stock and the benefits ultimately received;
but the statutory language cannot be extended to such a remote consequence; it
could be carried to any length in a chain of subsidiaries; and to say that such
a thing was envisaged by the ordinary expression used in the statute is to
speculate and not interpret. (Emphasis added by
the Respondent.)
[61] It is submitted that
Rand J.’s caution is particularly important in the context of multinational
conglomerates where there are several layers of subsidiaries resident around
the world. Respondent’s counsel asks, for example, whether legal fees incurred
to restructure one of the subsidiaries in the group such as the nitrogen
company so as to maximize its earning capacity would be deductible to PCS on
income account because of the possible eventual flow of dividends to PCS from
the profits of this operating company. It is submitted that accepting such a
proposition would render paragraph 18(1)(a) nearly meaningless by
removing the distinction between the business and property source of income and
add in the phrase “directly or indirectly for the purpose of gaining or
producing income from the business”.
[62] It is submitted that
this point was made clear in Neonex International Ltd. v. R. where the capital nature of
legal fees associated with a failed share acquisition was emphasized. In that
case, the corporate taxpayer was in the business of making and selling
advertising signage and was a parent company of a conglomerate with over 50
subsidiaries. The taxpayer was denied the deduction of legal fees it incurred
in its failed take-over bid of another corporation. In the trial court
decision, which was upheld on this issue by the Federal Court of Appeal,
Marceau J. noted:
… I don't see how buying shares,
not in order to sell at a profit but with the view to holding and owning same,
can be said to be a business within the meaning of that word in the Income
Tax Act. As Martland, J said in Irrigation Industries Ltd v Minister
of National Revenue, [1962] C.T.C. 215 at 221, 62 D.T.C. 1131 at 1133,
shares "constitute something the purchase of which is, in itself, an
investment". The plaintiff was in the business of making and selling
signs, and it was also in the business of supplying funds and management
services to its subsidiaries. But the acquisition itself of the shares of those
subsidiaries which were to keep carrying on their own businesses, can only be
regarded as a pure investment. … the legal expenses here in question … were
outlays associated with an "investment transaction", they were made
in connection with the acquisition of a capital asset. They were, therefore,
expenditures on capital account.
[63] The submission of
the Respondent essentially concludes that the consulting fees were capital
outlays which could be recognized under the Act as part of the adjusted
cost base of PCS’s shares of the various subsidiaries involved in the series of
transactions. Since there was no basis for allocating the cost amongst all of
the subsidiaries whose shares in the series of transactions had been disposed
of then, in effect, the expenses could not be recognized at all.
[64] It is argued that if
I accept that the purpose of every step of the reorganization was for the
purpose of earning income from the shares in the Luxemburg entity, then I must
still disallow the subject expenses as being capital in nature. The shares are
capital in nature. Any enhanced value to PCS from the expenditure would be
reflected by such asset.
[65] Further, Respondent’s
counsel noted that PCS, in taking advantage of the rollover provisions of the Act
in subsection 85.1(3) in respect of the disposition of shares of a foreign
affiliate, accepted the characterization of the transfer of its shares of
Finance LLC and other entities as capital transactions. It was submitted that
PCS cannot characterize these transactions as capital in order to obtain one
benefit under the Act and then re-characterize them as being on current
account for another purpose of the Act in advancing its appeal.
[66] Respondent’s counsel
also cites Rona v. R. where
the Court held as follows:
… 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". (Emphasis
added by the Respondent.)
[67] As well, it was
emphasized that the purpose of paragraphs (18)(1)(a) and 18(1)(b)
is to distinguish those expenditures that are attributable to producing income
in the year from a business or property source from those that have a benefit
to the income producing process for more than one year. In British Columbia
Electric Railway Co. v. Minister of National Revenue, Abbott J. summarized
the purpose of the provisions as follows:
The principle underlying such a
distinction is, of course, that since for tax purposes income is determined on
an annual basis, an income expense is one incurred to earn the income of the
particular year in which it is made and should be allowed as a deduction from
gross income in that year. Most capital outlays on the other hand may be
amortized or written off over a period of years. …
[68] With respect to the
consulting fees being entitled to eligible capital expenditure treatment, the
Respondent asserts that any claim to such entitlement is not warranted under
the provisions of the Act. It is submitted that none of the consulting
fees constitute eligible capital property of PCS because none of them were
incurred for the purpose of gaining or producing income from PCS’s business
within the meaning of the definition of such property in subsection 14(5) of
the Act. The reasons for asserting that none of the consulting fees were
incurred for that purpose are the same as that relied on in respect of the
submissions on paragraph 18(1)(a).
[69] Respondent’s counsel
also acknowledged in argument the possibility that there might be another
avenue to argue the deductibility of the consulting fees. He acknowledged that
it was the Canada Revenue Agency’s (“CRA”) position that custodial costs
incurred by a parent company in a multinational group to manage and protect its
investment in the subsidiaries might be deductible provided they are incurred
for the sole benefit of the parent company.
He argued, however, that the evidence confirmed that the consulting fees were
not in the nature of custodial costs.
[70] I note, here, that
each of the parties made submissions in reply to the submissions of the other.
I have not found it helpful to reiterate those further submissions in these
Reasons.
Analysis
[71] While appreciating
that the authorities have suggested that the analysis of paragraphs 18(1)(a)
and (b) of the Act should proceed in that order, in the context
of the instant case, I do not find that to be a particularly useful approach.
If the subject expenses are capital in nature no deduction will be allowed
under paragraph 18(1)(a) regardless where an analysis of that paragraph
will lead.
[72] Consideration of the
deduction limitation in paragraph 18(1)(b) in this case will, in my
view, lead to a conclusion that the subject expenses are capital in nature.
That, in turn, will lead to an analysis of section 14 and a determination of
the question as to whether the subject expenses are eligible capital
expenditures.
[73] Still, addressing
the purpose of incurring the subject expenses needs to be examined for two
reasons. First, to determine what it is that has been acquired. It is
ultimately the nature of that which is acquired that will determine the nature
of the subject expenses. Second, the analysis of section 14 will require a
finding of the purpose for incurring it. Accordingly, I will proceed with my
analysis under the following headings:
a)
The
overall or end result purpose of the transactions vs. viewing each transaction
in the series independently;
b)
Capital
outlays;
c)
The
Capital Asset Acquired;
d)
Eligible
Capital Expenditures; and
e)
Conclusion.
a) The overall or
end result purpose of the transactions vs. viewing each transaction in
the series independently
[74] It is fair to say,
based on the evidence, that the consulting fees were incurred to advise and
ultimately assist in implementing a plan whereby the cashflow from the Notes
could, at least for a time, be repatriated or made available to PCS in the most
tax efficient manner. That was the purpose of incurring the subject expenses. The
plan required that PCS purchase the shares of a new company, the Luxemburg
entity that was to acquire the Notes. That simplistic “end result” overview
identifies a tangible property acquired to which the subject expenses
can reasonably attach. Alternatively, it identifies an “end result” intangible
structure to which the subject expenses can reasonably attach. If either such
attachment is in fact appropriate, then, it must be recognized that the purpose
of incurring the subject expenses should be determined by the overall or end result
of the series of transactions entered into.
[75] The Respondent argues,
in effect, that the subject expenses attach to the various transactions in the
series and that the authorities preclude an analysis that looks to the final
result in determining the purpose of incurring the expenditure.
[76] I do not agree with
the Respondent’s position. The structure and share purchase in this case were
only of value if the result was tax effective. That is, it was only of value if
the after tax cashflow from the Luxemburg entity was enhanced relative to that
obtained through the investment in Finance LLC. This required that the down
stream income producing asset (the Notes) be acquired by the target company
(the Luxemburg entity) in such a way as would permit this result. The tax
effectiveness of the share purchase was essential to proceeding. For the share
purchase to be tax effective, a variety of taxes, such as capital tax on the
target company, had to be avoided or minimized and a routing of the asset
needed to be carefully planned. The vendor of the asset might have little
interest in that structure except to ensure it was tax effective for it and
provided the cost of the plan itself was not passed on to it. The plan,
the structure, was designed entirely for the ultimate benefit of the purchaser
of the shares in the Luxemburg entity as a means to access a tax effective cashflow.
That is who properly bears the cost of the plan. The consulting fees must
attach to that which it ultimately acquired: the share in the Luxemburg entity
or the organization holding structure that gave PCS what it paid its
consultants to deliver.
[77] In coming to this
conclusion, I have not lost sight of the fact that the Luxemburg entity has, in
becoming the direct owner of the Notes, benefited from the plan. However, the
purpose for incurring the fee was not that. It is the purpose of the party that
properly bears the expense for its account that drives the analysis of its
nature. Further, there is nothing sinister in acknowledging that the Luxemburg
entity was not brought into existence to benefit from the ownership of the
Notes. As I will note later in these Reasons, I have no reason to believe that the fiduciary governors of the foreign
entities involved in the plan, including the Luxemburg entity, acted contrary
to their legal understanding of the purposes and objects of their respective
entities. The Luxemburg entity existed to provide PCS with funds derived from
the Notes.
[78] Adding that the
former owner of the targeted asset, Finance LLC, is a subsidiary of PCS brings
in an additional consideration. The pre-tax income stream from the targeted
asset derives from an income interest already indirectly held by PCS through
Finance LLC. Re-acquiring that interest indirectly in a different form on a tax
effective basis in Canada by a share for share exchange, or series of exchanges, on a rollover
basis, again only benefits PCS, the indirect purchaser. Again then, the plan,
the structure, is ultimately entirely for the benefit of the purchaser of the
shares in the Luxemburg entity. Allocations to other entities, as suggested by
the Respondent, would not be appropriate in this case.
[79] I note here, as well,
that the plan as a whole leaves Finance LLC, and two other companies created as
part of the plan, with nothing – they have volunteered or been forced by their
respective shareholders, to commit suicide. That is neither troublesome nor
consequential, in my view. Shareholders have the power to cause that and more
importantly, it underlines that the consulting fees were really of no value to
them.
[80] That said, my
inclination is that the separate entities argument, and the argument that the
overall purpose of a series of transactions cannot displace the legal
significance of each transaction viewed independently, are misconceived in this
case.
[81] With respect to the separate entities issue, I
noted earlier that the raison d’être of the intermediary entities did
not inherently put them in a conflict of interest position with PCS. I do not mean to suggest that the absence of a
conflict of interest stems from there being no minority shareholders or because
the corporate veil must be pierced. I say this because it is not unlawful for
entities to come into existence for limited purposes and limited times. While I
was not shown any constating documents or been guided by any foreign law
experts, I have no reason to believe that the fiduciary governors of these
foreign entities acted contrary to their legal understanding of the purposes
and objects of their respective entities. This is not to suggest that any were
the mere agents of another entity. No such assertion was made by the parties. That
said, I do not find recognizing a full allocation of the consulting fees to PCS
as in any way violating the separate entities doctrine. Every entity paid its
own costs relating to every step in the reorganization.
[82] In coming to this
conclusion, it is questionable whether or not I am turning a blind eye to the
principles set down in Singleton and Novopharm in respect of
interest expenses. There is also the question of whether coming to that
conclusion would be turning a blind eye to the authorities that rely on the
language in each of paragraphs 12(1)(c) and 18(1)(a) as saying
that the purpose test in both should be applied in the same manner. It must be
understood, however, that for tax purposes interest expenses on a loan
transaction are not fixed by that particular initiating transaction. When the
interest obligation is incurred, the authorities treat the purpose of the loan
as open-ended. That is, it is not an expense necessarily incurred for any
particular purpose or result until a second transaction occurs which, in turn,
on a strict application of the Act, dictates the purpose for incurring
the expense as actually demonstrated by that second transaction. There is a necessary
sequence involving a critical or pivotal second transaction. It is the direct
use of the proceeds of the loan that is strictly considered in the case of
interest expenses.
[83] A professional fee
paid for a reorganization of a holding, particularized from start to finish
before being undertaken, has no critical or pivotal second transaction that the
Act focuses on. Without that focus, isolating transactions in a series
so as to ignore the end, predetermined, result as the purpose of the expenditure
in this case makes little sense, in my view. This is not a novel view in the
context of determining the nature of an expenditure related to a corporate
reorganization as illustrated by the authorities reviewed under the next
heading of these Reasons.
[84] Further, I am not
dissuaded from that view by the decision in Novopharm. Consulting fees in
that case were treated under section 18(1)(a) as having been paid to
earn income on the same basis as the interest expense which was to look at the
direct, initial, use of the loan proceeds and ignore the ultimate purpose of
the loan and consulting fees. That conclusion, however, cannot be taken as
dispositive of the case at bar. The consulting fees in Novapharm were
tied to the loan. The purpose test as it applied to one had to apply to the
other. They were inseparable. That has no similarity to the case at bar.
[85] As well, even if I
were to agree that the intermediary transactions must be viewed independently,
I would attribute little or no value to an apportionment made to anything other
than the cost of the shares in the Luxemburg entity or the plan created and
orchestrated to ensure holding those shares would be tax- effective. If the
expenses incurred by PCS for its own benefit must attach to intermediary steps,
they should only attach to those steps that actually involved PCS in a
transaction. If it received shares in a BVI company then arguably a portion of
the consulting fees could be attributed to those shares. If it received shares
in an Irish company then arguably a portion of the consulting fees could be
attributed to those shares. However, the apportionment, if any, would be
negligible. While it is true that the shares of intermediaries that hold the
Notes will have value, and will have a cost base (that might end up in the cost
of the shares in the Luxemburg entity under the Canadian rollover rules), does
not mean that the professional fees incurred by PCS must be apportioned on the
basis of those values. One has nothing to do with the other. Indeed, all such
expenses have only, and necessarily, been incurred as part of a plan to bring
the shares in the Luxemburg entity into existence in an effective manner in
order to maximize PCS’s access to funds derived from the Notes. There is no
other reason to incur them and as such the subject expenses in respect of the
independent transactions, as stand alone, isolated, independent transactions,
would have little or no value to PCS. As well, as noted, they have no value to
these other entities.
b) Capital outlays
[87] Whether the
consulting fees were paid as part of the cost of the shares of the Luxemburg
entity or for the plan to reconstruct a pipeline through which down stream
interest income could be moved will not change their capital nature. Either
way, the reorganization was a worthwhile project. It was known to have a
limited life, but it is a capital project nonetheless. All the transactions
engaged in by PCS were capital in nature. The fees associated with those
capital transactions must then be recognized as incurred on account of capital.
[88] The Appellant argues
that the consulting fees were incurred to repair an existing structure. Repairs
are on-going recurrent expenses that may well have enduring benefits but are, nonetheless,
required in the normal course of business and must be recognized as current expenses.
An analogy might be drawn to repairs to rental properties where the cost of a
new roof would generally be accepted as a current expense since the repair was
not so substantial as to constitute replacement of the asset. The repair did
not add value, it maintained value; it maintained the cashflow. However, the scenario in this case
is different. What existed prior to the reorganization was an external pipeline
feeding the coffers of PCS. PCS paid the planning and design costs to rebuild a
new and entirely different pipeline. In such a case the repair analogy fails to
recognize the coming into existence of an entirely new structure. This calls on
a different line of authorities which hold that the costs of such
reconstruction are capital in nature.
[89] As well, this is not
a case such as in Pantorama Industries
Inc. v. R. where monies were paid each year
to ensure an existing structure could continue to be exploited profitably. In
the case at bar, an entirely new structure was constructed.
[90] In any event, the
Appellant’s argument that the subject expenses were made for the purpose of earning
income from its business brings with it the need to recognize that the new
structure allowed for that. Costs associated with new income earning structures
are capital in nature. An early authority for the capital nature of
expenditures on a reorganization is found in Canada Starch Company Limited v.
Minister of National Revenue where Jackett J. found
that generally speaking:
(a)
… 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.
[92] Another and recent example referring to the capital
nature of an outlay made in the course of a corporate reorganization is found in Imperial
Tobacco Canada Ltd. v. R. where Bowie J. agreeing with the
Crown found that an
outlay made in the
course of a corporate reorganization to achieve an assurance that some end goal
will be completed or achieved in a manner that will have value, will be on
capital account. At paragraph 12, Justice Bowie stated
that “The real question in each case is
"what was the expenditure calculated to effect from a practical and
business point of view?"”. Consideration of the ultimate effect of the
expenditure is then of paramount importance. He relied on the Federal Court of
Appeal decision in Kaiser Petroleum Ltd. v. R. where
expenditures incurred to reshape the
capital structure of the taxpayer’s organization were found to be capital in
nature. In that reorganization, which offered an inducement to employees to
relinquish stock options, the plan was not undertaken to discharge obligations
to employees which might have been on income account, but rather the dominant
aspect of it, and I would add the desired resulting aspect of it, was to
reshape the capital structure of the company. Monies paid out to employees
pursuant to the reorganization were accordingly on capital account.
[97] While the
Appellant’s alternative argument accepts the subject expenses as having been
made on account of capital, its principal argument was that they had no
enduring benefit and, accordingly, they should not be treated on capital
account. It was argued that structural changes to achieve a tax advantage are
by their nature of an uncertain life and should not be viewed as affording any
enduring benefit.
[101] Distinguishing BJ
Services and International
Colin on the basis of
there being something of value acquired by PCS in the instant case requires a
determination as to what that something of value is. In this regard, I tend to
concur with the Appellant that the something acquired was the intangible plan
or structure conceived by the professional advisors in consideration of the
consulting fees paid to them by PCS.
[102] Returning to my
simplistic overview of the reorganization, I have said that it is fair to say,
based on the evidence, that the consulting fees were incurred to advise and
assist in the purchase of shares of a new company that was to acquire an asset
of considerable value. The asset was the Notes and the shares were shares in
the Luxemburg entity. That simplistic overview identified the only tangible
property acquired to which the subject expenses can reasonably attach. However,
that ignores the paramount focus of the task assigned to the professional
advisers that were paid the consulting fees. That focus was not the tangible
capital asset that PCS ultimately acquired – it was the intangible survey of
the landscape of an international network of corporate finance and taxation
intended to give rise to, and ultimately did give rise to, a plan of
reorganization that satisfied the objectives of PCS.
[103] There is too
much here that is not related to the mere acquisition of the shares of the
Luxemburg entity to treat the consulting fees as a cost of those shares. It is
the plan that achieved a tax efficient result that had value. Indeed, the
subject expenses were not ultimately about increasing income from the shares,
it was about avoiding a U.S.
tax imposed on it that was impairing its operational requirements.
d) Eligible Capital
Expenditures
The taxpayer seeks a deduction under
paragraph 20(1)(b) which allows a declining balance deduction claim “in respect
of a business” of up to 7% of its cumulative eligible capital. To obtain such a
deduction in respect of the subject expenses, it must then have them included
as part of its cumulative eligible capital. Cumulative eligible capital is
defined in subsection 14(5) to be a function of the total of eligible capital expenditures
“in respect of a business”. Eligible capital expenditures “in respect of a
business” are defined in subsection 14(5) to mean an outlay on account of
capital incurred for the purpose of earning income from the business.
(Emphasis added.)
I might refer to this as the “deduction side”
of eligible capital regime. The “income side” of the regime concerns the reduction
of cumulative eligible capital and the recapture of the deductions claimed and
the triggering of any gain when an eligible capital property is disposed of. It
is interesting to note, however, that there is no requirement that an eligible
capital property, or any particular type of capital asset, be acquired to have
an outlay regarded as an eligible capital expenditure. That is, while the
income side of section 14 seeks to identify a particular type of property, that
has no impact on the framing of the deduction side of section 14 and paragraph
20(1)(b).
Put another way, the scheme of these
provisions on the income side contemplates intangibles that are capable of
disposition at a price, such as goodwill. This can be seen as follows: eligible
capital property defined in sections 248 and 54 means any property of the
taxpayer proceeds of disposition of which will be an eligible capital amount “in
respect of a business” of the taxpayer. Eligible capital amount is defined in section
248 and subsection 14(1) as the amount that is “E” in the formulation of the
taxpayer’s cumulative eligible capital. “E” is the amount which, as a result of
a disposition, the taxpayer is entitled to receive “in respect of the business”
carried on by the taxpayer where the consideration paid by the taxpayer “therefore”
was an eligible capital expenditure. In simpler language then, if you can ascribe
proceeds to something sold in respect of a business and the consideration paid
to acquire that something was an eligible capital expenditure, then those
proceeds reduce the cumulative expenditure pool and can potentially give rise
to recapture and a gain under subsection 14(1). That no eligible capital property
even comes into existence at the time of the expenditure and that the
intangible benefit acquired is not capable of disposition, has no bearing on
whether an expenditure is an eligible capital expenditure.
[105] The intangible tax
planned pipeline in the case at bar is not something like goodwill. There is
nothing about it that is capable of being sold or disposed of for identifiable proceeds.
The intellectual property right to the plan is not even asserted to be owned by
the Appellant. The subject expenses were made for the use of the plan. If
it is an eligible capital expenditure it will be afforded a 7% declining
balance deduction without the income component of section 14 ever coming into
play. In a sense it is, as in the case of a current expense, being recognized
as extinguished at the end of its prescribed useful life.
[106] All that said, the
question to be determined is whether the subject expenses were eligible capital
expenditures “in respect of a business” defined in subsection 14(5) to mean an
outlay on account of capital incurred for the purpose of earning income from
the business.
[107] Initially, I found it
quite troubling to accept that cases like Boulangerie St-Augustine, BJ Services and International Colin went so far as to say that an
expenditure to save tax was one incurred for the purpose of earning income. Tax savings do not enhance income. In
the case at bar the dividend “income” received by PCS from downstream
operations was not reduced by the withholding tax sought to be reduced. Cashflows,
available dollars to spend on debt service and on operations, were reduced but
not “income”. My concern over this did not seem to be shared by the Respondent.
Indeed, Respondent’s counsel not only did not raise that aspect of the purpose
test in the subject provisions but did not pursue the point even after I tried,
on more than one occasion, to lead him there. In such circumstances, it is not
the tendency of this Court to take a harder stand than that taken by the
Respondent or its client, the CRA, if that stand, consistently applied,
reflects a tolerant practice that is not contrary to the terms of the Act as
applied by the authorities. Further, while I was not given any authorities that
went this far, it strikes me that tax planning expenditures are normal
recurring costs of maintaining one’s operations in a position to earn income. The link is there, albeit indirect.
From a pragmatic business point of view, ignoring that reality would be to
ignore the dictates of cases like BJ Services even though there is no
express suggestion in them that the reference in paragraph 18(1)(a) to
“income” includes a reference to after tax cashflow.
[108] From a pragmatic
business point of view the subject expenses
did satisfy a cashflow need integral to the conduct of PCS’s business. Practically
speaking tax planning costs are incurred in the ordinary course of business and
expenses so incurred should not so readily be divorced from its income earning
activities. Once
the expenditure is divorced from the specific investment that gave rise to the
income, in this case the shares in the Luxemburg entity, it must attach to the
business that benefited from it. PCS’s business was
enhanced by being part of a global market in fertilizers. While mining and marketing potash
is its business, potash does not exist in a vacuum. It is a component of
fertilizer – its value and marketability as a nutrient is interdependent with phosphate
and nitrogen. Investing in other entities with a view to being a leading player
in this aspect of its own business cannot be divorced from its own
income earning activity. While that may not make the direct investment in
shares a business expense, expenditures incurred to improve the efficiency of
the investment to enable better exploitation
of its own business by increasing its debt service capability and increasing its
funding of Canadian operations are expenditures incurred for the purpose of earning
income from its business. That the expenditure was capital in nature by virtue
of paragraph 18(1)(b) does not change that finding.
[109] While, but for
paragraph 18(1)(b) that finding may well apply to paragraph 18(1)(a),
it is all the more appropriate that it apply in the context of section 14. The
context of that section appears to me to put even less emphasis on the
directness of the link between the expenditure and business revenue stream per se.
[110] Recalling that the
requirement in section 14 is that an eligible capital expenditure be “in
respect of a business”. In my view, that informs the construction of the
purpose test in that definition. That is, the language used in the context of
section 14, which gives rise to a deduction to paragraph 20(1)(b), is
not identical to the language used in paragraph 18(1)(a). If, as
described in cases like Boulangerie
St-Augustine, BJ Services and International Colin an indirect link of an expenditure to
the business of the taxpayer is sufficient in the context of paragraph 18(1)(a)
then it is all the more appropriate to acknowledge the sufficiency of indirect
links in the case of identifying eligible capital expenditures.
[111] For comparison purposes,
consider the following provisions:
20(1) Deductions permitted
in computing income from business or property -- Notwithstanding paragraphs 18(1)(a),
(b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be
deducted such of the following amounts as are wholly applicable to that source
or such part of the following amounts as may reasonably be regarded as
applicable thereto
…
(b) cumulative eligible capital amount -- such amount as the taxpayer may
claim in respect of a business, not exceeding 7% of the taxpayer's cumulative eligible capital
in respect of the business at the end of the year; (Emphasis added.)
…
14.(4) “Eligible Capital
Expenditure” 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 … (Emphasis added.)
…
18.(1) In computing the income of a taxpayer
from a business or property no deduction shall be made in respect of
(Emphasis added.)
General
limitation
(a)
an outlay or expense except to the extent that it was made or incurred by the taxpayer
for the purpose of gaining or producing income from the business or property;
[112] The purpose limitation in section
18 is potentially broadened by applying the phrase “in respect of” to an
outlay or expense. On the other hand, that the purpose limitation in respect of
eligible capital expenditures is potentially narrowed by the repeated
references their being those that exist “in respect of a business”. The words “in respect of” are, as expressed by the Supreme
Court of Canada, words of the widest possible scope. “They import such meanings
as “in relation to”, “with reference to” or “in connection with”. The phrase
“in respect of” is probably the widest of any expression intended to convey
some connection between two related subject matters.” While one cannot go so far as to
say that the Act expressly states that an eligible capital expenditure
is one made in respect of a business, the context of those provisions is
sufficiently different, in my view, as to warrant more latitude to indirect
connections between an expenditure and income from a business than might be the
case in respect of the application of paragraph 18(1)(a). Expenditures,
made in the course of business on intangibles that have insufficient substance
to be eligible capital property might more often than not only have an indirect
connection to business earnings but the scheme of the Act cannot, in my
view, be taken so narrowly as to create a “nothing” out of expenses such as the
consulting fees here. That is what the Respondent advocates in this case. It is
not an acceptable position, in my view. The deduction for cumulative eligible
capital amounts in paragraph 20(1)(b) has to be taken as sufficiently permissive
in cases of expenditures such as this which are incurred to enhance the economic
and financial viability of one’s business.
(e) Conclusion
[113] All that remains to be
said is that for the reasons set out above, the appeals are allowed, with costs,
on the basis that the consulting fees were eligible capital expenditures of the
Appellant in the years incurred.
Signed at Winnipeg, Manitoba this 20th day of April 2011.
"J.E. Hershfield"
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