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Citation: 2003TCC900
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Date: 20031203
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Docket: 2002-2464(IT)G
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BETWEEN:
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BJ SERVICES COMPANY CANADA
THE SUCCESSOR TO NOWSCO WELL SERVICE
LTD.,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Campbell, J.
INTRODUCTION
[1] This appeal concerns the
deductibility of expenses incurred by Nowsco Well Service Ltd.
("Nowsco") in response to a hostile takeover bid by
BJ Services Company Canada ("BJ") an occurrence
that became prevalent in the Canadian corporate landscape during
the 1990s. On April 1, 1996, BJ approached Nowsco with an
unsolicited merger proposal for the purchase of all of the common
shares of Nowsco at a price of $27.00 per share. In the weeks
following this proposal, the directors of Nowsco sought financial
and legal advice and as a result incurred substantial fees from
RBC Dominion Securities Inc. ("RBC"), Simmons &
Company International of Houston, Texas ("Simmons"),
Blake Cassels & Graydon law firm ("Blake"), KPMG
Peat Marwick Thorne Accountants (KPMG) and finally MacLeod Dixon
Law Firm ("MacLeod"). The Appellant incurred additional
expenses in soliciting a "white knight" that would be
interested in presenting an alternative competitive proposal to
acquire the shares of Nowsco. As a result, two sets of expenses,
referred to as "hello" and "break" fees, were
incurred and became payable to this so called "white
knight" - Great Lakes Chemical Corporation
("GLCC").
BACKGROUND AND FACTS
[2] On June 13, 1996, BJ was
successful, despite a bid by GLCC, in acquiring the shares of
Nowsco. For the taxation year ending June 13, 1996, Nowsco
deducted all of the foregoing expenses in computing its income
for tax purposes. The Minister of National Revenue (the
"Minister") eventually reassessed and denied the
deductions, from which the Appellant, being the successor to
Nowsco, has appealed.
[3] During the opening remarks,
counsel advised that a number of minor issues had been resolved,
to be reassessed by the Minister in accordance with the outcome
of this appeal. It was agreed that the legal fees paid to Blake
and the accounting fees paid to KPMG would be deductible together
with some other corporate and miscellaneous expenses. For the
purposes of this appeal, I am left to decide the deductibility of
the following expenses:
(1)
RBC
$13,070,777.00
(2)
Simmons
$5,171,164.00
(3) GLCC - (a) hello fees of
$6,900.000.00
(b) break fees of
$23,601.591.00
[4] BJ Services Company Canada v.
R., [2002] G.S.T.C. 124 (T.C.C.), the companion case to the
present one, decided by Justice Miller, dealt with the
application of the goods and services tax and the eligibility for
input tax credits for the legal and financial advisory fees of
Blake, RBC and Simmons. Justice Miller found that the fees were
incurred in the course of the "commercial activities"
of Nowsco pursuant to subsection 169(1) of the Excise Tax
Act. This case is concerned not only with the deductibility
of the RBC and Simmons fees under the Income Tax Act but
also the deductibility of the GLCC "hello" and
"break" fees.
[5] Nowsco was a publicly traded
corporation carrying on the business of providing well
stimulation and pipeline services in the oil and gas industry. It
has been in business since the early 1960s. Through the years,
this company grew from a handful of employees to a staff of over
2,000 individuals working worldwide. According to the evidence of
Stanley Shouldice, the corporate CEO, Nowsco became a publicly
traded company in 1971. He had been one of the principal
influences with Nowsco over the years, overseeing company
revenues rise to the hundreds of millions in the 1990s. By 1995,
Nowsco had become the largest Canadian company in this industry
in respect to revenue, staff and research and development. Mr.
Shouldice's pride in these accomplishments was obvious
throughout his testimony and certainly justifiable.
[6] Following is an abbreviated
summary of the sequence of events as it unfolded commencing on
April 1, 1996:
(1) On April 1, 1996, Nowsco received an
unsolicited offer from BJ to purchase the shares of Nowsco for
$27.00 per share.
(2) On April 2, 1996, the Board of Directors
of Nowsco met and formed a Special Committee comprised of three
independent Board Members to advise on this proposal. This
Committee advised Nowsco, among other things, to retain legal and
financial advisors.
(3) On April 2, 1996, Nowsco retained the
financial services of RBC to evaluate the BJ proposal plus any
subsequent proposals.
(4) On April 4, 1996 Nowsco also retained
Simmons, an investment bank specializing in the oil industry, as
supplementary American financial advisors to assist RBC.
(5) On April 9, 1996, BJ formally presented
the proposal to the Board of Nowsco, with the proviso that Nowsco
commit to negotiating exclusively with BJ until April 19, 1996.
Nowsco rejected this request.
(6) On April 12, 1996, BJ offered their
proposal directly to the shareholders of Nowsco.
(7) On April 16, 1996, the Nowsco Special
Committee engaged Blake, Cassels law firm to advise it on a
number of legal issues arising from the takeover proposal.
(8) On April 19, 1996, RBC advised the Board
of Nowsco that the initial BJ proposal was inadequate and should
be rejected. A Directors' Circular was prepared and
circulated to shareholders recommending that the BJ offer be
rejected.
(9) During this period, Nowsco and its
advisors contacted other parties hoping another more attractive
offer would be made.
(10) Although never contacted by Nowsco, GLCC expressed
interest in making a proposal and between April 19, 1996 and May
1, 1996 negotiations ensued. GLCC eventually offered $30.90 per
share. The Special Committee and Nowsco's advisors
recommended that the GLCC offer was reasonable and that it be
accepted.
(11) On May 4, 1996, Nowsco and GLCC entered into an
agreement accepting the GLCC offer. As part of the terms of this
agreement and as recommended by the advisors, Nowsco agreed to
pay GLCC a non-contingent fee of $6,900,000.00 (the
"Hello" fee) plus a contingent fee (the
"Break" fee), which would be paid if a more attractive
unsolicited bid was made and accepted by Nowsco which would
nullify the GLCC offer.
(12) On May 6, 1996, the Board of Directors issued a
second Directors' Circular to Nowsco shareholders
recommending the GLCC offer.
(13) On June 3, 1996, BJ responded by amending its
initial proposal and increased the consideration to $35.00 per
share.
(14) On June 6, 1996, RBC advised Nowsco that this
second BJ offer was reasonable. On this same date, the Board of
Nowsco issued another Directors' Circular to its shareholders
recommending acceptance of BJ's second offer.
(15) On June 13, 1996, BJ acquired all of the issued and
outstanding common shares of Nowsco, according to the compulsory
acquisition provisions of the Business Corporation Act of
Alberta.
[7] Counsel for both the Respondent
and the Appellant agreed that Justice Miller's review of
the facts in the companion GST case accurately set forth the
events leading to the BJ takeover. An agreed statement of facts
and documents was entered. It may be beneficial to reproduce the
more detailed portions of the agreed facts:
Background
1. During the relevant
period, Nowsco Well Service Ltd. ("Nowsco") was a
publicly traded corporation carrying on the business of providing
well stimulation and pipeline services in the oil and gas
industry, with a head office located at 1300, 801 -
6th Avenue S.W., Calgary, Alberta. The annual reports
of Nowsco for the calendar years 1990 through 1995 are attached
hereto as Tabs 1 through 6, and a list of Nowsco's largest
customers by strategic business unit is attached hereto as Tab
7.
2. At all material times
Nowsco was a taxable Canadian corporation for the purposes of the
Income Tax Act (Canada) (the "Act"), with a
December 31 taxation year end.
3. During 1992, Nowsco
adopted a mission statement, a copy of which is attached hereto
as Tab 8, stating among other things, that it will ensure
superior growth in shareholder value by providing quality
services and engineering to the international energy market.
4. BJ Services Canada,
Inc. ("BJ Canada") was an indirect wholly owned
subsidiary of BJ Services Company ("BJ") throughout the
relevant period and up until the amalgamation of BJ Canada with
Nowsco, as described below.
The Takeover of Nowsco
5. On April 1, 1996,
representatives of BJ approached Nowsco to negotiate a friendly
merger and proposed the purchase of all the common shares in
Nowsco for $27 per share (the "Initial Proposal"). The
representatives of BJ made it clear that if the Board of
Directors (the "Board") failed to accept the Initial
Proposal within ten days, BJ, through BJ Canada, would make an
unsolicited offer directly to the shareholders of Nowsco without
the Board's approval. A copy of the letter of April 4,
1996 from BJ to Nowsco is attached hereto as Tab 9.
6. On April 2, 1996, the
Board met to discuss the Initial Proposal and formed a special
committee, comprised of three independent Board members, to
advise on all matters relating to this proposal (the
"Special Committee"). At this meeting, Bennett Jones
Verchere (as they were then known) advised the Board that (i) the
Board had a general duty to act honestly, in good faith and in
the best interests of the corporation in determining whether or
not to support the Initial Proposal, (ii) that the directors
had a fiduciary obligation to obtain the highest price for
Nowsco's shares and (iii) that the requirement to obtain the
highest price for Nowsco's shares had generally been
interpreted to require the Board to engage in an auction of
Nowsco's shares and to retain financial advisors to advise
them of the value of Nowsco's shares. The minutes of such
meeting are attached hereto as Tab 10.
7. Expert financial and
legal advisors were engaged to provide assistance to Nowsco.
8. On April 2, 1996,
Nowsco engaged the services of RBC Dominion Securities Inc.
("RBC") as financial advisors with respect to the
Initial Proposal and any subsequent proposals that might arise.
This engagement was formalized in a letter agreement dated April
6, 1996 and accepted by Nowsco on April 19, 1996 (the "RBC
Agreement"), which is attached hereto as Tab 39.
9. Under the RBC
Agreement, RBC was exclusively engaged as the Canadian financial
advisor to Nowsco, effective as of April 4, 1996, with respect to
the Initial Proposal and:
"with respect to any possible responses thereto,
including, without limitation, the review of alternatives to
maximize shareholder value including the solicitation of
additional take-over bid offers, a recapitalization, asset sales,
or the sale of all or part of [Nowsco] by way of merger, share
exchange, amalgamation, arrangement, reorganization or
otherwise."
10. The RBC Agreement further provided
that the financial advisory services included, without
limitation, advice and assistance in evaluating the Initial
Proposal or subsequent offers and opinions as to the fairness of
the Initial Proposal or subsequent offers from a financial
perspective.
11. On April 4, 1996, Nowsco engaged
the services of Simmons & Company International of Houston,
Texas ("Simmons"), an investment bank specializing in
the oil service and equipment industry, as special financial
advisors to assist Nowsco and RBC in determining a course of
action with respect to the Initial Proposal and any subsequent
proposals that might arise. This engagement was formalized in a
letter agreement dated April 15, 1996 and accepted by Nowsco on
April 25, 1996 (the "Simmons Agreement"), a copy of
which is attached hereto as Tab 41.
12. According to the Simmons
Agreement, Simmons was also engaged to:
(a) assist
with an understanding and presentation of the status and
potential impact of Nowsco's technology to potential
acquirers of Nowsco;
(b) assist
with efforts to approach other companies as alternatives to a
takeover by BJ;
(c) share
industry data and information to assist Nowsco and RBC in
determining a fair value for the common shares in Nowsco; and
(d) respond to
any other requests from the Board and senior management of Nowsco
in their efforts to maximize shareholder value.
A copy of a memorandum prepared by Simmons and relating to
Nowsco's technology and product development efforts is
attached hereto as Tab 42.
13. On April 9, 1996, the Initial
Proposal was formally presented to the Board by representatives
of BJ with the request that the Board commit to negotiating
exclusively with BJ until April 19, 1996, the period given to the
Board to consider and negotiate the final terms of the Initial
Proposal. BJ proposed that failing agreement on a transaction by
April 19, 1996, Nowsco could negotiate with other interested
parties and BJ, through BJ Canada, could make a takeover bid
directly to the shareholders of Nowsco. The Board refused this
request on the basis that committing to exclusive negotiations
could prejudice Nowsco's alternatives in responding to the
Initial Proposal. The minutes of such meeting together with
copies of the proposal from BJ and a presentation made by RBC are
attached hereto as Tabs 13(a), 13(b) and 40, respectively.
14. On April 12, 1996, BJ Canada
formally offered the Initial Proposal to shareholders of Nowsco,
as shown by the Offer to Purchase from BJ Services Canada Inc.
attached hereto as Tab 43.
15. On April 16, 1996, the Special
Committee engaged Blake Cassels & Graydon
("Blakes") to provide the Special Committee with legal
advice regarding the independence of the Special Committee and a
number of other legal issues that arose from April 2, 1996 to
June 13, 1996, including advice with respect to representations
made to the Securities Commissions of Alberta and Ontario. The
minutes of the April 16, 1996 meeting of the Special Committee
and a copy of the memorandum prepared by Blakes are attaches
hereto as Tabs 13 and 38, respectively.
16. On April 19, 1996, RBC advised the
Board that, in RBC's opinion, the consideration under the
Initial Proposal was inadequate. RBC provided a formal opinion to
this effect to the Board on April 22, 1996. The Board also
received the report of the Special Committee on April 22, 1996,
recommending that the Board advise shareholders to reject the
Initial Proposal. The minutes of the April 19 and April 22, 1996
meetings of the Board and the minutes of the April 22, 1996
meeting of the Special Committee are attached hereto as Tabs 16,
17 and 18, respectively.
17. Based on the recommendations of
the Special Committee and RBC, the Board unanimously recommended
to the shareholders of Nowsco that they reject the Initial
Proposal in a Directors' Circular dated April 22, 1996 (the
"First Directors' Circular"), a copy of which is
attached hereto as Tab 44.
18. From April 2, 1996, Nowsco and its
advisors were in contact with other parties interested in
acquiring the assets of Nowsco, the common shares in Nowsco, or a
combination thereof.
19. Nowsco received an unsolicited
expression of interest from Great Lakes Chemical Corporation
("GLCC") and between April 29, 1996 and May 2, 1996,
Nowsco and its advisors met with GLCC to negotiate the terms of
an offer to acquire the common shares of Nowsco and a
pre-acquisition agreement relating thereto.
20. On May 4, 1996, Nowsco and GLCC
entered into a pre-acquisition agreement (the "GLCC
Agreement"), whereby GLCC agreed to make a takeover bid to
acquire the common shares in Nowsco at a price equal to $30.90
per share on the terms described in the GLCC Agreement (the
"GLCC Offer"), a copy of which agreement is attached
hereto as Tab 45. The Board agreed, inter alia, to
cooperate with and support the GLCC Offer, including recommending
it to Nowsco's shareholders, to waive the application of the
shareholder rights protection plan, to accelerate the vesting of
options to acquire shares in Nowsco and to not solicit any
further proposals. GLCC further agreed that it would honour
Nowsco's existing employment and severance agreements.
21. In addition, GLCC was entitled
under the GLCC Agreement to receive a non-contingent fee equal to
$6,900,000 (the "Hello Fee") plus a contingent fee if
an unsolicited proposal was made and accepted such that the GLCC
Offer was not accepted or upon the occurrence of certain other
specified events. The GLCC Agreement specified that the
contingent fee payable to GLCC was equal to 3% of a superior
proposal, or, if no superior proposal was made, the contingent
fee was $20,900,000.00. If a superior proposal was made, the GLCC
Agreement further provided that GLCC would have the opportunity
to amend the GLCC Offer to meet that proposal prior to Nowsco
entering into an agreement in respect of such superior
proposal.
22. GLCC insisted that Nowsco agree to
the payment of the Hello Fee and the contingent fee as a
condition of their agreeing to make an offer to acquire all of
the issued and outstanding shares of Nowsco.
23. Nowsco entered into the GLCC
Agreement on the recommendation of the Special Committee and
Nowsco's advisors, who concluded that the GLCC Offer was the
best alternative to Nowsco and its shareholders and that the
terms and conditions of the GLCC Agreement were reasonable. In
particular, the financial and legal advisors advised the Board
that the quantum of the Break Fee was reasonable in the
circumstances and provided the Board with a chart outlining the
quantum of Selected Canadian Break & Topping Fees between
1987 and 1996, a copy of which is attached hereto as Tab 67.
24. On May 6, 1996, RBC provided
Nowsco with an opinion that the GLCC Offer was fair from a
financial point of view, a copy of which is attached hereto as
Tab 46.
25. On May 6, 1996, GLCC made the GLCC
Offer to the shareholders of Nowsco, as shown by the Offer to
Purchase from GLCC attached hereto as Tab 47.
26. On May 6, 1996, the Board issued a
Directors' Circular to shareholders of Nowsco, recommending
the GLCC Offer (the "Second Directors' Circular'), a
copy of which is attached hereto as Tab 48. The following factors
were cited in the Second Directors' Circular as being
considered by the Board in deciding that the GLCC Offer was the
best alternative available to Nowsco and its shareholders:
(a)
Nowsco's businesses, financial condition, results of
operations and future prospects;
(b) the fact
that the consideration offered under the GLCC Offer represented a
$3.90 per share (14.4%) increase over the consideration offered
under the Initial Proposal and a premium of 51% over the closing
price reported on The Toronto Stock Exchange on April 2,
1996 (the day before the Initial Proposal was made public);
(c) RBC's
opinion as to the fairness of the GLCC Offer from a financial
point of view;
(d) the advice
of RBC and Simmons relating to various financial and other
matters concerning Nowsco, the GLCC Offer and the alternatives
available to Nowsco;
(e) the view
of the Board that, while more favourable proposals from other
interested parties was a possibility, the GLCC Offer was the best
alternative before the Board at that time; and
(f) the
fact that the GLCC Agreement and the GLCC Offer did not preclude
the possibility of a subsequent superior proposal.
27. On May 17, 1996, BJ extended the
offer period for the Initial Proposal to May 27, 1996
as shown in the Notice of Extension of the Offer to Purchase from
BJ Services Canada Inc. attached hereto as Tab 49.
28. On June 3, 1996, BJ Canada amended
the Initial Proposal by increasing the consideration offered to
$35 per share and extending the offer period to
June 13, 1996 (the "Second BJ Offer"), as
shown in the Notice of Variation and Extension of Offer to
Purchase from BJ Services Canada Inc. attached hereto as Tab
50.
29. On June 6, 1996, RBC provided
Nowsco with an opinion that the Second BJ Offer was fair from a
financial point of view, a copy of which is attached hereto as
Tab 51.
30. On June 6, 1996, the Board issued
a Directors' Circular to the shareholders of Nowsco,
recommending the Second BJ Offer (the "Third Directors'
Circular"), a copy of which is attached hereto as Tab
52.
31. In the course of responding to the
foregoing developments, the Board and the Special Committee met
on several other occasions to discuss, among other matters,
retaining RBC and Simmons, the Initial Proposal, the GLCC
Agreement, the GLCC Offer and issues relating to and arising from
those matters. Copies of the minutes of Board and Special
Committee meetings, as the case may be, of
April 3, April 4, April 16, April 18, April 23, April
25, April 29, May 1, May 3, May 6, May 13, May 15, May 21, May
23, May 28, May 29, June 3, June 5 and June 6 are attached hereto
as Tabs 11, 12, 14, 15 and 19 through 37.
32. During the currency of the
takeover bid, BJ Canada made an application to the Securities
Commissions of Ontario and Alberta for a cease trade order in
respect of the GLCC Offer and a waiver of Nowsco's
shareholder rights protection plan, a copy of the primary
submission of BJ Canada is attached hereto as Tab 53. Nowsco also
responded to the application and submissions of BJ Canada and a
copy of the primary response of Nowsco is attached hereto as Tab
54.
33. On June 13, 1996, BJ Canada
acquired greater than 90% of the common shares in Nowsco, which
allowed BJ Canada to acquire all of the issued and outstanding
common shares in Nowsco by virtue of the compulsory acquisition
provisions in the Business Corporations Act, S.A. 1981, c.
B-15 (the "Takeover"). As the Takeover resulted in
BJ Canada acquiring control of Nowsco, there was a deemed
year-end pursuant to subsection 249(4) of the Act.
34. On July 31, 1996, Nowsco
amalgamated with BJ Canada and subsequently amalgamated with
3032419 Nova Scotia Company on October 1, 1999 to form
Nowsco-Fracmaster Company. Nowsco-Fracmaster Company
subsequently changed its name to BJ Services Company Canada
effective May 23, 2000 and BJ Services Company Canada
continues to be the successor of Nowsco.
Fees paid to RBC, Simmons and GLCC
35. The fees outlined in the RBC
Agreement for the financial advisory services provided by RBC
depended on whether a transaction resulted from the Initial
Proposal or any subsequent proposals within one year of the RBC
Agreement. If no transaction occurred, RBC would have been
entitled to a fee equal to $2,000,000. If a transaction occurred,
there were two possible fee structures depending on the nature of
the transaction. If more than 50% of the outstanding common
shares in Nowsco were acquired by BJ, or any other third party,
if Nowsco were combined, merged or amalgamated with any other
entity, if Nowsco disposed of all or substantially all of its
assets or any other acquisition of Nowsco was effected (a
"Change of Control Transaction"), RBC would be entitled
to a non-contingent fee equal to $2,000,000 plus an incentive
fee, calculated on an incremental scale, based on the aggregate
value of the Change of Control Transaction in excess of the
Initial Proposal. Where there was an acquisition or sale of
assets or securities other than a Change of Control Transaction,
RBC would be entitled to a fee equal to 0.625% of the value of
the consideration paid to Nowsco on this transaction.
36. Under the RBC Agreement, Nowsco
was required to pay an initial engagement fee of $500,000
immediately and a further $150,000 upon the provision of an
opinion on the fairness of the Initial Proposal. These fees were
deposits to be applied against the fees described above. The
$500,000 engagement fee was paid on April 22, 1996 and the
$150,000 fee payable on the provision of a fairness opinion was
paid on April 24, 1996, as shown by the Statements of Account
from RBC attached hereto as Tabs 55 and 56, and cancelled cheques
from Nowsco attached hereto as Tabs 57 and 58.
37. As the Takeover was a Change of
Control Transaction, RBC was entitled to the non-contingent fee
of $2,000,000 plus the incentive fee. The aggregate fees paid to
RBC under the RBC Agreement, including the engagement fee and
expense reimbursement of $56,705, was $13,070,777 (the "RBC
Fees"), the balance of which was paid on June 7, 1996
as shown by the Statement of Account from RBC and cancelled
cheque from Nowsco attached hereto as Tabs 59 and 60.
38. In consideration for their
financial advisory services, the Simmons Agreement provided that
Simmons was entitled to a non-contingent fee equal to USD$250,000
plus an incentive fee, calculated on an incremental scale, based
on the value of a closed transaction in excess of the Initial
Proposal, subject to a minimum of USD$250,000.
39. Under the Simmons Agreement,
Nowsco was required to pay the non-contingent fee equal to
USD$250,000 immediately and the incentive fee on the closing date
of the transaction. The non-contingent fee, along with an expense
reimbursement of USD$9,424.95, was paid by wire transfer on June
12, 1996, as shown by Tabs 63 and 64 attached hereto.
40. On the closing of the Takeover,
Simmons was entitled to the incentive fee. The aggregate fees
paid to Simmons under the Simmons Agreement, including the
non-contingent fee and the expense reimbursement of $9,424.95,
was USD$3,759,425, or CDN$5,171,164, (the "Simmons
Fees"), as shown by the Statement of Account from Simmons
attached hereto as Tab 61. The incentive fee was paid by wire
transfer on June 10, 1996, as shown by Tabs 62 and 64
attached hereto.
41. Nowsco paid GLCC the Hello Fee via
wire transfer on May 7, 1996 as is shown by Tab 65 attached
hereto. On June 7, 1996 Nowsco paid GLCC the 3% contingent fee
described in paragraph 21 above in the amount of $23,601,591 (the
"Break Fee"), as shown by Tab 66 attached hereto, in
accordance with the terms of the GLCC Agreement as GLCC had
decided not to use its right of first refusal to match the Second
BJ Offer.
42. The quantum of the RBC Fees, the
Simmons Fees, the Hello Fee and the Break Fee and (collectively
referred to herein as the "Expenses") were reasonable
in the circumstances.
43. For financial reporting purposes,
in accordance with well-accepted principles of business practice,
the Expenses were properly deducted by Nowsco as general and
administrative expenses in the computation of its profit for the
period.
44. For its taxation year ending June
13, 1996, Nowsco deducted the Expenses in computing its income
for tax purposes.
ISSUES
[8] Counsel also agreed on the issues
to be decided and set them out within the statement of agreed
facts and documents as follows:
(a) whether the
Expenses are deductible in computing Nowsco's income for its
taxation year ending June 13, 1996;
(b) if any of the
Expenses are not deductible in computing Nowsco's income
because of the restrictions in paragraphs 18(1)(a) or
18(1)(b) of the Act, whether such Expenses are deductible in
computing income pursuant to either of paragraphs 20(1)(e) and
20(1)(bb) of the Act; and
(c) if any of the
Expenses constitute capital outlays for the purposes of paragraph
18(1)(b) of the Act and do not satisfy the requirements for
deductibility under either of paragraphs 20(1)(e) and 20(1)(bb),
whether the amount of such Expenses constitute "eligible
capital expenditures" pursuant to subsection 14(5) of the
Act.
APPELLANT'S POSITION
[9] The Expenses, incurred by Nowsco
pursuant to a hostile takeover bid, were expenditures
necessitated to meet legal requirements and the expectations of
the public capital markets, where Nowsco financed its business
operations. Therefore these Expenses were incurred for the
purpose of gaining or producing income for Nowsco in light of the
requirements imposed on it. They are properly deducted from the
income of the business in computing Nowsco profit, pursuant to
section 9 of the Act. As these expenses were incurred
solely in respect to the takeover bid, were wholly within the
taxation year in question, reduced the resources of Nowsco to pay
income tax in that year, had no relationship to any prior or
subsequent period and resulted in no enduring benefit, they
should not be characterized as capital expenses but should be
currently deductible.
[10] Appellant raised the following
alternative arguments:
(1) the expenses are deductible
as financing expenses under paragraph 20(1)(e),
notwithstanding paragraphs 18(1)(a) and
18(1)(b);
(2) the RBC and Simmons fees are
deductible under paragraph 20(1)(bb) as they involved
advice respecting the sale of shares of Nowsco;
(3) if the expenses were
incurred for the purpose of gaining of producing income but are
capital outlays, and do not fall under the preceding two
alternative arguments, they are eligible capital expenditures
pursuant to subsection 14(5) of the Act.
RESPONDENT'S POSITION
[11] The expenses are not deductible from
the business income, as they were incurred in response to a
takeover bid, aimed at maximizing shareholder value and were not
incurred for the purpose of gaining or producing income. The
disallowed expenses relate to fees paid for advice and assistance
to pursue alternative purchasers and to create and operate a
bidding auction for the sale of the shares. As a result the
expenses were not for the purpose of increasing Nowsco's
income from its business but for the purpose of increasing the
price that Nowsco shareholders would realize on a sale of their
shares. In addition, the expenses were not required by any
specific legislative provision.
[12] In the alternative, if the expenses are
found to have been incurred by Nowsco in relation to its business
operations and not primarily for the benefit of the shareholders,
the expenses should be capital outlays in accordance with
paragraph 18(1)(b). Therefore no deduction can be made in
computing the income of Nowsco for the year ending June 13,
1996.
EVIDENCE
[13] Counsel advised that much of the
evidence and exhibits would be very similar to those presented in
the GST companion case. However, there was additional evidence
presented at this hearing concerning the hello and break fees
paid to GLCC, that were not at issue in the companion case.
[14] Two witnesses were called -Stanley
Patrick Shouldice, former CEO and Chairman of Nowsco, and Ian
Bruce, who was presented and accepted as an expert investment
banker with expertise in mergers and acquisition
transactions. Mr. Shouldice outlined the growth of
Nowsco business operations throughout the years. The importance
of shareholder expectations and shareholder confidence in Nowsco
was paramount throughout the years, according to Shouldice. This
was reflected in the following mission statement which Nowsco
adopted in 1992:
Nowsco will ensure superior growth in shareholder value by
providing quality services and engineering to the international
energy market. Nowsco will accomplish this by providing the best
value to the client through quality management and industry
leading solutions delivered with integrity and safety by the best
people in the service industry.
His evidence was that maximizing shareholder value was always
the underlying factor in the business decisions of Nowsco over
the years. He spent a considerable portion of his working time on
gaining an understanding of shareholder expectations, by
organizing and attending international shareholder road shows,
conducting annual visits to the major shareholders, fielding
daily calls and obtaining necessary advice and instructions,
where warranted, in handling shareholder matters. His evidence
was that the manner in which the takeover bid was handled was
consistent with the usual business practice and philosophy that
fuelled the corporate activities. He believed that shareholder
value and confidence was of utmost importance, as this dictated
the success of Nowsco in raising money in the public markets,
where shareholders constantly monitored the performance of Nowsco
against comparable companies. Mr. Shouldice explained why a
Special Committee was immediately set up to deal with the
takeover bid and why advisors were required to provide advice on
the legal and financial ramifications, particularly in respect to
the company's foremost obligation of maximizing shareholder
value, as reflected in the mission statement. He also explained
that the "hello" fee was paid to reimburse GLCC for
out-of-pocket costs it incurred in making an alternative bid to
BJ's proposal. The "break" fee was triggered and
payable to GLCC only in the event of an accepted higher bid,
subsequent to their offer. It protected GLCC in initially
presenting a higher official bid. Data from the advisors to
Nowsco showed that the break fee was both reasonable and
competitive when compared to similar situations and as Mr.
Shouldice explained "... it was, in essence, the price of
doing business with Great Lakes".
[15] Ian Bruce explained how the Dey
Committee in Ontario was struck to address the responsibilities
of directors in the face of increasing merger and acquisition
activity in the 1980's and the perceived failure of directors
to act as diligently as they could be. This committee looked at
elements of corporate governance and pointed out that board
members have a higher personal liability and standard to ensure
shareholder protection in the area of takeovers. Mr. Bruce
also referred to National Policy Number 38 which would have
applied to Nowsco at the time of the takeover bid. This policy
statement set out a framework by which corporations, that were
subjected to unsolicited takeover offers, should conduct their
activities. He pointed out that there is express acknowledgement
within this policy that the primary objective of takeover
legislation is to protect the bona fide interests of
shareholders of the target company so that fully informed
decisions can be made. Part of this strategy involved advance
defense preparation due to the short time frame available in
responding to a bid. Nowsco had instituted a shareholder
protection plan prior to the BJ bid in 1996. Due to the intense
nature and short time frame of a takeover bid and the developing
law respecting Director liability, it is typical, explained
Bruce, to form special committees and engage outside advisors to
responsibly and adequately review alternatives. In fact he could
not think of a single case where outside financial advisors had
not been hired and in some cases two or three were hired. He
characterized Nowsco's response to the BJ bid as "... a
very expertly managed and executed response and it is totally
consistent with the highest expectations of public market
expectations". He characterized the break fee to GLCC as
slightly higher than the average but well within the reasonable
range and absolutely commonplace in corporate takeovers. He
explained that break fees operate as an inducement to potential
alternate bidders to come forward, as GLCC did, knowing that they
have some insurance that the deal may get done and that a further
bid by BJ would not come in at $30.91 per share, for example, as
opposed to the $30.90 GLCC offer.
ANALYSIS
[16] Although there are some aspects of the
decision of Justice Miller, in the GST companion case, that are
similar to the present case, the hurdles imposed by the Income
Tax Act are not only different but more numerous. Unlike
Justice Miller, however, I have the benefit of several
Supreme Court decisions in this area, as well as the recent cases
of Boulangerie St-Augustin Inc. v. R., 95 DTC 2149
(T.C.C.), later approved by the Federal Court of Appeal, and
International Colin Energy Corporation v. R.,
2002 DTC 2185 (T.C.C.). The two latter cases dealt with
the deduction of professional advisory fees incurred in takeover
bids. Both decisions traced the case law that has developed since
the Supreme Court case of British Columbia Electric Railway
Co. Ltd. v. Minister of National Revenue, 58 DTC 1022,
Associate Chief Justice Bowman succinctly stated the appropriate
approach and tests at paragraph 43 in International Colin
Energy Corporation:
43. The approach outlined
by Abbott J. is one that has traditionally been followed. One
first asks the question "Was the payment made for the
purpose of gaining or producing income from a business or
property?" If the answer is no the question whether it is on
capital account is irrelevant. If the answer is yes the
application of paragraph 18(1)(b) must be considered. If
the deduction of the payment is not prohibited under
paragraph 18(1)(a), but is nonetheless caught by
paragraph 18(1)(b), it must then be determined
whether any of the specific provisions of the Income Tax
Act that permit capital expenditures in a business context
(such as the paragraphs in subsection 20(1) apply. Indeed
subsection 20(1) operates even if the payment is caught by both
paragraphs 18(1)(a) and (b).
[17] The first of these tests (whether the
expenses are made for the purpose of gaining or producing
income?) arises from the wording of paragraph 18(1)(a) of
the Act. It states:
18(1) General limitations -- In
computing the income of a taxpayer from a business or property no
deduction shall be made in respect of
(a) general
limitation -- 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;
[18] The predecessor provision to
18(1)(a) was more restrictive as it required that expenses
be totally, exclusively and necessarily laid out or expended for
the purpose of gaining or producing income.
[19] "Income" from a business or
property must be determined in conjunction with subsection 9(1)
which reads:
9(1) Income - Subject to this Part, a
taxpayer's income for a taxation year from a business or
property is the taxpayer's profit from that business or
property for the year.
[20] Generally, business expenses will be
deductible and this deductibility flows from the concept of
profit, which is referred to in subsection 9(1) but is not
defined in the Act. The difficulty is that in determining
profit, what is considered an expense for business purposes may
not necessarily be permitted as a deductible expense under the
Act for income tax purposes. Justice Archambault canvassed
this question in Boulangerie St-Augustin, and after
reviewing relevant case law, concluded that although a Court may
consider generally accepted accounting principles, it is the
accepted principles of commercial trading, or accepted principles
of business, that will be the primary aid in determining net
profit. The Supreme Court in Canderel v. R., [1998] 1 SCR
147 emphasized the key role that these interpretive aids play in
determining an accurate picture of a taxpayer's profit in any
given year. I agree with the view taken in these cases that the
business approach best depicts the reality of the financial
picture of a taxpayer and is the best method to determine the
answer to the first test (are the expenses for the purpose of
gaining or producing income?).
[21] It is pursuant to subsection 9(1), and
not paragraph 18(1)(a), that a taxpayer may deduct
expenses incurred to gain or produce income. It is paragraph
18(1)(a) (together with paragraph 18(1)(b)) that
provides the limitations or restrictions in this respect.
[22] Justice Abbott in British Columbia
Electric Railway Co. Ltd. at page 1027 stated that:
Since the main purpose of every business undertaking is
presumably to make a profit, any expenditure made "for the
purpose of gaining or producing income" comes within the
terms of Section 12(1)(a) whether it be classified as an income
expense or as a capital outlay.
[23] The criteria for deductibility was
broadened when the words "wholly, exclusively and
necessarily" were removed from the predecessor to
18(1)(a).
[24] Justice Archambault in Boulangerie
St-Augustin Inc. reviewed Justice Abbott's
explanation for the change of interpretation from earlier cases
in respect to paragraph 12(1)(a), now 18(1)(a) at
paragraph 44:
44. To explain this change
of interpretation, Abbott J. indicated that paragraph 12(1)(a) of
the Income Tax Act (Act of 1948), S.C. 1948, c. 52 now
paragraph 18(1)(a) of the Act, no longer contained the words
"wholly, exclusively and necessarily" of paragraph 6(a)
of the Act of 1927. Iacobucci J. also underscored the effect of
this change in Symes, supra, at page S.C.R. 731
(C.T.C. 56, DTC 6012):
On more than
one occasion since the amendment, it has been recognized that the
current language of the Act suggests a broader rationale for the
deductibility than did the former.
[25] This broader "rationale for
deductibility" suggests that the concept of expenses will
include not only direct expenses, relating to a company's
product or services, but will also include ancillary expenses,
such as maintaining shareholder relations, which are necessary
for the company to conduct its operations.
[26] This view is expressed in the Supreme
Court decision of British Columbia Power Corp. v. M.N.R.,
67 DTC 5258:
48. In my opinion, the
reasonable furnishing of information from time to time to
shareholders by a company respecting its affairs is properly a
part of the carrying on of the company's business of earning
income and a corporate taxpayer should be entitled to deduct the
reasonable expense involved as an expense of doing business.
[27] This same view was followed by Justice
Wilson in the Supreme Court decision of Mattabi Mines Ltd. v.
Ontario (Minister of Revenue), [1988] 2 S.C.R. 175:
...The only thing that matters is that the expenditures were a
legitimate expense made in the ordinary course of business with
the intention that the company could generate a taxable income
some time in the future. ...
[28] The question of whether ancillary
expenses constitute an integral part of a business was considered
by Justice Miller in the GST companion case. Justice Miller
concluded at paragraph 66:
...any activity engaged in by the company which is related to
the shareholders, provided that it is commercial and not personal
in nature, is a commercial activity for the purposes of the
Excise Tax Act.
[29] Although the test under the Excise
Tax Act is different, I am inclined to the same view in my
analysis under the Income Tax Act. Although
paragraph 18(1)(a) does not use the phrase "in
the course of" but relies on the phrase "for the
purpose of", the Supreme Court, in Symes v. R, [1994]
1 C.T.C. 40, 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. They not only satisfied a need
of the company but were necessitated in dealing with the
practicalities of a takeover bid environment. As Justice Miller
stated, in BJ Services Company Canada, at paragraph
41:
...While the purpose is most directly connected to the
corporate marketplace, rather than the goods and services
marketplace, the two necessarily overlap in a public company
context. The public company is in that corporate marketplace to
access funds. It is critical that that marketplace have
confidence in the company's ability to maintain and grow its
value. This is done in a number of ways. As Mr. Shouldice
indicated in answer to the question as to what drives up
shareholder value:
[31] Justice Archambault, in Boulangerie
St-Augustin Inc., echoes these views at paragraphs 48 and 49
when he states:
[48] A corporation must
communicate regularly with its shareholders. The latter are
usually a major source of capital for the business's
operation. They insist on being informed in order to monitor
their investment in that corporation. Good relations with its
shareholders are important for a corporation, particularly if its
wishes in future to issue new shares in order to finance its
activities. As the Supreme court of Canada recognized in
British Columbia Power, the expenses to communicate with
its shareholders were legitimate expenses made in the ordinary
course of a corporation's business.
[49] In the instant case,
Boulangerie was required to incur expenses to communicate with
its shareholders in order to comply with the provisions of
section 134 of the SA. It provided information concerning its
business, the holders of its shares, its directors and its
officers so that its shareholders could make an informed
decision. It made its recommendation to the shareholders taking
into account the interests of its business, of its employees and
of its customers. The recommended bid was not the most
advantageous for its shareholders. The costs to draft legal
documents such as a resolution by the corporation authorizing the
transfer of shares from one shareholder to another, are expenses
inherent in the management of every business corporation. These
communication and share transfer costs are part of general
administrative expenses which every corporation must incur in
order to earn its business income. The exception of
18(1)(a) does not apply to those expenses.
[32] Justice Archambault rejected the same
arguments of the Crown, as were presented in this case, and that
is, that the expenses were connected to protection of shareholder
value and were not incurred in the operation of its business
operations or alternatively that the expenses were capital in
nature.
[33] Just as in the Boulangerie
St-Augustin Inc. case, the Nowsco Board of Directors reacted
to the BJ takeover bid in a professional and responsible manner.
Following the advice of its independent Special Committee,
skilled financial and legal advisors in the area of mergers and
acquisitions, were hired and eventually a broad auction was
pursued. When Nowsco elected to become and remain a public
company, in order to finance its operations and expansions
through the public markets, it knowingly decided to operate in a
marketplace, which, by the 1990s, was fraught with hostile
takeover bids. In such a marketplace, shareholders expect
informed communication from its Board, which goes hand in hand
with a shareholder's insistence on maximization of its
shareholder value. This is a critical need particularly at the
time of a hostile takeover bid, from both the shareholder view
point and from the corporate view point, especially if the Board
of Directors is to maintain its credibility and shareholder
confidence. The evidence of both Shouldice and Bruce, together
with many of the exhibits, bolster my opinion on the public
capital market expectations, as well as the legal obligations and
ramifications for Boards of Directors in such a climate.
[34] Associate Chief Justice Bowman, in
International Colin Energy Corporation, held that advisory
fees, incurred by a taxpayer in seeking a transaction to
alleviate failing finances, were currently deductible. In the
present case, Nowsco sought financial and legal advice because of
an unsolicited takeover bid and in the process sought out a broad
auction. In both cases, the expenses arose as a result of the
necessary response to developments arising in the operation of
the business to produce income. Although there is a distinction
between direct and indirect, or ancillary expenses, as they
relate to business operations, one may be no less important than
the other in maintaining the overall viability of the corporate
operations. During the time of a takeover bid, certain legal and
public financial market expectations have developed and I see no
reason to exclude from deductibility those costs which a taxpayer
must incur to comply with those obligations. It is simply, and
rightly so, just one of the costs of doing business in such a
marketplace. Such costs are commercial in nature and as part of
the business activities of Nowsco, are therefore incurred for the
purpose of gaining or producing income.
[35] The Minister has alleged that the fees
were incurred in the course of maximizing the share price on a
potential disposition and cannot meet the test of having been
incurred for the purpose of gaining or producing income. This
view has been resoundingly denied by this Court in
International Colin Energy Corporation, where Associate
Chief Justice Bowman has stated at the following
paragraphs:
[46] ... [The merger] was
intended to improve the ability of the appellant to earn income
by combining its resources with that of another entity. If the
shareholders' investment was improved by holding shares in a
larger and commercially stronger entity, this was the result of
an improvement in the income earning ability of the appellant
within the larger combined entity. Obviously improved earnings
enhance share prices and the value of the shareholders'
investment. To say however that an expense that is calculated to
improve a company's ability to earn income constitutes a form
of disguised dividend or shareholder benefit because it may
improve the value of the shares and is therefore non-deductible
under paragraph 18(1)(a) strikes me as getting the
cart before the horse.
[47] Patently here the services
performed by ARC were intended to improve the appellant's
income and the fees paid were laid out to earn income from the
appellant's business. Accordingly the basic factual and legal
assumption on which the Crown's case rests has been
demolished.
(...)
[52] ... For one thing neither
the factual premise that ICEC was acting on behalf of its
shareholders, nor the alternative premise that it was acting on
behalf of Morgan, has any foundation in the evidence. The board
of directors was acting in the interests of the appellant. If
this happened to be of some benefit to the shareholders or to
Morgan it does not make the appellant their agent.
[36] The Crown's view on the expense
deductibility in the present case is fundamentally inconsistent
with the economic and business realities of the world of mergers
and acquisitions. It is a basic common sense approach to view
maximizing share price as inextricably interwoven with the
business of any company, whether that be public or otherwise.
Shouldice was clear in his evidence that maximizing shareholder
value was behind all of the business decisions which Nowsco made.
Further evidence of the importance to Nowsco of maximizing
shareholder value can be found in its mission statement (Tab 8 of
Volume l of the Statement of Agreed Facts and Book of Agreed
Documents), which was drafted in 1992, long before the BJ
bid.
[37] Shareholder confidence is the
foundation for both maintenance and future expansion of corporate
operations. Present and potential shareholders represent the
source of funding for public companies. Shouldice estimated that
he spent, on average, approximately one-half hour in each of his
work days devoted to maintaining shareholder confidence in the
company's handling of shareholder's investments. The
evidence of Shouldice was that he was expected to maximize
shareholder value in everything he did. When improving share
price is integral to every business decision, how can one
classify this as anything other than a part of the business of
running Nowsco. The public market expectations dictated several
courses of action that a company could take in the event of a
takeover bid. Mr. Bruce outlined these options in his
evidence. Bruce confirmed that Nowsco responded in textbook
fashion and that the expenses, including the "hello"
and "break" fees, were not only reasonable but
standard. Nowsco was obligated to react to the takeover bid with
due diligence and in the best interests of Nowsco. As explained
by Bruce, Nowsco simply did not have the option of saying
"no" to the proposal. To ignore the BJ offer and take
no action could invite potential legal action from dissatisfied
shareholders against either the directors or the company, or
both, resulting from a breach of obligations to act in the best
interests of shareholders and to maximize share price. The Board
had an obligation to seek a better alternative, in the form of a
white knight, if one existed, even though no specific legislative
requirement existed. National Policy 38 in fact recognizes
that the corporate objective in a takeover bid is to protect the
bona fide interests of the shareholders of target
companies. This is quite apart from the ordinary common law
responsibilities of directors in takeover bids.
[38] In summary, these expenses, although
related to maximizing shareholder value, were so integral to
conducting its business that they cannot be divorced from the
corporate activities of gaining and producing income. Although
Justice Miller in the GST companion case, concluded that
there was a necessary overlap, between what he characterized as a
"corporate marketplace", which mandated maximization of
shareholder value, and the "goods and services
marketplace" in which the daily oil servicing activities of
Nowsco existed, I am not as keen to compartmentalize the business
operations of Nowsco for the purposes of my analysis under the
income tax provisions. I prefer to accept the characterization by
Shouldice in referring to the two areas of maximizing shareholder
value and the daily oil activities of Nowsco as part of "one
great big wheel". These two areas are so intertwined that,
as Shouldice testified, maximizing shareholder value formed part
of the fundamental business philosophy, which was behind every
business decision Nowsco made. I cannot sum it up better, than
Shouldice did, when he testified:
... everything we did, every budget, every time we hired
somebody, every time we fired somebody, every time we opened a
new station, every time we moved to a new country, the first
question asked was, What's it gonna do to the bottom line?
The bottom line being the earnings per share.
Shareholders provided Nowsco the funding and if this was lost
or withdrawn, customers would be lost, staff laid off and
eventually, taken to the extreme, Nowsco operations would shut
down. It is simple logic that maximizing shareholder value must
be inextricably tied to the bare bones of gaining or producing
income on a daily basis in any corporate environment. How can it
be anything but? Given the circumstances, the expenses were part
of the general overall costs, a corporation must incur to earn
income, even though these expenses have no direct link to revenue
generating activities but are related to shareholder interests.
It is good and wise corporate behaviour to attend to shareholder
interests and expenses incurred in doing so are simply part of
the cost of doing business in the corporate marketplace.
[39] Because the Appellant has succeeded
under paragraph 18(1)(a), I must turn now to
paragraph 18(1)(b) and the Crown's second argument
that these expenses should be treated as capital outlays. If I
conclude that these expenses are capital in nature, there will
generally be no deduction unless they constitute "eligible
capital expenditures" under subsection 14(5) of the
Act. If however I conclude that they are not capital in
nature, then they will be fully deductible from income, as I have
concluded that the expenses have been shown to be incurred for
the "purpose of gaining or producing income".
[40] The specific limitation in respect to
capital expenditures is set out in paragraph 18(1)(b)
of the Act. Much of the same case law used to determine
the first issue in this appeal is also applicable to the income
versus capital expenditure issue. Justice Archambault in
Boulangerie St-Augustin Inc. referred to comments in
Algoma Central Railway v. M.N.R., 67 DTC 5091 where
Justice Jackett stated:
The "usual test" applied to determine
whether such a payment is one made on account of capital
is," was it made 'with a view of bringing into existence
an advantage for the enduring benefit of the appellant's
business'"?
Following this reasoning, what then did Nowsco have in
"view" when it incurred these expenses? Nowsco's
purpose in engaging the financial and legal advisors was to
maximize shareholder value in accordance with the legal
obligations of its Board of Directors in the face of a takeover
bid. Once it became apparent that Nowsco was going to be sold,
this involved a further bona fide effort on the part of
the Board to hold a broad auction and locate a white knight for
the shares and then to make reasonable and informed
recommendations to its shareholders via a directors'
circular. Certainly this process is inextricably linked to the
shares of Nowsco but the company is nevertheless one step removed
from their sale. The ultimate decision to tender the shares to an
acquiring company was entirely left to the discretion of the
shareholders.
[41] In his analysis, Justice Archambault in
Boulangerie St-Augustin Inc. stated at paragraphs 56 and
57:
[56] The evidence adduced at the
hearing did not show that Boulangerie had incurred its
professional fees in order to obtain any other enduring benefit.
For example, the professional fees were not incurred by
Boulangerie in order to obtain funds. There was no subscription
of shares of its capital stock. All that was done was to replace
all the shareholders by a single shareholder. Nor was there any
evidence that professional fees have been incurred by Boulangerie
as part of an attempt to obtain a new shareholder with
considerable financial resources to facilitate expansion plans or
a new shareholder with a specific technology which might secure
synergistic benefits. If it had been the case, it would have been
necessary to make a detailed analysis of the circumstances to
determine if these are capital expenditures.
[57] ... On the contrary, the evidence showed that Boulangerie
incurred these professional fees in order to comply with
section 134 of the SA, which requires a corporation to
inform its shareholders so that they can make an informed
decision, even though the board did not make a recommendation to
its shareholders. The fact that in some circulars the board made
a recommendation taking Boulangerie's long-term interests
into account does not change the nature of the expenses incurred
in order to prepare the circulars. In any case, if those
professional fees provided Boulangerie with an enduring benefit,
this was only a secondary consequence of those expenses.
[42] Associate Chief Justice Bowman in
International Colin Energy Corporation was more to the
point and stated it succinctly at paragraph 48 as
follows:
[48] I shall mention briefly the
argument that the payment is on capital account even though I do
not think it is properly before the court. It is not necessary to
discuss the myriad of authorities. They are well known and have
been fully reviewed in Johns-Manville Canada Inc. v. R.,
[1985] 2 S.C.R. 46 (S.C.C.). Here no capital asset was acquired,
nothing of an enduring benefit came into existence nor was any
capital asset preserved.
Here the Minister agreed that Nowsco obtained no enduring
benefit when it incurred the expenditures, that they do not
relate to any prior or subsequent taxation year of the company,
and that they were deducted against current income in accordance
with well established business principles.
[43] Many of the principles, which I have
reviewed from the cases employed in my analysis of the first
issue, are equally applicable in this determination. The approach
established in the case of Canderel is equally applicable
in determining whether expenses are on account of capital, as it
applies in determining whether expenses are deductible. The
primary objective is to create an accurate portrayal of
Nowsco's income in accordance with well accepted and
established principles of business practice. In light of the
Crown's admissions in respect to these expenses, and because
no evidence was presented to show that capitalizing these
expenses could result in a more accurate portrayal of
Nowsco's income either in the present year under appeal or
any other year, I do not accept that current deductibility is
prohibited by paragraph 18(1)(b).
[44] I consider the decision by Associate
Chief Justice Bowman in International Colin Energy
Corporation to be pivotal in the conclusions I have drawn
here. The Crown tried to distinguish this case partly on the
facts and partly on comments contained in that decision, which
the Crown contended were obiter. It is true that the
taxpayer in International Colin Energy Corporation was
struggling financially and hired advisors to pursue alternatives
to its financial woes. Nowsco was financially healthy. The Crown
argued that Nowsco incurred fees which enhanced shareholder value
but Justice Bowman in International Colin found that there
had been no effort by the advisors to enhance shareholder value
and the share price was not enhanced by any action taken by the
advisors. In dealing with paragraph 18(1)(b), Justice
Bowman provided some brief comments, which the Crown argued I
should give little weight to. Many of the admissions by the
Minister fully engage the comments of Justice Bowman, although
they may be obiter in the context of International
Colin. In the present case, the Minister's officer
testified at discovery proceedings as follows (Discovery
Read-Ins, pp. 37-39):
Q. And would you
agree with me that it creates an accurate picture of a particular
period if you record the revenues and expenses that properly
relate to that period?
A. Yes.
Q. And you'd
agree with me that Nowsco incurred the expenses in the period in
question.
A. They incurred the
amounts. Whether they are expenses or not I guess is
debatable.
Q. You would agree
with me that they are not amounts or expenditures that have any
relationship to a prior period?
A. Yes.
Q. And you'd
agree with me that they're not expenditures that have any
relationship to a future period?
A. Yes.
Q. And you'd
agree with me that making these expenditures reduced the
resources that Nowsco had available to pay income taxes, for
example.
A. Yes, they reduced
the cash of the company.
...
Q. Would you agree
with me that the expenses were incurred solely in the context of
the takeover bid?
A. Yes.
Q. And would you
agree with me that the purpose of incurring them was exhausted
once the takeover was completed?
A. The purpose of
spending the money was to increase the share price. Once the
share price had increased and the shares had been sold to BJ,
then there was no enduring benefit of the $50 million.
I agree with Appellant's submissions that this case is an
arguably stronger one, against characterization of the expenses
as capital outlays, than in the International Colin case.
In the case before Justice Bowman, the expenses were
incurred voluntarily by the taxpayer and were motivated because
of its financial problems and to preserve its business. Yet
Justice Bowman rejected the argument on capital treatment.
Here if it had not been for BJ's unsolicited takeover bid,
Nowsco would never have sought to make changes to its capital
structure. It was a leader in its industry, being the largest
company of that type in Canada. Revenues had grown from $198
million in 1990 to $480 million in 1995. The expenses incurred in
1996 were solely in response to the BJ bid, which landed on the
lap of the Board of Directors completely out of the blue. The
entire process began and ended within an approximate 60-day
window period, in the same financial period. I can see no
justification for capitalizing these expenses and certainly no
logic in applying them to some subsequent period where there is
no causal link to the corporate activities. In fact, on
reflection I am inclined to question the validity of
characterizing the initial sale of corporate shares as a capital
outlay. Once the initial sale occurs by the company in the public
market, the shares inherit a quasi-independent existence within
the "corporate marketplace" (as Justice Miller named it
in the companion case) and cannot be perceived as providing the
issuing company with any enduring or lasting benefit. In fact
they may be viewed as an enduring burden and not a benefit to the
issuing company because once funds are received for shares sold,
then the responsibilities fall on the company for compliance with
securities regulations, maintaining shareholder relations and
confidence, and producing financial reports.
[45] Appellant counsel referred me to a
number of other cases, including the case of Johns-Manville
Canada Inc. v. The Queen, [1985] 2 S.C.R. 46, where ten
specific factors were reviewed to assist in determining whether
an expense is income or capital in nature. I think it is
sufficient, for the purposes of my conclusions here, to state
that on a review of the general principles contained in
John-Mansville Canada Inc. and applying a common sense
approach to the facts in this case, my characterization of the
expenses as income in nature are supported. No capital asset was
acquired, no capital asset was preserved, and no enduring benefit
was obtained in incurring these expenditures. The expenses did
not relate to any prior or subsequent period. I conclude that
Nowsco has correctly deducted these expenses against current
income in accordance with well-established business principles
and that they are not outlays on account of capital.
[46] In conclusion, I want to deal with the
Appellant's alternative arguments, although I have
effectively disposed of the appeal in the foregoing analysis. The
Appellant argues that notwithstanding paragraphs 18(1)(a)
an 18(1)(b) the financing expenses could be deductible
under paragraph 20(1)(e). This provision provides for
a 20% annual deduction of the expenses, until deducted in full,
where the expenses are incurred in the course of an issuance or
sale of shares. Appellant relied on the case of M.N.R. v.
Yonge-Eglington Building Ltd., [1974] C.T.C. 209
(F.C.A.), where at paragraph 13, the phrase "in the
course of" for the purposes of
paragraph 11(1)(cb), the predecessor to
paragraph 20(1)(e) was interpreted broadly as
follows:
... it seems to me that the words "in the course of"
... are not a reference to the time when the expenses are
incurred but are used in the sense of "in connection
with" or "incidental to" or
"arising from" and refer to the process of
carrying out or the things that must be undertaken to carry out
the issuing or selling or borrowing for or in connection with
which the expenses are incurred.
[47] Although I have accepted the
Appellant's principal argument, I do believe that these
expenditures could also be characterized as culminating in an
occurrence within the broad scope of
paragraph 20(1)(e), as interpreted in M.N.R. v.
Yonge-Eglington Building Ltd. If I give this paragraph its
plain and ordinary meaning then the entire process, of incurring
these expenses, regardless of who eventually acquired the Nowsco
shares, may in my opinion be viewed as having been incurred in
the course of the eventual sale of the shares to BJ. In
considering a similar argument in International Colin Energy
Corporation, Associate Chief Justice Bowman, although finding
its unnecessary to decide this issue, made the following
comments:
The question is however whether "in the course of the
sale...of the shares of the capital stock of the
taxpayer..." is to be restricted to a sale by the
corporation of its own shares.
There are respectable arguments on either side. It is arguable
that "sale" by its juxtaposition with
"issuance" means a sale by the company of its own
shares and not a sale by shareholders of their shares. It is
equally arguable that "issuance" by itself is quite
broad enough to cover a sale by a company of its own shares and
that there was no need to add the word sale if all that was meant
was a sale by the company. Therefore "sale" must imply
something else and the only thing it can refer to is a sale by
the shareholders in the course of a corporate transaction of the
type involved here where the interests of the corporation are
affected. I find the argument attractive not only because it
makes sense commercially but because the more restrictive
interpretation requires reading into the statute words that are
not there.
[48] The Appellant also relied alternatively
on paragraph 20(1)(bb), which provides for the deduction
of investment counsel expenses in computing income from a
business or property. Appellant argues that the evidence supports
that the advice given to Nowsco by RBC and Simmons was investment
advice respecting the sale of shares. Respondent argues that
paragraph 20(1)(bb) requires a connection between the
taxpayer's source of income and the expense claimed and
allows a deduction of certain expenses paid for advice on
purchasing or selling shares or for services for administration
or management of shares. The Respondent argues that Nowsco cannot
rely on this provision as it did not seek to sell or manage its
shares, because the shares belonged to others. Although there is
validity to the Respondent's argument, it may in fact be too
narrow an interpretation of this provision. In light of my
conclusions however, I need not decide this issue here.
[49] And finally the Appellant proposes in
the alternative again that if the expenses were incurred for the
purposes of gaining income but are capital outlays pursuant to
paragraph 18(1)(b) and do not fall under any of the
preceding alternative arguments, then they are eligible capital
expenditures pursuant to subsection 14(5). When I re-examine the
nature of the expenses incurred by Nowsco, it is evident that my
initial characterization of the expenses as non-capital in
nature is far more appropriate from a common sense approach, than
to attempt to slot them under a subsection 14(5) analysis.
[50] For the above reasons, the appeal is
allowed with costs and the assessment for the period ending June
13, 1996 is referred back to the Minister of National Revenue for
reconsideration and reassessment on the basis that the fees to
RBC, Simmons and GLCC are deductible in computing the
Appellant's income.
Signed at Ottawa, Canada this 3rd day of December 2003.
Campbell, J.
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