Boulangerie St-Augustin Inc. v. Her Majesty the Queen, [1995] 2 CTC 2149

Archambault J.T.C.C.:-In 1990, three corporations wanted to take over Boulangerie St-Augustin Inc. (Boulangerie). Each of those corporations made a takeover bid (TOB) for all its shares. Boulangerie’s board of directors was required to send its shareholders a circular prepared in accordance with the rules set down by the Quebec Securities Act (SA) for each of those bids. At that time, Boulangerie incurred costs of $62,622, claiming only $9,375 of that amount as operating expenses for tax purposes. Having considered the balance of $53,247 as an eligible capital expenditure, it claimed the sum of $2,576 under paragraph 20(1)(b) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71- 72, c. 63) (the "Act"). The Minister of National Revenue (the Minister) disallowed the deduction of these two amounts on the ground that they were not expenses incurred for the purpose of gaining income from a business as required by paragraphs 18(l)(a), 14(5)(b) and 20(1 )(b) of the Act. In its notice of appeal, Boulangerie adopted a new approach and claimed the entire deduction of $62,622 in computing its income for 1990, relying on paragraphs 20(1 )(g) and 18(1 )(a) of the Act. At the start of the hearing, counsel for Boulangerie informed the Court that his client waived the $500 deduction of fees because that sum was not related to the TOB. As to the other fees totalling $62,122, the parties agreed that they had been incurred in the context of the TOB.

Facts

The head office of Boulangerie is located in St-Augustin-de- Desmaures in the Québec City area. This corporation, founded in 1946 as a cooperative under the Cooperative Syndicates Act, was subsequently transformed into a company under Part IA of the Companies Act. At the time of the continuation, the 240 associates became holders of one class A share and one class B share of the company. In 1990, its board of directors was composed of seven directors, including five farmers from the area, and two grocers, including Gerard Brousseau. Boulangerie operated an industrial baked goods production and distribution business. At the time, it had a turnover of about $7,000,000 and 95 employees in its service.

On March 23, 1990, Gérard Brousseau Inc. (Brousseau), belonging to Gérard Brousseau, made a TOB for all of Boulangerie’s shares in circulation. Brousseau offered to pay $13,500 cash per class A share and $7,289 per class B share. The offer was valid until April 23, 1990.

Boulangerie requested advice from Jean DeBlois of the law firm DeBlois, Gauthier, Samson, Thivierge (the DeBlois law firm) as to its legal obligations with respect to this TOB. Boulangerie, whose shares are not quoted on the stock exchange, was not a private company (within the meaning of the SA) since it had more than 50 shareholders. Under section 134 of the SA, its board of directors was required to send a circular to all its shareholders. Boulangerie asked the DeBlois law firm to prepare it. Mr. DeBlois recommended retaining Boulangerie’s auditors, the firm of Raymond, Chabot, Martin, Paré (RCMP), to advise Boulangerie and collaborate with the DeBlois law firm. The DeBlois law firm prepared the board of directors’ circular, complying with the provisions of the SA, in particular providing the information required under Schedule 12 of the Securities Regulations. The circular of April 2, 1990 described the offeror Brousseau and its bid. It provided a host of information designed to enable the shareholders to make an informed decision. [1] In particular, it contained information pertaining to the intentions of Boulangerie’s directors and officers with respect to the bid and described the number of shares held by each of the directors and officers. It confirmed that none of Boulangerie’s directors or officers except Mr. Brousseau held shares of the offeror. There was no agreement between the offeror and its directors or officers. It confirmed the total number of Boulangerie’s shares in circulation at March 23, 1990, the date of the bid, and specified that Boulangerie had allowed the offeror to examine its books and records in order to obtain certain information to enable it to submit its bid. Lastly, the circular confirmed that there had been no major change in the company’s financial situation. The circular contained no financial statements and did not refer to any appraisal of the corporation.

In that circular, the board of directors made no recommendation as to Brousseau’s bid. One of the reasons was the fact that Boulangerie had received a second TOB from Corporation d’acquisition Gadoua (Gadoua). The latter had offered to pay $17,500 cash per class A share and $7,500 cash per class B share. In its second circular sent to its shareholders on April 11, 1990, the board of directors provided the same kind of information as that contained in the first circular. However, it recommended that Gadoua’s offer be accepted because it believed that the purchase price of the shares was reasonable and fair in the circumstances and that that bid was in the corporation’s best interests. The board was satisfied with the offeror’s assurances of Boulangerie’s continuity, permanence and development. The bid made by Gadoua was valid until April 23, 1990.

On April 23, 1990, Boulangerie received a third TOB from Corporation d’acquisition Gaudreault et Roussin (Gaudreault). The bid price was $20,600 cash per class A share and $7,500 per class B share. A new circular had to be sent. On April 23, 1990, the bid made by Brousseau elapsed since the shareholders did not file enough shares for it to be accepted. Brousseau did not renew its offer. Boulangerie’s board of directors met on April 25, 1990 and reviewed the two bids still valid, that is those of Gaudreault and Gadoua. Although that from Gaudreault was financially more advantageous for shareholders, the board of directors decided to recommend that its shareholders accept Gadoua’s bid. Its reasons were recorded in the minutes of the board of directors’ meeting of April 25, 1990. The relevant excerpt reads as follows:

Having regard to the fact that all the members of the board of directors present:

- are still satisfied that Corporation d’ Acquisition Gadoua is in a position to guarantee the company’s continuity, permanence and development;

- are not convinced that the payment (and related financing) of the price bid for the shares by Corporation d’Acquisition Gaudreault & Roussin might not compromise the company’s continuity and financialplans;

— have no knowledge that any representative or agent of Corporation d’ Acquisition Gaudreault & Roussin has communicated with the company’s authorities to obtain the information essential to the bid’s preparation and submission (including financial information) or to visit the company’s facilities;

— are of the view that the bid by Corporation d’Acquisition Gaudreault & Roussin contains no assurances that it would enable them to adequately assess the company’s prospects for continuity, permanence and development if the said bid were accepted;

— have been informed of the fears and apprehensions which have been raised in the company’s employees by the potential purchase of the shares by Corporation d’Acquisition Gaudreault & Roussin; and

— are of the opinion that the relations which the company maintains with its clientele could be changed as a result of acceptance of the bid made by Corporation d’ Acquisition Gaudreault & Roussin;

It is resolved on a motion duly seconded and unanimously passed:

(a) to maintain the recommendation of the board of directors appearing in the circular of April 11, 1990 to accept the bid made by Corporation d’Acquisition Gadoua and to recommend that the holders of the company’s shares accept the said bid; and

(b) to recommend that the bid made by Corporation d’ Acquisition Gaudreault & Roussin not be accepted and thus that the shareholders not tender their shares in response to it or sign or file the letter of acceptance relating thereto.

[Emphasis added; translation.]

On June 8, 1990, Gaudreault improved its takeover bid by adding one class A share of its capital stock, having a face value of $100, to the price already bid for each of Boulangerie’s class A shares. On June 15, 1990, Gadoua’s bid was accepted by more than 90 per cent of Boulangerie’s shareholders and Gadoua became Boulangerie’s new owner.

In addition to the three TOBs, Boulangerie received seven notices of extension and, as required by the SA, had to produce and send to its shareholders a circular for each of those amendments. The DeBlois law firm’s fees were $49,922.09 and those of RCMP $12,200.

Boulangerie St-Augustin Inc.’s claims

Boulangerie contends that it was entitled to deduct these legal and accounting fees because they were incurred at the time of the three TOBs in accordance with its legal obligation to prepare and distribute information circulars to its shareholders. The purpose pursued by Boulangerie was not to thwart a takeover by these three offerors, but rather to comply with its obligations under the SA. The recommendation which it made was based on Boulangerie’s best interests, that is to ensure the company’s continuity, permanence and development. Those expenses were deductible because the circulars were financial reports pursuant to subparagraph 20( 1 )(g)(iii) of the Act, which provides as follows:

20(1) Notwithstanding paragraphs 18(l)(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:

(g) where the taxpayer is a corporation,

(iii) an expense incurred in the year in the course of printing and issuing a financial report to shareholders of the taxpayer or to any other person entitled by law to receive such report....

Boulangerie contended alternatively that it was permitted to deduct its circular costs under paragraph 18( 1 )(a) of the Act. It relied in particular on a decision rendered by the Supreme Court of Canada in B.C. Power Corporation Ltd. v. M.N.R., [1968] S.C.R. 17, [1967] C.T.C. 406, 67 D.T.C. 5258. Lastly, if the Court were to conclude that those expenses were not wholly allowable as expenses under paragraph 18(1 )(a) of the Act, Boulangerie contended that its expenses constituted eligible capital expenditures and that it was entitled to claim the amount provided at paragraph 20(1)(b) of the Act.

Minister's claims

The Minister argued that these expenses were not incurred for the purpose of gaining income from the business operated by Boulangerie. Those expenses were subject to the exception of paragraph 18(1 )(a) of the Act. The expenses incurred by Boulangerie were related to the protection of its shareholders’ interests and did not constitute expenses incurred in the operation of its business.

The circulars sent in accordance with the provisions of the SA did not constitute financial reports within the meaning of paragraph 20(1 )(g) of the Act. According to the Minister, that provision concerned documents which were sent regularly, that is monthly, quarterly, semi-annually or annually. The circulars sent by Boulangerie were not of this nature.

As to the application of paragraph 20(1)(b) of the Act, the Minister claimed that these expenses did not constitute eligible capital expenditures within the meaning of paragraph 14(5)(b) of the Act since they were not expenses incurred for the purpose of gaining income from a business. Even if the Court concluded that such was the case, it nevertheless would admit that Boulangerie was entitled to treat these expenses as eligible capital expenditures.

Analysis

Counsel for the parties were unable to cite a Canadian decision concerning the deductibility of legal expenses incurred at the time of a TOB. Given the large number of TOBs made in recent years, it is surprising to note that this issue has not yet been examined in a tax case. I will analyze Boulangerie’s arguments in the order in which they were submitted.

Deduction under subparagraph 20(1 )(g)(iii) of the Act

Boulangerie claimed that it could deduct the expenses incurred to draft circulars pursuant to a specific provision of the Act, that is subparagraph 20( 1 )(g)(iii) of the Act. To be able to invoke it, it was essential that the circulars it had prepared constitute "financial reports" as contemplated by the said paragraph. The Act does not contain a definition of this expression. Reference must therefore be made to the common usage of this expression in general or specialized dictionaries. In the Nouveau Petit Robert, "rapport" (report) is defined as "a more or less official account rendered" [translation]. The word "financier" (financial) is defined as: "relating to finance, to finances. Relating to pecuniary resources, to money".

In the Dictionnaire de la comptabilité et des disciplines connexes by Fernand Sylvain, "report" is defined as a "detailed and itemized presentation concerning a fact or a set of facts, describing the status of one or a number of issues with a view to informing the recipient, preparing and informing his decisions" [translation]. The word "financial" is defined as follows: "pertaining to financing, to the management of the funds of a business or public organization and, more broadly, to the determination of a business’s accounts" [translation]. The expression "financial reporting" is defined in the same dictionary as "action, for a business, of communicating financial information to the public mainly by means of its financial statements (or accounts) which it publishes annually, quarterly or monthly" [translation].

The following definitions appear in Black's Law Dictionary, 6th Edition:

Financial reports. See Annual report; Financial statement; Profit and loss statement.

Financial statement. Any report summarizing the financial condition or financial results of a person or organization on any date or for any period. Financial statements include the balance sheet and the income statement and sometimes the statement of changes in financial position. See also Annual report.

Annual report. A report to stockholders and other interested parties prepared by a corporation once a year; includes a balance sheet, an income statement, a statement of changes in financial position, a reconciliation of changes in owners’ equity accounts, a summary of significant accounting principles, other explanatory notes, the auditor’s report, and often comments from management about the year’s business and prospects for the next year. By law, any public corporation that holds an annual stockholders meeting is required to issue an annual report.

In the Grand Dictionnaire Encyclopédique Larousse, Vol. 8, "état financier" (financial statement) is described as follows: "Law and Econ. (financial) report, annual statement of a business’s income and financial management made by the board of directors (or governors) before the annual meeting of shareholders" [translation].

To grasp more fully the scope of this expression, it is helpful to recall that paragraph 20(1 )(g) of the Act is similar to paragraph 11(1)(cc), which was added to the Income Tax Act (Act of 1952) pursuant to an amendment to that Act assented to on July 18, 1959. The purpose of this amendment, which applies to the taxation years 1955 and following, was to nullify the effects of the decision rendered by the Exchequer Court in Distillers Corporation Seagrams Ltd. v. M.N.R., [1958] C.T.C. 305, 58 D.T.C. 1168. The decision of the Tax Appeal Board (55 D.T.C. 18) is dated December 30, 1954. In that decision, Thurlow J. concluded that stock transfer expenses, listing fees and expenses related to the corporation’s annual mailings to its shareholders did not constitute expenses incurred for the purpose of gaining income from a business. He wrote as follows on this issue (ibid., at page C.T.C. 312-13, 1173):

Different considerations apply to the remaining items of expense, namely the legal expense for 1950, incurred for legal advice for the benefit of certain shareholders, and the stock transfer expense, listing fees for common stock, printing and stationery in connection with the annual meeting of shareholders and proxy expense. The purpose for which these expenses were incurred appears from the evidence, and / am quite unable to understand on what basis it can be said that any of them was incurred for the purpose of gaining or producing income from the appellant’s business or in the pursuit of its incomegaining activities. No doubt they are expenses which, as Mr. Sandilands said, must be incurred by a corporation whose shares are listed on the stock exchanges,

but they are incurred in the course of the appellant’s dealings with its own shareholders as shareholders and in connection with the administration incident to the capital structure and arrangements of the appellant, rather than in carrying out activities which form any part of the business or process or function or means by which the appellant’s income is gained or produced.

[Emphasis added.]

In his view, the exception of paragraph 12(l)(a) of the Act of 1952, today paragraph 18( 1 )(a) of the Act, applied to those expenses.

Having regard to the historical context of the addition of paragraph 20(1 )(g) to the Act and to the definitions stated above, I believe that the definition of "annual report" given by Black’s Law Dictionary corresponds most closely to the notion of "financial report" contemplated by this paragraph. This is a report addressing a corporation’s financial situation, generally including financial statements and often officers’ comments on the corporation’s activities.

From a reading of the circulars prepared by Boulangerie for its shareholders, one notes that these documents constitute reports, but not financial reports. They do not contain financial statements or information from financial statements: they contain no "financial picture" of Boulangerie’s business. The fact that the board of directors, as its counsel claimed, had to consult the financial statements in order to make its recommendation to the shareholders was not sufficient to brand this document as a financial report.

Rather the purpose of the circular from the board of directors was to provide information for their decision respecting a TOB. It contained little financial information. In particular, the circular informed the shareholders about the directors and officers and the shares which they held in the corporation and the offeror, their intention and their recommendation with respect to the bid, whether there were agreements between an offeror and the corporation’s officers with respect to their position and the extent to which the offeror could hold an interest in Boulangerie. The only heading among the roughly 15 appearing in the circular of April 2, 1990 that concerns the financial situation was that under which the board stated that there had been no major change in the corporation’s situation since the date of the previous financial statements. In my view, the circulars did not constitute financial reports within the meaning of subparagraph 20(l)(g)(iii) and Boulangerie may not claim the deduction provided by that provision.

Deduction under subsection 9(1) of the Act

Boulangerie argued alternatively that the professional fees of $62,122 were operating expenses which Boulangerie could deduct under paragraph 18(1 )(a) of the Act, which provides:

18(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of:

(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....

In reading this paragraph, one notes that this provision does not grant the taxpayer the right to deduct expenses; on the contrary, it states a restriction, an exception of a general nature. Subsection 18(1) of the Act provides that "no deduction shall be made in respect of..." in computing the income of a taxpayer from a business. In addition to paragraph (a), one may cite as examples paragraph 18(1)(b), which concerns a payment on account of capital; paragraph 18(1)(e), an amount as or on account of a reserve; paragraph 18(1)(h), personal or living expenses and paragraph 18(l)(t), amounts payable under the Act. It is thus not pursuant to paragraph 18(1)(a) of the Act that a taxpayer may deduct the expenses which he incurs for the purpose of earning business income. Rather it is under subsection 9(1) of the Act which defines business income as a "profit". [2] The word "profit" represents net profit, gross revenues less all expenses incurred in order to earn them.

Boulangerie’s interpretation of paragraph 18(1)(a) of the Act is not the only one. There has been confusion on this subject for at least 50 years. However, in a recent decision by the Supreme Court of Canada, Symes v. Canada? [3] Iacobucci J. clearly describes the scope of paragraph 18( 1 )(a) and the correlation between that paragraph and section 9 of the Act. lacobucci J. writes:

At one time, it was not clearly understood whether the authority for deducting business expenses was located within what is now subsection 9(1) or within what is now paragraph 18(1 )(a). In a series of decisions culminating in Royal Trust Co. v. M.N.R., [1957] C.T.C. 32, 57 D.T.C. 1055 (Ex. Ct.), however, Thorson P. recognized that the deduction of business expenses is a necessary part of the subsection 9(1) "profit" calculation.

In other words, the "profit" concept in subsection 9(1) is inherently a net concept which presupposes business expense deductions. /t is now generally accepted that it is subsection 9(1) which authorizes the deduction of business expenses; the provisions of subsection 18( 1 ) are limiting provisions only. See R. v. MerBan Capital Corp., [1989] 2 C.T.C. 246, 89 D.T.C. 5404 (F.C.A.).

[Emphasis added, except for ’’authority" and ’’net’’.]

How is net profit determined for the purposes of subsection 9(1) of the Act? It is Thorson J. again who gives us the answer in Royal Trust Co. v. M.N.R., [1957] C.T.C. 32, 57 D.T.C. 1055, at page 40 (D.T.C. 1059) in referring to the decision which he rendered in Imperial Oil Ltd. v. M.N.R., [1947] C.T.C. 353, 3 D.T.C. 1090 (Ex. Ct.):

the first approach to the question whether a particular disbursement or expense was deductible for income tax purpose was to ascertain whether its deduction was consistent with ordinary principles of commercial trading or well accepted principles of business and accounting practice and that if it was the next enquiry should be whether the deduction was within or without the exclusions of paragraph 6(a). My only present observation is that I should have omitted the reference to accounting practice which I made in that case.

[Emphasis added.]

The decisions that followed Royal Trust did not always fully grasp the scope of this last phrase of Thorson J.’s, on which moreover he did not expand. Some have stated that net benefit must be determined in accordance with generally accepted accounting principles (GAAP). Others have said instead that accepted principles of commercial trading (APCT) should be followed. In Symes, supra, at page 723 (C.T.C. 52, D.T.C. 6009), lacobucci J. decided that the courts are not bound by GAAP:

Any reference to GAAP connotes a degree of control by professional accountants which is inconsistent with a legal test for "profit" under subsection 9(1). Further, whereas an accountant questioning the propriety of a deduction may be motivated by a desire to present an appropriately conservative picture of current profitability, the Income Tax Act is motivated by a different purpose: the raising of public revenues. For these reasons, it is more appropriate in considering the subsection 9(1) business test to speak of "well accepted principles of business (or accounting) practice" or "well accepted principles of commercial trading ".

[Emphasis added, except for ’’legal”.]

Finally, it should be stated that, as Jackett J. wrote in Associated Investors of Canada Ltd. v. M.N.R., [1967] C.T.C. 138, 67 D.T.C. 5096, at page 143 (D.T.C. 5099) (Ex. Ct.), the question of the determination of net income is a question of law:

Profit from a business, subject to any special directions in the statute, must be determined in accordance with ordinary commercial principles. (Canadian General Electric Co. v. M.N.R., 1962 S.C.R. 3, [1961] C.T.C. 512, 61 D.T.C. 1300, per Martland J. at page 12 (C.T.C. 520, D.T.C. 1304).) The question is ultimately "one of law for the Court". It must be answered having regard to the facts of the particular case and the weight which must be given to a particular circumstance must depend upon practical considerations. As it is a question of law, the evidence of experts is not conclusive.

[Emphasis added.]

According to the approach stated by Thorson J. and approved by the Supreme Court of Canada in Symes, the first stage thus consists in determining whether the professional fees were deductible under subsection 9(1) of the Act, that is to say in accordance with APCT.

The evidence showed that Boulangerie retained the services of the DeBlois law firm to advise it on the procedure to follow with respect to the TOBs made to its shareholders. Its board of directors needed to be guided and advised. Its main task consisted in preparing an information circular for each of the bids and each of the extensions. This mandate was entrusted to the DeBlois law firm. The latter recommended hiring the RCMP to assist it in this effort and to advise the board of directors. An analysis of the DeBlois law firm’s professional statements of account shows that, in addition to drafting the circulars, it also studied, in particular, the SA and the Companies Act, met with representatives of the offerors, those of the Commission des valeurs mobilières du Québec, attended the meetings of the board of directors and the meetings of shareholders. It also drafted certain legal documents resulting from the acceptance of Gadoua’s TOB, including in particular the share transfer resolution. RCMP’s fee statements provide this laconic description of its services: "consultation, meetings and discussions respecting the sale of shares" [translation].

In his reply to the notice of appeal, the Minister took for granted the fact that Boulangerie had only reported $9,375 as operation expenses in its financial statement. The balance was capitalized as eligible capital expenditure. In its answer to the reply, Boulangerie alleged that it had reported the whole sum of $62,622 in its income statement as operating expenses, but, at the federal level, it considered the sum of $53,247 as an eligible capital expenditure. Only the sum of $9,375 was considered as an operating expense.

In support of this claim, Boulangerie filed its financial statements at the hearing and the income statement for the five and a half month-period ended June 16, 1990 [4] shows a sum of $207,561 as administrative expenses, including $72,368 for professional fees. Furthermore, professional fees of $13,675 were noted in its financial statements for the two-month period ended August 11, 1990. [5] The chartered accounting firm RCMP signed the auditors’ reports and stated that, in its opinion, these statements were prepared in accordance with GAAP.

The Minister did not dispute the validity of this accounting treatment or RCMP’s opinion. In determining APCT, the Court can certainly take GAAP into account, while recognizing that it is not bound by those principles. In Symes at page 736 (C.T.C. 59, D.T.C. 6014) lacobucci J. acknowledged that this could be a clue that this expense is a business expense:

It may be relevant in a particular case to consider whether a deduction is ordinarily allowed as a business expense by accountants. This is not to revert to the notion that accountancy will govern under subsection 9(1) of the Act, since accountants "have no special expertise in making" (Brooks, supra, at page 256) the business versus personal expense judgment. Instead, such evidence may simply indicate that a particular kind of expenditure is widely accepted as a business expense.

[Emphasis added.]

Let’s analyze the reasons for which the expenses were made. The evidence reveals that they were made to comply with section 134 of the SA which provides as follows:

134. Sending of circular The board of directors of the offeree company shall cause a circular prepared in the form prescribed by regulation to be sent not later than ten days from the date the takeover bid is made, to the holders of securities of the class sought by the bid and to the holders of securities carrying the right to purchase, during the offer, securities of that class, if they are resident in Québec according to the addresses entered in the records of the offeree company or are resident in Québec in fact and make a request therefor.

Recommendation to holders The circular may contain a substantiated notice recommending that the security holders accept or reject the offer they have received. If, however, the board decides not to make a recommendation, the absence of any recommendation must be explained.

[Emphasis added.]

One should note that under section 134 of the SA every company is required to have a circular prepared. One notes, however, that the board of directors is not required to make a recommendation on the subject of a TOB. However, a board of directors which decides not to make a recommendation must give reasons for its decision. The circulars provide information relating principally to Boulangerie, that is its business, its officers and its capital. Based on Schedule 12 of the SA Regulations, which describe the information which the circular must contain, it is clear that the purpose sought by the legislature is to inform the shareholders. In Canadian Business Corporations [6] the purpose is described as follows:

Following the report of the Kimber Committee, mandatory statutory codes were enacted across Canada dealing with takeover bids, designed to protect the general investing public by avoiding potential abuses while interfering as little as possible with the takeover bid technique as a means of effecting a business combination. 101 Also, the codes were designed to ensure that all shareholders are given equal access to adequate information in the course of a takeover bid.

101. See infra, footnote 113, for references to the relevant statutory provisions in each jurisdiction.

[Emphasis added.]

Securities Law and Practice contains the following description of the historical context in which the Ontarian legislator enacted the obligation for the board of directors to prepare a circular:

20.13.1 Mandatory Directors’ Circular

Under the former Securities Act, a directors’ circular was required only if the directors of the target corporation recommended to the target shareholders acceptance or rejection of the takeover bid. As stated by the Select Committee on Company Law in its 1973 Merger Report (page 36):

The Committee can think of no valid reason why the issue of a directors’ circular should depend on whether the directors propose to recommend acceptance or rejection of the bid. The shareholders of the offeree company should be entitled to as much information as possible to enable them to form a reasoned judgment regarding acceptance or rejection of the bid. The directors’ circular provides information which should be made available to the shareholders under all circumstances. This is particularly so with respect to the statements required by the directors’ circular as to whether or not each director and senior officer of the offeree company has accepted or intends to accept the offer on his own behalf and the requirement for disclosure of any information which might indicate any material change in the financial position or prospects of the offeree company since the date of its last published financial statements. The Committee therefore recommends that a directors’ circular be made mandatory in the case of all takeover bids.

[Emphasis added.]

This obligation of Boulangerie’s to communicate with its shareholders is similar to the one it has under the Companies Act to provide its shareholders with the corporation’s financial statements. [8] Having to look after one’s shareholders is part of the periodic administrative duties of a company doing business. The same goes for legal drafting fees for the transfer of shares. I believe that business people consider these expenses as necessary business expenses and that they are deductible as general administrative expenses under APCT.

Exception of paragraph 18( l)(a) of the Act

Having concluded that a corporation may deduct these expenses under subsection 9(1) of the Act, the second stage consists in determining whether the exception of paragraph 18(1 )(a) of the Act applies to them. In support of the application of this exception, the Minister invoked the following three decisions:

-Distillers, supra;

-Montreal Coke and Manufacturing Co. v. M.N.R., [1944] C.T.C. 94, [1944] 3 D.L.R. 545 (P.C.);

-Dominion Natural Gas Co. v. M.N.R., [1941] S.C.R. 19, [1940-41] C.T.C. 155, 1 D.T.C. 499-133 (S.C.C.).

In Distillers, it will be remembered that Thurlow J. of the Exchequer Court disallowed as expenses the costs of providing information to the shareholders concerning the annual meeting. His conclusion was as follows (supra, at page C.T.C. 313, D.T.C. 1173):

Their deduction is, accordingly, prohibited by paragraph 12(1 )(a), and not only a fraction but the whole of them should be disallowed as deductions.

Although Thurlow J. cited no decision in support of his conclusion, his reasoning was consistent with the direction of the case law stated in Montreal Coke and Dominion Natural Gas. In the former, the Privy Council had interpreted paragraph 6(a) of the Income War Tax Act, R.S.C. 1927, c. 97 (Act of 1927), similar to paragraph 18(1 )(a) of the Act, which provided that outlays not "wholly, exclusively and necessarily" incurred for the purpose of earning income were not deductible. Lord MacMillan concluded: "Expenditure, to be deductible, must be directly related to the earning of income". [9] The expenses relating to the business’s financial operations did not meet this test:

Of course, like other business people, they must have capital to enable them to conduct their enterprises, but their financial arrangements are quite distinct from the activities by which they earn their income. No doubt, the way in which they finance their businesses will, or may, reflect itself favourably or unfavourably in their annual accounts, but expenditure incurred in relation to the financing of their businesses is not, in their Lordship’s opinion, expenditure incurred in the earning of their income within the statutory meaning. [10]

[Emphasis added.]

In Dominion Natural Gas, legal expenses had been incurred in 1934 to defend the right to operate a natural gas distribution concession. Duff C.J. concluded that those expenses did not meet paragraph 6(a) of the Act of 1927. [11] He relied in particular on a decision of the House of Lords which rejected the deduction of costs related to the purchase of machinery and the temporary conversion of a plant during the First World War. Lord Clyde wrote the following in Lothian Chemical Co. v. Rodgers, (1926) 11 Tax Cases 508, at page 521:

It was expenditure which was made for the purpose of acquiring the disposal of property or plant which was to be used in the business of the company, namely, the manufacture of some chemical products and, in this case, of one chemical product in particular, and which was to be so used, not for the purpose of making profit in any particular year, but for the purpose of such manufacture so long as that manufacture might be carried on.

The interpretation that appears from these three decisions is that an expense may not be considered to be made for the purpose of earning income from a business if it is a capital expenditure. However, this over- restrictive interpretation of paragraph 18(1 )(a) is not consistent with the current state of the law. The Supreme Court of Canada adopted a contrary interpretation in 1958 in B.C. Electric Railway Co. v. M.N.R., [1958] S.C.R. 133, [1958] C.T.C. 21, 58 D.T.C. 1022 at page 137 (C.T.C. 31; D.T.C. 1027):

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 paragraph 12(1 )(a) whether it be classified as an income expense or as a capital outlay.

[Emphasis added.]

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, D.T.C. 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.

The restrictive interpretation adopted by Thurlow J. in Distillers, supra, in 1954 must be set aside not only because it is based on a case law trend which is obsolete today, but also because it was implicitly reversed in 1967 by the Supreme Court of Canada in British Columbia Power, supra, note 2. In that case, Martland J., without mentioning Distillers, concluded that the corporation’s expenses for providing information to its shareholders constituted a wholly deductible expense in computing the corporation’s income and that the exception of 12(1 )(a) of the Act of 1952 (now 18( 1 )(a) of the Act) did not apply to those expenses (Ibid., at page S.C.R. 29, C.T.C. 416-17):

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.

[Emphasis added.]

In that case, the government of British Columbia expropriated the shares which that corporation had held in a subsidiary which operated an electrical distribution network. The taxpayer had incurred major legal expenses in order to contest that expropriation. Those expenses were considered as a capital outlay contemplated by the exception of paragraph 12(1 )(b) of the Act of 1952. However, the expenses incurred by the taxpayer to inform its shareholders on the subject of its activities constituted operating expenses.

Thus one notes that the Supreme Court of Canada has not followed the interpretation adopted in Montreal Coke, Distillers and Dominion Natural Gas. A corporation’s expenses to communicate with its shareholders are part of the process of earning business income. It is no longer necessary for the expenses to relate directly to the business’s operation, as the Privy Council affirmed in Montreal Coke. A more generous interpretation has been adopted of the expression ’’expenses incurred for the purpose of gaining income from a business”. To illustrate the liberalization of the deduction principle relative to paragraph 18(l)(a) of the Act, Iacobucci J. cited Wilson J. in Mattabi Mines Ltd. v. Ontario (Minister of Revenue), 1988 2 S.C.R. 175, [1988] 2 C.T.C. 294 at page 189 (C.T.C. 301). In that case, Wilson J. examined a tax provision similar to paragraph 18(1 )(a) of the Act and drew the following conclusion:

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.

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 it 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.

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.

Exception of paragraph 18(1)(b) of the Act

Although those expenses were not incurred in order to earn income, it must be determined whether they constituted a capital outlay. To determine the nature of an expenditure, it is important to determine the reason for which a taxpayer has incurred an expense. Jackett J. stated in Algoma Central Railway v. M.N.R., [1967] C.T.C. 130, 67 D.T.C. 5091 at page 134 (D.T.C. 5093) (Ex. Ct.):

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’"?

The question is therefore whether what the appellant in this appeal had in "view" when it made the expenditures in dispute was "an advantage for the enduring benefit" of its business within the meaning of the test as it has been developed by the decisions.

In support of her claim that the exception of paragraph 18(1)(b) of the Act applied, counsel for the Minister cited in particular Dominion Natural Gas, supra, and The Queen v. Jager Homes Ltd, A-792-83 F.C.A., (English version, [1988] 1 C.T.C. 215, 88 D.T.C. 6119 (F.C.A.)). In Dominion Natural Gas Co., as seen above, these had been incurred in order to defend the taxpayer’s right to carry on its gas distribution business in Hamilton. In that case, Duff C.J. found that there was no distinction between the expenses incurred to obtain the right to carry on a business and those incurred for the purpose of preserving that right.

In Jager, the corporation had incurred expenses in order to dispute a petition to the court by one of its two principal shareholders to wind up the corporation. It should be noted that these two shareholders were husband and wife and this proceeding had been brought in the context of their divorce proceedings. Urie J. concluded that these expenses were (at page 224 (D.T.C. 6124):

... a large non-recurrent unusual expenditure made for the purpose of obtaining an advantage for the enduring benefit of the appellants’ trade...." In other words, the payments for legal fees were made to preserve the business entity, structure or organization not as the kinds of expenditures which are made to earn profits from the operation of such business entities.

[Emphasis added.]

He therefore concluded that these were capital outlays, the deduction of which was prohibited under paragraph 18(1)(b) of the Act.

In his reply to Boulangerie’s notice of appeal, the Minister made no allegation that the professional fees were incurred in order to obtain an enduring benefit for its business, except perhaps the following:

(c) according to the version of one agent of the appellant, these expenses constituted legal and accounting expenses incurred to thwart a takeover bid in order to preserve the existing shareholders’ position as owners of the appellant at the time those expenses were incurred....

[Translation.]

The evidence clearly contradicted this allegation. The board of directors recommended that its shareholders accept Gadoua’s TOB. The position of the existing shareholders was therefore not preserved. All the existing shareholders were replaced by Gadoua. The evidence did not show, as was the case in Jager, that Boulangerie wanted to ensure the survival of its business because the offerors wanted to wind it up. If the board of directors had been hostile to these TOBs and had incurred expenses in order to fight those bids and to maintain the status quo, in particular by hiring a business

appraiser to show that those bids were not reasonable or other advisors to assist it in putting defence mechanisms into place, [12] these expenses would have fallen under the application of paragraph 18(1)(b) of the Act. However, I do not have to rule on this issue in this instance.

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.

In its recommendation, the board of directors took into account a number of factors including Boulangerie’s "continuity, permanence and development" [translation]. This expression did not reveal any attempt to secure a benefit which it did not possess, but rather an interest in continuing to operate its business as before. Moreover, this was a factor explaining the board’s recommendation; it was not the goal pursued by the board in incurring the fees of $62,122. 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.

Counsel for the Minister tried to distinguish between the facts in British Colombia Power and those in the instant case. She emphasized that the taxpayer had informed its shareholders of the steps it had taken to dispute the British Columbia government’s expropriation of the shares which it had held in its subsidiary. Here the circulars provided the shareholders with information to help them make a decision concerning TOBs for their shares. In my view, this distinction does not change the scope of this case in any way. The circulars of the board of directors had to provide information on Boulangerie. In both cases, the costs were incurred to inform the shareholders.

It should also be emphasized that the costs incurred by British Colombia Power did not concern the current activities of that corporation and were not intended to provide them with the corporation’s financial Statements. The corporation entered into an exceptional correspondence with the shareholders concerning the expropriation of its assets. Moreover, that taxpayer was wound up pursuant to the settlement reached on the value of the subsidiary’s shares. What was involved then was information communicated on the subject of its efforts to preserve its business. This did not prevent the Supreme Court of Canada from concluding that the expenses incurred were operating expenses, not capital outlays. The sum of $62,122 did not constitute a capital outlay and the exception of 18( 1 )(b) does not apply.

For these reasons, the appeal is allowed and the assessment is referred back to the Minister for reassessment on the basis that the sum of $62,122 constitutes a wholly deductible expense in computing Boulangerie’s income for 1990, the whole with costs.

Appeal allowed.