13 December 2000 GST/HST Interpretation 31635 - ITC Eligibility of Costs Relating to Enhancing Shareholder Value

We have completed our review of the questions in your letter of June 6, 2000, concerning the issue of whether input tax credits (ITCs) may be claimed by XXXXX XXXXX on costs incurred by XXXXX in respect of certain advisory fees provided by an investment dealer.

Background

XXXXX was considering strategic alternatives to enhance shareholder value. The strategic alternatives included the potential sale of XXXXX, the sale of all or a material portion of its assets, a merger or other business combination, a strategic alliance of XXXXX (including joint ventures) with one or more other corporations, or the continuation of XXXXX current business plan. These strategic alternatives are referred to as Potential Transactions. In XXXXX, XXXXX entered into a contract with XXXXX was to provide services as a financial advisor in connection with the Potential Transaction. XXXXX shares were eventually purchased by XXXXX and the companies were merged. It is assumed that XXXXX was a GST/HST registrant involved in making taxable supplies and during the time at issue, XXXXX was not a financial institution for the purposes of the Excise Tax Act (ETA)

The costs under discussion consist of fees paid to the financial advisor, XXXXX. A letter of engagement describing the services to be provided by the financial advisor was provided. The letter explains that XXXXX was engaged to act as financial advisor to the Board and Special Committee in connection with the Potential Transaction. The services provided by XXXXX to the Board and Special Committee included: a review of the company and its related operations, an assessment of alternative means of enhancing shareholder value, to prepare and recommend a marketing strategy for review and approval, services related to the implementation of the Potential Transaction, a review of all indications of interest and final proposals, to assist with negotiations to reach a definitive agreement and provide services to facilitate an orderly closing of the transaction, provide a fairness opinion, act as soliciting dealer manager or co-manager subject to the terms and limitations of a separate letter agreement, and provide such other services as appropriate in the circumstances. The contract provided that XXXXX be paid a fee based on the Aggregate Transaction Value, as defined in the letter of engagement. The fee was payable on the day of closing of the Potential Transaction.

1) Should XXXXX be allowed an ITC on any portion of the XXXXX costs based on the engagement letter and applicable legislation?

XXXXX is not entitled to claim ITCs with respect to the fees paid to XXXXX based on the letter of engagement. The costs of inputs for the services relates to a purpose other than commercial activities (i.e. increasing shareholder value) and XXXXX has no ITC entitlement in respect of these inputs.

Generally, section 141.01 of the Act, enforces the requirement to allocate the inputs between commercial activities and activities that are not commercial activities. Subsection 141.01(2) of the ETA provides, in part, that where a person acquires or imports a property or a service for consumption or use in the course of an endeavour of the person, that person shall be deemed to have acquired or imported the property or service for consumption or use in the course of commercial activities of the person, to the extent that the service is acquired or imported by the person for the purpose of making taxable supplies for consideration in the course of the endeavour. From the letter of engagement, the costs do not meet the above criteria to be entitled to ITCs as they were not acquired for the purpose of making taxable supplies for consideration in the course of that endeavour. XXXXX acquired certain inputs in order to provide advice to the Board and Special Committee with the purpose of enhancing shareholder value.

Under certain circumstances, for example, take-over bids, the fulfilling of obligations under corporate or securities law in producing and distributing circulars for shareholders, which may include legal and accounting fees (charged by outside experts), valuation reports, fairness opinions, printing costs and mailing costs, has been considered to have been incurred for the purpose of making supplies for consideration in the course of the corporation's endeavour for purposes of section 141.01. Although securities or corporations law may not specifically require the hiring of outside experts, the corporate directors have little choice except to rely on reports of lawyers, accountants, engineers, appraisers or other persons whose profession lends credibility. The costs at issue do not fall into this category.

2) Income Tax Audit Communiqué AD-00-02 states that audit should allow the deduction of expenses relating to "fairness opinions". XXXXX of the engagement letter states that "if requested we shall provide a fairness opinion at no additional fee with respect to the Potential Transaction". Does the fact that no additional fee was charged for this service mean that we should allow no ITC in respect of the fairness opinion?

XXXXX was engaged as a financial advisor in connection with the Potential Transaction. The services are as a financial advisor. There is no additional fee involved in providing a fairness opinion and as such no ITC is available.

3) Most of the literature dealing with these sort of costs deal with situations where the taxpayer incurs costs in an attempt to ward off a hostile take-over bid. ITCs are restricted in these cases. In this situation the taxpayer is actively seeking a potential buyer[,] etc. Although both scenarios ultimately relate to the enhancement of shareholder value, is this situation distinct enough to warrant a different ITC treatment?

Whether a person is entitled to ITCs is a question of fact. In this particular situation the inputs relate to a purpose other than the making of taxable supplies in the course of commercial activity. This is not different than a hostile takeover bid, and the underlying concept in this particular situation is not distinct enough to warrant a different ITC treatment.

4) Does the fact that one of the strategic alternatives was the potential sale of assets affect the claiming of ITCs?

The fact that one of the strategic alternatives was the potential sale of assets does not affect the claiming of ITCs under subsection 141.01(2) given the facts of this particular case. The costs of inputs for the services relates to a purpose other than commercial activities (i.e. increasing shareholder value) and XXXXX has no ITC entitlement in respect of these inputs.

5) Income Tax Audit Communiqué AD-00-01 states under the Policy section "Generally, in the case of a friendly take-over bid, the Department will not dispute the deductibility of the costs to the extent they are reasonable". Does this statement have any impact on the eligibility of the ITCs?

The Income Tax Audit Communiqué AD-00-01 relates to deductions under the Income Tax Act. The ETA does not distinguish between friendly and hostile take-over bids. Whether a person can claim ITCs is a question of fact.

I trust these comments will be of assistance to you. Should you have any questions, please do not hesitate to contact me at (613) 954-7945.