6 February 2002 External T.I. 2001-0105605 - Tax Treatment of Transaction Costs

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Tax treatment of transaction costs: deductibility and shareholder benefits

Position: Question of fact

Reasons: The law

XXXXXXXXXX 2001-010560
Gwen Watson
February 6, 2002

Dear XXXXXXXXXX:

Re: Tax Treatment of Transaction Costs

We are writing in reply to your letter of October 9, 2001 wherein you requested a technical interpretation of the tax treatment, under the Income Tax Act (Canada) (the "Act"), of certain transaction costs incurred by a public corporation ("Pubco") in the course of: (i) a take-over of Pubco, or (ii) a sale of assets by Pubco. In particular, you have asked whether the following expenses incurred by Pubco would be deductible by Pubco and/or constitute a benefit to the shareholders of Pubco:

- professional fees with respect to: (i) advice on issues associated with the take-over or sale, (ii) advice on the tax treatment to the shareholders, and (iii) carrying-out any reorganizations necessary to facilitate the take-over; and

- fees for the services of a selling agent.

In addition, you have indicated that in some situations, the take-over of, or sale of assets by, Pubco would be completed, while in other cases it would not.

Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and the subject matter of an advance income tax ruling request. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. We are, however, prepared to provide the following comments.

Our comments

Deductibility of Transaction Costs

1) Generally

Paragraph 10 of Interpretation Bulletin IT-99R5 Legal and Accounting Fees dated December 11, 1998 (consolidated December 2000), indicates that the deductibility of transaction costs, including:

- fees of legal, accounting and other consultants relating to the structuring of the transactions;

- the cost of negotiating contracts; and

- the cost of obtaining letters patent, supplementary letters patent, amendments to them, etc.;

is dependent on the nature of the underlying transactions (as income or capital) and the applicability of the provisions of paragraphs 18(1)(a), 18(1)(b), 20(1)(e), or 20(1)(cc), or the definition of "eligible capital expenditure" in subsection 14(5), as the case may be.

Paragraph 2 of Interpretation Bulletin IT-143R2 Meaning of Eligible Capital Expenditure dated August 10, 1983, provides that an eligible capital expenditure, within the meaning of paragraph 14(5)(b), may broadly be defined as an outlay or expense incurred by a taxpayer:

- in respect of a business;

- as a result of a transaction occurring after 1971;

- on account of capital; and

- for the purpose of gaining or producing income from the business.

Further, in paragraph 14 of IT-143R2, the Agency states that expenses relating to incorporation, amalgamation or the reorganization of the corporation's affairs, are eligible capital expenditures if they satisfy the four requirements outlined above.

Whether an expense is incurred for the purpose of gaining or producing income or on account of income or capital is a question of fact to be determined on a case-by-case basis by reviewing all the surrounding circumstances. The Agency has consistently taken the position that transactions costs incurred to fight a take-over bid are incurred for the purpose of maintaining the ownership positions of the existing shareholders, and are not incurred for the purpose of gaining or producing income. Therefore, these expenses are not deductible by virtue of paragraph 18(1)(a) and are not eligible capital expenditures. See, for instance, paragraph 16 of IT-99R5 and the 1989 Revenue Canada Round Table, Question 10.

Although the characterization of an expense as income or capital is a question of fact, the Canadian courts have generally found that expenses incurred to preserve or protect a capital asset, expenses which secure a benefit of an enduring nature or expenses incurred with respect to investment transactions, will be on account of capital. See, for instance, Neonex International Ltd. v. The Queen, 78 DTC 6339 (FCA), D. Morgan Firestone v. The Queen, 87 DTC 5237 (FCA), Graham Construction Engineering (1985) Limited v. The Queen, 97 DTC 342 (TCC) and the cases cited therein.

With respect to an unsuccessful take-over or sale of assets, in the Agency's view, the expenses incurred by Pubco should generally be accorded the same treatment that they would have been accorded had the disposition attempt been successful.

The deductibility of specific expenses is discussed further below.

2) Directors' Circulars

In light of the Federal Court of Canada's decision in Boulangerie St-Augustin Inc. v. The Queen, 97 DTC 5012, affirming 95 DTC 164 (TCC), the Agency has revised its policy with respect to the deductibility of certain take-over bid costs. In Boulangerie, the Court found that legal and accounting fees incurred by the taxpayer to have three directors' circulars prepared, as required by the Quebec Securities Act, were deductible expenses under subsection 9(1) and were not precluded by either paragraphs 18(1)(a) or (b) of the Act.

The Agency's current view is that expenses incurred to meet the target's obligations imposed under a Securities Act and/or Business Corporations Act in producing circulars for shareholders concerning take-over bids would generally be deductible under subsection 9(1) of the Act, provided these expenses are reasonable. These expenses would normally include legal and accounting fees, costs of obtaining fairness opinions (valuation reports), and printing and mailing costs.

Where Pubco fights a proposed take-over, the Agency expects that Pubco will make a reasonable allocation of costs between those required to meet its obligations under a Securities Act and/or Business Corporations Act, which are deductible, and those incurred to put a defence mechanism in place, which the Agency views as non-deductible.

3) Expenses of Disposition

In the case of a completed sale of assets, Pubco may be entitled to deduct, in computing Pubco's capital gain or loss on the disposition of capital property under paragraphs 40(1)(a) or (b), any outlays and expenses to the extent that they were made or incurred by Pubco for the purpose of making the disposition. As indicated in paragraph 14 of IT-99R5, the Agency acknowledges that expenses of disposition may include legal and accounting expenses.

In the case of a sale of shares, Pubco will not be entitled to a deduction under paragraphs 40(1)(a) or (b) as Pubco is not the taxpayer disposing of property.

4) Deductions Under Subsection 20(1)

In the event that a particular expenditure is denied by either paragraphs 18(1)(a) or (b), Pubco may be entitled to a deduction under subsection 20(1). Some of the relevant provisions are further discussed below.

Investment Counsel Fees

Paragraph 20(1)(bb) expressly permits a taxpayer to deduct fees paid for advice on buying or selling a specific share or security or for services in respect of the administration or management of shares or securities of the taxpayer, provided that such fees are paid to a person whose principal business involves providing such advice or services. The Agency is of the view that this provision is applicable to taxpayers seeking to buy or sell, or obtain services, not the corporation whose shares are being sold. Therefore, this provision would not be available in respect of expenses incurred by Pubco on a take-over bid.

Expenses of Issuing Shares

Subparagraph 20(1)(e)(i) provides for the deduction of an amount incurred as an expense, which is not otherwise deductible, in the course of an issuance or sale of shares of the capital stock of the taxpayer. Paragraph 16 of Interpretation Bulletin IT-341R3 Expenses of Issuing or Selling Shares dated November 29, 1995 outlines the type of expenses which would be deductible pursuant to subparagraph 20(1)(e)(i). Included are costs of printing new share certificates and registrar's or transfer agent's fees.

Share Transfer Fees

Subparagraph 20(1)(g)(i) allows a corporate taxpayer to deduct an amount payable in the year as a fee for services rendered by a person as a registrar of or agent for the transfer of shares of the taxpayer.

Benefits

Your second query relates to whether the expenses incurred by Pubco in a take-over or sale of assets would constitute a benefit to the shareholders of Pubco. We have limited our comments to the application of subsections 15(1), 56(2) and 246(1) of the Act.

1) Subsection 15(1)

Subsection 15(1) provides that the amount or value of a benefit conferred on a shareholder by the corporation is required to be included in computing the shareholder's income, except to the extent that the benefit is conferred by any of the items listed in paragraphs (a) to (d) or to the extent that it is deemed by section 84 to be a dividend. Subsection 15(1) applies to benefits conferred on a shareholder or on a person in contemplation of that person becoming a shareholder. Accordingly, in the case of a take-over, the following comments are equally applicable to the shareholders of Pubco prior to the take-over bid, as well the new shareholders of Pubco after a successful take-over bid.

The question of whether corporate-paid expenses constitute a shareholder's benefit under subsection 15(1) depends on whether the expenses were incurred primarily for the benefit of the shareholder, which is a question of fact to be determined on a case-by-case basis.

As outlined in paragraph 14 of Interpretation Bulletin IT-432R2 Benefits Conferred on Shareholders dated February 10, 1995, if an amount paid by Pubco is included in the shareholder's income under subsection 15(1), Pubco would not be entitled to a deduction in respect of that amount in computing its business income.

2) Subsection 56(2) and Subsection 246(1)

The Agency would not normally consider a shareholder of Pubco to have received a benefit under subsection 56(2) in respect of transactions costs paid by Pubco by virtue of the fact that these fees would normally be included in calculating the recipient's business income. Similarly, to the extent a benefit is conferred, the shareholder would likely include the amount in income under subsection 15(1), with the result that subsection 246(1) would not apply.

We trust our comments will be of assistance to you. These comments are provided in accordance with the practice outlined in paragraph 22 of Information Circular 70-6R4, and are not binding on the Agency.

Yours truly,

for Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch