5 March 2003 External T.I. 2002-0151405 - Transaction Costs - Aborted Acquisition

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 incurred by Purchaser in respect of aborted share or asset acquisition

Position: Generally, the transaction costs incurred by Purchaser would be regarded as capital expenditures; it would be a question of fact whether these expenses would constitute eligible capital expenditures

Reasons: The law

XXXXXXXXXX 2002-015140
Gwen Watson
March 5, 2003

Dear XXXXXXXXXX:

Re: Transaction Costs - Aborted Acquisition

This is in reply to your letter of June 28, 2002, wherein you requested our views regarding the tax treatment, under the Income Tax Act (Canada) (the "Act"), of certain fees incurred in connection with an aborted purchase of shares or assets.

In your hypothetical scenario, Target and Purchaser, two taxable Canadian corporations, entered into an agreement whereby Purchaser has agreed to acquire either the shares or assets of Target. After entering into this agreement, Purchaser incurs the following expenses:

1. Fees paid to lawyers and accountants for due diligence of Target, advice on the implications to Purchaser of acquiring either the assets or shares of Target and advice on structuring the acquisition; and

2. Fees paid to investment bankers for commissions, finders' fees, deal structuring advice and negotiation assistance.

Based on the results of the due diligence and other investigations, Purchaser does not complete the acquisition of either the shares or assets of Target.

You have asked us to confirm that the costs incurred by Purchaser in respect of the aborted share or asset acquisition will be currently deductible in computing business income, on the basis of the principles expressed in Bowater Power Company v. MNR, 71 DTC 5469 (FCTD) and Kruger Pulp & Paper Ltd. v. MNR, 75 DTC 245 (TRB), or alternatively, that these expenses will be treated as an eligible capital expenditure and deductible under paragraph 20(1)(b).

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are 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. However, we are prepared to provide the following comments.

Our Comments

In Bowater and Kruger Pulp, the taxpayers incurred expenses in the course of investigating expansion opportunities relating to an existing business, which plans were eventually abandoned by the taxpayer. In each case, the court found that the expenses were deductible.

In our view, the principles expressed in the foregoing cases do not extend to situations involving the acquisition of a separate business or business entity. Normally, costs incurred by the purchaser in the course of a successful take-over, whether by way of the purchase of shares or assets, will be capital expenditures. In addition, in the case of an unsuccessful take-over, these costs will generally be accorded the same treatment, as either income or capital, which they would have been accorded had the acquisition attempt been successful. It is our view that these positions are supported by the cases of Brooke Bond Foods Ltd. v. The Queen, 84 DTC 6144 (FCTD), Neonex International Ltd. v. The Queen, 78 DTC 6339 (FCA), D. Morgan Firestone v. The Queen, 87 DTC 5237 (FCA) and Graham Construction Engineering (1985) Limited v. The Queen, 97 DTC 342 (TCC) (see also paragraph 16 of Interpretation Bulletin IT-99R5 Legal and Accounting Fees, consolidated in December 2000 and Question 2 from the Round Table at the 1999 Canadian Petroleum Tax Conference). Accordingly, the costs incurred by Purchaser in your hypothetical scenario will not be currently deductible by virtue of paragraph 18(1)(b), notwithstanding that the acquisition attempt was not successful.

With respect to your second question, paragraph 2 of Interpretation Bulletin IT-143R3 Meaning of Eligible Capital Expenditure dated August 29, 2002 describes an eligible capital expenditure as an outlay or expense made or incurred by a taxpayer:

(a) in respect of a business;

(b) as a result of a transaction occurring after 1971;

(c) on account of capital; and

(d) for the purpose of gaining or producing income from the business (whether or not income from the business was actually produced by such outlay or expense).

Further, in paragraph 23 of Interpretation Bulletin IT-143R3, the Canada Customs and Revenue Agency (the "CCRA") indicates that normally, the purpose test in paragraph (d) will not be satisfied where the fees are incurred in respect of aborted attempts to acquire shares. However, the CCRA will accept that these fees qualify as eligible capital expenditures if the taxpayer can demonstrate that the taxpayer intended to make the business of the target corporation part of a similar business that the taxpayer already operated, with the term "similar business" to be interpreted in accordance with the views set out in Interpretation Bulletin IT-259R3 Exchanges of Property dated August 4, 1998. As indicated in Question 35 of the Round Table at the 1999 Annual Conference of Quebec Region Technical Advisers, the CCRA will generally accept that a taxpayer intended to make the business of the target corporation part of a similar business where the taxpayer planned to amalgamate with, or wind-up, the target corporation after the acquisition. In any other case, it would remain a question of fact as to whether the taxpayer satisfies the similar business test expressed above.

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 70-6R5, and are not binding on the CCRA.

Yours truly,

Mark Symes
Section Manager
for Division Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch