5 March 2003 External T.I. 2002-0151455 - Transaction Costs Incurred by Purchaser

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 various acquisition scenarios

Position: Generally, if the acquisition is successful, the transaction costs incurred by Purchaser would be regarded as capital expenditures and added to the cost amounts of the shares or assets acquired; in the case of an aborted share or asset acquisition, it will be a question of fact whether these expenses will constitute eligible capital expenditures

Reasons: The law

XXXXXXXXXX 2002-015145
Gwen Watson
March 5, 2003

Dear XXXXXXXXXX:

Re: Transaction Costs Incurred by Purchaser

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 various scenarios.

In your hypothetical scenarios, Target and Purchaser are taxable Canadian corporations. Prior to committing to proceed with an acquisition, Purchaser incurs the following expenses in the course of determining whether to acquire the shares or assets of Target:

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

2. Fees paid to investment bankers for commissions and finders' fees.

Subsequently:

Scenario 1: Purchaser decides not to acquire the shares or assets of Target.

Scenario 2: Purchaser decides to acquire the assets of Target.

Scenario 3: Purchaser decides to acquire the shares of Target and will either wind-up Target or amalgamate with Target.

Scenario 4: Purchaser decides to acquire the shares of Target, but will not wind-up Target or amalgamate with Target.

You have asked us to confirm that the costs incurred by Purchaser in each of the foregoing scenarios will be currently deductible in computing business income, on the basis of the principles expressed in Interpretation Bulletin IT-475 Expenditures on Research and Business Expansion, dated March 31, 1981, Bowater Power Company Limited v. MNR, 71 DTC 5469 (FCTD) and Wacky Wheatley's TV & Stereo Ltd. v. MNR, 87 DTC 576 (TCC).

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

The authorities referred to by you generally deal with the deductibility of feasibility studies and similar expenditures to determine whether the taxpayer should expand an existing business. In these instances, the courts and the Canada Customs and Revenue Agency (the "CCRA") have generally taken the position that expenditures of this nature, made as part of the taxpayer's ordinary business operations, will be properly deductible in computing business income. Notably, these authorities have not directly dealt with business expansions by way of the acquisition of shares or assets of another corporate entity. It is our view that expenses incurred by a purchaser corporation to investigate whether to acquire a specific corporation or its business will generally be considered to be on capital account, notwithstanding that the expenses are incurred prior to any firm commitment on behalf of the purchaser corporation to proceed with an acquisition (see, for instance, Neonex International Ltd. v. The Queen, 78 DTC 6339 (FCA) and D. Morgan Firestone v. The Queen, 87 DTC 5237 (FCA)).

Our views regarding the specific tax consequences arising in each of your hypothetical scenarios are further detailed below.

Scenario 1:

As detailed in technical interpretation 2002-015140, in the case of an unsuccessful take-over, the costs incurred by the purchaser will normally be afforded the same treatment, as income or capital, which they would have been accorded had the acquisition attempt been successful. Accordingly, the expenses incurred by Purchaser will be regarded as being on account of capital notwithstanding that Purchaser did not proceed with the acquisition.

The question of whether these fees could qualify as eligible capital expenditures was also addressed in technical interpretation 2002-015140, as follows:

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 with respect to 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.

Scenario 2:

The CCRA generally takes the view that costs incurred by Purchaser in the course of a successful acquisition of assets will be capital expenditures that should be allocated between the costs of the various assets acquired, using a reasonable basis for such allocation.

Scenario 3 and 4:

Likewise, the CCRA generally takes the view that costs incurred by Purchaser in the course of a successful take-over will be capital expenditures that should be added to the cost of the shares so acquired. This would be the case irrespective of whether Purchaser intended to wind-up or amalgamate with Target after the acquisition of shares.

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