26 July 1996 Internal T.I. 9615787 - PROFESSIONAL FEES AND THEIR DEDUCTIBILITY

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 Department.

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

Principal Issues: Professional Fees and their Deductibility

Position:

Reasons: 20(1)(e)

			July 26, 1996

	Toronto TSO	Headquarters
	Albert Leung	Financial Industries
	443-2-2			  Division
	9-375
			7-961578

Professional Fees and costs on Information circular for restructuring of shares

This is in reply to your memorandum of April 25, 1996 requesting our advice and guidance as to whether the expenses incurred by the taxpayer in cancelling the dividend rights of the multiple voting shares by the issuance of a one-time special stock dividend to the MVS shareholders are deductible for tax purposes.

Facts

XXXXXXXXXX

XXXXXXXXXX

Issues

Are the costs incurred by XXXXXXXXXX deductible for tax purposes under paragraph 20(1)(e) or 20(1)(g) of the Income Tax Act (the "Act")?

Should the costs incurred by XXXXXXXXXX be allowable as eligible capital expenditure in accordance with subsection 14(5) of the Act.

Audit's Position

It is your opinion that the costs were incurred for the benefit of the MVS and especially the SVS shareholders and were not for the purposes of earning income from business or property for the following reasons:

1.They were incurred to reduce the complexity of the current structure of XXXXXXXXXX with a view to reducing the discount at which SVS generally trade relative to the underlying fair value of the Corporation's assets and improving market liquidity.

2.Permanently settling the economic rights of the MVS.

You are then of the opinion that XXXXXXXXXX is prohibited by paragraph 18(1)(a) and 18(1)(b) of the Act from claiming an expense and that they do not qualify under subsection 14(5) of the Act as an eligible capital expenditure.

Head Office Opinion

Paragraph 20(1)(e) of the Act

Paragraph 20(1)(e) of the Act provides that a taxpayer can deduct an amount for certain expenses that are incurred in the course of:

(i)an issuance or sale of

-shares in the capital stock of a corporation by the corporation,

- units in a unit trust by the unit trust,

- interests in a partnership by the partnership, or,

- interests in a syndicate by the syndicate.

With respect to the issue of deductibility of the expenses pursuant to 20(1)(e)(i) there are in effect two tests that have to be met. The first one is that the expenses must be "in the course of an issuance ...of shares of the capital stock of the taxpayer". The phrase "in the course of" was looked at by the courts in the Yonge-Eglinton Building Ltd. 74 D.T.C. 6180 (F.C.A.) case where the court stated "What appears to me to be the test is whether the expense, in whatever taxation year it occurs, arose from the issuing or selling or borrowing. It may not always be easy to decide whether an expense has so arisen but it seems to me that the words "in the course of" in section 11(1)(cb) are not a reference of time when the expenses are incurred but are used in the sense of "in connection with" or "incidental to" or "arising from" and refer to the process of carrying out or the things which must be undertaken to carry out the issuing or selling or borrowing for or in connection with which the expenses are incurred."

In addition to the above test, the expenses must meet the additional test imposed by the preamble to subsection 20(1) which is, "... 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 be regarded as applicable thereto...". As such, the expenses incurred must be wholly applicable to the issuance of the shares and not be only consequential or resulting from the issuance of the shares.

When a corporation enters into a transaction that results in the issuance or sale of shares of its capital stock, the following expenses would be deductible, pursuant to 20(1)(e)(i) of the Act, in computing income for the year in which they are incurred:

(a)legal fees in connection with the preparation and approval of a prospectus pertinent to the issuance or sale of shares, units, or interests;

(b)accounting or auditing fees in connection with the preparation of reports on financial statements and statistical data for inclusion in, or presentation with the prospectus.

(c)the cost of printing the prospectus, new share, unit, or interest certificates, etc;

(d)registrars' or transfer fees; and

(e)filing fees charged by any public regulatory body which requires the filing of a prospectus for acceptance.

You have brought forward the argument that the costs were incurred for the benefit of the MVS and especially the SVS shareholders and were not incurred for the purpose of earning income from business or property. In our opinion there does not have to be a general corporate purpose to meet the criteria in subparagraph 20(1)(e)(i) of the Act.

This position is confirmed in paragraph 13 of IT-341R3 in which we state:

"For expenses to qualify under paragraph 20(1)(e), in connection with the issuance or sale of shares, it is not necessary for the taxpayer to obtain additional capital by the issuance or sale of shares. For instance, a taxpayer may incur deductible expenses under paragraph 20(1)(e) in a capital reorganization when shares of one or more new share classes are substituted for shares of one or more old share classes."

It is therefore our opinion that only the expenses directly related to the issuance of the shares in the stock dividend are deductible pursuant to subparagraph 20(1)(e)(i) of the Act. We have not gone through the expenses and therefore have no comment on which expenses or what portion of these expenses directly relate to the issuance of shares as this is largely a question of fact which will have to be determined upon your examination of the expenses.

Paragraph 20(1)(g)

Pursuant to paragraph 20(1)(g)(iii) a corporation may deduct "an expense 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 the report".

The definition of financial report in the context of paragraph 20(1)(g)(iii) was recently looked at by the courts in Boulangerie St-Augustin Inc. 95 DTC 164 in which it was stated "I believe that the definition of "annual report" given by Black's Law dictionary corresponds most closely to this notion of "financial report" contemplated by this paragraph. This is a report addressing a corporation's financial situation, generally including financial statements and officers' comments on the corporation's activities."

We are of the opinion that directors' circulars are not financial reports. In our view a financial report only includes reports which inform of the ongoing results of a company's operations.

Although it is a question of fact, based on the information enclosed with your request, it would appear that the Joint Information Circular would not meet the definition of a "financial report" for purposes of paragraph 20(1)(g)(iii) and that no expenses incurred in the course of printing and issuing the Joint Information Circular would be deductible pursuant to paragraph 20(1)(g)(iii) of the Act.

Eligible Capital Expenditure

In order for an expense to be an eligible capital expenditure it must meet the definition contained in subsection 14(5) of the Act which states "... the portion of any outlay or expense made or incurred by the taxpayer, as a result of a transaction occurring after 1971, on account of capital for the purpose of gaining or producing income from the business, other than any such outlay or expense ..."

Therefore for an expense to be considered to be an eligible capital expenditure it has to be incurred on account of capital, in respect of a business and 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). As noted in the incoming letter, you are of the opinion that the expenses were incurred for the benefit of the MVS and especially the SVS shareholders and were not incurred for the purposes of earning income from business or property. Based on the limited information sent to us, we would agree with the assessment that the expenses were incurred to enhance the SVS shareholder value and were incurred on account of capital; that is the expenses have everything to do with the capital of structure of the company and nothing to do with the ongoing running of the company's day-to-day operations. As such, it would appear that these expenses would not meet the criteria of eligible capital expenditure as they were not incurred for the purpose of gaining or producing income from the business. This position is confirmed by the court case Her Majesty The Queen v. Jager Homes Ltd. and Jager Holdings (Calgary) Ltd. 88 DTC 6119 in which the court found that the legal fees were incurred to preserve the business entity, structure or organization of the taxpayers. They were not the kinds of expenditures which are made to earn profits from the operation of such business entities. The legal fees were on account of capital and therefore not deductible.

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch