5 June 1997 Internal T.I. 9704727 - SPECIAL WARRANT ISSUE 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 Department.

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

Principal Issues:

Are the issue expenses for Special Warrants deductible pursuant to paragraph 20(1)(e) of the Act

Position:

Yes, as they are incurred in the course of the issuance of shares of the capital stock of the corporation

Reasons:

Based on the facts of the case, as the shares of the corporation were actually issued

			June 5, 1997

	Calgary Tax Services Office	Headquarters
	Business Audit	Financial Industries
			  Division
	Attention:  Paulette Lepine
			7-970472

Special Warrant Issue Costs

This is in reply to your memorandums of February 19, 1997 and February 28, 1997 requesting our comments concerning Special Warrant Issue Costs and their deductibility pursuant to paragraph 20(1)(e) of the Income Tax Act (the "Act").

Facts

XXXXXXXXXX

TSO's Position

Our understanding of your position is that you are proposing to make the following adjustments to XXXXXXXXXX income tax returns:

XXXXXXXXXX

Head Office Opinion

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.

In our opinion, with respect to the issue of deductibility of the expenses pursuant to subparagraph 20(1)(e)(i) of the Act 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 to the 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) of the Act 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 reasonably 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. That is, there must be a clear connection between the amount sought to be deducted and the issuance of the shares.

Pursuant to paragraph 16 of IT-341R3 when a corporation has expenses that are incurred in the course of an issuance or sale of shares in the capital stock of the corporation the following expenses would be deductible in 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 for presentation with, the prospectus;

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

(d) registrars' or transfer agents' fees; and

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

It is our understanding that Special Warrants are issued for cash under a private placement exemption and entitle the purchaser to acquire equity shares or other securities of the issuer upon the exercise of the warrant and upon the clearance of the prospectus. Usually no additional consideration is payable on the exercise of the Special Warrants.

The Special Warrant transaction has been described as follows in O.S.C. Notice number 23 (Ontario Securities Commission):

"While the Special Warrant transaction is, in form, two separate distributions, the first an exempt private placement distribution and the second a conversion of the Warrants under a prospectus, it is the view of the Commission that such a transaction is, in substance, a single distribution under a prospectus of the underlying securities to the Warrant investors. The investors are generally entitled to the return of their purchase price if a prospectus is not filed and receipted, such that they are only ever at risk of being prospectus (and never private placement) investors; even where the issuer is not required to refund the proceeds if a final receipt for a prospectus is not obtained, the issuer is typically required to file a final prospectus, such that there is generally no material risk that financing will not be completed as a prospectus financing."

Pursuant to Black's Law Dictionary, a stock warrant is defined as:

"A certificate entitling the owner to buy a specified amount of stock at a specified time(s) for a specified price. Differs from a stock option only in that options are granted to employees and warrants are sold to the public. A "warrant" is an instrument issued by a corporation giving holder right to subscribe to capital stock of corporation at fixed price either for limited period or perpetually. ..."

In the description of a typical warrant it is noted that it is a certificate which gives the holder the option to purchase shares of the corporation that has issued the warrant. However in the case of Special Warrants this is not the case as each Special Warrant entitles the holder to acquire during a certain period after the issuance of the prospectus, at no additional cost, one Common Share and at the end of the period any unexercised Special Warrants will at such time be deemed to be exercised in full without any further action on the holder's part.

In our opinion, based on the particular facts of this case and in particular that the Special Warrants of XXXXXXXXXX were exercised and the common shares of XXXXXXXXXX were issued, that the expenses incurred in the issuance of the Special Warrants are deductible pursuant to paragraph 20(1)(e) of the Act as they were incurred in the course of an issuance or sale of shares of the capital stock of the corporation.

We have not gone through all the expenses contained in your submission and therefore have no comment on which expenses would be deductible pursuant to paragraph 20(1)(e), as this would be a question of fact.

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