Contract or Option Cancellation

Cases

Imperial Tobacco Canada Limited v. Canada, 2012 DTC 5003 [at 6508], 2011 FCA 308

option cash surrender payments made in course of capital reorganization

The taxpayer's predecessor ("Imasco") agreed with the owner of 42.5% of its common shares ("BAT") that it would encourage all the holders of options under the taxpayer's employee stock option plan to exercise or surrender their options on the acquisition by a Canadian subsidiary of BAT of all the other common shares of the taxpayer; and in this regard the taxpayer amended the plan to permit option holders to surrender their options for cash and to provide for accelerated vesting of unvested options.

Sharlow J.A. stated (para. 29):

In my view, there are three factors that point to the conclusion that the payments in issue were on capital account. First, they coincided with a reorganization of the capital of Imasco (the going private transaction and amalgamation). Second, the arrangements put in place for making the payments facilitated and were intended to facilitate the capital reorganization. Third, the payments were intended to and did end all future obligations of Imasco to deal with its own shares, which can fairly be described as a once and for all payment that resulted in a benefit to Imasco of an enduring nature.

The Queen v. Kaiser Petroleum Ltd., 90 DTC 6603 (FCA)

In an agreement between the U.S. parent of the taxpayer and Kaiser Resources Ltd. for the sale by the U.S. parent of shares of the taxpayer to Kaiser Resources Ltd. for $33.50 per share, it was agreed that the U.S. parent would cause the taxpayer to offer to pay to each employee holding employee stock options the difference between $33.50 per share and the exercise price in order to obtain the cancellation of such options. The payment of such amounts by the taxpayer was held to be a disbursement that was made as a "once and for all payment which had a direct effect on the capital structure of the corporation" and, accordingly, was a capital expenditure.

Angostura International Ltd. v. The Queen, 85 DTC 5384, [1985] 2 CTC 170 (FCTD)

An amount of $500,000 paid in order to secure the surrender by the payee distributor of its rights to distribute aromatic bitters and alcoholic mixes was held to be "a relatively transitory or short-term revenue expenditure made in the ordinary course of the plaintiff's income-earning enterprise", and thereby deductible. The distributorship agreements in question were terminable on short notice (one year or three months) and the taxpayer did not acquire by virtue of the cancellation agreement the distributorship network of the payee, or any other advantage of an enduring character.

Bomag (Canada) Ltd. v. The Queen, 84 DTC 6363, [1984] CTC 378 (FCA)

The vendor of the assets of an earth compaction machine manufacturing business shortly after executing the asset sales agreement entered into a "consulting and sales agency" agreement with the purchaser wherein it was agreed that the vendor would be retained as a consultant to the purchaser and be paid a commission of $2,000 for each of 10 earth compaction machines when the purchaser sold them. Half a year later (when none of the 10 machines had yet been sold) the vendor was paid $20,000 for a general release from all claims against the purchaser.

It was found that although the consulting and sales agency agreement had a term of only 1 year and the vendor was entitled to its commission regardless whether it participated in the sale of the 10 machines or not, there was nothing in the consulting and sales agency agreement which would "lead the reader thereof to conclude that its true nature was to provide [the vendor] with additional consideration for the sale of its assets." The $20,000 payment accordingly was made "to terminate a sales agency agreement and the commissions payable thereunder" rather than "being the purchase of an enduring benefit by way of the acquisition of a business structure."

Payments made to secure the surrender of a franchise so that the taxpayer could become the franchisee were made on capital account.

Canada Forgings Ltd. v. The Queen, 83 DTC 5110, [1983] CTC 94 (FCTD)

Large payments, made to chief executives of Canada Forgings in return for the surrender by them of their employee stock options, were not deductible to Canada Forgings because they were made in order to ensure that no minority shareholdings in Canada Forgings would arise following the acquisition of all its shares by another company, and not as a bonus in respect of services performed by the executives.

Sunshine Mining Co. v. The Queen, 75 DTC 5126 (FCTD)

Damages (including interest) paid by the taxpayer as a consequence of its failure to perform exploration work under an agreement to earn one-half interests in mining properties were on capital account given that the true nature of the monies paid was, in effect, the purchase price for the one-half interests it would have received if it had performed the work.

Automatic Toll Systems (Canada) Ltd. v. MNR, 74 DTC 6060, [1974] CTC 30 (FCTD)

The taxpayer agreed to pay a company owned by an individual ("Bastien") with political connections a fee equal to 10% of all sales or rentals secured by the company during a six-year period from the Quebec Autoroute Authority. When the Lesage government fell in 1966, Bastien lost his influence and the taxpayer sought to relieve itself of the obligation to pay commissions under a major anticipated contract with the authority, which the taxpayer was negotiating itself.

A $60,000 payment made by the taxpayer to Bastien's company (effected through a "mechanism", suggested by Bastien, of purchasing certain shares and leases) was fully deductible on the authority of the Anglo-Persian case.

Locations of other summaries Wordcount
Tax Topics - General Concepts - Substance 78

Dymo of Canada Ltd. v. MNR, 73 DTC 5171, [1973] CTC 205 (FCTD)

When the taxpayer decided to itself distribute one of its product lines it agreed with the sole distributor of the line (which did not have an exclusive agency) that it would pay the distributor over four years an amount equal to the gross margin of the distributor for a six month period, that the distributor would sell its trade receivables to the taxpayer for their value and would provide its customer lists and a non-compete covenant. In light of the non-exclusive character of the agency arrangement and the fact that the taxpayer already knew who were the customers, Walsh, J. held that the "appellant by the agreement acquired no rights or advantages of an enduring nature which it did not already have, nor did it benefit from the elimination of a competitor since it had at all times the right to cancel the agreement with the [distributor] which was not for a fixed term." The payments were deductible.

Johnston Testers Ltd. v. MNR, 65 DTC 5069 (Ex Ct)

The taxpayer, an oil well testing company, paid $146,000 to the holders of patents which it had been licensed to use for an extended period in consideration for periodic royalties but which were no longer useful to it because it was now using an improved tool of its own invention. In finding that the payment was deductible, Gibson J. found that the true purpose of the payment (p. 5075):

"was not to get rid of a capital asset (which was a mere incidental result), but instead it was to get rid of an onerous annual expense in respect to a business that it proposed to and did carry on, and such payment was made in the course of such continuing business; and that as a result no advantage or benefit either positive or negative accrued to the capital account of the appellant ..."

Bedford Overseas Freighters v. MNR, 59 DTC 1008 (Ex. Ct.)

decided concurrently with Halifax Overseas Freighters Ltd. v. MNR, 59 DTC 1013 (Ex. Ct.) and Falise Steamship Co. Ltd. v. MNR, 59 DTC 1016 (Ex. Ct.)

When a vessel of the taxpayer ceased to be operational due to a need for major repairs, the taxpayer agreed with the charterer to cancel the charter party in consideration for the payment by the taxpayer of $130,203.44, thereby eliminating potential substantial claims by the charterer. In finding the deduction of the sum was not prohibited by ss.12(1)(a) and (b) of the pre-1972 Act, Dumoulin J. rejected a submission of the Crown that the sum should be viewed as having been laid out to acquire a fixed asset (noting at p. 1012 that the taxpayer "never parted with their ownership but merely with the temporary management and use of the steamer") and noted that deductibility was not affected by the fact that the outlay was reducing a potential loss rather than reducing profit (noting at p. 1013 that "a forfeit payment of this nature is a normal risk integrated with appellant's regular marine operations").

British Columbia Electric Railway Company Limited v. The Minister of National Revenue, 58 DTC 1022, [1958] CTC 21, [1958] S.C.R. 133

Payments totalling $220,000 which the taxpayer made to various municipalities in order to obtain their acquiescence to its application to effectively terminate its obligation to provide passenger railway service in the area and instead provide bus service, were non-deductible capital expenditures. Locke J. stated (at p.1026):

"The franchises held by the appellant ... were capital assets. The payments in question were made to obtain relief from the obligation to maintain passenger service, an obligation which was resulting in heavy annual losses to the company, and the relief obtained ... substantially increased the value of the franchises to the appellant."

See Also

Shoppers Drug Mart Limited v. The Queen, 2008 DTC 2043, 2007 TCC 636

Various employees of the taxpayer had been granted stock options by the taxpayer's parent ("Imasco"), a public corporation, and the option plan had been amended to provide that the employees could surrender their options for a cash payment equal to the options' accrued value. After Imasco had agreed with another corporation to support a transaction under which the other corporation would acquire the common shares of Imasco held by the public and cause a going-private transaction to occur, Imasco accelerated the vesting of the options and agreed with the taxpayer that the taxpayer would reimburse Imasco for an amount equal to all cash payments made by Imasco to employees who surrendered their options.

In finding that the payment in excess of $54 million so made by the taxpayer was not a capital expenditure, Bowman C.J. stated (at para. 22) that:

"I start from the premise that in the ordinary course a payment made by an employer to an employee for the surrender of his or her option under a stock option plan to acquire shares of the company is a deductible expenses to the company."

and (at para. 31):

"The fact that a subsidiary reimburses its parent for compensation paid to the subsidiary's employees does not turn the payment into a capital expenditure just because the parent company is in the midst of a corporate reorganization."

Bowman C.J. noted (at para. 33) that the Kaiser case was distinguishable on the basis that in this case there was no "reshaping of the capital structure" of the taxpayer.

Dubois c. La Reine, 2007 DTC 1534, 2007 TCC 461 (Informal Procedure)

In finding that legal fees incurred by the taxpayer as a result of her cancellation of an agreement to purchase a building were capital expenditures, Paris J. stated (at para. 21):

"If the Appellant in the case at bar had completed the purchase of the building, its price would certainly have been a capital expenditure. The amount that she paid to get release from her obligation to purchase the building is therefore closely tied to what would have been a capital asset, and its character would be the same."

Shuchat v. MNR, 61 DTC 119 (TAB)

The taxpayer paid $10,000 to a tenant for the agreement of the tenant to vacate the premises. As a result the taxpayer was able to lease the vacated space to another tenant at more than double the previous rent.

Mr. Fordham found that the payment was deductible notwithstanding s. 12(1)(a) of the pre-1972 Act given that "a lease is simply a particular form of contract" and, therefore, contract-cancellation cases such as Halifax Overseas Freighters Ltd. v. MNR, 59 DTC 1013 (Ex. Ct.) should be binding.

Vodafone Cellular Ltd. v. Shaw, [1997] BTC 247 (C.A.)

The taxpayer made a lump-sum payment to terminate an agreement under which an American company agreed to supply the taxpayer from time to time at its request with future know-how in consideration for an annual fee equal to 10% of the taxpayer's consolidated pre-tax profits for 15 years. After noting (at p. 250) the prima facie presumption that a lump sum commutation of recurring revenue payments is itself a revenue payment and (at p. 251) the exception from this presumption where "the liability to make recurring revenue payments is reduced or brought to an end by the modification or disposal of an identifiable capital asset", he then stated (at p. 253):

"Expenditure to acquire future know-how is paid to obtain a service; it is not made to acquire an enduring asset, but a commodity which is turned over or exploited in the course of trade at a comparatively early date."

Baker Lovick Ltd. v. MNR, 91 DTC 1041 (TCC)

The taxpayer, in order to sublet the portion of its Calgary office space which was excess to its needs, paid an inducement payment of $157,806 to the subtenant, a lease agent's commission of $23,325 and legal fees of $7,972. Taylor J. found that these payments were deductible because they were made "in order to reduce its ongoing obligation to the landlord to pay rent for the excess space" (p. 1043). On the other hand, a commission paid by the taxpayer to a real estate agent in order to locate Toronto leasehold premises for it was a capital expenditure.

J. Gadsden & Co. Ltd. v. C.I.R. (N.Z.) (1964), 14 A.T.D. 18 (N.Z.S.C.)

The taxpayer, which had agreed to pay a royalty to an American company in consideration for the provision by the American company of technical knowledge and of plans on an on-going basis, was entitled to deduct a payment made by it in consideration for the cancellation of the agreement. The cancellation became desirable after the taxpayer's merger with another company which had its own technical assistance agreement with another overseas company.

Gresson J. found that the lump sum "was merely a commutation of a recurring annual expenditure, and thus was entitled to be treated as an ordinary business expense. It was approximately the actuarial equivalent in value of the residual annual royalty obligation, and it was identical in character" (p. 24) and that the elimination of the contract "left the capital structure of the appellant unaffected" (p. 25).

A. Leon Company Limited v. MNR, 61 DTC 517 (TAB)

Payments made by a dealer in furniture and home furnishings to landlords for the termination of the leases for two of its unprofitable stores were fully deductible when paid by it.

Ablan Leon Limited v. MNR, 61 DTC 519 (TAB)

Among the liabilities assumed by the taxpayer on taking over the business of a predecessor was the obligation to continue making lease termination payments. Because this obligation was assumed in connection with the purchase of a business, the associated payments were non-deductible capital expenditures.

West African Drug Co., Ltd. v. Lilley (1947), 29 TC 140 (K.B.D.)

The taxpayer was obligated under the terms of its lease of premises that had been used by it for a pharmacy in Accra to continue paying the rent of £490 per year for the remaining 12 years of the lease even though those premises were entirely destroyed by an earthquake, and to rebuild the premises. In confirming a finding of the Commissioners that the taxpayer was not entitled to deduct the sum of £3,000 that it had paid for the cancellation of this lease, Atkinson J. stated (at p.146):

"The payment was made in order to get rid of a burdensome capital asset. It was not made merely in order to commute certain annual revenue payments."

W. Nevill & Co. Ltd. v. Federal Commissioner of Taxation (1937), 4 A.T.D. 187 (HC)

In finding that instalments of a lump sum payment made by the taxpayer to a joint managing director in consideration of his cancelling his employment agreement with the company were expenditures of a capital nature, Dixon J. stated (at p.197) that the lump sum:

"... was made for the purpose of organising the staff and as part of the necessary expenses of conducting the business. It was not made for the purpose of acquiring any new plant or for any permanent improvement in the material or immaterial assets of the concern. The purpose was transient and, although not in itself recurrent, it was connected with the ever recurring question of personnel."

Anglo-Persian Oil Co., Ltd. v. Dale (1931), 16 TC 253 (C.A.)

The taxpayer, which had entered into a long-term agreement with another company for it to act as the taxpayer's agent in managing its business in Persia and the East and to carry out sales of its petroleum products there, obtained the cancellation of this agreement on the payment of £300,000 to the agent. The payment was charged to revenue in five annual deductions of £60,000.

In finding that the agency contract did not form part of the fixed capital of the taxpayer, with the result that the amount paid was deductible notwithstanding contrary finding of the Commissioners, Lawrence L.J. noted that (p. 269):

"It is not open to doubt that under ordinary circumstances where a trader, in order to effect a saving in his working expenses, dispenses with the services of a particular agent or servant, and makes a payment for the cancellation of the agency or service agreement, such a payment is properly chargeable to revenue."

He also noted that the sum, although large, nonetheless was small in relation to the annual profits of the Company. In addition, as noted by Romer L.J., given that the effect of the arrangement was to replace one agent by others, the "business of the Company continued exactly as it was before the change" (p. 276).

Mallett v. Staveley Coal and Iron Co., Ltd. (1928), 13 TC 772 (C.A.)

In finding that lump sums paid by a colliery company in order to secure a reduction in the scope of (in one case) or the cancellation (in the other case) of two mining leases (and thereby release its liability to restore the surface) were on capital account, Lawrence L.J. first noted (at p. 787) that the company's trade did not consist of acquiring mining leases and selling those mining leases but, rather, of the winning and selling of coal, and then stated (at p. 788):

"... it cannot, in my opinion, reasonably be said that the consideration paid for and the acceptance of the surrender was a sum wholly and exclusively expended for the purpose of winning and selling the coal in which the Company traded. In substance and in fact it was a sum paid for the purpose of getting rid of the capital asset of the Company which had become burdensome to the Company."

Sargant L.J. characterized (at p. 786) one of the payments as "being made for the purpose of putting an end to the existence of a disadvantage or onerous asset for the enduring benefit of the trade" and the other payment as being "made for the purpose of modifying the conditions of an existing asset so as to make the resulting term more advantageous or less disadvantageous for the enduring benefit of the trade."

B.W. Noble, Ltd. v. Mitchell (1927), 11 TC 372 (CA)

Although the taxpayer, which was an insurance and reinsurance broker, had cause to dismiss one of its directors, and to require him to transfer his valuable shares to the other directors for their nominal par value, the taxpayer did not dismiss him in order to avoid the possibility of public scandal. A substantial sum which the taxpayer agreed to pay to the director in five annual instalments in order to secure his retirement was found not to be a capital expenditure for purposes of Rule 3(f). The payments were made not to secure an actual asset but in order to avoid a detriment to the continued conduct of its existing trade, and they did not have a once-and-for-all character because they in no way ensured that a similar incident would not occur in the future.

Royal Insurance Co. v. Watson (1896), 3 TC 500 (HL)

The agreement for the sale of the business of The Queen Insurance Company ("Queen") to the taxpayer provided that the taxpayer was to retain the services of the current manager of Queen at a salary of £4,000 per annum subject to a right of the taxpayer to commute the salary. In the event, a commutation payment of £55,846 was made by the taxpayer to the manager shortly after the purchase of the business. This payment was characterized as part of the consideration which the taxpayer was required to pay for the business of Queen, with the result that it was found to be a capital expenditure.

Administrative Policy

31 March 2011 Internal T.I. 2011-0291701I7 -

Payments made by a public company which was the target of a takeover bid in paying employees to surrender vested stock options were capital expenditures in light of Imperial Tobacco and Kaiser.

12 July 2011 Internal T.I. 2010-0366321I7 - Tax treatment of break fees received

In indicating that a break fee arguably should be included in income under the surrogatum principle (in addition to being so included on alternative grounds), CRA suggested that the break fee arguably is compensation for the transaction and opportunity costs that the bidder incurred "on current account" and wasted because its takeover bid failed.

27 January 2004 Internal T.I. 2003-004476 -

A REIT which previously had entered into an advisory agreement with a company and its shareholders for the provision to it by them of advisory services was permitted to deduct that portion of a lump sum payment (satisfied, in part, by the issuance of REIT units) that was determined to be in respect of the elimination of the obligation to make future advisory fee payments. Although key employees of the company were contemporaneously hired (and minor capital assets were acquired), the termination agreement did not identify the termination payments as being for the acquisition of know-how or other intangible property.

12 June 2003 Internal T.I. 2003-001100 -

As a result of selling a business the taxpayer was no longer able to fulfill its obligations under a supply contract and negotiated a termination of the contract in consideration for the payment by it of a termination fee. The fee paid was on capital account given that it was made in relation to the cessation of a business of the taxpayer. However, the taxpayer would be allowed to treat the termination payment as an eligible capital expenditure.

14 November 2000 External T.I. 2000-004835 -

The position of the Agency that an employer may deduct a payment it elects to make instead of issuing shares pursuant to the exercise by an employee of an employee stock option is consistent with the Kaiser case (90 DTC 6603).

Locations of other summaries Wordcount
Tax Topics - Income Tax Act - Section 7 - Subsection 7(3) - Paragraph 7(3)(b) employer option to pay cash 143

9 November 2000 External T.I. 2000-004820 -

S.7(3) would apply to deny the deduction to a Canadian corporation of the cost of acquiring shares of its U.S. parent for sale to its employees under a stock option plan.

1996 Ruling 3-961895 -

At the time a corporate employer enters into negotiation for the sale of all its assets to an arm's length purchaser, it amends its employee stock option plan to permit the employees, at their option, to receive the economic value of their options in cash rather than only being able to exercise their options. CCRA rules that ss.7(3)(b), 18(1)(a), 18(1)(b) and 67 will not apply to deny deduction to the employer with respect to any amounts paid in cash as a result of an option holder's election to receive the economic value of the stock options.

IT-467R "Damages, Settlements and Similar Payments"

Where amounts originally payable under a contract would have been deductible, amounts paid to settle that contract will also generally be deductible.

89 C.M.TC - "Leasing Costs"

general discussion; an amount paid in the ordinary course of a property rental business to a non-anchor tenant is on income account; special exceptions re agency-type payments, reversions of improvements to landlord and take-overs of a tenant's previous lease obligations.

IT-359R2 "Premiums and Other Amounts With Respect to Leases"

15. An amount a tenant pays to cancel a lease or sublease is deductible by the tenant in computing income from a business or property provided the rent is so deductible.

An amount paid to obtain or extend a lease generally is made on capital account. In the case of a landlord, an amount paid to obtain cancellation of a lease generally is on income account.

Articles

Krasa, "The deductibility of fines, penalties, damages, and contract termination payments", November - December 1990 Canadian Tax Journal, p. 1399.

Dunbar, "Employers may be Precluded from Deducting Severance Payments", Taxation of Executive Compensation and Retirement, December 1989/January 1990

Discussion of deductibility of golden parachutes.