Rio Tinto Alcan Inc. v. The Queen, 2016 CCI 172
The Tax Court of Canada has decided that fees paid by a bidder to investment bankers for advice that assists the bidder in assessing whether or not a bid should be made are fully deductible. The Court distinguished between expenses incurred for services to assist the board of directors of the bidder in its decision-making process and in the fulfillment of its oversight function ("Oversight Expenses"), and fees for services that facilitate the execution of a capital transaction (the acquisition of the target) ("Execution Expenses").
Oversight Expenses were held by the Court to be deductible under both subsection 9(1) and paragraph 20(1)(bb) of the Income Tax Act (Canada). Execution Expenses are to be added to the cost of the shares of the target acquired by the bidder. Subsection 9(1) is the profit computation provision and paragraph 20(1)(bb) allows for the deduction of investment advisory fees (subject to certain conditions being met), even if such fees are capital expenditures.
This is a welcome development and clarification by the Court.
The Canada Revenue Agency has long taken the position that such investment banking fees incurred by a bidder were non-deductible capital expenses, all of which form part of the cost of the shares of the target acquired by the bidder.
The rationale of the Court in allowing the deduction of Oversight Expenses as current expenses was that they relate to the management of a corporation's income-earning process, which includes the allocation or reallocation of capital for the purpose of maximizing the income earned by the corporation. The Court noted that ineffective oversight over the capital allocation process is a formula for disaster that often leads to a decline in earnings and cash flow and, as a result, the destruction of shareholder value. In this context, Oversight Expenses serve an income-earning purpose.
The Court noted that Oversight Expenses do not create enduring benefits for taxpayers (the hallmark of a capital expenditure). Rather, it is the actual implementation of an approved capital transaction that creates the enduring benefit. Consequently, advice given to the board of directors to assist it in the decision-making process undertaken as part of the exercise of the board's oversight function are deductible as current expenses, in contrast with expenses incurred as part of the implementation of a transaction leading to the acquisition of capital property. To ascertain such distinction, the Court looks at the primary purpose of the work performed. Was the work commissioned primarily to assist in the oversight or management process, or was it primarily linked to the implementation of a transaction carried out on capital account?
Given the different tax treatment of Oversight Expenses and Implementation Expenses, bidders will want to clearly identify in retainer/engagement agreements with investment banks the particular services to be performed and the fee to be paid for such services. To the extent such services are provided to the bidder to assist in its decision-making process of whether to proceed with a bid (and the terms of such bid), the fee for such services should be clearly identified (to the extent possible). This will aid the bidder is substantiating the deduction of such fees.
Where Oversight Expenses are incurred in circumstances where a bid is not made or is not successful, such expenses should also be fully deductible. In such a case, Execution Expenses, if any, should likely be treated as eligible capital expenditures (75% of which are deductible on a 7% declining balance basis until the end of 2016, after which such expenses will be a new depreciable property class, deductible at a 5% annual depreciation rate).
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