In Morguard Corporation v. The Queen, 2012 TCC 55, Justice Boyle of the Tax Court of Canada considered whether a "break fee" received by a predecessor of the Appellant (for the purposes of this discussion, the "Appellant") in respect of its unsuccessful attempted acquisition of a public corporation, was received on account of income or capital (there was also a procedural issue that will not be discussed in this post). Based on the approach set out in Ikea Ltd. v. Canada, [1988] 1 SCR 196, 98 DTC 6092, affirming 96 DTC 6526 (FCA) and 94 DTC 1112 (TCC), Justice Boyle concluded that, on the facts, a break fee such as the one received by the Appellant was taxable on account of income because the negotiation and inclusion of break fees in the Appellant's acquisition agreements was an integral part of its commercial business operations and activities.
The relevant facts in this case are quite simple. In early 1997, the Appellant commenced implementation of its business strategy of assembling direct or indirect ownership of, or controlling positions in, real estate companies. As a result of this business strategy, the Appellant acquired large/controlling interests in a number of real estate companies.
In 1998, the Appellant acquired 19.2% of Acanthus Real Estate Corporation ("Acanthus"). In June 2000, the Appellant made a hostile take-over bid for all of the remaining shares in Acanthus at a purchase price of $8.00, thereby increasing its position to 19.9%. Following negotiations between Acanthus and the Appellant, the parties entered into a pre-acquisition agreement in order to give support and deal protection to the Appellant and the bid. Pursuant to this pre-acquisition agreement, it was agreed that the Appellant would acquire all the outstanding shares of Acanthus at a purchase price of $8.25 per share and that Acanthus would, inter alia, pay a break fee of $4.7 million to the Appellant if a better bid was received and accepted by Acanthus.
On June 29, 2000, Acanthus received an unsolicited bid from a third-party (the "Third-Party") for all of the outstanding shares of Acanthus at a purchase price of $8.75. Attempting to thwart the Third-Party bid, the Appellant increased its bid to $9.00 per share on July 2, 2000. At that time, the Appellant and Acanthus entered into an amending agreement (the "Amending Agreement") to the original pre-acquisition agreement, pursuant to which a superior offer from a third-party would need to be for at least $9.30 per share and the break fee was increased to $7.7 million.
Ultimately, Acanthus accepted an offer from the Third-Party for $9.40 and the Appellant chose not to match the offer. Consequently, the Amending Agreement was terminated and Acanthus paid the Appellant the $7.7 million break fee. In addition to the $7.7 million break fee (the "Break Fee"), the Appellant realised a gain of $4.8 million on the sale of its shares of Acanthus.
The Appellant argued that the Break Fee was a capital receipt and therefore should not be taxable because it was not received in respect of a disposition of property (i.e. no property was actually disposed of). Critical to the Appellant's argument was, the fact that (a) the Break Fee was received in relation to the acquisition of shares of Acanthus, which was a capital investment, and (b) the receipt of the Break Fee was the only time the Appellant had ever received a break fee in attempting to implement its real estate company acquisition strategy.
After dismissing the Appellant's "windfall" argument, Justice Boyle noted that Ikea is the leading modern case on the characterization of extraordinary or unusual receipts in the business context. In that case, the taxpayer sought to assemble long-term leaseholds from which to operate its business. In doing so, the taxpayer received a "tenant inducement payment" which it treated on capital account because the payment was received in respect of a long-term lease, which is capital in nature. All levels of court found that the receipt was on income account because the leaseholds were necessary to the business of the taxpayer and they were a necessary incident to the conduct of the taxpayer's business. Consequently, the capital purpose (assembling long-term leaseholds) was not the relevant link to be considered.
Citing the reasons for Judgment in the Tax Court of Canada in Ikea, Justice Boyle noted, at paragraph 43, that Justice Bowman was correct in finding "that the payment was clearly received and inextricably linked to [the taxpayer's] ordinary business operations, and further that no question of linkage to a capital purpose could even be seriously entertained." In this case, Justice Boyle found that break fees were expected incidents of the Appellant's business strategy of entering into acquisition agreements with real estate corporations, regardless of how unusual the receipt of such a payment may be and, therefore, the Break Fee was an amount received in the course of the Appellant's business and commercial activities. Consequently, the receipt of the Break Fee by the Appellant was on account of income.
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