Canada: Proposed Amendments On Tax Cost And Expenses

Last Updated: July 24 2006

This article was originally published in Blakes Bulletin on Mergers & Acquisitions Tax - June 2006

Article by Ron Richler, ©2006 Blake, Cassels & Graydon LLP

On November 17, 2005, the federal Department of Finance released draft amendments to the Canadian Income Tax Act (the Tax Act) that will change the way costs and expenses paid in the form of shares or options are recognized for tax purposes. In the Ontario Budget of March 23, 2006, Ontario announced that it will parallel the federal proposals if implemented.

These proposals are an overreaction and, in some respects, a misguided reaction to the Alcatel case recently decided by the Tax Court of Canada. In Alcatel, a corporation granted stock options to employees involved in research and development. When the employees exercised those options, the corporation took the position that the stock option benefit (the value of the shares less the exercise price) was an expenditure in respect of salary paid to employees doing research and, therefore, entitled the corporation to an increased investment tax credit. The court agreed with the corporation. It noted that the provision in the Tax Act that denies a deduction from income for stock option benefits to employees is not applicable to investment tax credits.

Not surprisingly, the Department of Finance felt the need to react to the Alcatel decision. If the correct tax policy is that a corporation should not be permitted to deduct employee stock option benefits, it should also not be permitted to obtain tax credits for employee stock option benefits. Whether that is the correct tax policy is another story, but suffice it to say that the Department is currently wedded to it.

The proposed amendments could have been restricted to expanding the provision mentioned above to apply not only to deductions but also to investment tax credits. Unfortunately, this was not the approach taken by the Department. There was concern that the broad interpretation given to "expenditures" in Alcatel has implications beyond employee stock options. Although these have not been identified, the Department has, nevertheless, proposed wide-ranging rules.

Cost And Expense Of Corporations

The first proposed rule, and the one causing the greatest concern, is that if a corporation acquires property or incurs an expense that is paid for by the issuance of its shares, its cost or expense will be limited to the amount added to its paid-up capital, for tax purposes, of its shares.

If enacted, this rule would replace the existing law, as developed by the courts, that the cost of property acquired through the issuance of shares is the price agreed upon by the parties (unless modified by a specific rule in the Tax Act). As stated by the Federal Court of Appeal in the recent Teleglobe case, absent fraud or other factors that would make the transaction impeachable, "it is the agreement of the parties, not the capital accounts which is determinative of the cost".

It was pointed out to the Department that the existing law as expressed in Teleglobe is sensible and that the proposed rule is not. The main concern is that paid-up capital is not necessarily a good measure of cost. Many corporations have shares with nominal par value. For example, a Delaware corporation could have shares that are worth CAD 100 each but have a par value of only CAD 0.01 each. The paid-up capital for tax purposes cannot exceed the par value of the shares. If the corporation bought all the shares of another corporation at an agreed price of CAD 1,000,000 to be paid for by issuing 10,000 of its shares, its tax cost under the existing law would be CAD 1,000,000 but under the proposals would be CAD 100.

The unfairness of this result has been recognized by the Department. But instead of scrapping the proposal and reverting to the existing law, it has suggested that the proposal will be modified so that tax cost would include not only the amount added to paid-up capital but also any contributed surplus.

Contributed surplus is, however, an accounting concept and the rules for when contributed surplus is recognized are not precise and may differ from jurisdiction to jurisdiction.

There are other problems with the proposal, such as when paid-up capital for tax purposes is reduced by a provision of the Tax Act (e.g., section 84.1 or 212.1) on certain types of transaction. While there are good tax policy reasons to reduce paid-up capital in these situations, it does not make sense to also reduce tax cost.

The Department has been urged, including by the Joint Committee on Taxation of the Canadian Bar Association and the Canadian Institute of Chartered Accountants, to reconsider this proposal and revert to the existing law as set out in Teleglobe, subject to fixing any specific problems the Department might identify.

Cost And Expense Of Trusts And Partnerships

When a partnership or trust incurs a cost or expense that is paid for by issuance of units or interests of the partnership or trust, the Department is proposing a much more sensible rule.

Here, the cost or expense will be limited to the lesser of the value of the units or interests issued and the consideration received by the partnership or trust.

In most commercial transactions, the parties would agree on a price that is equal to both the value of the units or interests to be issued by the partnership or trust and the consideration to be received by it. In these cases, there would be full recognition of the cost or expense under the proposal. It is not clear why a similar rule is not proposed for corporations as opposed to the proposal discussed above.

Issuance Of Options

The third proposal is that if a taxpayer incurs a cost or expense that is paid for by the issuance of an option to acquire its shares or units, no amount will be recognized for tax purposes.

It is difficult to understand the tax policy reason for denying a cost or expense that is paid for by the issuance of an option. For example, if a corporation buys property at a price of CAD 1,000 and pays the price by issuing share purchase warrants having a value equal to CAD 1,000, its cost of the property should be CAD 1,000. If this proposal is enacted, its cost would be zero.

Exercise Of Options

Finally, we get to the concern raised by the Alcatel decision. The fourth proposal is that if any cost or expense would otherwise be recognized on the issuance of shares or units when an option is exercised (as the court found in Alcatel), that cost or expense is to be reduced by the option benefit.

This proposal would, in many circumstances, make sense from a tax policy perspective if recognition were given for the value of options at the time of their issuance, as argued above, but contrary to the third proposal described above. That is, the cost or expenditure should be determined when the bargain is made and the options are issued. If the options have value at the time they are issued, that value should be recognized for tax purposes as part of the cost or expense. Any increase in value of the options after the time the bargain is struck, should, generally, not be relevant to cost or expense. There could, however, be exceptions.

Let’s consider options granted to non-employee consultants as remuneration for services (staying clear of the provision in the Tax Act mentioned above that denies a deduction for stock option benefits to employees). For example, a taxpayer that issues options to consultants, where the exercise of the options is conditional on continued service, may be giving consideration for those services not just on the grant of the options but also on the exercise of the options. In that example (which is similar to the situation in Alcatel except that there the options were granted to employees), the proper tax policy may be that tax recognition should be given to theoption benefit. Under the Department’s proposals, however, no recognition will be given in any circumstances to the option benefit.

Conclusion

One can only hope that sober second thought will prevail and that the Department of Finance will take heed of the many representations made in reaction to these proposals. To date, though, indications from the Department are that a fundamental rethinking of the issues will not happen. Rather, it seems to be intent on pushing through these proposals with limited modifications, such as to recognize contributed surplus on the issuance of shares. This would be unfortunate. A problem (the Alcatel decision) that could have been fixed with a minor amendment will, instead, trigger changes fraught with uncertainty and unfairness.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Events from this Firm
12 Sep 2017, Seminar, Toronto, Canada

Please join us as we take an in-depth look at the legislation and the impact on the industry.

14 Sep 2017, Seminar, Toronto, Canada

Change, stress and uncertainty are ever]present factors in todayfs legal environment, and specific aspects about the practice of law make it difficult to thrive in the profession long term. Luckily, there are specific research]based strategies that have been shown to help lawyers thrive and lead to more effective ways to manage stress and pressure.

5 Oct 2017, Seminar, Toronto, Canada

Blakes is proud to host our New to In-House Series, designed to bring together junior and mid-level in-house counsel for a candid exchange of insights to highlight and address some of the challenges and opportunities facing in-house lawyers in their roles today.

 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.