The Tax Court of Canada has recognized in a recent case that
"oversight expenses" – notably investment banking
and other professional advisory fees for services rendered to
boards of directors in their discharge of oversight
responsibilities – should be fully deductible, even in the
context of a planned M&A transaction. The Canada Revenue Agency
has traditionally taken a hard line on expenses incurred by an
acquirer or a target and has denied deductibility on the basis that
these expenses are of a capital nature. Under CRA's position,
such expenses have had limited to no practical tax benefit. By
rejecting CRA's position, the Rio Tinto Alcan Inc.
vThe Queen (2016 TCC 172) decision has delivered
a significant victory for companies, especially given the magnitude
of fees associated with M&A transactions. Oversight expenses
accepted as deductible by the Tax Court in Rio Tinto Alcan
included investment banking fees for financial modelling and for
financial and valuation opinions culminating in a fairness opinion.
Moreover, given the broad rationale adopted by the Court, this case
potentially establishes the basis for deductibility of oversight
expenses in other capital transactions such as reorganizations and
financings [at para 88]:
"Simply put, Oversight Expenses are current expenses
because they relate to the management of a corporation's
income-earning process. Proper management includes the
judicious allocation or reallocation of capital for the
purpose of maximizing the income earned by the corporation.
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....Oversight Expenses serve an income-earning
The Tax Court also analyzed some specific statutory provisions
pleaded by the appellant as alternative bases for deduction. It
found that a majority of the investment banking fees were
deductible as expenses for advice as to the advisability of
purchasing specific shares (which in this case were all of the
shares of the target) and were not a commission, even though
elements of the fee were contingent on milestones being achieved.
Similarly, legal fees for competition hearings were deductible as
costs of representation. These fees can also be substantial in a
large multi-jurisdictional M&A transaction that may involve, as
this case did, mandated divestitures of assets, often necessitating
a spin-out or other reorganization.
Not all expenses associated with M&A and other capital
transactions will be fully deductible as oversight expenses –
those fees primarily linked to the execution of a capital
transaction will continue to be treated as non-deductible capital
outlays, except to the extent of any specific statutory deduction,
such as certain financing amounts. Fees that were not deductible as
oversight expenses in Rio Tinto Alcan included investment
banking fees for active negotiations with the target, and
fees for government relations and PR advice in the
target's home country (France). Because the evidentiary burden
is on taxpayers to prove deductibility, companies should draft
engagement letters for investment bankers, lawyers and other
professional services firms with a clear demarcation between the
deliberation and implementation phases of a transaction and should
set expectations of advisors to clearly allocate their fees
–"engaged re Project Code Name" will not suffice.
With a little care up front, companies will be able to deduct
substantial fees incurred in M&A and potentially other
transactions that would previously have been denied by CRA.
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.
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