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
This is a welcome development and clarification by the
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
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
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).
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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