Canada: Rio Tinto Alcan v. The Queen: Welcome Expansion Of The Canadian Tax Deductibility Of M&A Transaction Expenses

Last Updated: March 2 2017
Article by Claire M.C. Kennedy and Anu Nijhawan

Executive Summary

In a welcome decision for Canadian acquirors and targets, the Tax Court of Canada recognized, in Rio Tinto Alcan Inc. v The Queen,1 that certain oversight expenses—including certain investment banking and other professional advisory fees—should be deductible in the context of M&A transactions. This is particularly so where such services are provided to enable the board of directors of the acquiror or target to determine whether to proceed with the transaction. The Court also established a principled basis for the deductibility of transaction expenses in a far broader set of circumstances than those previously accepted by the Canada Revenue Agency (the CRA), in particular, in situations in which a board is discharging its oversight function prior to a decision to implement a particular transaction(s). The decision is under appeal; if affirmed, it will represent a significant expansion of the deductibility of transaction fees. The onus will remain on the taxpayer to prove the expenses are deductible based on the new criteria; engagement letters for advisors and their invoices, clearly demarcating oversight activities in respect of proposed transaction(s) from the implementation phases, should be prepared accordingly.

Background

At issue in Rio Tinto was the deductibility to Alcan (the Canadian predecessor to Rio Tinto Alcan) of approximately $100 million in transaction expenses, including legal, investment banking, financial, and other professional advisory fees, incurred in the course of two related transactions—a public corporate acquisition of a French aluminum company and a related spin-off of certain assets as mandated by competition authorities as a condition of the public takeover. Consistent with the CRA's historical position, the government (referred to as the Crown) argued that the expenses were not deductible on a current basis on the grounds that such expenses were incurred in the context of a capital transaction.2 Subject to certain statutory exceptions, capital expenses have limited immediate use to corporate taxpayers under Canadian tax law.3 In allowing a large proportion of the expenses to be deducted on a current basis, the Court rejected the CRA's position, recognizing the importance of the board of directors' oversight function on a corporation's income-earning process.

Importance of the Board's Oversight Function

Significant to the ultimate result of the case, the Court recognized the importance of the board of directors' role in determining whether or not to proceed with a transaction and in allocating capital resources. Noting that ineffective oversight over the capital allocation process can lead to a decline of earnings and cash flow and that modern day shareholders demand scrupulous oversight, the Court acknowledged that effective oversight requires independent advice which the board relies on in approving a capital expenditure. The expenses incurred to facilitate this advice are not capital in nature—rather, they are integral to the corporation's income-earning process.

This conclusion is consistent with prior case law that held that the Crown's hardline view on expense deductibility was "fundamentally inconsistent with the economic and business realities of the world of mergers and acquisitions" and adding that "it is a basic common sense approach to view maximizing share price as inextricably interwoven with the business of any company"4 . The taxpayer was assisted in this regard by its evidence which showed that one of its business priorities was the maximization of shareholder value and that it has a long history of acquisitions and transactions entered into for increased revenues, earnings and economic value. Given that most companies, both public and private, would take such a position, the case represents a significant relaxation of the deductibility of M&A transaction expenses to businesses.

Oversight Expenses vs. Execution Costs: The Distinction

The Court drew a distinction between "oversight expenses," which are expenses which assist the board in the decision-making process and in the fulfilment of its oversight function, and "execution costs," which are expenses incurred as part of the implementation of a specific transaction or set of transactions leading to the acquisition of capital property. In analyzing the category into which a particular expense falls, the Court looks at the primary purpose of the work performed—were the expenses incurred primarily to assist in the oversight or management process or were they primarily linked to the implementation of a transaction carried out on capital account?

Oversight expenses, the Court held, are fully deductible on the basis that (i) they relate to the management of a corporation's income-earning process, including the allocation of capital for the purpose of maximizing the income earned by a corporation and (ii) such expenses do not per se create an enduring benefit (a hallmark of a capital expense). In contrast, execution expenses are not currently deductible, in that they pertain to the actual implementation of an approved capital transaction that does create an enduring benefit.

The onus will be on the taxpayer seeking a deduction to adduce evidence showing that the expenses in question are properly classified as oversight expenses. The Court did, however, provide assistance to taxpayers by adopting, in the circumstances of Rio Tinto, a "bright line" date test for distinguishing between the two categories. Specifically, the Court endorsed a distinction based on whether or not there was a binding commitment to proceed with the project in question. Expenses incurred prior to formally entering into the transactions were deductible as oversight expenses since the taxpayer was aggressively involved in the pursuit of increased shareholder value on a "frequent and recurring" or continuous basis. Although not discussed in the case, the analysis therein suggests that the oversight expenses should continue to be fully deductible, even if a transaction is not successful.

Once a framework for negotiations had been established, however, expenses incurred in the context of active negotiations were more closely linked with the implementation of the transaction and hence constituted "execution costs."

Examples of Deductible Oversight Expenses

Within the framework described above, the Court in Rio Tinto then considered the specific deductibility of a number of different transaction costs, which broadly fell into five categories: (1) investment advice; (2) public relations; (3) legal and accounting advice; (4) printing and issuance of documents; and (5) representations to government authorities.

With respect to the acquisition, the Court held that certain investment advisory fees were deductible when they were incurred during the deliberation phase of the deal, including fees for financial modelling and for financial and valuation opinions culminating in a fairness opinion. In this respect, the Court was persuaded by the fact that the fairness opinion was necessary to demonstrate that the directors acted with due care in approving the transaction. On the other hand, investment advisory fees incurred in the context of active negotiations and in connection with price negotiations were not deductible, as they were more closely linked to the implementation phase.

With respect to the spin-off, the Court allowed the deduction of investment advisory fees incurred prior to final approval of the transaction. More specifically, out of 389 days spent on the transaction, 345 days predated final approval. Thus 88.69% of the fees were deductible from income.

As an alternative basis for deduction, Alcan raised a provision of the Canadian Income Tax Act that expressly allows for the deduction of certain investment advisory fees incurred for advice as to the advisability of purchasing specific shares. The Court indicated that the fees found to be deductible under the analysis described above would also be deductible under this alternative provision. While the provision does not apply to fees that are a "commission," the fees in this case were fixed prior to the completion of the transaction. The fees that were found to be implementation costs, however, were still not deductible on the alternative basis.

In contrast, the Court held that public relations fees did not constitute oversight expenses. The evidence showed that such expenses were necessary for the smooth implementation of the transaction, due to the need for careful and strategic communication with the public since the takeover was politically sensitive in France. Query if public relations expenses or communication expenses incurred in the deliberation phase could be deductible as oversight expenses. Printing costs for the preparation and delivery of documents that were legally required were also not oversight expenses as the preparation and delivery of the documents was an essential step in the implementation of the transactions. Notably, certain fees were not deductible due to insufficient evidence describing the nature of the fees, reminding all taxpayers of the necessity to adduce sufficient evidence.

Conclusions

The case demonstrates that significant transaction fees can be deducted on a current basis under Canadian tax law, with proper management and careful maintenance of records. Recognizing that the taxpayer will in all cases bear the onus of proving deductibility, corporations and their boards of directors should take care in documenting all board meetings considering potential transactions to demonstrate that board oversight is part of the everyday business of the corporation. Given the benefit, from a tax perspective, of characterizing an expense as an oversight expense, care should be taken to allocate expenses to ensure that there is a demarcation between the deliberation and implementation phases of a transaction. Expenses that pertain to 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 should, ideally, be subject to separate retainer agreements and, in all events, clearly identified as such in any invoices.

Transaction fees associated with M&A transactions can be substantial, particularly in the case of transactions with multi-jurisdictional components and those involving pre- and post- closing reorganizations required to meet conditions related to the mandated divestiture of assets or the rationalization and integration of operations. The decision in Rio Tinto is therefore a welcome development in Canadian tax law.

Footnotes

1.Tinto Alcan Inc. v. R., 2016 TCC 172, currently on appeal to the Federal Court of Appeal.

2.Paragraph 18(1)(b) of the Income Tax Act (Canada) precludes a deduction for an outlay or expense made or incurred on account of capital."

3.The Crown argued that the expenses incurred in connection with the corporate acquisition should be added to the tax cost base of the shares acquired and that the expenses incurred in connection with the spin-off should be deducted from the proceeds of disposition received.

4.See, e.g., BJ Services Company of Canada v. The Queen, 2003 TCC 900.

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.

Authors
Claire M.C. Kennedy
Anu Nijhawan
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
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
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

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 or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq 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 of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions