International operations are very complex. Every operation, whether it be the setup of a corporate group structure or transactions involving the acquisition or sale of a pre-existing structure involve a lot of work before and during the operation.
Important amounts of resources are spent in determining the feasibility, profitability, structural efficiency or tax-efficiency of the operation. And no matter which country is involved, there is invariably one question that will come out in the end: can the cost of all this work and effort be used to offset taxable income?
The answer depends on many things and varies depending on the country. It can often be the reason for audits with the local tax authorities.
This is what happened in Canada to the Rio Tinto Alcan Inc. group “Alcan”. On June 2018, a Federal Court of Appeal ruling was rendered on the deductibility of the expenses incurred by Alcan in the context of an international acquisition.
What is interesting in this ruling is the diversity of the expenses being claimed and the depth of the court’s analysis.
Alcan, a Canadian based corporation listed on the Toronto, New York and London stock exchanges wished to acquire offshore corporations to consolidate its aluminum business. The expenses under review were incurred in either one of two operations:
• The first operation was the acquisition of “Pechiney”, a French industrial concern in the aluminum sector;
• The second operation was a reorganisation of the group to separate the ownership of certain aluminum mills in answer to concerns raised by competition regulators in Europe and America. This “Novelis transaction” objective was to roll two out of four aluminum mills situated in Europe as well as others situated around the globe to Novelis, a corporation created for this express purpose and directly held by Alcan’s shareholders.
These transactions resulted in an enormous amount of expenses. The total sum of the expenses under appeal was in the amount of CAD$ 97,134,008.
In the Appeal, the focus was made on the following expenses:
• Investment banker’s services;
− The analysis of business and financial conditions, including the preparation of financial models before the Pechiney transaction;
− The analysis made for the Novelis transaction;
− The services concerning compliance to securities laws for both operation;
− The alternate transactions analysis;
• Advertising services;
• Printing and issuing financial reports services;
− In the Pechiney transaction;
− In the Novelis transaction;
In Canada, for an expense to offset income, it must have been made on account of income and not on account of capital. In the Court of Appeal’s analysis, there are three considerations that really stand out for this determination:
1. Whether the expense was incurred on account of income or on account of capital “must be undertaken in light of the taxpayer’s business and commercial activities”[1].
• In this case, Alcan being a public corporation had a greater need of oversight on its operation needing the board members to seek independent professional advice as guidance in their decision-making process. As such, oversight services were considered deductible.
2.Decision-making process expenses (Oversight expenses) must be differentiated from implementation costs, which are on account of capital if they were incurred in the process of acquiring or creating a capital asset. On the other hand, an expense “incurred in the course of deciding whether or not to acquire or create a capital asset, does not mean it is necessarily made on account of capital”[2].
• The advertising fees were part of the implementation process. As such, as the purpose of the fees was to facilitate the smooth implementation of the acquisition and not to address a current business concern, they are considered to be on account of capital and are non-deductible.
• Alcan made numerous acquisitions prior to Pechiney. The evaluation of the acquisition opportunities was a constant and recurrent investment banker expense for Alcan and formed part of its annual costs of business. The court ruled that the expense was on account of income and not capital.
3. Exceptions exists to the rule that capital expenses are non-deductible. There is one such exception for expense incurred for advice on the sale of some or all securities of a corporation. The eligibility requirements of this provision have to be met and even then, its application is subject to other restrictive provisions.
• The Federal Court of Appeal mentioned in Obiter that should the case be brought before the Supreme Court of Canada and should this court rule that the expenses were capital in nature, they would still be deductible under the application of paragraph 20(1) (bb) ITA. However, the Court refused to determine the application of restrictive provision 40(1)(a) ITA.
• There also exist specific provisions related to financial reports. To be able to use those provisions, it must be determinable that the expense was incurred specifically for printing financial information.
• The court could not determine with precision the portion of the fees directly related to the printing of financial information. As such, the entirety of the amount was ruled to be on account of capital and non-deductible.
In this case, the investment bankers’ fees under appeal were considered to be deductible, while the advertising fees and the reporting fees were not. From the court’s analysis, we can see this end result may very well turn out entirely different in another situation.
The most important part of this case is the three clear guidelines to consider in making the determination: 1) the result is influenced by the taxpayer’s business and commercial activities; 2) whether the fees are incurred in prevision or contemplation of the operation or in accomplishing it will impact the end result; and 3) exceptions and restrictive provisions might exists for specific expenses.
About the Authors:
Mathieu Ouellette, CPA, CA, LLM Tax, is a Tax Partner at Crowe BGK
Connect with him: [email protected]
Daniel A. Brisebois, LLB, DDN, M Tax, is a Tax Specialist at Crowe BGK
Connect with him: [email protected]
[1] Canada v. Rio Tinto Alcan Inc., 2018 FCA 124, para. 71 “Canada v. Rio Tinto Alcan”
[2] Canada v. Rio Tinto Alcan, supra note 1, para. 72