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Federal Court of Appeal Affirms Tax Court Decision that Free Parking at School is a Taxable Benefit in the “Branksome Hall” Cases

On December 1, 2011, the panel of Justice John Maxwell Evans, Justice Carolyn Layden-Stevenson and Justice David Stratas of the Federal Court of Appeal heard the “Branksome Hall” parking cases (Geraldine Anthony, Heather Friesen, Leslie Morgan, Jarrod Baker v. The Queen (2011 FCA 336)). The appeals were dismissed with a unanimous judgment delivered from the bench by Justice Layden-Stevenson shortly after Appellants’ counsel concluded his oral argument.

As discussed in an earlier post, the appeals of four employees of Branksome Hall (a private school in Toronto) (the “Appellants”) were heard collectively as test cases and on common evidence. The Appellants and approximately 100 other employees of Branksome Hall were reassessed for their 2003 and 2004 taxation years to include $92 per month (inclusive of GST and PST) in their income, representing the value of free parking provided by their employer. The issues were whether parking provided to the Appellants by their employer was a taxable benefit under paragraph 6(1)(a) of the Income Tax Act (the “Act”) and, if so, how the value of that benefit should be assessed.

Counsel for the Appellants argued in his opening statement that this is a case of the Canada Revenue Agency casting its tax net as wide as possible and attempting to tax items that it had not taxed in the past. In response to this statement, Justice Evans noted that the Federal Court of Appeal is required to apply the law as prescribed under paragraph 6(1)(a) of the Act and not make any findings on the practices of the Canada Revenue Agency.

The Appellants’ submissions focused on Justice Brent Paris’ conclusion in the Tax Court of Canada that the value of the taxable benefit was its fair market value. They argued that fair market value should only be applied to cases where there is an open market to test competitive prices. Since the demand for parking at Branksome Hall only came from staff members and Branksome Hall was restricted from charging members of the public for parking as a result of zoning restrictions, there was no open market and, therefore, fair market value should not be applied. The Appellants submitted that the value of the taxable benefit should be determined by considering only the cost incurred by the employer to provide the benefit.

In delivering reasons for judgment on behalf of the panel, Justice Layden-Stevenson stated that the Court: a) agrees with the Tax Court’s finding that even if it is accepted that the parking benefit to the Appellants should be valued at Branksome Hall’s cost of providing the parking, the evidence adduced by the Appellants was not sufficient to prove what those costs were; b) rejects the argument that the fair market value is an appropriate method of valuation only when there is an open market for the benefit in issue; and c) finds that the Appellants’ argument has been overtaken by the decision of the Federal Court of Appeal in Spence v. The Queen (2011 FCA 200).

In Spence v. The Queen (2010 TCC 455), the Tax Court had valued an employment benefit of reduced tuition costs by using the cost approach instead of the fair market value approach. The Federal Court of Appeal reversed the Tax Court’s decision and applied the fair market value approach to the taxable benefit on June 13, 2011 – after the Appellants in the “Branksome Hall” cases had submitted their Memorandum of Fact and Law.

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Federal Court of Appeal Affirms Tax Court Decision that Free Parking at School is a Taxable Benefit in the “Branksome Hall” Cases

Federal Court of Appeal Affirms Tax Court Decision that Payment to Extinguish Employee Stock Option Plan is Capital Expenditure: Imperial Tobacco Canada Limited v. The Queen

On November 10, 2011, the Federal Court of Appeal (the “FCA”) delivered a unanimous decision in Imperial Tobacco Canada Limited v. The Queen, 2011 FCA 308. As discussed in an earlier post, the panel of Justice Marc Nadon, Justice Karen Sharlow and Justice Eleanor Dawson were asked to determine whether a one-time, lump sum payment of approximately $118 million made to employees to extinguish an employee stock option plan was a deductible expense or a payment on account of capital which is precluded from deduction by paragraph 18(1)(b) of the Income Tax Act (the “Act”).

The FCA dismissed the appeal of Imperial Tobacco Canada Limited (“Imasco”) and upheld Justice Bowie’s decision in favour of the Crown in Imperial Tobacco Canada Limited v. The Queen, 2010 TCC 648 noting that the decision of the Tax Court of Canada (the “Tax Court”) was “consistent with the evidence and the applicable legal principles.”         

Justice Sharlow found, notwithstanding the decision by Chief Justice Bowman of the Tax Court that a similar payment made in the course of the same series of transactions was fully deductible (Shoppers Drug Mart Limited v. The Queen), three factors that pointed to the conclusion that the payment was made on account of capital:

(i) the payment coincided with a reorganization of the capital of Imasco (the going private transaction and amalgamation);

(ii) the arrangements put in place for making the payment facilitated and were intended to facilitate the capital reorganization; and

(iii) the payment was intended to and did end all future obligations of Imasco to deal with its own shares, which can be described as a once and for all payment that resulted in a benefit of an enduring nature.

Justice Sharlow did acknowledge that there were two factors in favour of Imasco, namely, that (a) the employee stock option plan was entered into to provide a form of employee compensation and did make periodic cash payments for the surrender of options, and (b) the payment for the optioned shares represented only a small portion of the outstanding shares of Imasco (just over 1%).

In the end, the FCA followed its 1990 decision in Kaiser Petroleum Ltd. v. The Queen. Justice Sharlow agreed with Justice Bowie that the distinctions between the circumstances of Imasco and the facts in Kaiser were “distinctions without a difference”. Furthermore, the FCA rejected Imasco’s argument that Kaiser is not in step with current economic realities on the basis that it was decided at a time when employee stock option plans were not commonly used as part of the ordinary compensation package for employees of all levels.

In light of the significant difference in approach to the issue on substantially the same facts between the Federal Court of Appeal and Chief Justice Bowman in Shoppers, it would not be surprising if a leave application is filed with the Supreme Court of Canada.  As Justice Ian Binnie, formerly of the Supreme Court of Canada, noted in a recent interview, the function of counsel applying for leave is to kick the ball up in the air in an interesting way and the judges will grab it.”  That may very well be easier here than in many other tax disputes.

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Federal Court of Appeal Affirms Tax Court Decision that Payment to Extinguish Employee Stock Option Plan is Capital Expenditure: Imperial Tobacco Canada Limited v. The Queen

Capital Expenditure or Expenditure on Revenue Account? Judgment Reserved by FCA in Imperial Tobacco Canada Limited v. The Queen

As discussed in an earlier post, the Federal Court of Appeal (the “FCA”) heard submissions in Imperial Tobacco Canada Limited v. The Queen on October 26th, 2011. Justice Marc Nadon, Justice Karen Sharlow and Justice Eleanor Dawson heard the taxpayer’s appeal in Toronto.

The panel will determine whether a one-time, lump sum payment of approximately $118 million made to employees to extinguish an employee stock option plan was a deductible expense (as the taxpayer contends) or an outlay on account of capital which is precluded from deduction by paragraph 18(1)(b) of the Income Tax Act (as the Crown contends).

Imperial Canada Tobacco Limited (the “Appellant”) argued that the most important question that needed to be considered by the panel (and one that was not considered by the Tax Court of Canada) was whether there was an enduring benefit to the taxpayer. During argument, the panel was quite interested in why the Appellant agreed to facilitate the immediate vesting and exercise or surrender of all of the options to bring the stock option plan to an end. The Appellant maintained that “settling up” the stock option plan was a housekeeping matter that allowed it to satisfy its obligations before the completion of a going private transaction.

In addition to the 2007 decision of Chief Justice Donald Bowman in Shoppers Drug Mart Limited v. The Queen (“Shoppers”), the Appellant relied on three other cases (Boulangerie St-Augustin v. The Queen, International Colin Energy v. The Queen and BJ Services Company Canada v. The Queen) which permitted the deduction of expenditures incurred in the context of other corporate transactions.

The Crown argued that the cash payment to eliminate the stock option plan was a condition of the transaction and was not made in the ordinary course of the Appellant’s business. It was an extraordinary expense meant to facilitate the take-over transaction. The Crown also emphasized that the enduring benefit test should not be determinative. In this regard, the Crown relied on M.N.R. v. Algoma Central Railways, Johns-Manville Canada Inc. v. The Queen and Gifford v. The Queen.

The judgment will be eagerly anticipated as it remains to be seen whether the panel will follow the 1990 decision of the FCA in Kaiser Petroleum Ltd. v. The Queen, where it determined that a payment made to extinguish an employee stock option plan in the course of implementing a take-over transaction was a capital expenditure, or whether it will find persuasive the more recent decision of Chief Justice Donald Bowman of the Tax Court of Canada in Shoppers. In Shoppers, Chief Justice Bowman began with the proposition that “in the ordinary course a payment made by an employer to an employee for the surrender of his or her option under a stock option plan to acquire shares of the company is a deductible expense” and found that that did not change even in the context of a going private transaction.

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Capital Expenditure or Expenditure on Revenue Account? Judgment Reserved by FCA in Imperial Tobacco Canada Limited v. The Queen

Transfer Pricing Case Opens in the Tax Court of Canada – McKesson Canada Corporation v. The Queen

A transfer pricing trial commenced on October 17, 2011, in the Tax Court of Canada in Toronto.  Mr. Justice Patrick Boyle will decide whether paragraph 247(2)(a) of the Income Tax Act (the “Act”) applies to the transaction at issue (the factoring of accounts receivable) to reduce the deduction of an amount paid by a Canadian corporation to a non-resident affiliate which assumed the risks of collecting the Canadian corporation’s accounts receivable.  The agreed-upon discount rate was 2.2% but the Minister of National Revenue (the “Minister”) says it would have been just over 1% had the parties been dealing at arm’s length.  The trial is expected to take approximately 6-7 weeks.  The hearing began on Monday, October 17, 2011 with an opening statement by counsel for the Appellant, McKesson Canada Corporation (“McKesson Canada”).

McKesson Canada contracted to sell its accounts receivable to a related, non-resident company, McKesson International Holdings III S.à R.L. (“McKesson International”). McKesson Canada and McKesson International agreed to a variable discount rate that would be applied to the accounts receivable.  The rate was calculated using a formula that resulted in a discount rate of 2.2% for the 2003 taxation year.  According to the terms of the agreement, all bad debt risk relating to the accounts receivable that were sold was assumed by McKesson International. The discount rate was intended to compensate McKesson International for assuming the risk that some of the accounts receivable may not be collected and would have to be written off.

The Minister disallowed a portion of the amounts deducted by McKesson Canada in respect of the discount on the sale of accounts receivable. The Minister determined that, based on the terms and conditions in the agreement, the discount rate that would have been agreed upon had the parties dealt with one another at arm’s length would not have exceeded 1.0127%. Accordingly, the Minister added some $26 million to the Appellant’s income for its 2003 taxation year, reflecting a discount rate of 1.0127% rather than the rate of 2.2% as agreed by the parties.

In his opening statement, counsel for McKesson Canada contended that the issue should be whether the discount rate agreed upon by the parties was appropriate for an arm’s length transaction given the amount of risk that was being transferred from the vendor to the purchaser of the accounts receivable and that the issue should not be what the discount rate should be if the principal terms of the contract were changed to reflect some other hypothetical agreement used by the Minister for purposes of his assessment.

In addition to the Part I appeal, there is a Part XIII appeal as well. The issue there is whether McKesson Canada conferred a benefit on its controlling shareholder, McKesson International, under subsection 15(1) of the Act by selling certain of it accounts receivable and, therefore, whether McKesson Canada should be deemed to have paid a dividend to McKesson International under paragraph 214(3)(a) of the Act. Including interest, the Part XIII assessment is approximately $1.9 million.

In conclusion, counsel for McKesson Canada argued that the Part XIII assessment is barred by virtue of the Canada-Luxembourg Income Tax Convention (1999) (the “Treaty”), which is applicable since McKesson International is a company existing under the laws of Luxembourg. As Article 9(3) of the Treaty includes a five year time limit for changes by Canada to the income of a taxpayer, the time for the adjustment expired on March 29, 2008 (before the Part XIII assessment was mailed).

The hearing continues.

For the link to the Part I Notice of Appeal, click here.

For the link to the Part I Amended Reply, click here.

For the link to the Part XIII Amended Notice of Appeal, click here.

For the link to the Part XIII Reply, click here.

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Transfer Pricing Case Opens in the Tax Court of Canada – McKesson Canada Corporation v. The Queen