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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