Tax Court Allows Deduction For Advisory Fees In M&A Transaction

The Tax Court of Canada has recognized in a recent case that "oversight expenses" - notably investment banking and other professional advisory fees for services rendered to boards of directors in their discharge of oversight responsibilities - should be fully deductible, even in the context of a planned M&A transaction. The Canada Revenue Agency has traditionally taken a hard line on expenses incurred by an acquirer or a target and has denied deductibility on the basis that these expenses are of a capital nature. Under CRA's position, such expenses have had limited to no practical tax benefit. By rejecting CRA's position, the Rio Tinto Alcan Inc. v The Queen (2016 TCC 172) decision has delivered a significant victory for companies, especially given the magnitude of fees associated with M&A transactions. Oversight expenses accepted as deductible by the Tax Court in Rio Tinto Alcan included investment banking fees for financial modelling and for financial and valuation opinions culminating in a fairness opinion. Moreover, given the broad rationale adopted by the Court, this case potentially establishes the basis for deductibility of oversight expenses in other capital transactions such as reorganizations and financings [at para 88]:

"Simply put, Oversight Expenses are current expenses because they relate to the management of a corporation's income-earning process. Proper management includes the judicious allocation or reallocation of capital for the purpose of maximizing the income earned by the corporation. 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....Oversight Expenses serve an income-earning purpose."

The Tax Court also analyzed some specific statutory provisions pleaded by the appellant as alternative bases for deduction. It found that a majority of the investment banking fees were deductible as expenses for advice as to the advisability of purchasing specific shares (which in this...