Canadian Tax Adviser
December 6, 2011
CRA Rules on Tax Treatment of Break Fee Receipts
Toronto, Moskowitz + Meredith LLP
In a recent internal technical interpretation (TI), CRA Rulings was asked whether break fees received by a taxpayer should be included in income,
or whether the amounts represented non-taxable capital receipts. CRA
Rulings concluded that break fees received by a taxpayer on a failed
transaction should be included in income under section
9 or paragraph 12(1)(x) of the Act or, alternatively, as proceeds of
disposition of capital property under section 14.
This 14-page TI is interesting because it reviews several provisions in the Act
relevant jurisprudence including BJ Services Company, RCI Environnement and Manrell. The TI also considers the meaning of
various terms including "property" and "reimbursement".
The facts in this TI are unclear since much of the information
has been sanitized and no substitute names were given to the parties.
that the facts are that a taxpayer (Purchaserco) received break fees from
another taxpayer (Opco) as a result of Purchaserco's unsuccessful bid to
acquire all of Opco's outstanding common shares.
The TI notes that while break fees are common in most merger
and acquisition transactions, it does not appear that taxpayers consistently
characterize break fees receipts.
CRA Rulings was asked by the CRA auditors whether received break fees should be represented as:
- Income from business or property under subsection 9(1)
- Amounts to be given the same treatment as the item for which it was
intended to compensate under the surrogatum principle
- Eligible capital amounts
- Income such as an inducement or reimbursement under paragraph 12(1)(x)
- Capital gains
- Non-taxable capital receipts.
In the CRA auditors' request to CRA Rulings for its
interpretation, the auditors noted that the purpose of the acquisition was to
combine the two corporations' operations to achieve operating synergies and
efficiencies, enhance future growth and be better positioned to compete for
acquisition opportunities as the corporations' industry continued to consolidate.
Once achieved, all of these goals would maximize shareholder value.
result, the auditors'
position is that the Tax Court of Canada's decision in BJ Services
Company should be applied so that the
break fees should be considered ancillary business income under subsection
9(1) of the Act.
Alternatively, the CRA auditors noted that break fees typically provide
compensation to an initial bidder for its ongoing time and effort,
out-of-pocket expenses, internal costs and opportunity cost if an event
occurs which prevents the bid from being completed. As such the CRA auditors
said that the
surrogatum principle should apply so that the tax treatment of a settlement payment or
damages should parallel the tax treatment for the item for which the payment
is intended to compensate. Further, the break fees are
compensation for transaction costs (or wasted expenditures) incurred by
Purchaserco, and opportunity costs due to the failed bid.
Where the break fees exceed the transaction costs incurred, the CRA auditors' opinion
is that the excess value should be attributed to the forgone
annual operating and corporate cost savings that is expected to be realized in the
short term. Since any realized operating and cost savings are reflected in
a company's profit under section 9 of the Act, then the surrogatum principle
dictates that the portion of the break fees that was paid to compensate for the
opportunity cost associated with foregone cost savings would also be on
account of income and be included in income under subsection 9(1) in the
year of receipt. Similarly, the tax treatment of the break fees
intended to compensate for the transaction costs incurred by Purchaseco
related to its takeover bid for Opco would parallel the tax treatment of the
Before providing its opinion, CRA Rulings stated that "the
characterization of a break fee receipt for income tax purposes may differ
from case to case, depending on the particular facts of each case".
CRA Rulings agreed with the CRA auditors' rationale and conclusion that
break fees should be included in income under subsection 9(1). CRA Rulings also agreed that break fees could represent a reimbursement,
contribution or assistance for expenses incurred by Purchaserco in offering to purchase Opco's shares. As a result,
these fees were not included in income under subsection 9(1), they should
be included in income under paragraph 12(1)(x).
CRA Rulings found that the break fees could also be considered
proceeds of disposition of Purchaseco's rights under the bid for Opco's
shares. As such, it found that the fees could be included in
Purchaserco's income under subsection 14(1).
Interestingly, CRA Rulings stated that it was also necessary to consider
whether the proposed restrictive covenant rules in section 56.4 could apply
to the break fees. CRA Rulings stated that the restrictive covenant rules
were broad enough to include the fees, unless they satisfied the exceptions
to these rules in subsection 56.4(3).
For more information, contact your KPMG adviser.