A Canadian Acquisitionco acquired Canadian Targetco for a cash base price plus earnout obligations, and then immediately merged with Targetco under a short-form amalgamation. The Rulings Directorate rejected Amalco’s treatment of the earnout payments subsequently made by it as eligible capital expenditures. In the course of addressing its submission that, by analogy to CRA’s position that interest on a borrowing to acquire shares of a target continued to have the original purpose following the disappearance of the target shares on amalgamation and the direct holding of the underlying income-producing assets, the earn-out payments also had an income-producing purpose stated:
[A]lthough we indicated at the 2002 Annual Conference of the Canadian Tax Foundation that our position regarding the deductibility of interest in the context of a leveraged buy-out followed by an amalgamation was supported by the flexible approach of linking adopted... Ludco…there is no “tracing” of the assets of the amalgamated corporation as a replacement or substitution for the shares of the target corporation that no longer exist following the amalgamation. While it might be argued that the amalgamated corporation “acquires” the assets of the predecessor corporations upon the amalgamation, the assets are not legally replacing the shares of the predecessor corporations. Notwithstanding this technical difficulty, from a policy standpoint, it was the CRA’s view that interest should be deductible in the context of a leveraged buy-out followed by an amalgamation. Our position is supported by the general scheme of section 87 which is to treat the amalgamated corporation as a continuation of the predecessor corporations standing in their place with respect to assets, liabilities and tax accounts. Of particular relevance is the rule in subparagraph 87(2)(c)(ii), which provides that the amalgamated corporation may deduct in computing its income for a taxation year any amount paid or payable by it in that year that would, if it had been paid or payable by the predecessor corporation in its last taxation year, have been deductible in computing the income of the predecessor corporation for that year.