Principal Issues: [TaxInterpretations translation] Are the integration costs paid by Aco on behalf of the new subsidiaries of Aco current expenses or capital expenses?
Position: We are of the view that Aco was justified in considering the costs as current expenses.
Reasons: Expenses incurred to earn management fee income based on Aco’s practice of incurring expenses for its subsidiaries and charging those expenses to its subsidiaries. At the time the initial expenses were incurred, it was likely that the corporations for which the expenses were incurred would become subsidiaries of Aco and that it would be able to charge the amounts.
July 29, 2004
Quebec Tax Services Office Headquarters Mr. Martial Labbé Sylvie Labarre, CA Business Audits (613) 957-8953
2004-006597
Integration costs on acquisition of shares
This letter is a follow-up to your memo of March 5, 2004 in which you asked us for our opinion on the above subject. We have also taken into account the memos of April 6, 2004 and June 30, 2004 sent to us by Ms. Chantal Viel. We apologize for the delay in responding to this request.
Facts
XXXXXXXXXX Holding Corporation ("Aco") is a holding corporation that holds subsidiaries engaged in the sale of XXXXXXXXXX.
Aco earns income from its investments. It also incurs operating expenses for its subsidiaries and charges them such amounts as a management fee based on XXXXXXXXXX.
Aco is held by XXXXXXXXXX ("Bco").
On XXXXXXXXXX, Bco entered into an agreement to acquire the shares of two XXXXXXXXXX corporations with XXXXXXXXXX. The agreement provided that certain regulatory approvals had to be obtained and that the closing date of the transaction to acquire the shares of the two XXXXXXXXXX corporations (the "Acquired Corporations") would be at the end of the month in which the approvals were obtained, but not before XXXXXXXXXX or later than XXXXXXXXXX. The agreement provided that the parties would be obligated to complete the transaction on the closing date if all conditions listed in the agreement were satisfied.
The agreement of XXXXXXXXXX also provided that a subsidiary of Bco could acquire the shares instead of Bco. Pursuant to this clause, Aco became the purchaser of the shares of the Acquired Corporations.
The closing date of the transaction was set as XXXXXXXXXX.
Aco requested from the firm of XXXXXXXXXX a steps plan in order to integrate the Acquired Corporations and a quote of their estimated fees to implement this integration in the first months after the acquisition. XXXXXXXXXX sent Aco an engagement letter. XXXXXXXXXX sent the following invoices relating to the integration project:
XXXXXXXXXX.
These costs were invoiced to the two Acquired Corporations at the same time as the other costs incurred for those two corporations. The representative of Aco attached a copy of the invoice sent to the two Acquired Corporations.
Question
You wish to know whether the integration costs incurred by Aco in respect of the Acquired Corporations are current expenses, deductible in computing Aco's income, or whether they are instead capital expenditures, the deduction of which is disallowed pursuant to paragraph 18(1)(b) of the Income Tax Act (the "Act"), which must be added to the cost of the acquired shares.
Our Comments
According to what you indicated to us and the documents provided by the taxpayer, Aco had a practice of incurring certain expenses for its subsidiaries and then invoicing the subsidiaries for those expenses in the form of management fees. In fact, Aco invoiced the integration fees at the beginning of the taxation year following the year in which they were incurred.
Even though Aco undertook integration costs of its new subsidiaries before the closing date of the transaction to acquire the shares of those subsidiaries and thus incurred some costs before the acquisition, we are of the view that it could have expected to earn income by charging those costs to the acquired subsidiaries since it was very likely that the shares would be acquired by Aco or its parent corporation. Indeed, the proposed acquisition by Aco had already been presented to its board of directors in XXXXXXXXXX and according to the agreement signed on XXXXXXXXXX, Bco or one of its subsidiaries had the obligation to acquire the shares of the Acquired Corporations at the closing date unless certain conditions were not satisfied by the vendor or the Acquired Corporations.
Furthermore, most of the integration costs were charged to Aco by the service provider after the closing date, for services performed after the closing date. Given that the integration of the Acquired Corporations had to take place following the acquisition, but from the time of the acquisition of the shares, for the smooth running of their own business, Aco had good business reasons to incur costs on behalf of the Acquired Corporations prior to the acquisition of the shares in order to plan for this integration. In our view, the fact that this planning was done before the acquisition of the shares does not change the nature of the costs and does not allow us to consider them as costs incurred to acquire the shares of the Acquired Corporations when the integration was for the purpose of making the necessary changes in the operations of the subsidiaries.
Consequently, we are of the view that Aco was justified in deducting the integration costs in computing its business income and not treating them as capital expenditures because it seems to us that the integration costs paid by Aco were not incurred to acquire the shares of the subsidiaries or to change the structure of Aco but were incurred by Aco for the same purpose as the payment of expenses in respect of its other subsidiaries, i.e., to receive management fees or to be reimbursed for the expenses. This expense does not have the character of an enduring benefit to Aco since the management fees were received in the same or subsequent year. In addition, incurring the integration fees on behalf of the Acquired Corporations was part of the management operations of Aco's business.
The integration fees were deductible from Aco's income in the year in which they are incurred, i.e. XXXXXXXXXX. As there does not appear to have been any undue delay in billing the integration fees to the acquired subsidiaries, the management fees were taxable income under section 9 of the Act in the XXXXXXXXXX year. The tax treatment would be the same if, instead of receiving income in the form of management fees, Aco received income in the form of reimbursement by its subsidiaries of expenses it had incurred on their behalf.
Our position on the deductibility of integration costs to the parent corporation does not allow us to reach a conclusion on the deductibility to the subsidiaries of the costs it charged them on XXXXXXXXXX. While our general position on such costs is that they are expenses of a current nature, the relevant facts at the subsidiary level would have to be examined in order to take a definitive position.
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, the electronic library version can be provided. Alternatively, the client may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Ms. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
We hope that these comments are of assistance. Should you require further information on the content of this document, please do not hesitate to contact us.
Ghislaine Landry, CGA
for the Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch