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By Peter Menyasz
Canada’s Federal Court of Appeal upheld the right of mining giant Rio Tinto Alcan Inc. to deduct C$51.6 million ($39.3 million) in legal, banking, and regulatory expenses used to acquire a competitor and spinoff a business unit.
The ruling confirms that Canadian courts are taking a more expansive view of business expense deductibility in comparison to the federal tax agency. The more liberal approach better reflects modern business practices, tax lawyers told Bloomberg Tax.
“This reflects a new realism in the courts when dealing with the taxation of business activities. The formalism of the late 19th and early 20th centuries is giving way to an attempt to see the tax world through the eyes of the people making real business decisions,” William Innes, counsel in the Toronto office of Rueters LLP, said June 29.
The Court of Appeal upheld the Tax Court of Canada’s 2016 finding that a substantial portion of Rio Tinto’s payments to investment bankers—for advice on whether to acquire French firm Pechiney S.A. and how to structure the deal—were deductible, the Court of Appeal said in a June 25 ruling. The ruling was made public June 28.
Rio Tinto Alcan and its counsel didn’t respond to requests for comment.
The tax court’s analysis was consistent with precedents on expense deductibility, and while its use of the term “oversight expenses” was novel, it was based on correct reasoning, the appellate court said. The tax court correctly found that in addition to selling aluminum, acquiring corporations to generate revenue and increase shareholder value is a core element of the company’s business model, the appellate said.
The “normal management” of business operations could “include the evaluation of a future course of action which may or may not result in the construction or acquisition of a capital asset,” the appellate court said. “As the Court pointed out, the mere fact that an expenditure is incurred in the course of deciding whether or not to acquire or create a capital asset does not mean it is necessarily made on account of capital.”
The case involved expenses in Rio Tinto’s C$6.2 billion ($4.7 billion) acquisition of Pechiney in 2003 and its 2004 spinoff to shareholders of its rolled aluminum products business.
Practitioners said the case is unlikely to move to the Supreme Court of Canada. The government has until Sept. 24 to seek leave to appeal it to the Supreme Court.
“It’s highly fact specific, doesn’t depart all that much from precedent and there are no ‘clangers’ that would attract their attention,” Innes said.
The ruling made a distinction between “oversight expenses” incurred in making decisions on acquisitions and divestitures, which are generally deductible, and “implementation costs” incurred in putting business decisions into effect, which generally aren’t deductible.
The distinction will make it difficult for the federal government to pursue the case further, said Corrado Cardarelli, a partner in the Toronto office of Torys LLP and chair of the firm’s tax practice.
The appellate court confirmed that a substantial portion of fees incurred by Rio Tinto Alcan in its hostile bid for Pechiney were currently deductible and the remainder, which related to implementing the bid, were capital expenditures, Cardarelli said June 29.
“The Federal Court of Appeal reviewed the jurisprudence in coming to this finding, so unless they got it ‘wrong’, it is hard to see on what basis the government could appeal,” he said.
The Canada Revenue Agency declined to comment on whether it might appeal.
The appellate court rejected Rio Tinto’s cross-appeal for additional deductions for advertising and reporting fees paid to publicists. accounting firms and the U.S. Securities and Exchange Commission.
The company argued that the Tax Court applied the wrong legal test to those expenses, but was just disagreeing with the court’s finding on the sufficiency and value of the evidence, the appellate court said. Those disputed fees related to implementing the deals, so they were capital expenditures, it said.
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