Capital v. Income in Imperial Tobacco Canada Limited v. Canada, 2011 FCA 308
Imperial Tobacco Canada Limited v. Canada, 2011 FCA 308 (CanLII), [Imperial] concerns the characterization of payments made by a corporation as being on account of income or capital. Payments on account of income are deductible, while payments capital in nature are not. Focusing on purpose instead of the form of the payments, the Federal Court of Appeal (“FCA”) held that the payments at issue were capital in nature, connected to the corporation’s capital structure, and a one-time expenditure intended to result in a benefit of an enduring nature, rather than ongoing payments related to the operating costs of the corporation. Accordingly, they were not deductible pursuant to paragraph 18(1)(b) of the Income Tax Act, RSC 1985, c 1 (5th Supp) (“ITA”).
Corporate Reorganization
The payments were made by Imasco Limited (“Imasco”) in the context of a corporate reorganization. A stock option plan granted Imasco employees the right to purchase shares of the company for fair market value as of the date the option was granted. However, Imasco retained the option to offer employees cash in return for surrendering the stock option.
To facilitate an ongoing corporate reorganization, a resolution was passed to offer all employees with stock options a cash payment in exchange. In total, Imasco paid $118 million to employees who surrendered their stock options.
Imasco claimed deductions for these payments on the basis that the payments were employee compensation. Canada Revenue Agency (“CRA”), relying on paragraph 18(1)(b) of the ITA disallowed the deductions, claiming these payments were made on account of capital and could not be deducted from Imasco’s income.
Tax Court of Canada
Imasco appealed to the Tax Court of Canada (“TCC”), which rejected the appeal, holding that the payments were payments made on account of capital.
The TCC looked beyond the fact that the payments were made to employees but instead to the purpose of the payments, which was not compensation, but to facilitate a corporate reorganization. The TCC also relied on the decision by the Supreme Court of Canada in Kaiser Petroleum Ltd. v Minister of National Revenue, [1990] 2 S.C.R. 36, which previously held that payments made to extinguish shares or share possibilities were capital in nature.
Federal Court of Appeal
Upholding the decision of the TCC, the FCA emphasized that there is no single test to determine whether a payment is made on account or income or capital but that determination requires a careful examination of the facts. While decisions such as British Insulated and Helsby Cables v. Atherton, [1926] A.C. 205 (H.L.) are helpful, stating that a capital expenditure is one which is made on a one-time basis with the intention of resulting in a beneficial advantage or asset, they serve more as guides rather than bright line tests.
The FCA affirmed the approach taken by the TCC, and considered the purpose and circumstances of the payments, holding that the payments were made to facilitate the corporate reorganization, rather than purely to compensate employees or as a part of its day-to-day activities. These payments were intended to eliminate Imasco’s future obligations regarding sales of its own shares – a “once and for all payment that resulted in a benefit to Imasco of an enduring nature”. Accordingly, the payments were made on account of capital.