Devon Canada Corporation v. The Queen

Devon Canada Corporation v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2018-08-20
Neutral citation
2018 TCC 170
File numbers
2013-1066(IT)G, 2013-1327(IT)G
Judges and Taxing Officers
Don R. Sommerfeldt
Subjects
Income Tax Act
Notes
A correction was made on October 30, 2018.
Decision Content
Dockets: 2013-1066(IT)G
2013-1327(IT)G
BETWEEN:
DEVON CANADA CORPORATION,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals called for hearing on May 1 and 2, 2017, at Calgary, Alberta and on October 30 and 31, 2017 and November 1, 2017,
at Toronto, Ontario. Submissions filed by the Appellant on August 14, 2017 and October 16, 2017 and by the Respondent
on September 22, 2017.
By: The Honourable Justice Don R. Sommerfeldt
Appearances:
Counsel for the Appellant:
Al Meghji, Edward Rowe,
Pooja Mihailovich, Joanne Vandale
Counsel for the Respondent:
Luther P. Chambers, Q.C.,
Patrick Vézina, Vincent Bourgeois
JUDGMENT
These Appeals are allowed and the reassessment and the determination of a loss that are the subject of these Appeals are referred back to the Minister of National Revenue for reconsideration and reassessment or redetermination, as the case may be, in accordance with the attached Reasons, and, in particular, on the basis that the Surrender Payments (as defined in the Reasons) were eligible capital expenditures (as defined in subsection 14(5) of the Income Tax Act, as it read in 2001).
Costs are awarded to the Appellant. The Parties shall have 30 days from the date of this Judgment to reach an agreement on costs, failing which the Appellant shall have a further 30 days to file written submissions on costs, and the Respondent shall have yet a further 30 days to file a written response. Any such submissions are to be limited to 10 pages in length. If the Parties do not advise the Court that they have reached an agreement and if no submissions are received within the foregoing time limits, costs shall be awarded to the Appellant in accordance with the Tariff.
Signed at Ottawa, Canada, this 20th day of August 2018.
“Don R. Sommerfeldt”
Sommerfeldt J.
Citation: 2018 TCC 170
Date: 20180820
Dockets: 2013-1066(IT)G
2013-1327(IT)G
BETWEEN:
DEVON CANADA CORPORATION,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Sommerfeldt J.
I. INTRODUCTION
[1] These Reasons pertain to two Appeals brought by Devon Canada Corporation (“Devon”) in respect of:
a) a reassessment (the “Reassessment”), as set out in a Notice of Reassessment dated September 3, 2008, issued by the Canada Revenue Agency (the “CRA”) on behalf of the Minister of National Revenue (the “Minister” ), in respect of the taxation year of a predecessor, Numac Energy Inc. (“Numac”), that ended on February 11, 2001; and
b) a determination of a loss (the “Determination”), as set out in a Notice of Determination of a Loss dated July 31, 2008, issued by the CRA on behalf of the Minister, in respect of the taxation year of a predecessor, Anderson Exploration Limited (“Anderson”), that ended on October 14, 2001.
[2] In the context of two corporate takeovers, by Anderson of Numac on or about February 12, 2001 and by Devon Energy Corporation (“DEC”) of Anderson on or about October 15, 2001, Numac and Anderson made payments (the “Surrender Payments”) to various individuals who held options to acquire shares of the respective corporations.
[3] In computing its income for the taxation year ended on February 11, 2001, Numac deducted the Surrender Payments (the “Numac Surrender Payments”) paid by it to its option holders who had elected to surrender their unexercised options to Numac in exchange for a cash payment calculated by reference to the difference between the takeover-bid price of a Numac share and the exercise price of the particular option. In computing its income for the taxation year ended on October 14, 2001, Anderson deducted the Surrender Payments (the “Anderson Surrender Payments”) paid by it to its option holders who had elected to surrender their unexercised options to Anderson in exchange for a cash payment calculated by reference to the difference between the takeover-bid price of an Anderson share and the exercise price of the particular option.
II. ISSUES
[4] As set out in the pleadings, the issues in these Appeals were, in essence:
a) In computing Numac’s income for the taxation year ended on February 11, 2001, was Numac entitled to deduct the Numac Surrender Payments pursuant to subsection 9(1) of the Income Tax Act (the “ITA”), [1] or was that deduction precluded by paragraph 18(1)(a) or (b) of the ITA?
b) If the Numac Surrender Payments were on account of capital, within the meaning of paragraph 18(1)(b) of the ITA, were they eligible capital expenditures, within the meaning of subsection 14(5) of the ITA, so as to be deductible in part pursuant to paragraph 20(1)(b) of the ITA, read in conjunction with subsection 111(5.2) of the ITA?
c) Were the Numac Surrender Payments deductible pursuant to subparagraph 20(1)(e)(i) of the ITA?
d) In computing Anderson’s income for the taxation year ended on October 14, 2001, was Anderson entitled to deduct the Anderson Surrender Payments pursuant to subsection 9(1) of the ITA or was that deduction precluded by paragraph 18(1)(a) or (b) of the ITA?
e) If the Anderson Surrender Payments were on account of capital, within the meaning of paragraph 18(1)(b) of the ITA, were they eligible capital expenditures, within the meaning of subsection 14(5) of the ITA, so as to be deductible in part pursuant to paragraph 20(1)(b) of the ITA, read in conjunction with subsection 111(5.2) of the ITA?
f) Were the Anderson Surrender Payments deductible pursuant to subparagraph 20(1)(e)(i) of the ITA?
[5] By letter dated April 25, 2017, counsel for Devon advised the Court that Devon would no longer be advancing the arguments that it had previously made in respect of issues a) and d) above. In other words, Devon implicitly acknowledged that the Surrender Payments were not deductible under subsection 9(1) of the ITA.
III. FACTS
[6] The Parties filed a Statement of Agreed Facts – Partial (the “SAFP”), [2] a two-volume Joint Book of Documents (the “JBOD”) [3] and a Supplementary Joint Book of Documents. [4] Unless otherwise indicated, the following facts are taken from the SAFP. A copy of the SAFP is attached as Appendix A to these Reasons.
A. Parties
[7] Devon was formed as the result of a number of amalgamations. Numac and Anderson were two of the corporations that participated in some of the amalgamations to form Devon.
[8] On or about February 12, 2001, Anderson (through a subsidiary) acquired all of the issued and outstanding shares of Numac by way of a takeover bid (the “Numac Acquisition”), described below. [5]
[9] Before February 12, 2001, Numac was a public corporation, the shares of which were listed and traded on the Toronto Stock Exchange (the “TSE”) and the American Stock Exchange. After the Numac Acquisition, the Numac shares were delisted from trading on those stock exchanges.
[10] Numac, together with its subsidiaries, was engaged in the active business of exploring for, producing and selling natural gas and other hydrocarbons in Canada. Numac and its successors, including Devon, continued to carry on this business after the Numac Acquisition.
[11] On or about October 15, 2001, DEC (through a subsidiary) acquired all of the issued and outstanding shares of Anderson by way of a takeover bid (the “Anderson Acquisition”), described below. [6]
[12] Before October 15, 2001, Anderson was a public corporation, the shares of which were listed and traded on the TSE and the New York Stock Exchange. After the Anderson Acquisition, the Anderson shares were delisted from trading on those stock exchanges.
[13] Anderson, together with its subsidiaries, was engaged in the active business of exploring for, producing and selling natural gas and other hydrocarbons in Canada. Anderson and its successors, including Devon, continued to carry on this business after the Anderson Acquisition.
B. Stock Option Plans
(1) Numac Stock Option Plan
[14] Before the Numac Acquisition, Numac had an employee stock option plan (the “Numac SOP”), which had come into existence before 2001. The Numac SOP was to be administered by the Numac Board of Directors, or a special committee thereof, appointed from time to time. At all relevant times, the Numac SOP was administered by the Compensation Committee of the Board of Directors of Numac.
[15] The Numac SOP provided for share option agreements (the “Numac SOAs”), with attached terms and conditions, to be entered into between Numac and its directors, officers and key employees (the “Numac Optionees”), to grant them options to purchase common shares of Numac for an option price specified in the SOAs and described therein as the “exercise price.” The Compensation Committee of the Board of Directors of Numac decided which of the Numac employees would receive options to acquire Numac shares in a given year.
[16] The Numac SOP provided that the Compensation Committee of Numac’s Board of Directors could “in its sole discretion, determine the time during which options shall vest.” Although the terms of the Numac SOAs varied, each SOA provided for vesting limitations, which had to be satisfied before the options could be exercised to acquire shares of Numac. Specifically, the vast majority of Numac SOAs provided that the options granted thereunder would vest in three equal parts (that is, one-third of the grant) on the first, second and third anniversaries of the date of grant. Upon satisfaction of those limitations, a Numac Optionee could exercise a vested option by paying to Numac the exercise price specified in the applicable SOA.
[17] The Numac SOP provided that the exercise price of an option was to be fixed by the Compensation Committee at the time the option was granted. The Numac SOP also provided that the exercise price could not be less than the closing price of the common shares of Numac on the stock exchange on which the shares were traded on the last trading day before the grant of the option.
[18] All of the Numac SOAs also provided that:
a) in the event of an amalgamation, arrangement, merger or other consolidation of Numac with another corporation (other than a wholly-owned subsidiary of Numac), the vesting of unvested options was accelerated such that the Numac Optionees had the right to exercise their options at that time; and
b) in the event of a formal bid being made to acquire more than 25% of the outstanding voting shares of Numac, and if Numac’s Board of Directors recommended acceptance of the offer, the vesting of unvested options was accelerated and such options could be exercised for the sole purpose of tendering the shares to the bid.
[19] The terms and conditions of the Numac SOAs provided that the Board of Directors of Numac had the discretion to permit unexercised options to be surrendered to Numac for cash equal to the amount by which the fair market value of the shares at the time of the surrender exceeded the exercise price, [7] but the Numac Optionees did not otherwise have the right to surrender and cash out their options. Before the Numac Acquisition, Numac’s Board of Directors had not previously exercised the discretion to permit the Numac Optionees to surrender their options for cash.
[20] The Numac SOP and the Numac SOAs provided that the options were not assignable by the Numac Optionees. The Numac SOP also provided that, if a Numac Optionee ceased to be a director, officer or full-time employee of Numac, the option would terminate on the expiry of the period determined by the Compensation Committee of Numac’s Board of Directors, which was to be no more than six months after that cessation. The terms and conditions of each Numac SOA further provided that, if a Numac Optionee’s employment was terminated without cause within 60 days of an amalgamation, merger or other consolidation of Numac with any one or more corporations, any unexercised option would terminate and become null and void.
(2) Anderson Stock Option Plan
[21] Before the Anderson Acquisition, Anderson had an employee stock option plan (the “Anderson SOP”), which had come into existence on or about December 31, 1994. It was amended and restated as of February 10, 1999, and further amended and restated on February 13, 2001.
[22] The Anderson SOP provided that:
a) the Board of Directors of Anderson had the authority to:
grant to Anderson’s officers, members of management and employees (the “Anderson Optionees”) options to purchase a number of Anderson’s common shares designated by the Board of Directors at the exercise price specified in the option grant;
fix the exercise price, which had to be equal to the closing price of the common shares on the TSE on the date of grant;
designate the period during which those options could be exercised, with the caveat that such period would not exceed ten years from the date of option grant; and
specify the vesting limitations that were required to be satisfied before the options could be exercised;
b) options granted under the plan were not assignable;
c) on the termination of an Anderson Optionee’s employment with Anderson, unexercised options were terminated;
d) in the event of a takeover of Anderson, any options that had not vested would immediately vest, giving the Anderson Optionees the right to exercise their options at that time; and
e) in connection with the exercise of options, the Anderson Optionees could, at the sole option of the Board of Directors, be entitled to obtain a loan from Anderson on terms prescribed in the Anderson SOP.
[23] Options granted under the Anderson SOP were governed by stock option agreements (the “Anderson SOAs”) between Anderson and the Anderson Optionees. The Anderson SOAs provided:
a) for a five-year expiry date of the particular option from the date of the grant of the option;
b) for a vesting limitation that had to be satisfied before the options could be exercised to acquire shares of Anderson; and
c) for the options to vest in three equal parts (that is, one-third of the grant) on the first, second and third anniversaries of the date of grant.
Upon satisfaction of those limitations, an Anderson Optionee could exercise a vested option by paying to Anderson the exercise price specified in the applicable Anderson SOA.
[24] Neither the Anderson SOP nor the relevant options granted pursuant to the Anderson SOAs gave the Anderson Optionees the right to unilaterally surrender their options in return for cash payments. However, the Board of Directors of Anderson had the discretion to permit vested unexercised options to be surrendered to Anderson for cash equal to the amount by which the fair market value of the shares at the time of their surrender exceeded the exercise price. [8] Before the Anderson Acquisition, the Board of Directors of Anderson had not previously exercised the discretion to permit the Anderson Optionees to surrender their unexercised options to Anderson for cash.
[25] The Anderson SOP was administered by the Board of Directors of Anderson, which had full and final discretion to interpret the provisions of the Anderson SOP and to prescribe, amend, rescind and waive rules and regulations to govern the administration and operation of the plan.
C. Numac Acquisition
(1) Anderson Acquires Numac
[26] On or about January 17, 2001, Anderson and Numac entered into a Pre‑Acquisition Agreement, pursuant to which:
a) Anderson expressed its intention to acquire all of Numac’s outstanding common shares, including any Numac shares that could become outstanding pursuant to the exercise of outstanding options under the Numac SOP, in consideration for a cash payment of $8.00 for each Numac share;
b) Numac represented that all option entitlements held by the Numac Optionees under the Numac SOP would accelerate and vest as a result of Anderson making the offer to acquire all of Numac’s outstanding shares, and that it would give immediate notice of the offer to all Numac Optionees;
c) the parties agreed that all options granted under the Numac SOP that were tendered to Numac for exercise, conditional on Anderson's takeover of Numac, would be deemed to have been exercised concurrently with the take-up of Numac shares by Anderson;
d) the parties agreed that, to the extent that the Numac Optionees did not exercise their options and tender the shares acquired to the Anderson offer, Numac was permitted to agree with the Numac Optionees that, in lieu of such persons exercising their options, Numac would pay to such Numac Optionees the difference between the purchase price for the Numac shares under the offer and the exercise price of their options, in exchange for the termination of their options;
e) Numac represented that all persons holding options were entitled to exercise their options and tender their Numac shares under Anderson’s offer, and that Numac’s Board of Directors would not, before the completion of the offer, grant additional options pursuant to the Numac SOP; and
f) Numac agreed to use commercially reasonable efforts to encourage and facilitate the Numac Optionees to either exercise their options and deposit all of the Numac shares issued in connection therewith under the offer, or to surrender all of their Numac options for cancellation.
[27] The closing price of the Numac common shares on the TSE on January 17, 2001 was $6.40 per share.
[28] By news release dated January 19, 2001, Anderson announced that it was mailing to Numac’s shareholders its formal offer to purchase all of the issued and outstanding common shares of Numac for cash consideration of $8.00 per share.
[29] On January 19, 2001, Anderson Acquisition Corp (“Anderson Acquireco”), an indirect wholly-owned subsidiary of Anderson, on behalf of Anderson, offered to purchase all of the Numac common shares at a price of $8.00 in cash for each share. On January 23, 2001, Numac’s Board of Directors issued to Numac shareholders a Directors’ Circular pursuant to which the Board recommended acceptance of Anderson Acquireco’s offer.
[30] By letter dated January 25, 2001, Numac advised the Numac Optionees that:
a) Anderson Acquireco’s offer to purchase all of the outstanding Numac common shares had triggered the acceleration of the unvested options;
b) they could elect to receive a cash payment from Numac for the value of their options, determined as the difference between $8.00 per share and the applicable exercise price (less applicable withholding tax) (the “Numac Cash Election”), or they could exercise their options by paying the applicable exercise price and acquiring the shares, and then tender the shares to the offer (the “Numac Exercise Election”); and
c) if a Numac Optionee failed to act on either alternative, that Numac Optionee would be deemed to have made the Numac Cash Election.
[31] In the letter dated January 25, 2001, the Numac Optionees were also advised that:
a) in order to facilitate the realization by the Numac Optionees of the value of their options, Numac agreed to purchase the options of the Numac Optionees who chose the Numac Cash Election;
b) a Numac Cash Election would become effective only if and when Anderson Acquireco took up the common shares of Numac under its offer and, if it did not take up and pay for the Numac common shares, Numac’s offer to purchase their options would be withdrawn, the Numac Optionees would not receive any payment for their options, and the options that had accelerated would revert to their previous vesting arrangements in accordance with the terms of the Numac SOP; and
c) the Numac Exercise Election would be effective only if Numac was satisfied that Anderson Acquireco’s offer would be completed and Numac deposited a letter of transmittal provided by the Numac Optionees together with their Numac Exercise Elections, whereupon the Numac Optionees would receive payment for their common shares of Numac by cheque at the price of $8.00 per share, and if Anderson Acquireco did not take up and pay for the Numac common shares under its offer, the options that had been accelerated would revert to their previous vesting arrangements in accordance with the terms of the Numac SOP, and the certified cheques, bank drafts or money orders delivered in satisfaction of the exercise price would be returned to them.
[32] Upon the closing of the Numac Acquisition on February 12, 2001, Numac shareholders tendered, and Anderson Acquireco acquired, 95,250,604, or approximately 98%, of the then outstanding Numac common shares, and the remaining 1,415,008 common shares that were not tendered were acquired through the compulsory share acquisition provisions in the Alberta Business Corporations Act (the “ABCA”). [9]
[33] As a result of the acquisition of control of Numac by Anderson Acquireco on February 12, 2001, Numac’s taxation year (the “Numac Taxation Year”) that would otherwise have included that date was deemed to end on February 11, 2001.
(2) Numac Surrender Payments
[34] During the Numac Taxation Year, options to acquire 7,228,829 Numac common shares were surrendered by the Numac Optionees who had made the Numac Cash Election. After the Numac Acquisition, Numac made cash payments (defined above as the “Numac Surrender Payments”) in the aggregate amount of $20,844,041 to the Numac Optionees who had made the Numac Cash Election.
[35] The Numac Surrender Payments made to the respective Numac Optionees were reported by Numac (or its successor) on the T4 slips issued to those optionees and were included in computing their employment income for the purposes of the ITA.
D. Other Facts Relevant to Numac
[36] On April 1, 2001, Anderson Acquireco amalgamated with Numac to form Numac Energy Inc. (“Numac Amalco”).
[37] On September 1, 2003, Numac Amalco amalgamated with Devon Amalco [10] to form Devon Canada Corporation (defined above as “Devon”), the Appellant in these Appeals.
[38] In computing Numac’s income under the ITA for the Numac Taxation Year, Numac Amalco (as successor to Numac) deducted the Numac Surrender Payments, relying on subsection 9(1) of the ITA. By means of the Reassessment, notice of which was dated September 3, 2008, the Minister reassessed Devon (as successor to Numac), to disallow the deduction of the Numac Surrender Payments. Devon (as successor to Numac) objected to the Reassessment by means of a Notice of Objection filed on November 27, 2008. The Minister confirmed the Reassessment by means of a Notice of Confirmation dated March 14, 2013.
[39] In its Notice of Appeal, Devon (as successor to Numac) claimed, in the alternative, that the Numac Surrender Payments were deductible as eligible capital expenditures at the time of the acquisition of control pursuant to subsection 111(5.2) and paragraph 20(1)(b) of the ITA, or as expenses under paragraph 20(1)(e) of the ITA.
E. Anderson Acquisition
(1) Devon Acquires Anderson
[40] On August 31, 2001, DEC, which was a US public company, and Anderson entered into a Pre-Acquisition Agreement, pursuant to which:
a) DEC expressed its intention to acquire, either itself or through a subsidiary corporation, all of Anderson’s outstanding common shares, including any Anderson shares that could become outstanding pursuant to the exercise of outstanding options under the Anderson SOP, in consideration for a cash payment of $40.00 for each Anderson share;
b) Anderson represented that all option entitlements held by Anderson Optionees under the Anderson SOP would accelerate and vest as a result of DEC making the offer to acquire all of Anderson’s outstanding shares, and that it would give immediate notice of the offer to all Anderson Optionees;
c) the parties agreed that all options granted under the Anderson SOP that were tendered to Anderson for exercise, conditional on DEC’s takeover of Anderson, would be deemed to have been exercised concurrently with the take-up of Anderson shares by DEC;
d) the parties agreed that, to the extent that any Anderson Optionees did not exercise their options under DEC’s offer, Anderson was permitted to agree with those Anderson Optionees that, in lieu of those Anderson Optionees exercising their options, Anderson would pay to those Anderson Optionees the difference between the purchase price for the Anderson shares under the offer and the exercise price of their options, in exchange for the termination of their options; and
e) Anderson represented, among other things, that all persons holding options were entitled to exercise their options and tender their Anderson shares under DEC’s offer, and that Anderson’s Board of Directors would not, prior to the completion of the offer, grant additional options pursuant to the Anderson SOP.
[41] The closing price of the Anderson common shares on the TSE on August 31, 2001 was $26.40 per share.
[42] On September 6, 2001, Devon Acquisition Corporation (“DAC”), a wholly-owned Canadian subsidiary of DEC, offered to purchase all of the Anderson common shares at a price of $40.00 in cash for each share. On September 6, 2001, Anderson’s Board of Directors issued to Anderson’s shareholders a Directors’ Circular pursuant to which the Board recommended acceptance of DAC’s offer.
[43] By memorandum dated September 25, 2001, Anderson advised the Anderson Optionees that:
a) the Anderson SOP provided for the acceleration of unvested options in order to provide the Anderson Optionees with the opportunity to tender to DAC’s offer the Anderson shares issuable on the exercise of unvested options;
b) Anderson’s Board of Directors had exercised its discretion under the Anderson SOP to permit the Anderson Optionees to elect either to receive a cheque for their options or to follow the traditional method requiring the optionees to exercise their options and to forward payments for the shares to Anderson by a certified cheque or bank draft;
c) the Anderson Optionees were required to complete an election form and to return it to a specified employee of Anderson;
d) if the Anderson Optionees desired to participate in the offer, they had two alternatives (both of which required the completion of the election form) for dealing with their vested and unvested options:
they could make an election (the “Anderson Cash Election”) to surrender their options to Anderson in consideration for a cash payment equal to the value of their surrendered options, which was equal to $40 a share less the particular option exercise price, or
they could make an election (the “Anderson Exercise Election”) to exercise their options and tender the shares to DAC’s offer.
[44] In the memorandum dated September 25, 2001, the Anderson Optionees were also advised that, if DAC did not take up and pay for the Anderson common shares under its offer:
a) the Anderson Cash Election would not take effect, Anderson’s offer to purchase their options would be withdrawn, they would not receive any payment for their options, their options would continue to exist and would be subject to the terms of the Anderson SOP, and the options that were accelerated would revert to their previous vesting arrangements; and
b) the Anderson Exercise Election would not take effect, the exercise of their options would be deemed not to have occurred, the certified cheques or bank drafts delivered by the Anderson Optionees to Anderson in payment of the exercise price would be returned to them, and the options that were accelerated would revert to their previous vesting arrangements.
[45] On the closing of the Anderson Acquisition on October 15, 2001, Anderson shareholders tendered, and DAC acquired, approximately 97% of the then outstanding Anderson common shares, [11] and the remaining 3% of the shares that were not tendered were acquired through the compulsory share acquisition provisions of the Canada Business Corporations Act. [12]
[46] As a result of the acquisition of control of Anderson by DAC, on October 15, 2001, Anderson’s taxation year (the “Anderson Taxation Year”) that otherwise would have included that date was deemed to end on October 14, 2001.
(2) Anderson Surrender Payments
[47] During the Anderson Taxation Year, options to acquire 3,291,445 Anderson common shares were surrendered by the Anderson Optionees who had made the Anderson Cash Election. After the Anderson Acquisition, Anderson made cash payments (defined above as the “Anderson Surrender Payments”) in the aggregate amount of $59,842,894 to the Anderson Optionees who had made the Anderson Cash Election. By reason of an acquisition-of-control condition that was triggered in respect of the operating line of credit that Anderson had with a major financial institution, Anderson was no longer able to access that line of credit. As a result, DAC lent Anderson sufficient funds to take care of its immediate cash needs, including the cash Anderson needed to make the Anderson Surrender Payments.
[48] The Anderson Surrender Payments made to the respective Anderson Optionees were reported by Anderson (or its successor) on the T4 slips issued to those optionees and were included in computing their employment income for the purposes of the ITA.
F. Other Facts Relevant to Anderson
[49] DAC and Anderson amalgamated on October 18, 2001 to form Devon Acquisition Corporation (“Devon Amalco”). On October 25, 2001, Devon Amalco continued under the ABCA [13] and changed its name to “Devon Canada Corporation.” [14]
[50] As indicated above, on September 1, 2003, Devon Amalco and Numac Amalco amalgamated to form Devon Canada Corporation (defined above as “Devon”), the Appellant in these Appeals. [15]
[51] In computing Anderson’s income under the ITA for the Anderson Taxation Year, Devon Amalco (as successor to Anderson), deducted the Anderson Surrender Payments, relying on subsection 9(1) of the ITA. On July 31, 2018, the Minister issued the Determination to Devon (as successor to Anderson) for the Anderson Taxation Year, to disallow the deduction of the Anderson Surrender Payments. Devon (as successor to Anderson) objected to the Determination by means of a Notice of Objection filed on October 28, 2008. The Minister confirmed the Determination by means of a Notice of Confirmation dated February 4, 2013.
[52] In its Notice of Appeal, Devon (as successor to Anderson) claimed, in the alternative, that the Anderson Surrender Payments were deductible as eligible capital expenditures at the time of the acquisition of control pursuant to subsection 111(5.2) and paragraph 20(1)(b) of the ITA, or as expenses under paragraph 20(1)(e) of the ITA.
IV. SUMMARY OF ORAL EVIDENCE
A. Fact Witnesses
(1) Brent Snyder
[53] Counsel for Devon called Brent Snyder and Michael Perlette as fact witnesses.
[54] Mr. Snyder is a professional geologist, who has worked in the oil and gas industry since 1983. After working as a geophysical technician for the first year and a half of his career, he took a position as a geologist with Texaco Canada Ltd. (“Texaco”) where he worked from 1984 to 1989. After Imperial Oil Limited (“Imperial”) acquired Texaco in 1989, Mr. Snyder worked as an exploration geologist for Esso Resources (“Esso”) for approximately two years. [16]
[55] Mr. Snyder testified that there were certain advantages to working for a larger oil company, such as Texaco or Esso. In particular, they offered competitive salaries and usually had attractive benefit packages, including a defined benefit pension plan. As well, the larger oil companies generally provided better training. However, in the 1990s it was generally acknowledged that greater rewards could be found by working for one of the junior oil and gas companies, which tended to be nimble and entrepreneurial and had more attractive compensation packages, which included not only a competitive salary but also bonuses and stock options, which were significant motivators. It was Mr. Snyder’s experience that, where any of his employers had a stock option plan, the employer posted its daily stock price on the computer screen of each employee in order to enhance the motivation. Mr. Snyder indicated that it was common in the 1990s for geoscientists to begin their careers with a large company and then move to a junior oil and gas company. In keeping with this trend, Mr. Snyder left Esso in 1991 and took a position with Murphy Oil Canada (“Murphy”).
[56] In the 1990s, Mr. Snyder worked for several independent oil and gas companies, specifically Murphy, Richland Petroleum (“Richland”) and Ulster Petroleum (“Ulster”). He stated that he was granted stock options at Richland and Ulster. Nothing was said one way or the other in respect of Murphy.
[57] In May 2000, Anderson acquired Ulster, whereupon Mr. Snyder became an employee of Anderson. His compensation package at Anderson included a salary, bonuses and stock options.
[58] Mr. Snyder stated that corporate acquisitions were not uncommon in the oil and gas industry in Alberta in the 1990s and early 2000s. In some acquisitions there was concern on the part of employees, particularly those employed by the target corporation, that they might lose their jobs as a result of the acquisition. That concern was less prevalent among the professionals, including geologists and other geoscientists, as they knew that their professional knowledge and credentials would be needed even after the acquisition.
[59] Mr. Snyder indicated that, in most of the corporate takeovers, the acquiror usually paid a premium above the market price to acquire the shares of the target. This was attractive for employees of the target who held options, as the higher price was reflected in the amounts paid to buy out the stock options. When Anderson purchased Ulster in 2000, Mr. Snyder realized a modest gain, as his Ulster stock options were cashed out.
[60] Several themes were prominent in the testimony given by Mr. Snyder:
a) Stock options were a very common feature of the compensation packages offered by the junior oil and gas companies in Alberta in the 1990s.
b) Stock options were used by junior oil and gas companies to attract talent.
c) Corporate acquisitions or takeovers were not uncommon in the oil and gas industry in Alberta in the 1990s and early 2000s.
d) A corporate takeover typically resulted in the stock options of the target corporation being subject to accelerated vesting, and optionees possibly being offered cash payments for the surrender of their options.
[61] When the acquisition of Anderson by DEC was formally announced, there was “a bit of concern” among the employees of Anderson as to what would become of them, “[b]ut it was different this time.” [17] The reason for the difference was that, when DAC (DEC’s acquiring subsidiary) acquired Anderson in October 2001, DEC’s Canadian operating subsidiary, known as Northstar Energy Corp. (“Northstar”), had approximately 200 to 250 employees, while Anderson had approximately 700 to 800 employees. The employees of Anderson anticipated that DEC would need to retain them in order to manage and operate the assets of Anderson.
[62] However, DEC, which was based in Oklahoma City, was not then well known in Calgary. Therefore, some of the employees of Anderson were not certain that they wanted to remain with Anderson after the acquisition. At that time, many of the oil and gas companies in Calgary were competing for employees, so the employees of Anderson were confident that they could readily find employment elsewhere if they decided not to stay with Anderson. [18]
[63] To address the concern that employees of Anderson might decide to go elsewhere, Larry Nichols, the president and chief executive officer of DEC, the parent of DAC, came to Calgary to meet with all of Anderson’s employees. He told them that they (as well as Anderson’s assets) were one of the reasons for which DAC had bought Anderson. In addition, he assured them that DEC would let the former employees of Anderson “continue to run the show” in Canada. [19]
[64] When Anderson acquired Ulster in May 2000 and Mr. Snyder became an employee of Anderson, he was granted 24,000 Anderson stock options. A year later, in May 2001, one-third of those options vested. Mr. Snyder exercised the vested options, acquired 8,000 shares of Anderson and sold those into the market. At approximately the same time, he was granted an additional 24,000 options by Anderson.
[65] When Devon made its takeover bid for Anderson in October 2001, Mr. Snyder could have exercised his 40,000 options and then sold the shares into the offer. However, exercising his options would have required a cash outlay in excess of $1,000,000. Therefore, it was much more attractive for him to accept the cash surrender alternative made available by Anderson. [20]
(2) Michael D. Perlette
[66] At the time of the hearing, Michael Perlette, a petroleum engineer, had worked in the oil and gas industry for approximately 33 years. When he testified, he was the manager of business development and corporate planning for Devon, a position that he had held since 2012.
[67] After obtaining a bachelor of science degree in petroleum engineering, Mr. Perlette was employed as an engineer by Amoco Canada (“Amoco”), [21] which was a large integrated oil and gas company. In January 1998, he moved to Canadian 88 Energy (“Canadian 88”), a junior oil and gas producer. By moving from Amoco to Canadian 88, Mr. Perlette avoided the possibility of receiving an international assignment, and, instead, was able to remain in Alberta. He had less security and more risk at Canadian 88, but he also had higher compensation, particularly as he was able to participate in Canadian 88’s stock option plan. He regularly received and exercised stock options, which permitted him to do well financially. In 2000, Mr. Perlette left Canadian 88 and moved to Northstar, which, by then, had been acquired by DEC. [22] At Northstar he worked on acquisitions and divestitures. He was compensated by salary, a savings plan, a bonus and participation in Devon’s stock option plan. As DEC’s stock prices were steadily increasing throughout the early 2000s, Mr. Perlette benefitted from his participation in the stock option plan.
[68] As Mr. Perlette worked in Devon’s acquisitions and divestitures group, he participated in the process of evaluating Anderson when Devon was contemplating whether to make a takeover bid. Mr. Perlette stated that in mid‑2001 there was a decline in the price of natural gas, which led to a decline in the trading price of the shares of Anderson. The acquisition team at Devon recognized the value of Anderson’s position in the Western Canadian Sedimentary Basin, particularly its natural gas reserves and undeveloped properties. Devon perceived that there was an opportunity to make a takeover bid for Anderson, as Devon realized that the value of Anderson was greater than that attributed to it by the marketplace. Devon was also interested in the assets in northeast British Columbia which were owned by Numac, which had recently been acquired by Anderson. Ultimately, those assets were retained, operated and worked first by Anderson and then by Devon.
[69] In addition, Devon also recognized the value attributable to Anderson’s employees, who had a good reputation and who were very nimble. Northstar had direct experience working with Anderson on joint properties, primarily in the foothills, where the Northstar employees and their Anderson counterparts were working well together. Devon/Northstar saw Anderson “as a company with quality people running a quality business.” [23] When Devon decided to acquire Anderson, the former wanted not only the hard assets of the latter, but it also “wanted what the company was, and that was the people, the management, the ability to run as a company.” [24]
[70] Mr. Perlette suggested that sometimes markets tend to overreact, which may create an opportunity to acquire a quality viable business at a time when the market might feel otherwise. [25] More