BJ Services Company Canada, the successor to Nowsco Well Service Ltd. v. The Queen

BJ Services Company Canada, the successor to Nowsco Well Service Ltd. v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2003-12-03
Neutral citation
2003 TCC 900
File numbers
2002-2464(IT)G
Judges and Taxing Officers
Diane Campbell
Subjects
Income Tax Act
Decision Content
Docket: 2002-2464(IT)G
BETWEEN:
BJ SERVICES COMPANY CANADA
THE SUCCESSOR TO NOWSCO WELL SERVICE LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Appeal heard on May 5, 2003 at Calgary, Alberta
Before: The Honourable Justice Diane Campbell
Appearances:
Counsel for the Appellant:
W. Clarke Hunter,
Harold A. Jacques
Dion J. Legge
Counsel for the Respondent:
Bonnie F. Moon
Mark Hazeltine
____________________________________________________________________
JUDGMENT
The appeal from the assessment made under the Income Tax Act for the period ending June 13, 1996 is allowed, with costs, and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 3rd day of December 2003.
"Diane Campbell"
Campbell, J.
Citation: 2003TCC900
Date: 20031203
Docket: 2002-2464(IT)G
BETWEEN:
BJ SERVICES COMPANY CANADA
THE SUCCESSOR TO NOWSCO WELL SERVICE LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Campbell, J.
INTRODUCTION
[1] This appeal concerns the deductibility of expenses incurred by Nowsco Well Service Ltd. ("Nowsco") in response to a hostile takeover bid by BJ Services Company Canada ("BJ") an occurrence that became prevalent in the Canadian corporate landscape during the 1990s. On April 1, 1996, BJ approached Nowsco with an unsolicited merger proposal for the purchase of all of the common shares of Nowsco at a price of $27.00 per share. In the weeks following this proposal, the directors of Nowsco sought financial and legal advice and as a result incurred substantial fees from RBC Dominion Securities Inc. ("RBC"), Simmons & Company International of Houston, Texas ("Simmons"), Blake Cassels & Graydon law firm ("Blake"), KPMG Peat Marwick Thorne Accountants (KPMG) and finally MacLeod Dixon Law Firm ("MacLeod"). The Appellant incurred additional expenses in soliciting a "white knight" that would be interested in presenting an alternative competitive proposal to acquire the shares of Nowsco. As a result, two sets of expenses, referred to as "hello" and "break" fees, were incurred and became payable to this so called "white knight" - Great Lakes Chemical Corporation ("GLCC").
BACKGROUND AND FACTS
[2] On June 13, 1996, BJ was successful, despite a bid by GLCC, in acquiring the shares of Nowsco. For the taxation year ending June 13, 1996, Nowsco deducted all of the foregoing expenses in computing its income for tax purposes. The Minister of National Revenue (the "Minister") eventually reassessed and denied the deductions, from which the Appellant, being the successor to Nowsco, has appealed.
[3] During the opening remarks, counsel advised that a number of minor issues had been resolved, to be reassessed by the Minister in accordance with the outcome of this appeal. It was agreed that the legal fees paid to Blake and the accounting fees paid to KPMG would be deductible together with some other corporate and miscellaneous expenses. For the purposes of this appeal, I am left to decide the deductibility of the following expenses:
(1) RBC $13,070,777.00
(2) Simmons $5,171,164.00
(3) GLCC - (a) hello fees of
$6,900.000.00
(b) break fees of
$23,601.591.00
[4] BJ Services Company Canada v. R., [2002] G.S.T.C. 124 (T.C.C.), the companion case to the present one, decided by Justice Miller, dealt with the application of the goods and services tax and the eligibility for input tax credits for the legal and financial advisory fees of Blake, RBC and Simmons. Justice Miller found that the fees were incurred in the course of the "commercial activities" of Nowsco pursuant to subsection 169(1) of the Excise Tax Act. This case is concerned not only with the deductibility of the RBC and Simmons fees under the Income Tax Act but also the deductibility of the GLCC "hello" and "break" fees.
[5] Nowsco was a publicly traded corporation carrying on the business of providing well stimulation and pipeline services in the oil and gas industry. It has been in business since the early 1960s. Through the years, this company grew from a handful of employees to a staff of over 2,000 individuals working worldwide. According to the evidence of Stanley Shouldice, the corporate CEO, Nowsco became a publicly traded company in 1971. He had been one of the principal influences with Nowsco over the years, overseeing company revenues rise to the hundreds of millions in the 1990s. By 1995, Nowsco had become the largest Canadian company in this industry in respect to revenue, staff and research and development. Mr. Shouldice's pride in these accomplishments was obvious throughout his testimony and certainly justifiable.
[6] Following is an abbreviated summary of the sequence of events as it unfolded commencing on April 1, 1996:
(1) On April 1, 1996, Nowsco received an unsolicited offer from BJ to purchase the shares of Nowsco for $27.00 per share.
(2) On April 2, 1996, the Board of Directors of Nowsco met and formed a Special Committee comprised of three independent Board Members to advise on this proposal. This Committee advised Nowsco, among other things, to retain legal and financial advisors.
(3) On April 2, 1996, Nowsco retained the financial services of RBC to evaluate the BJ proposal plus any subsequent proposals.
(4) On April 4, 1996 Nowsco also retained Simmons, an investment bank specializing in the oil industry, as supplementary American financial advisors to assist RBC.
(5) On April 9, 1996, BJ formally presented the proposal to the Board of Nowsco, with the proviso that Nowsco commit to negotiating exclusively with BJ until April 19, 1996. Nowsco rejected this request.
(6) On April 12, 1996, BJ offered their proposal directly to the shareholders of Nowsco.
(7) On April 16, 1996, the Nowsco Special Committee engaged Blake, Cassels law firm to advise it on a number of legal issues arising from the takeover proposal.
(8) On April 19, 1996, RBC advised the Board of Nowsco that the initial BJ proposal was inadequate and should be rejected. A Directors' Circular was prepared and circulated to shareholders recommending that the BJ offer be rejected.
(9) During this period, Nowsco and its advisors contacted other parties hoping another more attractive offer would be made.
(10) Although never contacted by Nowsco, GLCC expressed interest in making a proposal and between April 19, 1996 and May 1, 1996 negotiations ensued. GLCC eventually offered $30.90 per share. The Special Committee and Nowsco's advisors recommended that the GLCC offer was reasonable and that it be accepted.
(11) On May 4, 1996, Nowsco and GLCC entered into an agreement accepting the GLCC offer. As part of the terms of this agreement and as recommended by the advisors, Nowsco agreed to pay GLCC a non-contingent fee of $6,900,000.00 (the "Hello" fee) plus a contingent fee (the "Break" fee), which would be paid if a more attractive unsolicited bid was made and accepted by Nowsco which would nullify the GLCC offer.
(12) On May 6, 1996, the Board of Directors issued a second Directors' Circular to Nowsco shareholders recommending the GLCC offer.
(13) On June 3, 1996, BJ responded by amending its initial proposal and increased the consideration to $35.00 per share.
(14) On June 6, 1996, RBC advised Nowsco that this second BJ offer was reasonable. On this same date, the Board of Nowsco issued another Directors' Circular to its shareholders recommending acceptance of BJ's second offer.
(15) On June 13, 1996, BJ acquired all of the issued and outstanding common shares of Nowsco, according to the compulsory acquisition provisions of the Business Corporation Act of Alberta.
[7] Counsel for both the Respondent and the Appellant agreed that Justice Miller's review of the facts in the companion GST case accurately set forth the events leading to the BJ takeover. An agreed statement of facts and documents was entered. It may be beneficial to reproduce the more detailed portions of the agreed facts:
Background
1. During the relevant period, Nowsco Well Service Ltd. ("Nowsco") was a publicly traded corporation carrying on the business of providing well stimulation and pipeline services in the oil and gas industry, with a head office located at 1300, 801 - 6th Avenue S.W., Calgary, Alberta. The annual reports of Nowsco for the calendar years 1990 through 1995 are attached hereto as Tabs 1 through 6, and a list of Nowsco's largest customers by strategic business unit is attached hereto as Tab 7.
2. At all material times Nowsco was a taxable Canadian corporation for the purposes of the Income Tax Act (Canada) (the "Act"), with a December 31 taxation year end.
3. During 1992, Nowsco adopted a mission statement, a copy of which is attached hereto as Tab 8, stating among other things, that it will ensure superior growth in shareholder value by providing quality services and engineering to the international energy market.
4. BJ Services Canada, Inc. ("BJ Canada") was an indirect wholly owned subsidiary of BJ Services Company ("BJ") throughout the relevant period and up until the amalgamation of BJ Canada with Nowsco, as described below.
The Takeover of Nowsco
5. On April 1, 1996, representatives of BJ approached Nowsco to negotiate a friendly merger and proposed the purchase of all the common shares in Nowsco for $27 per share (the "Initial Proposal"). The representatives of BJ made it clear that if the Board of Directors (the "Board") failed to accept the Initial Proposal within ten days, BJ, through BJ Canada, would make an unsolicited offer directly to the shareholders of Nowsco without the Board's approval. A copy of the letter of April 4, 1996 from BJ to Nowsco is attached hereto as Tab 9.
6. On April 2, 1996, the Board met to discuss the Initial Proposal and formed a special committee, comprised of three independent Board members, to advise on all matters relating to this proposal (the "Special Committee"). At this meeting, Bennett Jones Verchere (as they were then known) advised the Board that (i) the Board had a general duty to act honestly, in good faith and in the best interests of the corporation in determining whether or not to support the Initial Proposal, (ii) that the directors had a fiduciary obligation to obtain the highest price for Nowsco's shares and (iii) that the requirement to obtain the highest price for Nowsco's shares had generally been interpreted to require the Board to engage in an auction of Nowsco's shares and to retain financial advisors to advise them of the value of Nowsco's shares. The minutes of such meeting are attached hereto as Tab 10.
7. Expert financial and legal advisors were engaged to provide assistance to Nowsco.
8. On April 2, 1996, Nowsco engaged the services of RBC Dominion Securities Inc. ("RBC") as financial advisors with respect to the Initial Proposal and any subsequent proposals that might arise. This engagement was formalized in a letter agreement dated April 6, 1996 and accepted by Nowsco on April 19, 1996 (the "RBC Agreement"), which is attached hereto as Tab 39.
9. Under the RBC Agreement, RBC was exclusively engaged as the Canadian financial advisor to Nowsco, effective as of April 4, 1996, with respect to the Initial Proposal and:
"with respect to any possible responses thereto, including, without limitation, the review of alternatives to maximize shareholder value including the solicitation of additional take-over bid offers, a recapitalization, asset sales, or the sale of all or part of [Nowsco] by way of merger, share exchange, amalgamation, arrangement, reorganization or otherwise."
10. The RBC Agreement further provided that the financial advisory services included, without limitation, advice and assistance in evaluating the Initial Proposal or subsequent offers and opinions as to the fairness of the Initial Proposal or subsequent offers from a financial perspective.
11. On April 4, 1996, Nowsco engaged the services of Simmons & Company International of Houston, Texas ("Simmons"), an investment bank specializing in the oil service and equipment industry, as special financial advisors to assist Nowsco and RBC in determining a course of action with respect to the Initial Proposal and any subsequent proposals that might arise. This engagement was formalized in a letter agreement dated April 15, 1996 and accepted by Nowsco on April 25, 1996 (the "Simmons Agreement"), a copy of which is attached hereto as Tab 41.
12. According to the Simmons Agreement, Simmons was also engaged to:
(a) assist with an understanding and presentation of the status and potential impact of Nowsco's technology to potential acquirers of Nowsco;
(b) assist with efforts to approach other companies as alternatives to a takeover by BJ;
(c) share industry data and information to assist Nowsco and RBC in determining a fair value for the common shares in Nowsco; and
(d) respond to any other requests from the Board and senior management of Nowsco in their efforts to maximize shareholder value.
A copy of a memorandum prepared by Simmons and relating to Nowsco's technology and product development efforts is attached hereto as Tab 42.
13. On April 9, 1996, the Initial Proposal was formally presented to the Board by representatives of BJ with the request that the Board commit to negotiating exclusively with BJ until April 19, 1996, the period given to the Board to consider and negotiate the final terms of the Initial Proposal. BJ proposed that failing agreement on a transaction by April 19, 1996, Nowsco could negotiate with other interested parties and BJ, through BJ Canada, could make a takeover bid directly to the shareholders of Nowsco. The Board refused this request on the basis that committing to exclusive negotiations could prejudice Nowsco's alternatives in responding to the Initial Proposal. The minutes of such meeting together with copies of the proposal from BJ and a presentation made by RBC are attached hereto as Tabs 13(a), 13(b) and 40, respectively.
14. On April 12, 1996, BJ Canada formally offered the Initial Proposal to shareholders of Nowsco, as shown by the Offer to Purchase from BJ Services Canada Inc. attached hereto as Tab 43.
15. On April 16, 1996, the Special Committee engaged Blake Cassels & Graydon ("Blakes") to provide the Special Committee with legal advice regarding the independence of the Special Committee and a number of other legal issues that arose from April 2, 1996 to June 13, 1996, including advice with respect to representations made to the Securities Commissions of Alberta and Ontario. The minutes of the April 16, 1996 meeting of the Special Committee and a copy of the memorandum prepared by Blakes are attaches hereto as Tabs 13 and 38, respectively.
16. On April 19, 1996, RBC advised the Board that, in RBC's opinion, the consideration under the Initial Proposal was inadequate. RBC provided a formal opinion to this effect to the Board on April 22, 1996. The Board also received the report of the Special Committee on April 22, 1996, recommending that the Board advise shareholders to reject the Initial Proposal. The minutes of the April 19 and April 22, 1996 meetings of the Board and the minutes of the April 22, 1996 meeting of the Special Committee are attached hereto as Tabs 16, 17 and 18, respectively.
17. Based on the recommendations of the Special Committee and RBC, the Board unanimously recommended to the shareholders of Nowsco that they reject the Initial Proposal in a Directors' Circular dated April 22, 1996 (the "First Directors' Circular"), a copy of which is attached hereto as Tab 44.
18. From April 2, 1996, Nowsco and its advisors were in contact with other parties interested in acquiring the assets of Nowsco, the common shares in Nowsco, or a combination thereof.
19. Nowsco received an unsolicited expression of interest from Great Lakes Chemical Corporation ("GLCC") and between April 29, 1996 and May 2, 1996, Nowsco and its advisors met with GLCC to negotiate the terms of an offer to acquire the common shares of Nowsco and a pre-acquisition agreement relating thereto.
20. On May 4, 1996, Nowsco and GLCC entered into a pre-acquisition agreement (the "GLCC Agreement"), whereby GLCC agreed to make a takeover bid to acquire the common shares in Nowsco at a price equal to $30.90 per share on the terms described in the GLCC Agreement (the "GLCC Offer"), a copy of which agreement is attached hereto as Tab 45. The Board agreed, inter alia, to cooperate with and support the GLCC Offer, including recommending it to Nowsco's shareholders, to waive the application of the shareholder rights protection plan, to accelerate the vesting of options to acquire shares in Nowsco and to not solicit any further proposals. GLCC further agreed that it would honour Nowsco's existing employment and severance agreements.
21. In addition, GLCC was entitled under the GLCC Agreement to receive a non-contingent fee equal to $6,900,000 (the "Hello Fee") plus a contingent fee if an unsolicited proposal was made and accepted such that the GLCC Offer was not accepted or upon the occurrence of certain other specified events. The GLCC Agreement specified that the contingent fee payable to GLCC was equal to 3% of a superior proposal, or, if no superior proposal was made, the contingent fee was $20,900,000.00. If a superior proposal was made, the GLCC Agreement further provided that GLCC would have the opportunity to amend the GLCC Offer to meet that proposal prior to Nowsco entering into an agreement in respect of such superior proposal.
22. GLCC insisted that Nowsco agree to the payment of the Hello Fee and the contingent fee as a condition of their agreeing to make an offer to acquire all of the issued and outstanding shares of Nowsco.
23. Nowsco entered into the GLCC Agreement on the recommendation of the Special Committee and Nowsco's advisors, who concluded that the GLCC Offer was the best alternative to Nowsco and its shareholders and that the terms and conditions of the GLCC Agreement were reasonable. In particular, the financial and legal advisors advised the Board that the quantum of the Break Fee was reasonable in the circumstances and provided the Board with a chart outlining the quantum of Selected Canadian Break & Topping Fees between 1987 and 1996, a copy of which is attached hereto as Tab 67.
24. On May 6, 1996, RBC provided Nowsco with an opinion that the GLCC Offer was fair from a financial point of view, a copy of which is attached hereto as Tab 46.
25. On May 6, 1996, GLCC made the GLCC Offer to the shareholders of Nowsco, as shown by the Offer to Purchase from GLCC attached hereto as Tab 47.
26. On May 6, 1996, the Board issued a Directors' Circular to shareholders of Nowsco, recommending the GLCC Offer (the "Second Directors' Circular'), a copy of which is attached hereto as Tab 48. The following factors were cited in the Second Directors' Circular as being considered by the Board in deciding that the GLCC Offer was the best alternative available to Nowsco and its shareholders:
(a) Nowsco's businesses, financial condition, results of operations and future prospects;
(b) the fact that the consideration offered under the GLCC Offer represented a $3.90 per share (14.4%) increase over the consideration offered under the Initial Proposal and a premium of 51% over the closing price reported on The Toronto Stock Exchange on April 2, 1996 (the day before the Initial Proposal was made public);
(c) RBC's opinion as to the fairness of the GLCC Offer from a financial point of view;
(d) the advice of RBC and Simmons relating to various financial and other matters concerning Nowsco, the GLCC Offer and the alternatives available to Nowsco;
(e) the view of the Board that, while more favourable proposals from other interested parties was a possibility, the GLCC Offer was the best alternative before the Board at that time; and
(f) the fact that the GLCC Agreement and the GLCC Offer did not preclude the possibility of a subsequent superior proposal.
27. On May 17, 1996, BJ extended the offer period for the Initial Proposal to May 27, 1996 as shown in the Notice of Extension of the Offer to Purchase from BJ Services Canada Inc. attached hereto as Tab 49.
28. On June 3, 1996, BJ Canada amended the Initial Proposal by increasing the consideration offered to $35 per share and extending the offer period to June 13, 1996 (the "Second BJ Offer"), as shown in the Notice of Variation and Extension of Offer to Purchase from BJ Services Canada Inc. attached hereto as Tab 50.
29. On June 6, 1996, RBC provided Nowsco with an opinion that the Second BJ Offer was fair from a financial point of view, a copy of which is attached hereto as Tab 51.
30. On June 6, 1996, the Board issued a Directors' Circular to the shareholders of Nowsco, recommending the Second BJ Offer (the "Third Directors' Circular"), a copy of which is attached hereto as Tab 52.
31. In the course of responding to the foregoing developments, the Board and the Special Committee met on several other occasions to discuss, among other matters, retaining RBC and Simmons, the Initial Proposal, the GLCC Agreement, the GLCC Offer and issues relating to and arising from those matters. Copies of the minutes of Board and Special Committee meetings, as the case may be, of April 3, April 4, April 16, April 18, April 23, April 25, April 29, May 1, May 3, May 6, May 13, May 15, May 21, May 23, May 28, May 29, June 3, June 5 and June 6 are attached hereto as Tabs 11, 12, 14, 15 and 19 through 37.
32. During the currency of the takeover bid, BJ Canada made an application to the Securities Commissions of Ontario and Alberta for a cease trade order in respect of the GLCC Offer and a waiver of Nowsco's shareholder rights protection plan, a copy of the primary submission of BJ Canada is attached hereto as Tab 53. Nowsco also responded to the application and submissions of BJ Canada and a copy of the primary response of Nowsco is attached hereto as Tab 54.
33. On June 13, 1996, BJ Canada acquired greater than 90% of the common shares in Nowsco, which allowed BJ Canada to acquire all of the issued and outstanding common shares in Nowsco by virtue of the compulsory acquisition provisions in the Business Corporations Act, S.A. 1981, c. B-15 (the "Takeover"). As the Takeover resulted in BJ Canada acquiring control of Nowsco, there was a deemed year-end pursuant to subsection 249(4) of the Act.
34. On July 31, 1996, Nowsco amalgamated with BJ Canada and subsequently amalgamated with 3032419 Nova Scotia Company on October 1, 1999 to form Nowsco-Fracmaster Company. Nowsco-Fracmaster Company subsequently changed its name to BJ Services Company Canada effective May 23, 2000 and BJ Services Company Canada continues to be the successor of Nowsco.
Fees paid to RBC, Simmons and GLCC
35. The fees outlined in the RBC Agreement for the financial advisory services provided by RBC depended on whether a transaction resulted from the Initial Proposal or any subsequent proposals within one year of the RBC Agreement. If no transaction occurred, RBC would have been entitled to a fee equal to $2,000,000. If a transaction occurred, there were two possible fee structures depending on the nature of the transaction. If more than 50% of the outstanding common shares in Nowsco were acquired by BJ, or any other third party, if Nowsco were combined, merged or amalgamated with any other entity, if Nowsco disposed of all or substantially all of its assets or any other acquisition of Nowsco was effected (a "Change of Control Transaction"), RBC would be entitled to a non-contingent fee equal to $2,000,000 plus an incentive fee, calculated on an incremental scale, based on the aggregate value of the Change of Control Transaction in excess of the Initial Proposal. Where there was an acquisition or sale of assets or securities other than a Change of Control Transaction, RBC would be entitled to a fee equal to 0.625% of the value of the consideration paid to Nowsco on this transaction.
36. Under the RBC Agreement, Nowsco was required to pay an initial engagement fee of $500,000 immediately and a further $150,000 upon the provision of an opinion on the fairness of the Initial Proposal. These fees were deposits to be applied against the fees described above. The $500,000 engagement fee was paid on April 22, 1996 and the $150,000 fee payable on the provision of a fairness opinion was paid on April 24, 1996, as shown by the Statements of Account from RBC attached hereto as Tabs 55 and 56, and cancelled cheques from Nowsco attached hereto as Tabs 57 and 58.
37. As the Takeover was a Change of Control Transaction, RBC was entitled to the non-contingent fee of $2,000,000 plus the incentive fee. The aggregate fees paid to RBC under the RBC Agreement, including the engagement fee and expense reimbursement of $56,705, was $13,070,777 (the "RBC Fees"), the balance of which was paid on June 7, 1996 as shown by the Statement of Account from RBC and cancelled cheque from Nowsco attached hereto as Tabs 59 and 60.
38. In consideration for their financial advisory services, the Simmons Agreement provided that Simmons was entitled to a non-contingent fee equal to USD$250,000 plus an incentive fee, calculated on an incremental scale, based on the value of a closed transaction in excess of the Initial Proposal, subject to a minimum of USD$250,000.
39. Under the Simmons Agreement, Nowsco was required to pay the non-contingent fee equal to USD$250,000 immediately and the incentive fee on the closing date of the transaction. The non-contingent fee, along with an expense reimbursement of USD$9,424.95, was paid by wire transfer on June 12, 1996, as shown by Tabs 63 and 64 attached hereto.
40. On the closing of the Takeover, Simmons was entitled to the incentive fee. The aggregate fees paid to Simmons under the Simmons Agreement, including the non-contingent fee and the expense reimbursement of $9,424.95, was USD$3,759,425, or CDN$5,171,164, (the "Simmons Fees"), as shown by the Statement of Account from Simmons attached hereto as Tab 61. The incentive fee was paid by wire transfer on June 10, 1996, as shown by Tabs 62 and 64 attached hereto.
41. Nowsco paid GLCC the Hello Fee via wire transfer on May 7, 1996 as is shown by Tab 65 attached hereto. On June 7, 1996 Nowsco paid GLCC the 3% contingent fee described in paragraph 21 above in the amount of $23,601,591 (the "Break Fee"), as shown by Tab 66 attached hereto, in accordance with the terms of the GLCC Agreement as GLCC had decided not to use its right of first refusal to match the Second BJ Offer.
42. The quantum of the RBC Fees, the Simmons Fees, the Hello Fee and the Break Fee and (collectively referred to herein as the "Expenses") were reasonable in the circumstances.
43. For financial reporting purposes, in accordance with well-accepted principles of business practice, the Expenses were properly deducted by Nowsco as general and administrative expenses in the computation of its profit for the period.
44. For its taxation year ending June 13, 1996, Nowsco deducted the Expenses in computing its income for tax purposes.
ISSUES
[8] Counsel also agreed on the issues to be decided and set them out within the statement of agreed facts and documents as follows:
(a) whether the Expenses are deductible in computing Nowsco's income for its taxation year ending June 13, 1996;
(b) if any of the Expenses are not deductible in computing Nowsco's income because of the restrictions in paragraphs 18(1)(a) or 18(1)(b) of the Act, whether such Expenses are deductible in computing income pursuant to either of paragraphs 20(1)(e) and 20(1)(bb) of the Act; and
(c) if any of the Expenses constitute capital outlays for the purposes of paragraph 18(1)(b) of the Act and do not satisfy the requirements for deductibility under either of paragraphs 20(1)(e) and 20(1)(bb), whether the amount of such Expenses constitute "eligible capital expenditures" pursuant to subsection 14(5) of the Act.
APPELLANT'S POSITION
[9] The Expenses, incurred by Nowsco pursuant to a hostile takeover bid, were expenditures necessitated to meet legal requirements and the expectations of the public capital markets, where Nowsco financed its business operations. Therefore these Expenses were incurred for the purpose of gaining or producing income for Nowsco in light of the requirements imposed on it. They are properly deducted from the income of the business in computing Nowsco profit, pursuant to section 9 of the Act. As these expenses were incurred solely in respect to the takeover bid, were wholly within the taxation year in question, reduced the resources of Nowsco to pay income tax in that year, had no relationship to any prior or subsequent period and resulted in no enduring benefit, they should not be characterized as capital expenses but should be currently deductible.
[10] Appellant raised the following alternative arguments:
(1) the expenses are deductible as financing expenses under paragraph 20(1)(e), notwithstanding paragraphs 18(1)(a) and 18(1)(b);
(2) the RBC and Simmons fees are deductible under paragraph 20(1)(bb) as they involved advice respecting the sale of shares of Nowsco;
(3) if the expenses were incurred for the purpose of gaining of producing income but are capital outlays, and do not fall under the preceding two alternative arguments, they are eligible capital expenditures pursuant to subsection 14(5) of the Act.
RESPONDENT'S POSITION
[11] The expenses are not deductible from the business income, as they were incurred in response to a takeover bid, aimed at maximizing shareholder value and were not incurred for the purpose of gaining or producing income. The disallowed expenses relate to fees paid for advice and assistance to pursue alternative purchasers and to create and operate a bidding auction for the sale of the shares. As a result the expenses were not for the purpose of increasing Nowsco's income from its business but for the purpose of increasing the price that Nowsco shareholders would realize on a sale of their shares. In addition, the expenses were not required by any specific legislative provision.
[12] In the alternative, if the expenses are found to have been incurred by Nowsco in relation to its business operations and not primarily for the benefit of the shareholders, the expenses should be capital outlays in accordance with paragraph 18(1)(b). Therefore no deduction can be made in computing the income of Nowsco for the year ending June 13, 1996.
EVIDENCE
[13] Counsel advised that much of the evidence and exhibits would be very similar to those presented in the GST companion case. However, there was additional evidence presented at this hearing concerning the hello and break fees paid to GLCC, that were not at issue in the companion case.
[14] Two witnesses were called -Stanley Patrick Shouldice, former CEO and Chairman of Nowsco, and Ian Bruce, who was presented and accepted as an expert investment banker with expertise in mergers and acquisition transactions. Mr. Shouldice outlined the growth of Nowsco business operations throughout the years. The importance of shareholder expectations and shareholder confidence in Nowsco was paramount throughout the years, according to Shouldice. This was reflected in the following mission statement which Nowsco adopted in 1992:
Nowsco will ensure superior growth in shareholder value by providing quality services and engineering to the international energy market. Nowsco will accomplish this by providing the best value to the client through quality management and industry leading solutions delivered with integrity and safety by the best people in the service industry.
His evidence was that maximizing shareholder value was always the underlying factor in the business decisions of Nowsco over the years. He spent a considerable portion of his working time on gaining an understanding of shareholder expectations, by organizing and attending international shareholder road shows, conducting annual visits to the major shareholders, fielding daily calls and obtaining necessary advice and instructions, where warranted, in handling shareholder matters. His evidence was that the manner in which the takeover bid was handled was consistent with the usual business practice and philosophy that fuelled the corporate activities. He believed that shareholder value and confidence was of utmost importance, as this dictated the success of Nowsco in raising money in the public markets, where shareholders constantly monitored the performance of Nowsco against comparable companies. Mr. Shouldice explained why a Special Committee was immediately set up to deal with the takeover bid and why advisors were required to provide advice on the legal and financial ramifications, particularly in respect to the company's foremost obligation of maximizing shareholder value, as reflected in the mission statement. He also explained that the "hello" fee was paid to reimburse GLCC for out-of-pocket costs it incurred in making an alternative bid to BJ's proposal. The "break" fee was triggered and payable to GLCC only in the event of an accepted higher bid, subsequent to their offer. It protected GLCC in initially presenting a higher official bid. Data from the advisors to Nowsco showed that the break fee was both reasonable and competitive when compared to similar situations and as Mr. Shouldice explained "... it was, in essence, the price of doing business with Great Lakes".
[15] Ian Bruce explained how the Dey Committee in Ontario was struck to address the responsibilities of directors in the face of increasing merger and acquisition activity in the 1980's and the perceived failure of directors to act as diligently as they could be. This committee looked at elements of corporate governance and pointed out that board members have a higher personal liability and standard to ensure shareholder protection in the area of takeovers. Mr. Bruce also referred to National Policy Number 38 which would have applied to Nowsco at the time of the takeover bid. This policy statement set out a framework by which corporations, that were subjected to unsolicited takeover offers, should conduct their activities. He pointed out that there is express acknowledgement within this policy that the primary objective of takeover legislation is to protect the bona fide interests of shareholders of the target company so that fully informed decisions can be made. Part of this strategy involved advance defense preparation due to the short time frame available in responding to a bid. Nowsco had instituted a shareholder protection plan prior to the BJ bid in 1996. Due to the intense nature and short time frame of a takeover bid and the developing law respecting Director liability, it is typical, explained Bruce, to form special committees and engage outside advisors to responsibly and adequately review alternatives. In fact he could not think of a single case where outside financial advisors had not been hired and in some cases two or three were hired. He characterized Nowsco's response to the BJ bid as "... a very expertly managed and executed response and it is totally consistent with the highest expectations of public market expectations". He characterized the break fee to GLCC as slightly higher than the average but well within the reasonable range and absolutely commonplace in corporate takeovers. He explained that break fees operate as an inducement to potential alternate bidders to come forward, as GLCC did, knowing that they have some insurance that the deal may get done and that a further bid by BJ would not come in at $30.91 per share, for example, as opposed to the $30.90 GLCC offer.
ANALYSIS
[16] Although there are some aspects of the decision of Justice Miller, in the GST companion case, that are similar to the present case, the hurdles imposed by the Income Tax Act are not only different but more numerous. Unlike Justice Miller, however, I have the benefit of several Supreme Court decisions in this area, as well as the recent cases of Boulangerie St-Augustin Inc. v. R., 95 DTC 2149 (T.C.C.), later approved by the Federal Court of Appeal, and International Colin Energy Corporation v. R., 2002 DTC 2185 (T.C.C.). The two latter cases dealt with the deduction of professional advisory fees incurred in takeover bids. Both decisions traced the case law that has developed since the Supreme Court case of British Columbia Electric Railway Co. Ltd. v. Minister of National Revenue, 58 DTC 1022, Associate Chief Justice Bowman succinctly stated the appropriate approach and tests at paragraph 43 in International Colin Energy Corporation:
43. The approach outlined by Abbott J. is one that has traditionally been followed. One first asks the question "Was the payment made for the purpose of gaining or producing income from a business or property?" If the answer is no the question whether it is on capital account is irrelevant. If the answer is yes the application of paragraph 18(1)(b) must be considered. If the deduction of the payment is not prohibited under paragraph 18(1)(a), but is nonetheless caught by paragraph 18(1)(b), it must then be determined whether any of the specific provisions of the Income Tax Act that permit capital expenditures in a business context (such as the paragraphs in subsection 20(1) apply. Indeed subsection 20(1) operates even if the payment is caught by both paragraphs 18(1)(a) and (b).
[17] The first of these tests (whether the expenses are made for the purpose of gaining or producing income?) arises from the wording of paragraph 18(1)(a) of the Act. It states:
18(1) General limitations -- In computing the income of a taxpayer from a business or property no deduction shall be made in respect of
(a) general limitation -- an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from the business or property;
[18] The predecessor provision to 18(1)(a) was more restrictive as it required that expenses be totally, exclusively and necessarily laid out or expended for the purpose of gaining or producing income.
[19] "Income" from a business or property must be determined in conjunction with subsection 9(1) which reads:
9(1) Income - Subject to this Part, a taxpayer's income for a taxation year from a business or property is the taxpayer's profit from that business or property for the year.
[20] Generally, business expenses will be deductible and this deductibility flows from the concept of profit, which is referred to in subsection 9(1) but is not defined in the Act. The difficulty is that in determining profit, what is considered an expense for business purposes may not necessarily be permitted as a deductible expense under the Act for income tax purposes. Justice Archambault canvassed this question in Boulangerie St-Augustin, and after reviewing relevant case law, concluded that although a Court may consider generally accepted accounting principles, it is the accepted principles of commercial trading, or accepted principles of business, that will be the primary aid in determining net profit. The Supreme Court in Canderel v. R., [1998] 1 SCR 147 emphasized the key role that these interpretive aids play in determining an accurate picture of a taxpayer's profit in any given year. I agree with the view taken in these cases that the business approach best depicts the reality of the financial picture of a taxpayer and is the best method to determine the answer to the first test (are the expenses for the purpose of gaining or produc