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The Federal Court of Appeal (“FCA”) recently released a judgment dealing with the tax treatment of “commitment fees” and “non-completion fees” (also known as “break fees”). The style of cause refers to Glencore Canada Corporation (“Glencore”). Glencore is a successor to Falconbridge Limited (“Falconbridge”).
Very summarily, in February 1995, Diamond Fields Resources (“Diamond Fields”) acquired, through its subsidiary Voisey’s Bay Nickel Company (“Voisey’s Bay Co.”), rights to mineral claims in a major nickel-copper-cobalt deposit (the “Deposit”). In the summer of 1995, it sold 25% of its shares in Voisey’s Bay Co. to Inco and entered into an agreement with Inco to market the nickel and cobalt production from the Deposit.
In early 1996, Diamond Fields approached Falconbridge, a major competitor of Inco, regarding the sale of its remaining 75% interest in Voisey’s Bay Co. It is important to note that Diamond Fields had already held discussions with Falconbridge in early 1995 regarding the acquisition of an interest in the Deposit, but those discussions fell through.
In February 1996, Falconbridge made an offer to Diamond Fields. According to the terms of the offer, “the outstanding common shares of [Diamond Fields] would be exchanged for a combination of Falconbridge shares, cash and exchangeable notes with a total value of approximately $4.1 billion.” Two fees were entrenched in the offer: a commitment fee of $28,206,106 and a non-completion fee of $73,335,881. The commitment fee was payable to Falconbridge at the outset. The right to the non-completion fee was included to compensate Falconbridge should Diamond Fields accept another offer. Diamond Fields eventually ended up accepting another offer (from Inco), which meant that Falconbridge became entitled to both the commitment and non-completion fees.
The Canada Revenue Agency (“CRA”) reassessed Falconbridge’s 1996 taxation year and included in its income the commitment and non-completion fees, less related expenses. Falconbridge appealed to the Tax Court of Canada (“TCC”). The TCC had to determine whether the fees were “income” and, in the alternative, whether they gave rise to a capital gain. With regard to the “income” issue, three positions were put forward: the fees were not income from a “source,” the fees were income from a source pursuant to section 3 of the Income Tax Act (“ITA”) and the fees were taxable under paragraph 12(1)(x) ITA.
The TCC dismissed Glencore’s appeal. The TCC relied on the Supreme Court of Canada decision in Ikea Ltd. v. Canada to conclude that the fees were income from a business pursuant to subsection 9(1) ITA and therefore did not go further in its analysis. The TCC stated:
72 Falconbridge primary objective was clearly to acquire a 75% interest in the Voisey’s Bay deposit but, in doing so, it made sure that all its takeover bid expenses would be covered by the Commitment Fee and that a substantial profit would be realized if the bid failed. In fact, Falconbridge did not take any financial risk by entering into the Merger Offer Delivery Agreement with DFR and had as a secondary objective to make a substantial profit within a very short period of time in the event that the bid failed.
73 It is clear from the evidence that Falconbridge was not in the business of acquiring or selling companies. The business of Falconbridge consisted of exploring, developing, mining, processing and marketing minerals. The activities undertaken by Falconbridge to grow its nickel business necessarily included the replacement of depleting ore reserves through various means such as exploration with its own staff but also through acquisitions of claims or interests in ore deposits by entering into joint ventures or partnership agreements with junior mining companies or prospectors. The attempted acquisition of DFR was structured differently than Falconbridge’s other acquisitions simply because DFR was a public company. The fact that Falconbridge’s attempt to acquire the Voisey’s Bay deposit took the form of a bid for the common shares of DFR is of no significance.
74 The potential acquisition of DFR was a means to acquiring the Voisey’s Bay deposit and the evidence clearly establishes that the Falconbridge’s business included the acquisition of mineral deposits.
75 The Break Fees received by Falconbridge were inextricably linked to Falconbridge’s ordinary business operations as a nickel mining company. Falconbridge pursued the Voisey’s Bay deposit for the purpose of making a profit. As a public company, all of Falconbridge’s activities were directed to that end i.e. to increase shareholder value. The potential acquisition of the Voisey’s Bay deposit was part of Falconbridge’s strategy for earning income from its business.
76 Falconbridge was carrying on its business when it negotiated the Merger Offer Delivery Agreement and the Arrangement Agreement, both of which provided for the fees in dispute. Falconbridge’s strategy in attempting to acquire the Voisey’s Bay deposit was to maximize shareholder value by maintaining and bolstering its ore reserves and by containing its production costs. These goals were inextricable interwoven with Falconbridge’s business. The Break Fees were ancillary business income received by Falconbridge in the course of earning income from business.
77 This conclusion is supported by the decision of the Supreme Court of Canada in Ikea Limited v. R.  1 S.C.R 196 (“SCC”) (“IKEA”), which is the leading case on the characterization of extraordinary or unusual receipts in the business context. IKEA did not include a tenant inducement payment in its computation of income for tax purposes on the basis that it was a “tax-free capital receipt”). The SCC held that the determination of the characterization of an extraordinary or unusual receipt involves the consideration of a number of factors including the commercial purpose of the payment and its relationship to the business operations of the recipient. The SCC considered that the tenant inducement payment was ordinary revenue from IKEA’s business operations. The tenant inducement payment arose out of obligations, i.e. the payment of rent and the operation of IKEA’s business in the leased premises, that were necessary incidents of the conduct of IKEA’s business. As such, the tenant inducement payment was “clearly received as part of [IKEA’s] ordinary business operations and was, in fact, inextricably linked to such operations” (para 33).
78 In this instance, the Break Fees were the subject of negotiations between two public companies, were paid pursuant to the terms of two agreements, and were necessary and integral parts of Falconbridge’s bid for DFR, the main purpose of which was the acquisition of the Voisey’s Bay nickel deposits.
Glencore appealed the TCC’s decision to the FCA. Unfortunately for Glencore, the FCA upheld the TCC’s decision, albeit on different grounds.
According to the FCA, the TCC made a mistake in relying on the IKEA decision because the tenant inducement payment received by IKEA in that decision was on account of income whereas the fees received by Falconbridge were on account of capital:
33 The Tax Court made factual findings that the Fees were linked to “pursuing the Voisey’s Bay deposit for the purpose of making a profit. As a public company, all of Falconbridge’s activities were directed to that end” (TC Reasons at para. 75). However, the Fees were actually linked to pursuing shares, not the Deposit itself. Either way, the linkage is to a capital purpose. The fact that the goal was to make a profit does not transform the linkage to a revenue item. The clear linkage was to capital.
After determining that the fees were not “income” because they were received on account of capital, the FCA turned to the issue of whether the fees gave rise to a capital gain. To have a capital gain, there has to be a disposition of “property.” Glencore submitted that “the Non-Completion Fee was received as compensation for the disposition of Falconbridge’s right to merge.” The FCA rejected that argument because “[n]either the Arrangement Agreement nor any other agreement provided Falconbridge with a right to merge. Diamond Fields did not promise that the merger with Falconbridge would be completed. It could not make that promise for two reasons. First, Falconbridge’s offer was directed to Diamond Fields shareholders. Diamond Fields could not promise their acceptance of the offer. Second, Diamond Fields’ board of directors was not obligated to support Falconbridge’s bid if there was a competing bid that, by virtue of their fiduciary duties, the directors were required to support.” The FCA therefore concluded that although the non-completion fee was received on account of capital, it did not give rise to a capital gain.
So far so good for Glencore, except that the FCA determined that the non-completion fee was captured under paragraph 12(1)(x) ITA. Without going through all the requirements under paragraph 12(1)(x) ITA, suffice it to say that the FCA found that it was “reasonable to consider that the Commitment Fee and the Non-Completion Fee were received by Falconbridge as an inducement to entice Falconbridge to commit to make an offer for the shares of Diamond Fields in accordance with the merger arrangements.”
With regard to the non-completion fee, the FCA quoted CW Shareholdings Inc. v. WIC Western International Communications Ltd., which stated that “[b]reak fees are intended to entice bidders to participate in an auction.” The FCA remarked that the record amply supported this fact. The FCA further stated:
62 It does not make any difference that the payment of the Non-Completion Fee was conditional on the bid failing. Subparagraph 12(1)(x)(iii) focusses on the reason for the payment. Diamond Fields agreed to make the payment in order to entice Falconbridge to make the offer.
63 In addition, the evidence as to Falconbridge’s motivation to negotiate a fee (i.e., to deter another bidder and to earn a profit if the bid failed) is not relevant to this issue. Subparagraph 12(1)(x)(iii) asks the question whether Diamond Fields made the payment as an inducement. Whether Falconbridge had different motivations is not relevant.
The peculiarity about this decision is that fees were received on account of capital, yet did not give rise to a capital gain (i.e., non-taxable capital receipts). In order to make the fees taxable, the FCA relied on paragraph 12(1)(x) ITA.
It is quite clear that Diamond Fields paid the commitment fee to induce Falconbridge to negotiate the purchase of the remaining 75% of the shares of Voisey’s Bay Co. However, it is less clear that the non-completion fee was paid for the same reason.
Diamond Fields gave Falconbridge the right to compensation should the bid fail. At the time the parties entered into the agreement, Falconbridge did not receive anything, but a conditional right to be compensated. Upon the bid failing, Falconbridge then became entitled to the non-completion fee. Can an amount received pursuant to a right to be compensated “reasonably be considered” to have been received as an inducement?
Dr. Guhan Subramanian, the expert witness in “deal protection devices” for the Crown at the TCC explained that “there is a two-fold purpose of break fees: to deter third parties from bidding and to compensate the first bidder. His testimony discussed the difficulty of quantifying costs associated with larger merger deals, such as opportunity costs, reputational costs, switching and searching costs and time spent by management. Mr. Subramanian’s opinion was that any deterrence effect, a break fee might have, would be reduced when the underlying assets of the target company are speculative.” (Emphasis added.) In addition to the above, the timing and the conditional nature of the payment, if we’re dealing with an inducement, are odd, although the FCA’s view is that “[i]t does not make any difference that the payment of the Non-Completion Fee was conditional on the bid failing.”
 Glencore Canada Corporation v. Canada, 2024 FCA 3.
 Glencore Canada Corporation v. The Queen, 2021 TCC 63 at para. 18.
  1 S.C.R. 196.
 Para. 43.
 Para. 57.
 (1998), 39 O.R. (3d) 755 (Ontario Court (General Division)).
 Para. 59.
 Para. 51.
 Para. 62.