MORGUARD CORPORATION Appellant v. HER MAJESTY THE QUEEN, 2012 FCA 306

Date: 20121121 Docket: A-92-12 Citation: 2012 FCA 306 CORAM: EVANS J.A. SHARLOW J.A. STRATAS J.A. BETWEEN: MORGUARD CORPORATION Appellant and HER MAJESTY THE QUEEN Respondent Heard at Toronto, Ontario, on November 20, 2012. Judgment delivered at Toronto, Ontario, on November 21, 2012. REASONS FOR JUDGMENT BY: SHARLOW J.A. CONCURRED IN BY: EVANS J.A. STRATAS J.A. Date: 20121121 Docket: A-92-12 Citation: 2012 FCA 306 CORAM: EVANS J.A. SHARLOW J.A. STRATAS J.A. BETWEEN: MORGUARD CORPORATION Appellant and HER MAJESTY THE QUEEN

Respondent REASONS FOR JUDGMENT SHARLOW J.A. [ 1 ] This is an appeal of a judgment of the Tax Court of Canada in which Justice Boyle dismissed Morguard Corporation’s appeal of a reassessment under the Income Tax Act , R.S.C. 1985, c. 1 (5 th Supp.) for the 2000 taxation year ( 2012 TCC 55 ). [ 2 ] The facts are well and fully stated in Justice Boyle’s reasons for judgment. For the purposes of this appeal, only a

summary is necessary here. [ 3 ] In 1997, Morguard adopted a business strategy of acquiring controlling interests in real estate companies. It entered into a number of transactions in pursuing that strategy. One was the acquisition in 1998 of a 19.2% interest in Acanthus Real Estate Corporation. Another was Morguard’s takeover bid in June of 2000, in which it sought to acquire all of the Acanthus shares it did not already own.

The bid was preceded by negotiations with the directors of Acanthus which led to a preacquisition agreement in which the directors agreed to support a Morguard bid at $8.25 per share, and to pay Morguard a break fee of $4.7 million if an unsolicited competing bid was made and the directors of Acanthus withdrew their support of the Morguard bid. [ 4 ] A competing bid was made at $8.50 per share. The directors of Acanthus withdrew their support of the Morguard bid and paid the $4.7 million break fee.

Morguard increased its bid to $9.00 per share, and the preacquisition agreement was amended to increase the break fee to $7.7 million. However, the competing bid was increased to $9.30 per share and then, following negotiations with Morguard, to $9.40 per share. Morguard declined to increase its bid further. [ 5 ] The directors of Acanthus supported the $9.40 competing bid. At that point Acanthus became obliged to pay Morguard the additional $3 million break fee, which was paid in July of 2000.

Morguard, which by then held 19.9% of the shares of Acanthus, accepted the competing bid and realized a capital gain of approximately $4.8 million on the sale of its Acanthus shares. [ 6 ] Morguard has never sold any of its interest in real estate companies, except for its shares of Acanthus. Up to the date of the Tax Court hearing, it had never received another break fee. [ 7 ] In filing its income tax return for the 2000 taxation year, Morguard reported its taxable capital gain on the sale of its Acanthus shares.

It also reported the break fee of $7.7 million, net of bid expenses of approximately $1.8 million, as a capital gain. The reported taxable capital gain (2/3 of the gain) was approximately $4 million. [ 8 ] In this Court, counsel for Morguard conceded, correctly in my view, that the break fee was not received as the proceeds of disposition of capital property. Therefore, for income tax purposes it is either income or a non-taxable capital receipt.

I note parenthetically that the 2006 amendments to the definition of “cumulative eligible capital” in subsection 14(5) of the Income Tax Act may bring within its scope any amounts received on account of capital in respect of a business. However, that amendment was not in effect in 2000 when Morguard received the break fee in issue in this case. [ 9 ] In 2005, the Minister reassessed Morguard to remove the taxable capital gain related to the $7.7 million break fee, replacing it with an income inclusion of $7.7 million less the reported bid expenses.

The net increase to Morguard’s income was approximately $1.9 million. Morguard appealed unsuccessfully to the Tax Court, and now appeals to this Court. [ 10 ] Justice Boyle found as a fact that the break fee was paid pursuant to an agreement negotiated by Morguard in connection with its potential acquisition of Acanthus, that Morguard pursued the acquisition in accordance with its established business strategy and in the ordinary course of its normal business operations, and that the receipt of the break fee was a normal and expected incident of its business activities.

These factual conclusions were reasonably open to Justice Boyle on the evidence presented. Indeed, as findings of fact they were not challenged by Morguard in this appeal. [ 11 ] Morguard’s appeal is based primarily on the statements from Justice Boyle’s reasons to the effect that Morguard was “essentially in the business of doing acquisitions and take-overs” (paragraph 45). Morguard argues that this statement is wrong in law

because it is not consistent with Neonex International Ltd. v. Canada (1978), 22 N.R. 284, [1978] C.T.C. 485, 89 D.T.C. 6339 (F.C.A.).Morguard argues that Neonex is authority for the proposition that the acquisition of capital properties does not and cannot, as a matter oflaw, be a business in itself. [12] Neonex was a corporation that carried on an electric sign and advertising business. It also, over a relatively short period oftime, acquired the shares of over 60 corporations to which it provided management services and financing in the form of loans.

Neonexincurred legal expenses in the course of an unsuccessful attempt to acquire a particular corporation. This Court held that the legalexpenses were not deductible because they were outlays on account of capital.

Morguard relies particularly on the following passagefrom Neonex dealing with this issue (at page 6346, D.T.C.) (my emphasis): In his Memorandum of Fact and Law counsel [for Neonex] put his case on thisissue as follows: In the course of carrying out those business activities [of acquiring targetcompanies, Neonex] incurred expenses in respect of staff, travel and legal andaccounting advice, all with a view to being able to earn income from its businessand property.

Throughout, as a conglomerate [Neonex] constantly entertained thenecessary and incidental risk of having its pursuits fall apart either because thetarget companies which it investigated were unsuitable for its purposes,unavailable on terms acceptable to vendor and purchaser, or unavailable because[Neonex] and others involved in the transactions were unable, for whatever reasonto perform and carry out the arrangements agreed upon.

A necessary andincidental risk, although an infrequent reality was the possibility of being engagedin legal disputes about rights and obligations assumed or acquired in the course ofits business. Expenses incurred in those circumstances were necessary andincidental to the conduct of [Neonex]'s business and are deductible in computingincome […]. A similar argument was made before the learned Trial Judge who found itdifficult to accept that the buying of shares with a view to retaining them can itselfbe said to be a business.

Rather, he held, [Neonex] was in the business of makingand selling signs and, as well, in the business of supplying management expertise,services and funds to the companies, the control of which it had acquired by thepurchase of shares. The acquisition of the shares was, in his view, not in itself abusiness but was, in each case, an investment made with a view to earning income,a fact that, as will be seen from the above quotation from [Neonex]'sMemorandum of Fact and Law, was admitted by [Neonex]. I wholly agree with this finding.

I also agree with the Trial Judge that the legalexpenses at issue herein -- those incurred in an effort to complete the takeover andthose incurred in seeking compensation in lieu of shares -- were outlays associatedwith an investment transaction and thus were made on capital account. [13] As I read Neonex, this Court accepted the finding of the trial judge that Neonex was not carrying on a business consisting ofthe acquisition of income producing assets.

I do not understand the Court to be establishing a rule of law that the acquisition of incomeproducing assets can never be a business in itself. [14] Morguard also relies on Firestone v. Canada, (FCA), [1987] 3 F.C. 200 (F.C.A.). In that case, this Courtheld that the costs incurred by Mr. Firestone in investigating 50 business opportunities with a view to acquiring medium sizedmanufacturing companies in financial difficulty and turning them to profitable account were not deductible. Most of the companiesinvestigated were not acquired.

The facts were found to be indistinguishable from the facts in Neonex, and accordingly the investigationexpenses were held not to be deductible because they were outlays on account of capital. I do not read Firestone as authority for a legalprinciple to the effect that the acquisition of income producing assets can never be a business in itself. [15] The conclusion that Morguard received the break fee on income account is consistent with the principles stated by theSupreme Court of Canada in Ikea Ltd. v. Canada, (SCC), [1998] 1 S.C.R. 196, which is the main case upon whichJustice Boyle relied.

I agree with Justice Boyle that it is now the leading case on the characterization of extraordinary or unusual receiptsin the business context (see his reasons, at paragraph 40). [16] Morguard argues that Justice Boyle misapplied the principles in Ikea, because the result in Ikea was based on a factualconclusion that the payment in issue was a reimbursement of rent (an expense on income account), and in this case there is no analogousfinding. I do not read Ikea as being based solely the conclusion that, in commercial terms, the receipt of a tenant inducement paymentmay be associated with a higher rent.

The test actually applied in Ikea involved consideration of a number of factors, including thecommercial purpose of the payment and its relationship to the business operations of the recipient.

[ 17 ] The issue in Ikea was whether a tenant inducement payment received in respect of a long term lease of store premises was on income or capital account. It was held to be an income receipt because, on the facts as found by the trial judge, it was received as part of the ordinary business operations of Ikea and was inextricably linked to such operations, even though it was received as a result of negotiations for a long term lease which would be a capital property. [ 18 ] I see no error of law in Justice Boyle’s understanding or application of Ikea .

Specifically, he made no error in applying the linkage test set out in Ikea . Given the facts as he found them, it was open to him to conclude that Morguard received the break fee on income account. [ 19 ] For these reasons, I would dismiss the appeal with costs. “K. Sharlow” J.A. “I agree John M. Evans J.A.” “I agree David Stratas” FEDERAL COURT OF APPEAL NAMES OF COUNSEL AND SOLICITORS OF RECORD DOCKET: A-92-12 (APPEAL FROM THE JUDGMENT OF JUSTICE BOYLE OF THE TAX COURT OF CANADA DATED FEBRUARY 24, 2012) STYLE OF CAUSE: MORGUARD CORPORATION v.

HER MAJESTY THE QUEEN PLACE OF HEARING: TORONTO, ONTARIO DATE OF HEARING: NOVEMBER 20, 2012

REASONS FOR JUDGMENT BY: SHARLOW J.A. CONCURRED IN BY: EVANS J.A. STRATAS J.A. DATED: NOVEMBER 21, 2012 APPEARANCES : Clifford Rand, David Mulna, Christopher Slade FOR THE APPELLANT Elizabeth Chasson, John Grant, Ernesto Caceres FOR THE RESPONDENT SOLICITORS OF RECORD : Stikeman Elliott LLP Toronto , Ontario FOR THE APPELLANT William F. Pentney Deputy Attorney General of Canada FOR THE RESPONDENT