The Tax Treatment of Transaction Costs—An Update on the Rio Tinto Alcan Case

By Tina Huang, CPA, CA; published in CPABC in Focus
Published: 11/01/2018

Generally, the term “transaction costs” is intended to capture all costs associated with a transaction, such as a merger, acquisition, or business combination. These costs may include (but are not limited to) the following: professional fees, such as legal, accounting, and consulting fees in connection to the planning and implementation of a transaction; break fees (penalties applied to a buyer or seller who walks away from a deal); and financing expenses.

The income tax treatment of transaction costs is not always clear. The primary issue is the determination of whether the costs should be capitalized or deducted for income tax purposes.

In Rio Tinto Alcan Inc. v. The Queen, 2018 FCA 124 (Alcan), the Federal Court of Appeal ruled that certain transaction costs are deductible for income tax purposes. The Alcan case rejects the notion that all transaction costs should automatically be capitalized and provides additional clarity as to the types of transaction costs taxpayers can deduct on a current basis.

General Principles for the Deductibility of Expenses

Over the years, the courts have consistently held that, for income tax purposes, business profits can be calculated in accordance with any well-accepted principles of accounting or business practice, subject to specific provisions of the Income Tax Act (ITA). There are two general limitation rules in subsection 18(1) of the ITA that limit the deductibility of all expenses to certain conditions: First, the expense must be incurred for the purpose of gaining or producing income from a business or property; and second, an expense that is capital in nature is not deductible unless the capital expenditure is expressly permitted by a specific provision of the ITA.

Determining whether a transaction cost relates to income or capital can be a difficult task. The courts have suggested that each expenditure should be looked at on a case-by-case basis and that the following three elements should be considered:

  1. Form: A recurring fee suggests that the expenditure is income-related; a one-time outlay suggests that the fee is capital in nature;
  2. Effect: The longer the enduring benefit resulting from an incurred expenditure, the more likely the expenditure is capital in nature; and
  3. Purpose: In addition to the general purpose of earning income from business or property, consideration should be given as to whether the incurred expenditure was part of ordinary business operations or more closely associated with the direct acquisition of a capital asset.

Alcan: Case specifics

The taxpayer, Rio Tinto Alcan Inc. (Alcan), paid significant transaction costs to various advisors. In particular, Alcan paid investment banks to advise on a potential merger transaction—specifically, on whether to proceed and, if so, how to structure the transaction.

Alcan deducted all of the consulting fees paid to the investment banks on the basis that the expenses were current in nature and incurred for the purposes of earning income from a business or property. However, the Canada Revenue Agency disallowed all of these expenses on the basis that they were capital in nature.

Photo: Pinkypills/iStock/Getty Images

In Rio Tinto Alcan Inc. v. The Queen, 2016 TCC 172 (Alcan), the Tax Court of Canada (TCC) partially rejected the CRA’s decision, with presiding Justice Robert J. Hogan designating certain fees for services as “oversight expenses” and others as “execution costs."1 Following a review of the TCC’s findings and related jurisprudence, the Federal Court of Appeal (FCA) upheld the TCC’s decision. The FCA agreed with the TCC’s approach of summarizing the expenses into the following two categories:

  1. Oversight expenses: These expenses do not have an enduring impact—they are current expenses incurred to assist management in the decision-making process and are deductible in the year incurred.

    In Alcan, this category encompassed the fees that were incurred to help the board of directors make management decisions about the company’s income-earning process. As Alcan’s board was responsible for providing oversight on the allocation of capital and making investment decisions (as evidenced by a long history of acquisitions), these types of transaction costs were of a frequent and recurring nature for the company. Thus, these expenditures were considered part of ordinary business operations, as it was the responsibility of Alcan’s management and directors to make informed decisions on behalf of the business.

    Even though, if acquired, the business under consideration would have become a capital asset for Alcan, the consulting services provided by the investment banks with regard to the acquisition’s viability merely assisted Alcan in making the investment decision. Therefore, the TCC found them to be oversight expenses.
  2. Execution costs: These costs generally consist of fees incurred to implement a transaction to purchase a capital asset—an enduring benefit—with the intention to hold it for the long term. Unlike oversight expenses, execution costs are generally incurred after the decision has been made to purchase the asset.

    Execution costs are considered capital in nature and are not deductible as current expenses in the year in which they are incurred.Accordingly, in Alcan, the TCC carved out a portion of the fees paid to the investment banks in connection with the work that was performed after the decision to invest had been made. The TCC found that the costs incurred post-decision were non-recurring costs associated with the actual implementation of the transaction and Alcan’s acquisition of the investment.

    Alcan argued that if the execution costs were not deductible, they should be capitalized to Class 14.1 (formerly eligible capital expenditures in section 14 of the ITA), a capital asset class on which a capital cost allowance could be claimed.2 However, the TCC found that the execution costs were more closely related to the implementation of the transaction rather than the enhancement of “the economic and financial viability of a business."3 This judgement was not challenged at the FCA level and, as a result, execution costs should not be added to Class 14.1.

  1. (paragraph 72)
  3. (paragraph 203)


Overall, the good news is that Alcan provides a precedent that not all transaction costs associated with the purchase of a capital asset are automatically of a capital nature (and thus not fully deductible in the year in which they are incurred). It is important to note that the TCC considered Alcan’s long history of making acquisitions in its decision to classify a portion of the transaction costs as oversight expenses. The TCC noted that an evaluation of corporate opportunities appeared to be an ongoing quest for Alcan’s directors, and—given this history—these evaluations were intrinsically linked to the income-earning process. A corporation making one-time or infrequent investment decisions should carefully consider whether any portion of the transaction costs it has incurred could be viewed as oversight expenses and deducted on a current basis.

Taxpayers should analyze each expenditure to determine if any portion of the transaction costs can be classified as oversight expenses and thus deducted for income tax purposes in the year in which they are incurred. Taxpayers should also remember that they bear the onus of proof as to the nature of the incurred transaction costs (whether oversight or execution). Accordingly, the taxpayer should ensure that they distinguish between the oversight and execution costs of each transaction in their documentation. This might involve identifying specific phases in the transaction process; documenting costs for each phase; and ensuring that third parties retained to assist with the transaction provide billings in support of their work during each specific phase of the process.


Tina HuangTina Huang is a senior manager in tax at BDO Canada LLP in Vancouver, where she specializes in personal and corporate tax planning for privately held businesses and high-net-worth individuals, corporate reorganizations, purchases and sales of a business, and estate planning. She thanks Karen O'Neill, senior tax manager at BDO, for her assistance with this article.


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