Glencore: Break Fee Received was “Inducement” Income under Paragraph 12(1)(x)

By Julia Zhuo, Torys LLP[1]

INTRODUCTION

In Glencore Canada Corporation v. The Queen (2024 FCA 3), the Federal Court of Appeal (“FCA”) dismissed the taxpayer’s appeal on whether fees related to a failed bid were received on income or capital account. The FCA held that the fees were included in income as an inducement payment pursuant to paragraph 12(1)(x).[2]

The taxpayer, Glencore, was a successor of Falconbridge, a mining company. Glencore was reassessed for the fees received by Falconbridge in 1996. In that year, Falconbridge entered into merger arrangements with Diamond Fields to acquire its publicly traded shares, and indirectly through its acquisition of the shares, a mining deposit indirectly owned by Diamond Fields (the “Deposit”). Falconbridge received a commitment fee of approximately $28 million (the “Commitment Fee”) upon entering into the merger arrangements. Later, Diamond Fields’ shareholders accepted a competing offer from Inco, a third party, to acquire the Diamond Fields shares, following which Falconbridge received a non-completion fee of approximately $73 million (the “Non-Completion Fee”, and collectively with the Commitment Fee, the “Fees”). The Non-Completion Fee is what practitioners commonly referred to as a break fee.

FCA ANALYSIS

The FCA’s analysis has three parts: (i) the Fees were not business income under subsection 9(1); (ii) the Non-Completion Fee was not received for the disposition of the right to merge, and therefore was not a capital gain; and (iii) the Fees were both “inducement” income under paragraph 12(1)(x).

In overturning the Tax Court of Canada (“TCC”)’s decision on subsection 9(1), the FCA found that the Fees had no linkage to revenue. Instead, the linkage was to capital - a proposed acquisition of shares which are capital assets. According to the FCA, the TCC misinterpreted the Supreme Court of Canada (“SCC”)’s decision in Ikea Ltd. v. Canada[3] by failing to read its reference to ordinary business operations in context. The question is not whether the Fees were linked to the taxpayer’s ordinary business operations. Rather, the question is “whether the Fees were linked to something on revenue account”. The FCA then went on to distinguish Morguard Corporation v. Canada[4] on the basis that, in Morguard, the taxpayer had been in the business of acquiring companies; in this case, Falconbridge was not.

The FCA’s capital gain analysis only applied to the Non-Completion Fee. The FCA found that it was not received for the disposition of the right to merge. No agreement in the merger arrangements provided Falconbridge with such right, since (i) Diamond Fields, a public company, could not promise that its shareholders would accept the offer; and (ii) Diamond Fields’ board of directors had fiduciary duties to consider a competing bid.

Finally, the FCA concluded that the Fees were both “inducements” under paragraph 12(1)(x). The Commitment Fee was payable simply by Falconbridge committing to make the offer. It therefore “induces Falconbridge to make the commitment”. The FCA also found that the Non-Completion Fee’s general nature was an inducement, citing Alberta Securities Commission’s decision in Re Bison Acquisition Corp.[5] that “[b]reak fees are intended to entice bidders to participate in an auction”. The FCA further commented that paragraph 12(1)(x)(iii) focuses on the reason for the payment, i.e., Diamond Fields agreed to make the payment in order to entice Falconbridge to make the offer. It made no difference that the Non-Completion Fee was conditional on the bid failing.  

LEAVE APPLICATION TO THE SCC

On March 5, 2024, the taxpayer filed a leave application with the Supreme Court of Canada.[6]

In its application, the taxpayer conceded that the Commitment Fee was an inducement, but argued that the break fee was not. It was not to “induce” anything, because it was only received when the deal fell apart, “at which point there is no longer any reason to induce the bidder to do something”. The taxpayer cited a 2012 article[7] for the position that break fees are received as “consolation” for a failed acquisition, not as an inducement to enter into a bid; they are “a form of liquidated damages or compensation for a lost opportunity to purchase shares”. The taxpayer also cited Alberta Power (2000) Ltd. v. The Queen[8]  with respect to the purpose of paragraph 12(1)(x) - it was intended to apply “where the inducement reduces the cost of acquiring an income producing asset”.

The taxpayer argued that the break fee should be taxed as a capital gain because it was received “pursuant to a disposition of property”. The relevant property is not the right to merge, but Falconbridge’s contractual rights under the merger agreement. The term “disposition” should include the termination of a contract, and the taxpayer cited case law  that a payment received for the termination of a contract gave rise to a capital gain.

The taxpayer also commented on the implications for section 56.4 (not in existence in 1996) and corresponding withholding taxes under paragraph 212(1)(i). According to the taxpayer, in recent years, the CRA has assessed break fees under section 56.4 as an amount received in respect of a restrictive covenant. Section 56.4 taxes such amount as income and provides an exception for payments received pursuant to a disposition of property.[9] According to the taxpayer, if the FCA’s decision that break fees are not received pursuant to a disposition of property stands, then going forward, break fees could be taxable under section 56.4 (which takes precedence over paragraph 12(1)(x)); this will also trigger a 25% withholding tax for non-residents by virtue of paragraph 212(1)(i), subject to any treaty relief.

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