http://decisions.fca-caf.gc.ca/fca-caf/decisions/en/item/143861/index.do
Canada v. Agnico-Eagle Mines Limited (April 26, 2016 – 2016 FCA 130, Trudel, Stratas, Ryer (author) JJ. A.).
Précis: Agnico-Eagle issued convertible debt denominated in US dollars in 2002 at a time when the US dollar was worth $1.588. In 2005 and 2006 most holders elected to convert the debt to shares at a time when the US dollar was worth $1.154. The few holders that did not convert had their debentures redeemed. The transaction resulted in a large economic loss for the corporation however because of appreciation in the share price primarily in late 2005 and early 2006. CRA assessed the corporation for an aggregate capital gain of roughly $62 million in the two taxation years. In a decision blogged earlier on this site Justice Woods of the Tax Court allowed the corporation’s appeal in respect of the conversions but not in respect of the redemptions. CRA appealed to the Federal Court of Appeal which adopted a completely different analysis holding that the original borrowing, measured in Canadian dollars as of the date of issuance was repaid by means of the issuance of 71.429 common shares valued at the New York Stock Exchange and Toronto Stock Exchange value, expressed in Canadian dollars, on the conversion date plus any cash received in lieu of the issuance of fractional shares. The Court of Appeal did not make any determination of the exact result of its decision since shares were converted in different amounts on a number of different dates, each involving different trading values and spot exchange rates. Nevertheless it would seem on the face of it that their decision would all but eliminate the gain assessed by CRA:
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Canadian Dollars
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Debenture Issue Price 15/2/02
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$1,588.10
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Conversion 14/2/06 - 127, 985 Debentures (89%) - 71.429 Common Shares
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$1,998.58
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Gain (Loss) - Economic
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-$410.48
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Gain (Loss) - per CRA ($1,588-($1,000*1.1541))
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$434.00
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Gain (Loss) - Tax Court Result ($1,588.10-$1,588.10)
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$0.00
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Gain (Loss) - Federal Court of Appeal Result ($1,588.10-($27.98*71.429))
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-$410.48
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Note - Bolded Losses on Corporation's Shares Not Deductible -
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definition of "disposition", para. (m), ss. 248(1) ITA.
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The Court of Appeal awarded costs to the Crown since they reversed the methodology adopted by the Tax Court which seems to be an aberration since their decision appears to essentially vacate the original reassessment.
Decision: The Court of Appeal adopted an approach to the calculation of the “amount” of gain or loss arising on the conversion based on the provisions of the debenture dealing with the calculation of amounts issued in lieu of fractional shares:
[90] Given that the Repayment Amount is an “amount”, for the purposes of paragraph 261(2)(b), in the absence of any indication in the Indenture as to how the quantum of the Repayment Amount must be determined, I would look to the definition of “amount” in subsection 248(1) for assistance. The relevant portion of that provision reads as follows:
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Definitions
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Définitions
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248.(1) In this Act,
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248.(1) Les définitions qui suivent s’appliquent à la présente loi.
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…
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[…]
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amount means money, rights or things expressed in terms of the amount of money or the value in terms of money of the right or thing, except that,
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montant Argent, droit ou chose exprimés sous forme d’un montant d’argent, ou valeur du droit ou de la chose exprimée en argent. Toutefois :
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…
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[…]
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[91] If applicable, this definition may well have led me to conclude that the Repayment Amount was the “value” of the Common Shares issued upon the repayment of each Convertible Debenture. In this regard, it seems to me that the value of a Common Share on each Conversion Date may well have been an amount determinable by reference to the trading price of a Common Share on the NYSE or TSX on each such date because the Taxpayer could, in all likelihood, have received such an amount if it had undertaken a treasury offering of its Common Shares on each such date.
[92] In this context, the establishment of the value of a Common Share on each Conversion Date would likely require evidence as to the relationship between the trading price of the Common Shares and the price at which underwriters would agree to market such shares. In this regard, the practice might be to price the treasury shares at a discount to the trading price of such shares on the applicable market. An example of this may be seen in the Indenture, in which the value of Common Shares issued on Redemptions was stipulated to be 95% of the “Current Market Price” of the Common Shares, as defined in clause 1.1 of the Indenture.
[93] Fortunately, the terms and conditions of the Indenture provide an answer as to how the quantum of the Repayment Amount was intended to be determined. The resolution of this matter is assisted by clause 12.4 of the Indenture, which has been reproduced above.
[94] This provision of the Indenture stipulates that upon the Conversion of Convertible Debentures, no fractional shares will be issued. Instead, the Holder is entitled to cash equal to the “current market value of the fractional share”, which is stipulated as the amount of the fraction multiplied by the “Sale Price” of a Common Share on the Conversion Date (if a “Trading Day” as defined in clause 1.1 of the Indenture). For this purpose, “Sale Price” is defined in clause 1.1 of the Indenture by reference to the trading price of the Common Shares on the NYSE. Further, clause 1.1 of the Indenture stipulates that “cash” refers to US currency.
[95] The operation of clause 12.4 of the Indenture may be illustrated by way of an example. If a Holder owned a single Convertible Debenture, clause 12.4 of the Indenture would apply with the result that, upon the Conversion of that Convertible Debenture, such Holder would receive 71 Common Shares and a US$ cash payment equal to the product of 0.429 times the “Sale Price” of a Common Share on the Conversion Date.
The Court also found that this approach dove-tailed with the approach adopted by the Directors of the corporation in approving the conversion:
[99] More importantly, my approach is essentially the same approach taken by the Directors in the Value of Consideration for Share Issuance Resolution. When the Directors of the Taxpayer passed the Value of Consideration for Share Issuance Resolution, it appears that they were complying with subsection 23(4) of the OBCA, which reads as follows:
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Value determined by directors
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Fixation de la valeur par les administrateurs
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23.(4) The directors shall, in connection with the issue of any share not issued for money, determine,
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23.(4) Lors de l’émission d’une action contre un apport autre qu’en numéraire, les administrateurs établissent :
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(a) the amount of money the corporation would have received if the share had been issued for money; and
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a) le montant que la société aurait reçu si l’action avait été émise contre un apport en numéraire;
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(b) either,
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b) et, selon le cas :
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(i) the fair value of the property or past service in consideration of which the share is issued, or
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(i) la juste valeur des biens ou du service rendu qui sert d’apport,
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(ii) that such property or past service has a fair value that is not less than the amount of money referred to in clause (a).
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(ii) le fait que la juste valeur de ces biens ou de ce service rendu n’est pas inférieure à la somme d’argent visée à l’alinéa a).
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[100] Having adopted the language of this provision of the OBCA in the Value of Consideration for Share Issuance Resolution, at least in part, it is apparent that the Directors were of the view that when the Taxpayer issued Common Shares on the Conversions, the consideration received by it for the issuance of those Common Shares was not money. Indeed, the Value of Consideration for Share Issuance Resolution provides that the consideration for the issuance of Common Shares on Conversions was the consideration that each Holder gave to the Taxpayer as stipulated in the Indenture.
[101] Under my interpretation of the conversion provisions of the Indenture, each Holder gave up such Holder’s right to receive US$1,000 per Convertible Debenture, in cash, at Maturity, along with all of such Holder’s other rights under the Indenture, when the indebtedness of the Taxpayer to such Holder was repaid upon each Conversion. Thus, the relinquishment of such rights constituted the consideration given by each Holder to the Taxpayer for the issuance of 71 Common Shares per Convertible Debenture plus the US$ cash payment in lieu of a fractional Common Share.
In the result the Court allowed the appeal and substituted its conclusions for those reached by the Tax Court:
[103] Applying the approach to the determination of the Repayment Amount that is, in my view, provided for the Indenture, it follows that the Repayment Amount in respect of each Convertible Debenture was, in essence, the US$ amount determined when the “Sale Price” of a Common Share, on each Conversion Date, as determined for the purposes of clause 12.4 of the Indenture, was multiplied by 71.429.
[104] The resulting US$ amount would then be converted to C$, in accordance with subsection 261(2) on each Conversion Date, and the determination of whether the Taxpayer made a gain, for the purposes of subsection 39(2), would be made by comparing the C$ amount, so determined, with $1,588, the C$ amount received by the Taxpayer on the Issuance Date. This calculation would be required with respect to each Conversion, as the Repayment Amounts would not necessarily be identical in respect of all Conversions. If the Repayment Amount in respect of any particular Conversion is less than the related Issuance Amount, the Taxpayer would have a gain, for the purposes of subsection 39(2), in respect of that Conversion.
Costs were awarded to the Crown which may be the result of the Court of Appeal not apprehending the seeming result of their ruling, i.e., all but vacating the original reassessment.
Comment: As I discussed in the blog of the Tax Court decision the reassessment under appeal seemed to defy common sense. Agnico-Eagle had to repay indebtedness of $1,588.10 by means of the issuance of shares having a market value of $1,998.58 resulting, on the face of it, in an economic loss of $410.48. While that loss is not recognized as a capital loss by virtue of paragraph (m) of the definition of “disposition” contained in subsection 248(1) of the Income Tax Act nevertheless by any realistic analysis it was an economic loss. The Crown’s position was simply tinkering with exchange rate differentials irrespective of the underlying economic substance. It is not unlikely that the Crown may consider applying for leave to appeal to the Supreme Court of Canada. To do so they must persuade a panel of the Supreme Court that the decision is arguably wrong. I believe they will have a difficult time doing that. Both the decision of the Court of Appeal and that of the Tax Court lead to results that are much more realistic than the analysis proffered by the Crown and, based on an analysis of the 89% of conversions that took place on February 14, 2019 set out at the beginning of this blog, do not give rise to any taxable income. It would be intellectually interesting to see whether the Supreme Court favoured the analysis of Justice Ryer in the Court of Appeal or Justice Woods in the Tax Court; on one level it is like a very sophisticated debate between expert tax practitioners. That however is not the test to be applied on a leave application. Is the result arguably wrong? In my view, no. No matter how fascinating the underlying debate, is this a matter of national importance? Again, in my view, no.