Supreme Court Dismisses Imperial Tobacco Leave to Appeal

On May 24, 2012, the Supreme Court of Canada dismissed Imperial Tobacco’s application for
leave to appeal from the Federal Court of Appeal’s decision in Imperial Tobacco Canada
Limited v. The Queen (2011 FCA 308).

The issue in Imperial was whether the taxpayer was entitled to deduct payments that it made to
its own employees and employees of its subsidiaries to surrender stock options (the “Payments”).
The taxpayer argued that the Payments were deductible in computing its income as they
represented employee compensation. The Minister argued that the Payments were on account of
capital because they were made during the course of a reorganization of the taxpayer’s capital.

Writing for the Federal Court of Appeal, Justice Sharlow held that the Payments were on account
of capital. In so doing, Justice Sharlow pointed to three factors in support of her conclusion: (1)
the Payments coincided with a reorganization of the taxpayer’s capital; (2) the arrangements
undertaken to make the Payments facilitated the taxpayer’s capital reorganization and were
intended to do so; and (3) the Payments were intended to and did end all future obligations of the
taxpayer in relation to the stock option plan which constituted a “once and for all payment” that
resulted in a benefit of an enduring nature to the taxpayer.

In reaching her decision, Justice Sharlow conceded that there were factors that supported the
taxpayer’s position that the Payments were on account of income (specifically, that the employee
stock option plan was entered into to provide employee compensation and the shares that the
employees surrendered were only a small portion of the taxpayer’s issued shares). However,
Justice Sharlow agreed with Justice Bowie of the Tax Court below that these factors did not have
sufficient weight to overcome those that indicated the Payments were on account of capital.