Judgments

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Decision Content

A-8-74
The Queen (Appellant) v.
The International Nickel Company of Canada Limited (Respondent)
Court of Appeal, Jackett C.J., Mackay and Bastin D.JJ.—Ottawa, June 19, 20, 1974.
Income tax—Profits from production of prime metal— Expenditures on scientific research—Expenditures not deductible from profits in computing base of depletion for producer—Income Tax Act, ss. 11(1)(b), 72(1Xa)—Regula- tion 1201(2)(a).
The Minister re-assessed the corporate taxpayer so as to deduct from its profits attributable to the production of prime metal, the expenditures on scientific research of $4.36 million for the year 1967 and $5.89 million for the year 1968, in computing depletion allowance to which the tax payer was entitled under section 11(1)(b) of the Income Tax Act and Regulation 1201(2)(a). This decision was reversed on appeal to the Trial Division ([1974] 1 F.C. 215). The Crown appealed.
Held, the conclusion of the Trial Division (adopting the decision in International Nickel Company of Canada Ltd. v. M.N.R. [1971] F.C. 213) should be affirmed, but on another ground. The normal manner of ascertaining the "profits" for any taxation year, attributable to production of prime metal from a "resource" is to ascertain the difference between the receipts reasonably attributable to the production of prime metals from the resources for that year and "the expenses of earning those receipts". The respondent's receipts for a taxation year from its production of prime metals were the amounts for which it sold prime metals in that year. The costs sustained by it in that year in carrying on long-term research cannot be regarded as costs of earning its proceeds from sales of prime metals in that year. The research was not part of the operation of producing and disposing of prime metals at all, but was a separate operation.
M.N.R. v. Imperial Oil Ltd. [1960] S.C.R. 735, applied. International Nickel Co. of Canada Ltd. v. M.N.R. [1971] F.C. 213; Home Oil Co. Ltd. v. M.N.R. [1955] S.C.R. 733 , considered.
INCOME tax appeal. COUNSEL:
N. A. Chalmers, Q.C., for appellant. Stuart Thom, Q.C., for respondent.
SOLICITORS:
Deputy Attorney General of Canada for appellant.
Osler, Hoskin & Harcourt, Toronto, for respondent.
The following are the reasons for judgment delivered orally in English by
JACKETT C.J.: This is an appeal from a judg ment of the Trial Division [[1974] 1 F.C. 215] by which an appeal by the respondent from its re-assessment under Part I of the Income Tax Act for the 1967 taxation year was allowed in respect of the issue referred to in paragraph 1 of a Memorandum of Agreement between counsel filed in the Trial Division, which paragraph reads as follows:
1. With respect of each of the years 1966, 1967, 1968 and 1969: whether scientific research expenditures deductible under section 72(1)(a) of the Income Tax Act incurred by the plaintiff during the year must be deducted in determining profits for the purpose of section 1201(2)(a) of the Regula tions under the Income Tax Act.
(There is also an appeal in which the same problem is raised in respect of the 1968 taxation year and which was heard at the same time on the same record.)
The relevant facts and the manner in which the matter was put before the Trial Division sufficiently appear from the following portion of the Reasons for Judgment of the learned Trial Judge [at pages 216-221]:
The plaintiff herein appeals to this Court from the re assessment for income tax by the Minister of National Revenue for the years 1967 and 1968, wherein he deducted from the plaintiff's profits attributable to the production of prime metal from the resources operated by it, for the purpose of computing depletion allowance to which it was entitled under section 11(1)(b) of the Income Tax Act and regulation 1201(2) of the Regulations made pursuant to the said Act, the sum of $4,363,282.00 for the year 1967 and the sum of $5,890,205.00 for the year 1968. The issues in both appeals are the same and by Order of the Court made August 22, 1973, the actions were tried together on common evidence.
By agreement between the parties dated August 8, 1973, the issues to be decided are as follows:
1. with respect to each of the years 1967 and 1968: whether scientific research expenditures deductible under section 72(1)(a) of the Income Tax Act incurred by the plaintiff during the year must be deducted in determining profits for the purpose of section 1201(2)(a) of the Regu lations under the Income Tax Act;
(2) that the issue regarding deductibility of scientific research expenditures in determining profits for the pur pose of section 1201(2)(a) of the Regulations for the years subsequent to the year 1965 is res judicata by virtue of the judgment of the Federal Court of Canada in the action of The International Nickel Company of Canada Limited v. M.N.R. [1971] F.C. 213;
(3) that if such expenditures for scientific research are held to be expenditures that are deductible in the determi nation of the plaintiff's profit from its business under section 4 of the Income Tax Act, the plaintiff is entitled to deduct the same amount in computing its income under the said section 4 pursuant to section 72(1) of the Act.
In his pleading and in his submissions at trial counsel for the plaintiff argued that the expenditures in respect of scientific research were of a capital nature as found by my brother, Cattanach J. in the case of The International Nickel Company of Canada v. M.N.R. (supra) and as such were not deductible in computing the plaintiff's "profits" for the purposes of regulation 1201(2) and that the word "profits" as so used must be interpreted in accordance with its usage within the context of the Income Tax Act and in accordance with judicial principles.
Counsel for the defendant did not argue strenuously that scientific research expenditures were not capital in nature in the sense found by Cattanach J. in the previous case. However, he did argue that the evidence adduced in this case was different than that in the previous case and that it had not been argued before Cattanach J. that the word "profits" in regulation 1201 was unrelated to the determina tion of income under section 4 of the Act, the only other place in which the word "profit" is used, and that the calculation of profits must be made in accordance with its ordinary meaning and generally accepted accounting princi ples. If this were so, profit would have to be determined by deducting from net revenues expenditures for scientific research incurred in the current fiscal year since they are partly causal of current revenues and partly of future reve nues. They should also be charged with past research expen ditures which resulted in profits during the current year. Since the plaintiff's accounting practice did not account for research expenditures against particular projects, it was not possible to determine those portions thereof attributable to current revenues. For this and other cogent reasons he argued that the best accounting practice was to charge such expenditures against net revenues for the current period.
In my view, the evidence adduced before me of the nature and extent of the scientific research engaged in by the plaintiff is no different from that adduced before Cattanach J. in the earlier case. At page 229 he succinctly describes the nature of that work as determined from the evidence adduced before him and I do not think that any testimony in this case changes it in any way:
The appellant in the present case because of the extent and nature of its business expends large sums on scientific research and had done so for many years. It employs highly qualified personnel whose exclusive function is to devote their entire time and outstanding ability to a con stant study of existing processes used by the appellant with a view to improving and making those processes more efficient as well as projects as to the feasibility of hitherto untried processes and methods or discovery of unknown processes. If those studies prove the feasibility of such new projects it has resulted and may again result in the appellant expending large sums to build a plant to utilize the process so discovered or an improvement on a process in use. It has been by this constant search for better ways that the appellant has kept in the forefront of its field.
This necessarily results in a continual outlay on scientif ic research by the appellant. It is a continuing and never ending programme.
At page 231 he pointed out that the plaintiff carefully segregated the expenditures on scientific research between those directed to creating new processes or improving exist ing processes from those directed to maintaining and operat ing existing processes, the information for such segregation being supplied from records kept by the many research departments of the plaintiff. The evidence before me showed conclusively that such segregation was still being maintained in the years 1967 and 1968. These expenditures were properly deducted in computing the depletion base for the purposes of regulation 1201 because they were "reason- ably attributable to the production of prime metal". It is argued that in addition to such costs there should also have been deducted in the years 1967 and 1968 those directed to creating new processes or improving existing processes. In my opinion there was no evidence adduced before me that the latter costs incurred in 1967 and 1968 were "reasonably attributable to the production of prime metal" in either of those years. As Cattanach J. pointed out at page 232:
For the appellant's own commercial purposes all such expenditures on scientific research were included in oper ating costs and not as capital costs. The segregation was made for the purpose of preparing income tax returns.
I do not attach great significance to this bookkeeping or accounting practice. The outlay on scientific research is not easily classifiable and I can readily understand why for commercial purposes the appellant would regard these
expenditures as affecting its net profit or loss. But differ ent considerations apply for income tax purposes.
It is quite understandable that a commercial enterprise in its books of account for its own purposes will treat certain classes of expenditures as revenue expenditures which are, in reality, for income tax purposes capital expenditures and conversely many items treated in the accounts of business as capital receipts are for income tax purposes taxable as income.
How an item is treated in the books of account is not the true or adequate test of the nature of the expenditure.
As I understand the essence of Lord Cave's declaration it is that an expenditure is of a capital nature when it is made with a view to securing an asset or advantage for the enduring benefit of the trade.
The intention of the appellant in embarking upon and continuing its programme of scientific research was to acquire for itself a fund of scientific "know how" upon which it could draw when necessity might arise. Some projects were abandoned. Some proved fruitless. Some continued over many years. Many projects were under taken which accounts for the continuing nature of the expenditure as does the fact that some projects take many years for their culmination. It is immaterial that some of the projects failed if the intention is such that had the object been realized an asset or advantage would have been obtained. If the ultimate object was an asset or advantage of a capital nature then the expenditures antecedent thereto, are also of a capital nature.
After having considered all of the facts which, as above stated, I find were substantially the same as those adduced before me, Cattanach J. concluded that the appellant's ex penditures for scientific research which it claimed as deduc tions under sections 72, 72A and by virtue of section 11(1)(1) in computing its taxable income for the year were expendi tures of a capital nature as a consequence of which those expenditures were not deductible in determining the base for the calculation of the depletion allowance for the purposes of regulation 1201. For the reasons given, I wholly agree with his conclusion and, subject to my disposition of the defendant's arguments with which I shall hereinafter deal, I find that in 1967 and 1968 the plaintiff's expenditures on scientific research, other than those directed to maintaining and operating existing processes, were capital in nature.'
Very briefly, the question is whether the cur rent expenses of operating its long-term
' Although all three questions put before the Trial Divi sion were put forward in this Court, having regard to our conclusion, it was only necessary to hear counsel on one of them.
research activities must be deducted in comput ing the base upon which the appellant is entitled to compute depletion allowance under Income Tax Regulation 1201(2), which reads as follows:
1201. (2) Where a taxpayer operates one or more resources, the deduction allowed is 331% of
(a) the aggregate of his profits for the taxation year reasonably attributable to the production of oil, gas, prime metal or industrial minerals from all of the resources operated by him,
minus
(b) the aggregate amount of the deduction provided by subsection (4).
As appears from his Reasons, the learned Trial Judge adopted the decision of Cattanach J. in an earlier case to the effect that the current expenses of the respondent's long-term research operations were capital expenses of the respondent's prime metal production business and, for that reason, were not deductible in computing its depletion base under Regulation 1201(2). In my view, his conclusion was right but I reach it by another route.
What has to be determined under Regulation 1201(2) is the respondent's profits for the 1967 taxation year "reasonably attributable to the production of ... prime metal". In my view, the correct approach to that question is to be found in Minister of National Revenue v. Imperial Oil Ltd. 2 per Judson J. at pages 744-45, where, dealing with an earlier version of Regulation 1201(2) (which did not differ in any material respect from the one now under consideration), he said, in effect, that the Regulation required, in relation to oil or gas wells, as a first step, that one "Determine the profits or losses of each producing well in the normal manner by ascer taining the difference between the receipts rea sonably attributable to the production of oil or gas from the well and the expenses of earning those receipts". In my view, therefore, the normal manner of ascertaining the "profits" for any taxation year attributable to production of prime metal from a "resource" is to ascertain the difference between the receipts reasonably
2 [1960] S.C.R. 735.
attributable to the production of prime metals from the resource for that year and "the expenses of earning those receipts".
Applying that view to our present problem, I should have thought that the respondent's "receipts" for the 1967 taxation year from its production of prime metals are the amounts for which it sold prime metals in that year and that our problem, therefore, is to determine whether the costs sustained by it in 1967 in carrying on long-term research were costs of earning its proceeds from sales in the year of prime metals. In my view, to state the problem is to answer it.
My view is not based on an attempt to trace a direct connection between each current expense incurred and the actual sales in the year. The matter must, of course, be regarded as a busi ness man would regard it. Nobody is going to inquire whether the expense incurred in the taxation year on scientific research directed to maintaining and operating existing processes, which research is a part of the process of pro ducing and disposing of prime metals, contribut ed exclusively to sales made in the year. They must be treated as current expenses, and, like such expenses as the expenses of advertising carried on in the year and the expenses for repairs done in the year, must be treated as current expenses of the year in which they were incurred.
My view of the problem in this case is based on the facts, as I appreciate them, that the research with which we are concerned is not part of the operation of producing and disposing of prime metals at all but is a separate operation that has nothing to do with the operation of producing and disposing of prime metals except in the remote sense that it is anticipated that its long-term results will provide the prime metal
production business of the future with the wherewithal to make it a more vigorous and successful operation than it would otherwise be. Such long time research is a long-term operation by the company which, in addition to any prof its it may produce directly, is designed to ensure a successful enduring metal production business for the respondent in the future. As such, the costs incurred are not expenses of the respond ent's production of prime metal. It is because that type of long-term research is not ordinarily part of a company's current profit-producing activities that section 72 is included in the stat ute to allow the deduction of its expenses in the computation of world income even though they might otherwise not be deductible in computing income for the purposes of Part I of the Income Tax Act at all.
One way of putting the matter in perspective is to assume that the respondent had operated its long-term research, as it might have done, so as to show it as an independent profit-making operation producing in any particular year either a profit or a loss. It would be quite clear that the revenues of such an operation would not be receipts reasonably attributable to the produc tion of prime metals for the purpose of Regula tion 1201(2) and that the expenses now in ques tion would be expenses of earning such revenues and not expenses of earning the receipts attributable to the production of prime metals. The result can be no different when the respondent chooses simply to turn its research results over to its operating people and chooses not to turn them to advantage, as it might do, for example, by embarking on a major licensing operation.
I fully appreciate that the result of the judg ment appealed from is that the depletion base may, in many cases, be much larger than the "income" that would, apart from section 11(1)(b), serve as a base for the calculation of income tax itself. However, when one considers the matter from that point of view, one is driven, I believe, to the conclusion that Regula tion 1201 was deliberately fashioned to leave that result open as was done in the case of the
predecessor regulation under consideration in Home Oil Co. Ltd. v. Minister of National Revenue.' A Method whereby any such result could have been avoided is to be found in the statute itself. Section 139(1a) of the Income Tax Act provides a formula for determining inter alia a taxpayer's income from a particular source for a taxation year. That formula requires that the taxpayer's income be comput ed in accordance with the Act on the assump tion that he had no income except from that source. Section 139(1b) then provides that, in applying section 139(1a) for certain purposes, all deductions in computing the taxpayer's income for the year for the purposes of Part I, with irrelevant exceptions, "shall be deemed to be applicable either wholly or in part to a par ticular source ...". That scheme of allocating income to a source was so devised that all deductions, such as research expenses, not otherwise deductible but made deductible by special statutory provisions, have to be allocat ed to some source of income. If that scheme had been adopted with reference to the deple tion base in Regulation 1201, research expenses would have been deductible in computing the depletion base. Regulation 1201 does not, how ever, adopt such a scheme. It provides for a calculation of profit reasonably attributable to the particular activity and, by Regulation 1201(4) 4 enumerates what is to be deducted from the profit so calculated. Moreover, while that enumeration specifically singles out such amounts as capital cost allowance (depreciation) and interest on borrowed money for deduction from gross profit in computing the depletion base, it does not require deduction in that com putation of the research expenses that are deductible in computing income by virtue of
[1955] S.C.R. 733.
1201. (4) For the purposes of subsections (2) and (3), there shall be deducted from the aggregate of the profits of a taxpayer for a taxation year reasonably attributable to the production of oil, gas, prime metal or industrial minerals from all of the resources operated by him, the aggregate of
(a) his losses, if any, for the taxation year reasonably attributable to the production of oil, gas, prime metal or industrial minerals from all the resources operated by him,
section 11(1)(j) and section 72. In the face of such a very precise formula adopted under statutory authority for the specific purpose of computing the depletion base, I am of the view that it is not open to the Courts to read into the statutory formula any unspecified deduction that might seem to be dictated by policy considerations.
For the above reasons, I formed the opinion at the conclusion of argument for the appellant that the conclusion of the Trial Judge was cor -
(b) any amounts deducted in computing the taxpayer's income for the taxation year under the provisions of paragraph (p) of subsection (1) of section 11 of the Act, section 83A of the Act, subsection (3) of section 85i of the Act, subsections (3) and (10) of section 141 of the Act and sections 1204 and 1205 of these Regulations,
(c) such part of any amount deducted in computing the taxpayer's income for the taxation year under paragraph (a) of subsection (1) of section 11 of the Act as,
(i) in the case of a taxpayer whose principle business is contract drilling, may reasonably be regarded as having been deducted in respect of property acquired for the purpose of production of oil, gas, metals or industrial minerals, and
(ii) in any other case, may reasonably be regarded as having been deducted in respect of property acquired for the purpose of exploring or searching for, or pro duction of, oil, gas, metals or industrial minerals,
to the extent that that part thereof has not already been deducted in computing profits for the purpose of subsec tion (2) or (3) or deducted under another paragraph of this subsection,
(d) any amount deducted in computing the taxpayer's income for the taxation year under paragraph (c) of sub section (1) of section 11 of the Act in respect of
(i) borrowed money used in connection with, or used for the purpose of acquiring property used in connec tion with, or
(ii) an amount payable for property used in connection with exploring or searching for, or production of, oil, gas, metals or industrial minerals, to the extent that the amount so deducted has not already been deducted in computing profits for the purpose of subsection (2) or (3) or deducted under another paragraph of this subsec tion, and
(e) amounts not included in computing the taxpayer's income for the year by virtue of subsection (5) of section 83 of the Act.
rect and that the judgment of this Court should be that the appeal be dismissed with costs.
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MACKAY D.J. concurred.
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BASTIN D.J. concurred.
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