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The Queen (Appellant) (Defendant) v.
Alberta and Southern Gas Co. Ltd. (Respondent) (Plaintiff)
Court of Appeal, Jackett C.J., Pratte and Urie JJ.—Ottawa, June 24, 1977.
Income tax — Calculation of income — Deductions — Section 245(1) deductions unduly and artificially reducing income, disallowed — Whether or not applicable to s. 66 deduction made following "carve-out" agreement concerning Canadian resource property — Income Tax Act, R.S.C. 1952, e. 148, ss. I2(1 )(g), 59, 66 and 245(1) as amended.
This appeal considers the income tax payable by the respond ent for 1972. Respondent had invested $4,000,000, that other wise would have been taxable, in "a working interest" in petroleum producing lands, pursuant to a "carve-out" agree ment. The agreement was to terminate on payment to respond ent of $4,000,000 plus interest, or on respondent's receiving that value of petroleum substances. The respondent deducted this sum from its income pursuant to section 66 of the Income Tax Act, and the Trial Division overturned the Minister's assessment disallowing the claim. The appellant's sole ground for appeal is that this deduction, even if otherwise permitted, was prohibited by section 245(1) because of its unduly and artificially reducing income.
Held, the appeal is dismissed. Section 245(1), considered in context in the scheme of the Act, is applicable to every class of deductible expenses. Section 245(1) does not operate, however, to prohibit the deduction at issue in this case. Section 66 must be read with section 59. Section 66 permits a deduction of the cost of a "Canadian resource property" and sections 59 and 12(1)(g) provide that the proceeds of disposition of such prop erty must be brought into income. These provisions have the obvious purpose of encouraging taxpayers to put money into such resource properties and keep it there. Since that is what the provisions are intended to encourage, a transaction that clearly falls within the object and spirit of section 66 cannot be said to unduly or artificially reduce income merely because the taxpayer was influenced in deciding to enter into it by tax considerations.
Harris v. M.N.R. [1966] S.C.R. 489, applied.
INCOME tax appeal.
COUNSEL:
J. A. Scollin, Q.C., and Neil W. Nichols for appellant.
F. R. Matthews, Q.C., and M. A. Putnam for respondent.
SOLICITORS:
Deputy Attorney General of Canada for appellant.
MacKimmie, Matthews, Calgary, for respondent.
The following are the reasons for judgment delivered orally in English by
JACKETT C.J.: This is an appeal from a decision of the Trial Division [[1977] 1 F.C. 395] in a proceeding in that Court concerning the tax pay able by the respondent under Part I of the Income Tax Act for the 1972 taxation year.
The facts are clearly set forth in the reasons for judgment of the learned Trial Judge and, as no attack has been made on his findings of fact, I will not re-state them but will merely summarize the facts, as I understand them, in so far as is neces sary for considering the basic question upon which this appeal turns.'
Such facts are:
1. The respondent acquires natural gas in Alberta and re-sells it, in large part, to an associated company for consumption in Cali- fornia.
2. Out of funds generated by an addition made for the purpose to the price charged to the associated company, the respondent endeavours to ensure future supplies of natural gas by vari ous methods adapted to further exploration for gas, viz:
(a) prepayments for known gas in the ground,
(b) loans to producers to assist in the de velopment of future resources to be dedicated to the respondent, and
(c) risk exploration activities;
and expenditures so made are, apparently, accepted by the appellant as deductible in com puting the respondent's income for purposes of income tax for the year in which they are made.
I There is also an appeal for the 1973 taxation year but what has to be decided in the two appeals would seem to be substan tially the same.
3. in 1972, the respondent derived from its sale of gas to its associated company $4,000,000 that was available for such purposes but did not expend them for such purposes in that year.
4. As that sum of $4,000,000 would, otherwise, be included in its income for 1972 for income tax purposes, the respondent, in 1972, adopted a "device" to "remove these amounts from the grasping reach of the tax collector and so pre serve the funds for the purpose to which they were dedicated", which "device" consisted in entering into a "carve-out" agreement with Amoco Petroleum Company Ltd. (hereinafter referr.el to as "Amoco"), a gas-producing com pany with which the respondent had gas pur chase agreements extending into the future.
5. The "carve-out" agreement was an agree ment whereby, in consideration of a payment by the respondent to Amoco of $4,000,000,
(a) Amoco assigned to the respondent a per centage of Amoco's "working interest" (i.e., a right, licence or privilege "to produce, take and dispose of petroleum substances") in cer tain lands, which lands were lands from which the respondent was to receive natural gas which it was to purchase under pre-existing contracts with Amoco;
(b) the respondent was entitled to hold the ass tl ed rights forever but subject to a provi sion that the rights would end when the respondent received
(i) petroleum substances to the value of $4,000,000 plus interest, or
(ii) the amount of $4,000,000 plus interest;
(c) the respondent could remove the pe troleum substances from the land and process and market the products itself, or it could permit Amoco to continue to extract them, refine them and dispose of the resultant prod ucts, in which event the proceeds of disposi tion of Hire respondent's share would go to the respondent (all costs of such operation being, in either event, assumed by Amoco).
6. The respondent permitted Amoco to continue the latter operation and, as was expected by the respondent when it entered into the agreement, in approximately a year, was paid by Amoco the amount of $4,000,000 plus interest out of the
proceeds of production as contemplated by the "carve-out" agreement so that its rights under the agreement came to an end.
The appellant, based on these facts, claimed to deduct, in computing its income for the purposes of the Income Tax Act for 1972, the sum of $4,000,000 paid for the "working interest" under section 66 of the Income Tax Act, which reads, in so far as relevant for the year in question, as follows:
66. (1) A principal-business corporation may deduct, in computing its income for a taxation year, the lesser of
(a) the aggregate of such of its Canadian exploration and development expenses as were incurred by it before the end of the taxation year, to the extent that they were not deductible in computing income for a previous taxation year, and
(b) of that aggregate, an amount equal to its income for the taxation year if no deductions were allowed under this sec tion or section 65, minus the deductions allowed for the year by subsections (2), (4), (6) and (7) and by sections 112 and 113.
(3) A taxpayer who is an individual or a corporation other than a principal-business corporation may deduct, in computing his income for a taxation year, the lesser of
(a) the aggregate of such of his Canadian exploration and development expenses as were incurred by him before the end of the taxation year to the extent they were not deduct ible in computing his income for a previous taxation year, and
(b) of that aggregate, the amount, if any, by which the greater of
(i) such amount as the taxpayer may claim, not exceeding 20% of the aggregate determined under paragraph (a), and
(ii) the aggregate of
(A) such part of his income for the taxation year as may reasonably be regarded as attributable to the pro duction of petroleum or natural gas from wells in Canada or to the production of minerals from mines in Canada,
(B) his income for the taxation year from royalties in respect of an oil or gas well in Canada or a mine in Canada, and
(C) the aggregate of amounts each of which is an amount, in respect of a Canadian resource property or a property referred to in paragraph 59(1)(c) or 59(3)(a) that has been disposed of by him, equal to the amount, if any, by which
(I) the amount included in computing his income for the year by virtue of section 59 in respect of the disposition of the property,
exceeds
(II) the amount deducted under section 64 in respect of the property in computing his income for the year,
if no deductions were allowed under section 65,
exceeds
(iii) the amount of any deduction allowed by the Income Tax Application Rules, 1971 in respect of this subpara- graph in computing his income for the year.
(15) In this section,
(b) "Canadian exploration and development expenses" incurred by a taxpayer means
(i) any drilling or exploration expense, including any gen eral geological or geophysical expense, incurred by him after 1971 on or in respect of exploring or drilling for petroleum or natural gas in Canada,
(iii) the cost to him of any Canadian resource property acquired by him,
(iv) his share of the Canadian exploration and develop ment expenses incurred after 1971 by any association, partnership or syndicate in a fiscal period thereof, if at the end of that fiscal period he was a member or partner thereof, and
(v) any expense incurred by the taxpayer after 1971 pur suant to an agreement with a corporation under which the taxpayer incurred the expense solely in consideration for shares of the capital stock of the corporation issued to him by the corporation or any interest in such shares or right thereto, to the extent that the expense was incurred as or on account of the cost of
(A) drilling or exploration activities, including any gen eral geological or geophysical activities, in or in respect of exploring or drilling for petroleum or natural gas in Canada,
(B) prospecting, exploration or development activities in searching for minerals in Canada, or
(C) acquiring a Canadian resource property,
(c) "Canadian resource property" of a taxpayer means any property acquired by him after 1971 that is,
(i) any right, licence or privilege to explore for, drill for, or take petroleum, natural gas or other related hydrocar bons in Canada,
The claim was disallowed by assessment and the proceeding in the Trial Division was, in effect, an appeal from that disallowance as well as from certain consequential adjustments in the respond-
ent's income as reported, to which reference will be made hereafter.
While there was an issue in the Trial Division as to whether the respondent was a "principal-busi ness corporation" as those words are defined in section 66, the Trial Division held that it was such a corporation and there is no appeal from that holding. The learned Trial Judge also held that the respondent had acquired a "Canadian resource property" within the meaning of those words in section 66 and allowed the appeal in so far as the deduction of $4,000,000 under section 66 was disallowed.
On the argument of the appeal in this Court, that conclusion was attacked on only one ground.
The question raised by the appellant is the question whether, assuming the expenditure of $4,000,000 was, otherwise, deductible, its deduc tion was prohibited by section 245(1) of the Income Tax Act, which reads:
245. (1) In computing income for the purposes of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or opera tion that, if allowed, would unduly or artificially reduce the income.
With regard to that question, the learned Trial Judge said [at page 412]:
With respect to the applicability of section 245 to the results of these agreements between the plaintiff and Amoco I do not think that section 245 is properly applicable in the circum stances of these appeals.
As I have previously stated, it has been laid down as a rule for the construction of statutes that where there is a special section and a general section in the statute a case falling within the special section must be governed thereby and not by the general section.
Section 66 and the sections immediately following dealing with exploration and development expenses of principal busi ness corporations quoted above are special sections and clearly express a particular intention of Parliament. On the other hand, section 245 is a general section and expresses a general intention.
In the present appeals the plaintiff has brought itself precise ly within the particular legislative intent expressed in the particular section 66. The general intention expressed in section 245 is incompatible with the particular intention expressed in section 66 from which it follows that section 66 must govern and not section 245.
With great respect, I cannot agree that the rule of interpretation referred to by the learned Trial Judge excludes the application of section 245(1) to
an amount that would otherwise be deductible under section 66. If it does, it is difficult to think of any case where section 245(1) would apply inasmuch as, in relation to any provision providing for a deduction in computing income, section 245(1) is always, by its nature, a general provision. Parliament must have intended the provision to have some effect and a non-statutory rule of inter pretation is merely a crystallization of the judicial reasoning employed in ascertaining Parliament's intention in enacting a particular provision.
To appreciate the respondent's submission that section 245(1) does not apply to an amount that is otherwise deductible under section 66, it is neces sary to consider the various classes of deductions to which it might apply.
The first question to ask in determining the deductibility of an outlay in computing "profit" for a year for the purposes of the Income Tax Act is whether the money was laid out to earn the profit for the year—i.e., in the case of profit from a business, was it a current business expenditure? 2 If the outlay passes this test, prima facie it is deductible; if it does not, prima facie, it is not deductible.
Other amounts are, however, specially made deductible by statute, for example,
(a) amounts on account of capital that would not otherwise be deductible because they are not current expenses of the year in question although they are related to the earning of profit from the business, such as interest on capital borrowed for the business, capital cost allowance and depletion,
(b) amounts that are deductible under statutory rules made for unusual situations in an attempt to obtain a result as equitable as possible having regard to the abnormal results obtained by applying the ordinary rules re computation of profits to such situations, and
2 Compare British Columbia Electric Railway Co. Ltd. v. M.N.R. [1958] S.C.R. 133, per Abbott J. (delivering the judgment of the majority) at pages 136-137.
(c) amounts that were not laid out for the earn ing of profit (either as current or capital expen ditures) but the deduction of which is allowed by Parliament to achieve some end that Parlia ment wishes to encourage (incentive allow ances).
The provision considered in the Harris case, to which I will refer, falls under the second of these classes and expenses allowed by section 66, as I understand it, fall under the second and third. Depending on the circumstances, section 66 would seem to provide for
(a) a carry forward of current expenditures made in respect of a previous year,
(b) a special scheme for the deduction of capital expenditures (i.e., pre-production costs of creat ing a production operation), and
(c) incentives for exploration and development.
The view expressed by the learned Trial Judge, as I understand it, depends upon reading section 245(1) as not applying to any deduction for which there is a special statutory provision. In my view, considering it in its context in the scheme of the Act, section 245(1) is applicable to every class of deductible expenses. Even if, reading the Act as a whole, I came to a different conclusion, I should feel constrained to hold that section 245(1) does apply to deductions such as those otherwise per mitted by section 66 by my reading of Harris y. M.N.R. 3 per Cartwright J., as he then was, deliver ing the judgment of the Supreme Court of Canada, at page 505 4 .
3 [1966] S.C.R. 489.
° I refer to the passage in his judgment that reads:
While, in view of the conclusions at which I have arrived on the points dealt with above, it is not necessary to express an opinion upon the other grounds on which counsel for the respondent opposed the appeal, I propose to state briefly my opinion on the position taken in ground (e) set out above which was fully argued.
Section 137 (1) of the Income Tax Act reads as follows:
137. (1) In computing income for the purposes of this Act, no deduction may be made in respect of a disburse ment or expense made or incurred in respect of a transac tion or operation that, if allowed, would unduly or artifi cially reduce the income.
(Continued on next page)
In my view, however, section 245(1) does not operate to prohibit the deduction at issue in this case. Section 66 must be read with section 59, which reads, in part:
59. (1) Where in a taxation year a taxpayer disposes of (a) a Canadian resource property,
the amount receivable by the taxpayer as consideration for the disposition thereof shall be included in computing his income for the year, notwithstanding that the amount or any part thereof may not be received until a subsequent taxation year.
and section 12(1)(g), which reads:
12. (1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable:
(g) any amount received by the taxpayer in the year that was dependent upon the use of or production from property whether or not that amount was an instalment of the sale price of the property (except that an instalment of the sale price of agricultural land is not included by virtue of this paragraph);
When one reads section 66, one finds that one of the things that is permitted is a deduction of the cost of a "Canadian resource property" and, when one reads section 59 and section 12(1)(g), one finds that the proceeds of disposition of such a property must be brought into income. These provisions for deduction and taxation of capital amounts seem to me to have the obvious purpose of encouraging taxpayers to put money into such resource properties and keep it there. That being what the provisions seem to have been intended to encourage, as it seems to me, a transaction that clearly falls within the object and spirit of section
(Continued from previous page)
If, contrary to the views I have expressed, we had accepted the appellant's submission that the transaction embodied in the lease was one to which s. 18 applied and that on the true construction of the lease and the terms of that section the appellant was prima facie entitled to make the deduction of the capital cost allowance of $30,425.80 claimed by him, I would have had no hesitation in holding that it was a deduction in respect of an expense incurred in respect of a transaction that if allowed would artificially reduce the income of the appellant and that consequently its allowance was forbidden by the terms of s. 137(1). The words in the sub-section "a disbursement or expense made or incurred" are, in my opinion, apt to include a claim for depreciation or for capital cost allowance, and if the lease were construed as above suggested the arrangement embodied in it would fur nish an example of the very sort of "transaction or opera tion" at which s. 137(1) is aimed.
66 cannot be said to unduly or artificially reduce income merely because the taxpayer was influenced in deciding to enter into it by tax considerations.
The Trial Division judgment also dealt with consequential items. Counsel for the appellant did not contend that these should be dealt with sepa rately from the deduction of the $4,000,000 item.
For the above reasons, I am of the view that the appeal should be dismissed with costs. By request of the parties, the judgment will provide for a reference back of the assessment for reassessment in accordance with the prayer for relief in the statement of claim.
PRATTE J. concurred.
URIE J. concurred.
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