Judgments

[1996] 1 F.C. 518

A-656-94

Her Majesty the Queen (Appellant)

v.

Fording Coal Limited (Respondent)

indexed as: Canada v. Fording Coal Ltd. (C.A.)

Court of Appeal, Strayer, Décary and McDonald JJ.A. —Ottawa, September 26 and November 15, 1995.

Income tax — Income calculation — Deductions — Successor rules — Applying Income Tax Act, s. 245, seeding transaction (successor mining corporation (Fording) transferring nominal interest (.001%) in productive resource property to predecessor mining corporation (Elco) before acquisition by successor corporation of all or substantially all of predecessor’s Canadian resource properties) not permitting deduction (over $13,000,000 in cumulative Canadian exploration expense (CCEE) and cumulative Canadian development expense (CCDE)), from successor’s future income from property already owned by it, of expenses incurred by predecessor prior to sale on other property subject of sale — Deduction of CCEE and CDEE amounts serving to artificially and unduly reduce Fording’s income.

This was an appeal from a decision of the Tax Court of Canada allowing an appeal by the respondent, Fording Coal Ltd., from a reassessment of its 1985 to 1990 tax years.

By an agreement in 1985, Elco Mining Ltd. (which had accumulated both cumulative Canadian exploration expense (CCEE) in the amount of $7,277,134 and cumulative Canadian development expense (CCDE) in the amount of $6,642,581) purchased from Fording a .001% interest in the Fording River coal mine. About a month later, Fording purchased all or substantially all of Elco’s Canadian resource properties, including the .001% interest in Fording. As a result of a joint election under subsections 66.1(4) and 66.2(3) of the Income Tax Act (successor rules), thereby making Fording a “successor corporation”, Fording deducted Elco’s CCEE and CCDE from the income generated by the Fording coal mine. Revenue Canada disallowed the deductions on the basis that Fording had adopted a tax avoidance scheme within section 245 of the Act and the deduction would artificially reduce taxpayer’s income. The Tax Court allowed Fording’s appeal from that decision on the basis that the literal and plain meaning of subsections 66.1(4) and 66.2(3) permits the deduction of these amounts; that there was no sham; and that subsection 245(1) of the Act (artificial transactions) did not apply.

Held (McDonald J.A. dissenting), the appeal should be allowed.

Per Strayer J.A.: The literal and plain meaning of the successor rules permits the deduction of these amounts. Where the words are clear they must prevail. There was no sham here: these were legal transactions which had the effect of transferring interests so as to make possible the claim by the respondent for the deductions.

However, the deduction was disallowed under section 245. It provides that “no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income”. In Nowegijick v. The Queen, [1983] 1 S.C.R. 29, the Supreme Court held that the words “in respect of” were of the widest possible scope. The deduction in this case had its origin in the disbursement or expense made or incurred by the predecessor company in respect of the Elco lands. The section did not require that a disbursement or expense have been made or incurred by the taxpayer in question. The wording was inclusive enough to cover disbursements or expenses incurred by Elco on Elco’s lands. The phrase “made or incurred in respect of a transaction or operation” modified “disbursement or expense” and seemed to add very little to the content of the latter.

The deductions unduly or artificially reduced income. Section 245 was not designed to disallow transactions or operations, but rather to deny them a tax consequence where income would be artificially reduced. Thus the central issue was the undue or artificial nature of the reduction of income, not the artificiality of the transaction. The deduction claim arose out of the seeding transaction which was not in accordance with normal business practice. That of itself was not determinative of the artificiality of the deduction, but it was relevant. The fact that the seeding transaction was incidental to the much larger transaction by which the taxpayer acquired a 50% interest in the Elk River coal joint venture was not relevant. Nor was the issue whether the seeding transaction was legally effective. It was. The crux of the matter was the artificiality of the deduction which was claimed solely in consequence of the seeding transaction.

It was not contradictory that subsection 245(1) could operate to disallow a deduction which the Act, as here, specifically authorized. It must be assumed that Parliament contemplated that deductions permitted under the criteria specified elsewhere in the Act could in some situations unduly or artificially reduce income, in which case they would be disallowed under subsection 245(1). The deductions, in the circumstances of the present case, were contrary to the object and spirit of the Act. The intention was to allow the purchaser of mining property to acquire along with that property (if the vendor so agrees) the benefit of unused tax pool deductions including CCEE and CCDE, available for use against income derived in the future from that property.

No public purpose would be served by allowing the deduction in the present case so as to allow the respondent to deduct, from future income from properties it previously owned, the expenses incurred in the past exploration and development of other newly acquired property which has produced nothing since its acquisition.

Per McDonald J.A. (dissenting): the appeal should be dismissed.

The Tax Court Judge did not err in concluding that Fording was permitted to deduct the CCDE and CCEE as it did. Fording freely admitted that the “seeding transaction” was entered into solely for tax purposes. That alone was not enough to invalidate the deductions to which it gave rise. As the Trial Judge said, a court should not excise a portion from a legitimate business agreement because it may have given rise to the kind of tax advantage the Minister later sought to have specifically prohibited by securing an amendment. There was nothing in the plain wording of the successor rules to prohibit what was done, nor did the respondent contravene the object and spirit of the Act. When the successor rules were amended in 1977 and in 1987, the Department fully understood the use of a seeding transaction as a tax planning strategy. Despite this awareness, when the amendments addressing the issue were finally introduced in 1987, they were not given retrospective effect. This was relevant, particularly when investigating the object and spirit of subsections 66.1(4) and 66.2(3).

There was no limitation on the amount of the interest a predecessor company was required to purchase in order for a successor company such as Fording to utilize the deductions as it did. The Court cannot and should not read in a threshold. Fording did not do anything that was not in keeping with either the plain wording or the object and spirit of the successor rules. An object and spirit analysis should not become a means by which every loophole or omission in the Act is rectified to the detriment of the taxpayer by a judiciary agreeable to the Minister’s frequent argument that such an interpretation of the section could not have been what Parliament intended.

Subsection 245(1) did not apply to the present case as there was no disbursement or expense made or incurred from which a deduction was claimed. The “transaction or operation” attacked as artificial was the seeding transaction. However, the expenses and disbursements comprising the CCDE and CCEE were not “made or incurred in respect of” the seeding transaction. And since the transaction was found to be within the object and spirit of the successor rules, it could not be said to be artificial and disallowed by subsection 245(1). If a section creates a complex means by which a taxpayer can receive a specific benefit, and if the taxpayer’s actions in so doing have been found to be in keeping with both the plain meaning and the object and spirit of the relevant sections, then subsection 245(1) cannot operate to disallow the deductions which arose.

STATUTES AND REGULATIONS JUDICIALLY CONSIDERED

Federal Court Rules, C.R.C., c. 663, R. 324.

Income Tax Act, S.C. 1970-71-72, c. 63, ss. 66.1(4) (as enacted by S.C. 1974-75-76, c. 26, s. 36; S.C. 1977-78, c. 1, s. 30; 1984, c. 1, s. 28), 66.2(3) (as enacted by S.C. 1974-75-76, c. 26, s. 36; S.C. 1977-78, c. 1, s. 31; 1979, c. 5, s. 21; 1980-81-82-83, c. 48, s. 35; 1984, c. 1, s. 29), 66.7(3) (as enacted by S.C. 1987, c. 46, s. 23), 66.7(4) (as enacted idem), 245(1).

CASES JUDICIALLY CONSIDERED

APPLIED:

Nowegijick v. The Queen, [1983] 1 S.C.R. 29; (1983), 144 D.L.R. (3d) 193; [1983] 2 C.N.L.R. 89; [1983] CTC 20; 83 DTC 5041; 46 N.R. 41; Canada v. Irving Oil Ltd., [1991] 1 C.T.C. 350; (1991), 91 DTC 5106; 126 N.R. 47 (F.C.A.); Shulman, Isaac v. Minister of National Revenue, [1961] Ex. C.R. 410; [1961] CTC 385; (1960), 61 DTC 1213; Fell (D) Ltd et al v The Queen, [1981] CTC 363; (1981), 81 DTC 5282 (F.C.T.D.); Consolidated-Bathurst Ltd. v. Canada, [1987] 2 F.C. 3 [1987] 1 C.T.C. 55; (1986), 87 DTC 5001; 72 N.R. 147 (C.A.).

DISTINGUISHED:

R v Alberta and Southern Gas Co Ltd, [1977] CTC 388; (1977), DTC 5244 (F.C.A.).

CONSIDERED:

Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536; (1984), 10 D.L.R. (4th) 1; [1984] CTC 294; 84 DTC 6305; 53 N.R. 241; Québec (Communauté urbaine) v. Corp. Notre-Dame de Bon-Secours, [1994] 3 S.C.R. 3; (1994), 63 Q.A.C. 161; 95 DTC 5017; 171 N.R. 161; Canada v. Antosko, [1994] 2 S.C.R. 312; [1994] 2 C.T.C. 25; (1994), 94 DTC 6314; Friesen v. Canada, [1995] 3 S.C.R. 103; [1995] 2 C.T.C. 369; (1995), 95 DTC 5551 (S.C.C.); Mattabi Mines Ltd. v. Ontario (Minister of Revenue), [1988] 2 S.C.R. 175; (1988), 53 D.L.R. (4th) 656; [1988] 2 C.T.C. 294; 87 N.R. 300; 29 O.A.C. 268; Canterra Energy Ltd. v. The Queen, [1987] 1 C.T.C. 89; (1986), 87 DTC 5019; 71 N.R. 394 (F.C.A.); Canada v. Mara Properties Ltd., [1995] 2 F.C. 433 [1995] 2 C.T.C. 86; (1995), 95 DTC 5168; 179 N.R. 363 (C.A.); Mark Resources Inc. v. Canada, [1993] 2 C.T.C. 2259; (1993), 93 DTC 1004 (T.C.C.); Inland Revenue Commissioners v. Westminster (Duke of), [1936] A.C. 1 (H.L.).

REFERRED TO:

R v Esskay Farms Ltd, [1976] CTC 24; (1975), 76 DTC 6010 (F.C.T.D.); McKee (G) v The Queen, [1977] CTC 491; (1977), 77 DTC 5345 (F.C.T.D.); Harris v. Minister of National Revenue, [1966] S.C.R. 489; (1966), 57 D.L.R. (2d) 403; [1966] CTC 226; 66 DTC 5189.

APPEAL from a decision of the Tax Court of Canada (Fording Coal Ltd. v. Canada, [1995] 1 C.T.C. 2734; (1994), 95 DTC 571 (T.C.C.)) allowing an appeal from a decision of the Minister of National Revenue disallowing a deduction of cumulative Canadian exploration expense and cumulative Canadian development expense claimed under subsections 66.1(4) and 66.2(3) of the Income Tax Act on the basis that the seeding transaction which permitted it fell within the ambit of section 245 of the Act. Appeal allowed.

COUNSEL:

Roger E. Taylor and Kathleen T. Lyons for appellant.

Warren J. A. Mitchell, Q.C., Karen R. Sharlow and James H. G. Roche for respondent.

SOLICITORS:

Deputy Attorney General of Canada for appellant.

Thorsteinssons, Vancouver, for respondent.

The following are the reasons for judgment rendered in English by

Strayer J.A.: I have read the reasons of my colleague McDonald J.A. I agree with his statement of the facts. As will be seen in the following analysis I also agree with him that the deductions in question are permitted by the literal meaning of subsections 66.1(4) [as enacted by S.C. 1974-75-76, c. 26. s. 36; S.C. 1977-78, c. 1, s. 30; 1984, c. 1, s. 28] and 66.2(3) [as enacted by S.C. 1974-75-76, c. 26, s. 36; S.C. 1977-78, c. 1, s. 31; 1979, c. 5, s. 21; 1980-81-82-83, c. 48, s. 35; 1984, c. 1, s. 29] of the Income Tax Act [S.C. 1970-71-72, c. 63] and that prima facie this literal interpretation should be applied. I respectfully disagree with him, however, with respect to the object and spirit of those deduction provisions, the interpretation of subsection 245(1), and the implications of the object and spirit of the deduction provisions for the application of that subsection.

I will deal with the three issues raised by the appellant as set out in the reasons of McDonald J.A.

Is the seeding transaction contrary to the object and spirit of the successor rules?

As described by the appellant, this issue really implies that the object and spirit of legislation should always be determinative of its application. I understand the appellant’s argument to be that if the successor rules are interpreted correctly according to their object and spirit, they do not permit the deduction, from the successor’s future income from property already owned by it, of expenses incurred by the predecessor prior to sale on other property which was the subject of the sale. I agree with the learned Trial Judge [[1995] 1 C.T.C. 2734 (T.C.C.)] and McDonald J.A. that the literal and plain meaning of subsections 66.1(4) and 66.2(3) permits the deduction of these amounts. I do not understand the leading authorities on the interpretation of taxing statutes such as Stubart Investments Ltd. v. The Queen[1] and Québec (Communauté urbaine) v. Corp. Notre-Dame de Bon-Secours,[2] although they call for a teleological approach to the interpretation of such statutes, to direct that the object and spirit of the Act are to govern even where the words are clear but not in accord with such object and spirit.[3] Where the words are clear they must prevail, subject to other provisions of the Act to be discussed later.

Further, I agree with the learned Trial Judge and McDonald J.A. that there was no sham here: these were legal transactions which had the effect of transferring and retransferring interests so as to make possible the claim by the respondent for the deductions.

Although I find, for reasons to be discussed later, that such a deduction in these circumstances is contrary to the object and spirit of the sections in question and of the Act, I do not consider this to be a justification for treating the “seeding transaction” as of no effect for the purposes of subsections 66.1(4) and 66.2(3). (I believe however, it may be relevant to the application of subsection 245(1), with which I will deal below.) I would note, in passing, that I do not seek to apply the general statement of Estey J. in the Stubart case where he stated that:

... the formal validity of the transaction may also be insufficient where ...

…

(c) “the object and spirit” of the allowance or benefit provision is defeated by the procedures blatantly adopted by the taxpayer to synthesize a loss, delay or other tax saving device ….[4]

It is apparent from the context that he is there speaking of situations where section 245 or its predecessor would not apply. I must confess to some uncertainty as to what he meant by “formal validity” of the transaction. I note that in Mattabi Mines Ltd. v. Ontario (Minister of Revenue)[5] the Supreme Court itself seems to have drawn back from giving effect to this particular “guideline” where the transaction was in accordance with the clear meaning of the legislative provisions in issue, notwithstanding the argument that the object and spirit of the legislation might be different. In any event, as I will next discuss, I find the deduction here to fall within subsection 245(1) and therefore the quoted passage is not directly relevant.

Were the CCEE [cumulative Canadian exploration expense] and CCDE [cumulative Canadian development expense] “disbursements or expenses” within subsection 245(1)?

At the time in question subsection 245(1) provided as follows:

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 operation that, if allowed, would unduly or artificially reduce the income.

If I understand the Trial Judge correctly, he concluded that because the respondent was seeking to make deductions, not because of expenses it had incurred but because of expenses incurred by its predecessor, there was no “disbursement or expense” being claimed by the respondent within the meaning of subsection 245(1). While the main reason appears to be that the expenses were incurred by a party other than the taxpayer, it may be surmised from jurisprudence cited by the Trial Judge that he regarded such a deduction when used by the successor to be in the nature of an allowance rather than representing a “disbursement or expense”. He cited some jurisprudence of the Federal Court Trial Division of the 1970’s in support of a strict interpretation of the words “disbursement or expense”.[6] Those cases were decided prior to the decision of the Supreme Court of Canada in Nowegijick v. The Queen[7] where the Court had this to say concerning the meaning of the phrase “in respect of”.

The words “in respect of” are, in my opinion, words of the widest possible scope. They import such meanings as “in relation to”, “with reference to” or “in connection with”. The phrase “in respect of” is probably the widest of any expression intended to convey some connection between two related subject matters.[8]

In that case the Court held that section 87 of the Indian Act [R.S.C. 1970, c. I-6] which provided that “no Indian or band is subject to taxation in respect of the ownership ... of any property” was broad enough to exempt taxable income of an Indian living on a reserve. Although taxable income is an artificial concept requiring calculations imposed by the Income Tax Act, such income would ultimately be derived from wages (i.e. personal property) and thus income tax was taxation “in respect of” personal property, a tax from which the appellant in that case was exempted by section 87.

The term “in respect of” appears twice in subsection 245(1). The deduction in question must be made “in respect of a disbursement or expense”. The deduction in this case surely had its origin in the disbursement or expense made or incurred by the predecessor company in respect of the Elco lands. The section does not require that a disbursement or expense have been made or incurred by the taxpayer in question. Using some of the similes of “in respect of” employed by the Supreme Court in Nowegijick I find it hard to see why the deductions claimed by the respondent in the present case were not made “with reference to” or “in connection with” the disbursements or expenses incurred by Elco on Elco’s lands even if in the books of the respondent this deduction might be regarded as an allowance.

For subsection 245(1) to apply the disbursement or expense on which the deduction is based must also be “made or incurred in respect of a transaction or operation”. The phrase “made or incurred in respect of a transaction or operation” modifies “disbursement or expense” and seems to add very little to the content of the latter. The disbursements or expenses here were made or incurred by Elco in respect of the operation of its mining lands and I see no need to consider this further.

Did these deductions unduly or artificially reduce income?

Notwithstanding its marginal note “Artificial transactions”, subsection 245(1) is directed to a “deduction ... that, if allowed, would unduly or artificially reduce the income”. The word “artificially” is an adverb modifying “reduce”, a verb whose subject is “deduction”. “Allowed” also modifies “deduction” and not “transaction” or “operation”: the section is not designed to disallow transactions or operations, but rather to deny them a tax consequence where income would be artificially or unduly reduced.[9] Thus the central issue is the undue or artificial nature of the reduction of income, not the artificiality of the transaction in question.

It has been held that one indicator that a deduction artificially reduces income is that it is based on a transaction or arrangement which is not in accordance with normal business practice.[10] In the present case the deduction claim arises out of the seeding transaction which in my view was not in accordance with normal business practice. It should first be noted that the respondent admits that there was no bona fide business purpose for this transaction unrelated to tax avoidance. That of itself is not determinative of the artificiality of the deduction, but is certainly relevant. In Stubart[11] Estey J. specifically stated in obiter that, where a transaction has no bona fide business purpose, then subsection 245(1) “may be found to be applicable depending upon all the circumstances of the case”. (Subsection 245(1) had no application in that case because the Crown had not invoked it.) The circumstances here underline the abnormality of the seeding transaction. It consisted of the respondent selling a minute interest (.001%) in the Fording mine to Elco for $10,000, with an irrevocable option to repurchase. It is clear from the circumstances that both parties intended this interest to be repurchased very soon, as it was within 28 days. The only advantage to Elco in the seeding transaction was that it received a royalty of $116.49 in respect of minerals produced from the Fording mine during that period. It is difficult to see in this an arrangement in accordance with normal business practice. What is apparent is that by the temporary sale of this minute interest the respondent sought to deduct, from its income from the Fording River coal mine, over $13,000,000 of expenses incurred by Elco on Elco lands prior to their acquisition by the respondent.

The learned Trial Judge gave some emphasis to the need to treat the seeding transaction as only incidental to the much larger transaction by which the respondent acquired a 50% interest in the Elk River coal joint venture. I am not persuaded that this is necessary. As noted above, what we must focus on is the artificiality of the deduction which is claimed solely in consequence of the seeding transaction. Were it not for the seeding transaction the purchase of the 50% interest in the joint venture would not be before the Court. I believe that the learned Trial Judge became preoccupied with this issue because in part he focussed on whether the seeding transaction was a legally effective one. While that might be relevant to the question of sham, it is not determinative of the application of subsection 245(1) which looks primarily to the artificiality of the deduction which in turn may be affected by the nature of the transaction out of which it arises. One does not reach subsection 245(1) if the transaction itself is a sham: this subsection applies where, notwithstanding the genuineness of the legal relationships established by the taxpayer, a deduction based on such a transaction would unduly or artificially reduce income.[12]

It was argued by the respondent, however, that subsection 245(1) could not operate to disallow a deduction which the Act, as here, specifically authorizes.

In response to this I would first observe that if subsection 245(1) has no application to deductions otherwise permitted by the Act then I can see no purpose or effect for this subsection. Nor should it be seen as a general provision which must be considered overridden by “special” provisions which permit deductions in certain circumstances. The Act must be read as a whole. It must be assumed that Parliament contemplated that deductions permitted under the criteria specified elsewhere in the Act could in some situations unduly or artificially reduce income, in which case they would be disallowed under subsection 245(1). There are certainly obiter dicta in the Supreme Court of Canada[13] and in this Court[14] to this effect.

Further, in the Alberta and Southern Gas Co case[15] Jackett C.J. looked to the object and spirit of the section permitting the deduction as a test of whether the deduction claimed would unduly or artificially reduce income. In that case he found the deduction to be within that object and spirit and therefore not to reduce income artificially. But I find that the deductions in the circumstances of the present case were contrary to the object and spirit of the Act. I do not understand the respondent to argue otherwise. The respondent simply relies on the literal interpretation of the Act as supporting its deductions. No one has suggested a rational legislative purpose which would be served by permitting the deductions in this case. I believe that the appellant has correctly described that intention as being to allow the purchaser of mining property to acquire along with that property (if the vendor so agrees) the benefit of unused tax pool deductions including CCEE and CCDE, available for use against income derived in the future from that property. There is eminent sense in encouraging: firstly, the initial investment through making expenses potentially deductible, with added value to the property by making those expense pools transferable to a purchaser; and secondly, the further development and putting into production of that same mining property by one who takes it over. But I can imagine no public purpose, nor has any been suggested, which would be served by allowing the deduction in the present case so as to allow the respondent to deduct, from future income from properties it previously owned, the expenses incurred in the past exploration and development of other newly acquired property which has produced nothing since its acquisition. In my view, these deductions being contrary to the object and spirit of the sections which nevertheless permit them, they may be seen as artificially reducing income.[16]

Conclusion

I would therefore allow the appeal with costs. As it appears that the judgment appealed from was in part consented to with respect to certain matters in issue between the parties I believe they should assist the Court in drafting the judgment of this Court. I therefore request the appellant to prepare a draft of the formal judgment to be submitted, on consent of the respondent as to form if possible, to the Court for approval. If agreement cannot be reached between the parties the appellant will have to move for judgment, preferably under Rule 324 [Federal Court Rules, C.R.C., c. 663].

Décary J.A.: I concur.

* * *

The following are the reasons for judgment rendered in English by

McDonald J.A. (dissenting): This is an appeal from a decision of the Tax Court of Canada in which the appeal by the respondent, Fording Coal Limited (Fording) from a reassessment of its 1985 through 1990 tax years was allowed.

BACKGROUND

By an agreement dated December 2, 1985, Elco Mining Limited (Elco) purchased from Fording an interest in the Fording River coal mine, which entitled Elco to take in kind and separately dispose of coal equivalent in value to its .001% interest in that mine. In an agreement dated December 30, 1985, Fording purchased all or substantially all of Elco’s “Canadian resource properties” which included both a 50% interest in the joint venture property known as the Elk River coal joint venture (an aspect the parties had been negotiating for some months) and Elco’s recently purchased .001% interest in the Fording coal mine. Elco had accumulated both cumulative Canadian exploration expense (CCEE) in the amount of $7,277,134 and cumulative Canadian development expense (CCDE) equalling $6,642,581. These cumulative accounts are referred to as “tax pools”. Fording and Elco then jointly elected under subsections 66.1(4) and 66.2(3) of the Income Tax Act,[17] thereby making Fording a “successor corporation”. As a successor corporation, Fording deducted Elco’s CCEE and CCDE from the income generated by the Fording coal mine. On reassessment, Revenue Canada disallowed the use of these deductions by Fording from the years 1985 through 1990. Fording argued that it was entitled to the deductions as claimed on the basis that Elco had an interest or right to take or remove minerals from the Fording coal mine by virtue of the .001% purchase. It is the position of the appellant, the Minister of National Revenue, that the Elco tax pools should only be used as deductions on income produced by the Elk River coal joint venture (there was no income from this property during the years in question) or at least limited to the income derived from Elco’s .001% interest. The Minister further argues that what Fording did was a tax avoidance scheme falling within the ambit of section 245 of the Act, as the deduction of the CCEE and CCDE amounts served to artificially and unduly reduce Fording’s income. The seeding transaction (the sale of the .001% interest) was merely entered into between the two in order to circumvent subsections 66.1(4) and 66.2(3) of the Act.

The relevant sections of the Act regarding the tax pool deductions are subsections 66.1(4) and 66.2(3) for Fording’s 1985 and 1986 tax years and subsections 66.7(3) [as enacted by S.C. 1987, c. 46, s. 23] and 66.7(4) [as enacted idem] for 1987 through 1990. Subsections 66.7(3) and 66.7(4) “grandfathered” the previous rules as they effected Fording coal. Therefore, subsections 66.1(4) and 66.2(3) are adequate for this discussion:

66.1 ...

(4) Where a corporation (in this subsection referred to as the “successor corporation”) has, at any time after May 6, 1974, acquired, by purchase or otherwise (including an acquisition as a result of an amalgamation described in section 87), from another person (in this subsection referred to as the “predecessor”) all or substantially all of the property of the predecessor used by him in carrying on in Canada such of the businesses described in any of subparagraphs 66(15)(h)(i) to (vii) as were carried on by him, and (except in the case of an amalgamation or a winding-up) the predecessor and the successor corporation have jointly elected in prescribed form on or before the day that is the earlier of the days on or before which either taxpayer making the election is required to file a return of income pursuant to section 150 for the taxation year in which the transaction to which the election relates occurred, there may be deducted by the successor corporation in computing its income under this Part for a taxation year, such amount as it may claim not exceeding the lesser of

(a) the cumulative Canadian exploration expense of the predecessor, determined at the time immediately after the property so acquired was acquired by the successor corporation, to the extent that it has not been deducted by the successor corporation in computing its income for a previous taxation year and has not been deducted by the predecessor in computing his income for any taxation year, and

(b) the amount that is equal to such part of its income for the year, if no deduction were allowed under this section, section 65 or 66 or the Income Tax Application Rules, 1971 in respect of this paragraph (minus the deductions allowed for the year by subsections (5) and 66(2), (6) and (7), sections 112 and 113 and the provisions of the Income Tax Application Rules, 1971 allowing a deduction for the purposes of this paragraph), as may reasonably be regarded as attributable to

(i) the disposition of any property described in any of subparagraphs 66(15)(c)(i) to (vii) owned by the predecessor immediately before the acquisition by the successor corporation of the property so acquired,

(ii) the production of petroleum or natural gas from wells, or the production of minerals from mines, situated on property in Canada in respect of which the predecessor had, immediately before the acquisition by the successor corporation of the property so acquired, an interest or a right to take or remove petroleum or natural gas or a right to take or remove minerals, and

(iii) the amount, if any, by which the aggregate of all amounts each of which is an amount

(A) required by subsection 59(2) or (2.1) to be included in computing its income for the year, and

(B) in respect of a reserve deducted in computing the predecessor’s income and deemed by paragraph 87(2)(g) or by virtue of that paragraph and paragraph 88(1)(e.2) to have been deducted by the successor corporation as a reserve in computing its income for a preceding year

exceeds the aggregate of amounts, if any, deducted in computing the successor corporation’s income for the year by virtue of subsection 64(1), (1.1) or (1.2) in respect of dispositions of property by the predecessor;

and, in respect of any expense included in the cumulative Canadian exploration expense referred to in paragraph (a), no deduction may be made under this section by the predecessor in computing his income for a taxation year subsequent to his taxation year in which the property so acquired was acquired by the successor corporation.

…

66.2 ...

(3) Where a corporation (in this subsection referred to as the “successor corporation”) has, at any time after May 6, 1974, acquired, by purchase or otherwise (including an acquisition as a result of an amalgamation described in section 87), from another person (in this subsection referred to as the “predecessor”) all or substantially all of the property of the predecessor used by him in carrying on in Canada such of the businesses described in any of subparagraphs 66(15)(h)(i) to (vii) as were carried on by him, and (except in the case of an amalgamation or a winding-up) the predecessor and the successor corporation have jointly elected in prescribed form on or before the day that is the earlier of the days on or before which either taxpayer making the election is required to file a return of income pursuant to section 150 for the taxation year in which the transaction to which the election relates occurred, there may be deducted by the successor corporation in computing its income under this Part for a taxation year, such amount as it may claim not exceeding the lesser of

(a) 30% of the amount by which

(i) the cumulative Canadian development expense of the predecessor, determined at the time immediately after the property so acquired was acquired by the successor corporation, to the extent it has not been deducted by the predecessor in computing his income for any taxation year and has not been deducted by the successor corporation in computing its income for a preceding taxation year,

exceeds

(ii) the aggregate of all amounts each of which is an amount that became receivable by the successor corporation in the taxation year or in a preceding taxation year, that is required to be included in the amount determined under clause 66.2(5)(b)(v)(A) by virtue of subsection 59(1.1) or paragraph 59(3.1)(a) and that may reasonably be regarded as attributable to the disposition by the successor corporation of any property owned by the predecessor immediately before the acquisition thereof by the successor corporation, and

(b) the amount that is equal to such part of its income for the year, if no deduction were allowed under this section, section 65, 66 or 66.1 or the Income Tax Application Rules, 1971 in respect of this paragraph (minus the deductions allowed for the year by subsection (4) and sections 112 and 113), as may reasonably be regarded as attributable to

(i) the production of petroleum or natural gas from wells, or the production of minerals from mines, situated on property in Canada in respect of which the predecessor had, immediately before the acquisition by the successor corporation of the property so acquired, an interest or a right to take or remove petroleum or natural gas or a right to take or remove minerals, and

(ii) the amount, if any, by which the aggregate of all amounts each of which is an amount

(A) required by subsection 59(2) or (2.1) to be included in computing its income for the year, and

(B) in respect of a reserve deducted in computing the predecessor’s income and deemed by paragraph 87(2)(g) or by virtue of that paragraph and paragraph 88(1)(e.2) to have been deducted by the successor corporation as a reserve in computing its income for a preceding year,

exceeds the aggregate of amounts, if any, deducted in computing the successor corporation’s income for the year by virtue of subsection 64(1), (1.1) or (1.2) in respect of dispositions of property by the predecessor;

and, in respect of any expense included in the cumulative Canadian development expense referred to in subparagraph (a)(i), no deduction may be made under this section by the predecessor in computing his income for a taxation year subsequent to his taxation year in which the property so acquired was acquired by the successor corporation.

In his decision, the learned Tax Court Judge canvassed the history of the successor rules which I will briefly review. Prior to 1955, if a company accumulated undeducted drilling and oil expenses, when it sold its property, the purchaser could not deduct those expenses as it had not personally incurred them. The successor rules allowed a successor corporation to access the predecessor’s unused resource pool deductions and deduct them against future income from the acquired property. Until 1977 the successor could deduct inherited expenses only against income reasonably attributable to the resource production of the property from which the predecessor had the right to take or remove resources immediately before the transfer. In 1977, the successor rules were amended to include the words “an interest” in subsection 66.1(4). As a result, the predecessor could pass on the ability to use certain forms of income against expenses incurred by the predecessor.

In 1987, the successor rules were again amended to limit “seeding”, but this was not done retroactively. On January 15, 1987, the Minister of Finance issued the Special Release Draft Income Tax Amendments, Acquisitions of Gains and Losses and Department of Finance Technical Notes. The commentary on subsections 66.1(4) and 66.1(5) found in the Technical Notes indicates that the situation in issue was anticipated by the Department:

Subsections 66.1(4) and (5) of the Act contain what are generally referred to as the successor and second successor rules for Canadian exploration expenses (CEE). These rules allow the unclaimed Canadian exploration expenses of a taxpayer (the “predecessor”) to be deducted by a corporation (the “successor”) that acquires all or substantially all of the Canadian resource properties of the predecessor or by another of the Canadian resource properties of the predecessor or by another corporation (the “second successor”) that acquires all or substantially all of the Canadian resource properties of the successor. These expenses may generally be deducted by the successor or second successor only against income from the disposition of Canadian resource properties owned by the predecessor and from production income from those Canadian resource properties in which the predecessor had an interest or right.

These restrictions in the deduction of CEE can be circumvented if the successor or second successor transfers a nominal interest in a productive resource property to the predecessor before the acquisition by the successor of all or substantially all of the predecessor’s resource properties—a so-called “seeding” transaction. In that case, the predecessor’s expenses may be deducted by the successor or second successor against all of its income from that resource property rather than just the portion of its income from the property that is attributable to the interest in the property that was acquired from the predecessor. The amendments to subparagraph [sic ] 66.1(4)(b)(ii) correct this defect by limiting the production income from the property against which the predecessor’s CEE may be deducted by the successor or second successor to the production income that may reasonably be regarded as attributable to the property interest or right that was owned by the predecessor.

These amendments are applicable with respect to acquisitions of property occurring after January 15, 1987 other than acquisitions of property occurring before 1988 where the persons acquiring the property were obliged on January 15, 1987 to acquire the property pursuant to agreements in writing entered into on or before that date.

There has been argument as to whether these amendments were meant to correct a defect in the legislation or to clarify the law. The Tax Court Judge however stated clearly that his decision did not rest on the Technical Notes.

THE DECISION UNDER APPEAL

The Minister did not object to the transaction as a whole, just to the seeding transaction. The Minister requested that the seeding transaction be extracted from the overall deal and viewed independently. There was no question either at trial or on appeal that the seeding transaction was anything other than tax motivated.

The learned Tax Court Judge held that had the seeding transaction been the entire transaction between Fording and Elco, Fording may have crossed the line, however it was part of a larger deal. The small amount of the interest in Fording that had been transferred to Elco could not change the legal effect of the contract. The Court cannot excise a portion from a legitimate agreement simply because it gives rise to favourable tax implications to the taxpayer.

The Act could have been amended more fully to address this issue in 1977. It was not. The Tax Court Judge held that the seeding transaction had to be viewed within the context and history of the successor rules and the intention of Parliament to allow predecessor’s expenses to be available for use by successor companies. A plain reading of subsection 66.1(4) was required. The section did not say anything about the extent of the interest a predecessor company required. Such a limitation was introduced into the legislation in 1987 by the introduction of the phrase: “the production from that property” to the successor rules.

The Tax Court Judge further held that, even standing alone, the seeding transaction could be totally valid, given the decision of the Court in Stubart Investments Ltd. v. The Queen.[18] In the facts of this case it did not stand alone, but rather was part of a larger, complex, independent and bona fide business purpose.

Regarding the application of subsection 245(1), the learned Tax Court Judge held that the section did not apply, as there was no disbursement or expense made or incurred from which a deduction was claimed. The difference between allowances and deductions for expenses and disbursements was discussed. Subsections 66.1(4) and 66.2(3) each make reference to the “cumulative Canadian exploration expense of the predecessor” which the Tax Court Judge concluded does not include the expense incurred by Fording in purchasing Elco, which allowed Fording to utilize the expenses incurred by that company. It was the predecessor Elco that incurred the expenses, not Fording. The successor rules gave Fording the benefit of the expenses Elco incurred.

The Tax Court Judge then addressed whether or not the transaction would otherwise be caught by the section. After reviewing the case law he concluded that the transaction did not offend the Act. An arrangement is not automatically brought within subsection 245(1) simply because it is motivated by tax considerations. As held in Mark Resources Inc. v. Canada,[19] and cited by the Tax Court Judge in his decision, one aspect of an entire arrangement cannot be challenged in total isolation:

Either the whole structure falls or it does not. It cannot be dismembered piecemeal. In any fiscally motivated scheme, if no sham is involved, there must necessarily be legally effective steps that have specific tax consequences. The tax results of each of those steps that forms an integral part of the entire scheme must be respected unless the Minister is prepared to say that the scheme as a whole fails.[20]

The seeding transaction was part of a larger transaction of considerable magnitude between two corporations entering into a legitimate business arrangement. The larger deal was not challenged by the Minister. The fact that a portion of the deal carried tax consequences is not extraordinary and there was no sham. At the time there was no clear legislative intent to restrict what took place. The learned Tax Court Judge held that subsection 245(1) did not apply and that Fording could claim the deductions as it did.

ISSUES ON APPEAL

1. Did the learned Tax Court Judge err in holding that the use of the seeding transactions to obtain “tax pools” for deductions against income was not contrary to the object and spirit of the Act and that the respondent was entitled to resource pool deductions against all of the income from the Fording coal mine?

2. Did the learned Tax Court Judge err in holding that there were no disbursements or expenses made or incurred within the meaning of subsection 245(1) and that, as such, subsection 245(1) did not apply to disentitle the respondent from deducting Elco’s resource pool deductions?

3. Did the learned Tax Court Judge err in holding that if there were such disbursements or expenses made or incurred in respect of which deductions were made in computing the respondent’s income for the 1985 through 1990 tax years, they did not artificially reduce the respondent’s income within the meaning of subsection 245(1)?

ANALYSIS

The first issue on appeal concerns the Tax Court Judge’s finding that subsections 66.1(4) and 66.2(3) (in regard to the 1985 and 1986 tax years) and subsections 66.7(3) and 66.7(4) (in regard to the 1987 through 1990 tax years) allowed Fording to deduct the CCDE and CCEE in the amounts it did. In my opinion, the learned Tax Court Judge did not err in concluding that Fording was permitted to deduct the CCDE and CCEE as it did.

Fording freely admitted that the “seeding transaction” was entered into solely for tax purposes. That alone is not enough to invalidate the deductions to which it gave rise. As was said in Inland Revenue Commissioners v. Westminster (Duke of):

Every man is entitled if he can to order his affairs so as that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax.[21]

The seeding transaction was one step in a series of transactions which comprised a legitimate business deal. I agree with the cautionary statements made by the Tax Court Judge on page 2761 of his decision where he says:

It is a major step for the Court to ignore the legal effects of the form of the transaction between the parties and to undertake a process equivalent to “reading down” or invoking the “blue pencil” doctrine on the basis that some of the substance of the overall purchase agreement is fiscally offensive to the Minister. It is one thing for parties to purport to contract between themselves to give rise to certain tax, or other advantages, or to purport to assign a particular status by contract, such as that of independent contractor, and to have a Court set aside their arrangement on the basis that they have attempted to do what legally cannot be done because the underlying facts do not support the putative categorization. It is another matter for a Court to excise a portion from a legitimate business agreement because it may have given rise to the kind of tax advantage the Minister later sought to have specifically prohibited by securing an amendment.

There is nothing in the plain wording of the successor rules to prohibit what was done, nor did the respondent contravene the object and spirit of the Act. The successor rules were under the continued scrutiny of the Department. They were amended in 1977 and then again in 1987. The Technical Notes, while by no means the final word on the subject, indicate that the use of a seeding transaction as a tax planning strategy was fully understood by the Department. Despite this awareness, when the amendments addressing the issue were finally introduced in 1987, they were not given retrospective effect. While the amendment to a piece of legislation is not necessarily indicative of an alteration in the previous state of the law,[22] the introduction of the amendments, the decision not to make them retroactive but rather to grandfather the existing provisions, and the evidence of the Technical Notes that the Department anticipated transactions such as those in issue, are relevant, particularly when investigating the object and spirit of subsections 66.1(4) and 66.2(3).

There was no limitation on the amount of the interest a predecessor company was required to purchase in order for a successor company such as Fording to utilize the deductions as it did. Counsel for the Minister has asked this Court to read in a threshold, although they offer no suggestion as to what that threshold should be or how it should be arrived at. The inappropriateness of doing so is obvious on the facts of this appeal. Much has been made of the egregiously small amount sold to and repurchased from Elco by Fording. Even if Fording had sold 50% of its interest in the Fording coal mine to Elco, the end result would be the same: twenty eight days later the interest would be back in Fording’s hands and the tax pools would have been deducted as they were. It appears to have been the blatantly small amount that changed hands in order to accomplish the scheme that troubles the Minister most. A windfall appears to have been created for the appellant by the transfer of .001%. However the fact remains that there was no limitation on the amount of the interest in the section and even if there had been the end result would have remained essentially the same. Having this Court create some arbitrary threshold as the Minister requests, absent further significant alterations to the section would not alter the result in this case, although it may make the Minister feel better about how those results were achieved. That alone is not sufficient reason for the Court to interfere to alter a legislative provision enacted by Parliament. Too much speculation would have to be engaged in by this Court, too much tinkering done with the plain wording of the Act, to achieve the result the Minister seeks.

Given the plain wording and history of the sections, I am not convinced that Fording did anything that was not in keeping with either the plain wording or the object and spirit of the successor rules. As Urie J. stated in Canterra Energy Ltd. v. The Queen:

... I have not been persuaded by my analysis of the regulation that that was not the result which the Governor in Council intended. If he did not, then the appropriate remedy for the future is readily available to him. If the regulation was not aptly worded to carry out his original intention it does not mean that this Court should preclude the taxpayer from taking advantage of the benefits of the provision as worded.[23]

Judges must be careful when engaging in an object and spirit analysis. It must not become a means by which every loophole or omission in the Act is rectified to the detriment of the taxpayer by a judiciary agreeable to the Minister’s frequent argument that such an interpretation of the section could not have been what Parliament intended. The judiciary is not to do the job of Parliament. Neither are we to contradict what Parliament has chosen to do in the face of a plainly worded section and with the evidence of obvious departmental consideration and specific legislative amendment. Presumably there was a policy objective in maintaining the section unchanged for as long as it was, and in later grandfathering the sections relevant to this appeal.[24] Parliament anticipated precisely the situation we are dealing with. They chose to address it in a specific way and amended the Act accordingly. In so doing it did not make the changes retroactive. It is not for the judiciary to do so.

Having concluded that the seeding transaction was in keeping with both the plain language and object and spirit of the successor rules, I now turn to the application of subsection 245(1) of the Act. Much confusion has surrounded the interpretation of section 245, confusion which hopefully will be somewhat alleviated by the new general anti-avoidance rules introduced to the Act in 1988 [S.C. 1988, c. 55, s. 185]. Particularly problematic is the conflicting case law concerning the application of subsection 245(1) found in Harris v. Minister of National Revenue[25] and McKee (G) v The Queen.[26] Subsection 245(1), as it then read, stated:

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 operation that, if allowed, would unduly or artificially reduce income.

The learned Tax Court Judge concluded that subsection 245(1) did not apply in the circumstances of this case. I agree with the Tax Court Judge’s findings as stated on page 2766 of his reasons for judgment:

Under the subsections of the Act at issue in the present appeal, 66.1(4) and 66.2(3), there is specific reference to the “cumulative Canadian exploration expense of the predecessor” which obviously cannot be the actual disbursement or expense made or incurred in respect of a transaction by which the successor corporation became entitled to utilize certain expenses previously incurred by another. Indeed, the right of the successor corporation to obtain certain benefits flowing from the fact the predecessor incurred expenses, is the entire rationale for that piece of legislation. Therefore, in my opinion, subsection 245(1) does not apply to the present appeal as there was no disbursement or expense made or incurred from which a deduction was claimed.

There is much to recommend the Tax Court Judge’s analysis of this section. The appellant argues that the seeding transaction was an avoidance transaction, because it had no bona fide business purpose and was not within the concept of commercial normalcy. As such, in arguing that subsection 245(1) should apply, the “transaction or operation” attacked as artificial is the seeding transaction: the sale and repurchase of the .001% interest in the Fording mine. The “deduction” in issue is Fording’s deduction of the tax pools. The expenses and disbursement comprising those pools were not “made or incurred in respect of” the seeding transaction. The respondent argued that the phrase “in respect of” must be given as wide a meaning as possible,[27] and that the key to subsection 245(1) is who made the deduction, not who incurred the expense or made the disbursement. The term “in respect of” is found twice in subsection 245(1), and meaning must be given it in both instances. Regardless of whether the CCEE and the CCDE are considered to be Elco’s expenses or Fording’s deemed expenses or the product of an allowance provision, they were not “made or incurred in respect of” the transaction or operation attacked as being artificial namely, the seeding transaction.

Given my above conclusions, it may not be necessary to continue with my analysis, however since the matter was fully argued before this Court, and since the Tax Court Judge made a finding on the issue, I will also address whether or not subsection 245(1) would have otherwise caught this transaction. In my opinion, it would not.

Subsection 245(1) would not operate to disallow the deductions made by Fording. I have found the seeding transaction to be in keeping with the object and spirit of subsections 66.1(4) and 66.2(3). Could subsection 245(1) now be used to disallow the deductions on the basis that they arose from an artificial transaction (the seeding transaction) and as such unduly or artificially reduced Fording’s income? I do not believe so.

As I stated in Canada v. Mara Properties Ltd.:

... I agree that the claimed loss on the sale of the land cannot be artificial because the loss is the product of a statutory deeming provision (subsection 88(1)) to which effect must be given.[28]

This statement was part of my dissenting judgment. Writing for the majority Mr. Justice Marceau found:

Even if subsection 88(1) operates to allow the respondent to consider the difference between the deemed cost and the actual proceeds of sale as a loss sustained in the course of its business, this loss could not be said to be “artificial” or “undue” as it would arise by specific operation of the Act.[29]

To determine whether a deduction will cause an artificial reduction of a taxpayer’s income, it is necessary to examine the transaction which gave rise to the deduction in question. If that transaction is in keeping with the relevant sections and the Act itself, then it cannot be artificial under subsection 245(1).

The Supreme Court of Canada in Stubart[30] held the object and spirit test to be less onerous than the test for artificiality under subsection 245(1). The transaction here in issue was found to be within the object and spirit of the successor rules, therefore it cannot be said to be artificial and disallowed by subsection 245(1).

Fording acknowledged that tax considerations motivated the seeding transaction, but that fact in and of itself is not enough to support a finding that an undue or artificial reduction of income occurred. The successor rules do not simply list generic deductions; they establish a complex means by which a successor company can utilize the expenses of a predecessor. Indeed it could be said that they create an artificial deduction, however it is one sanctioned, indeed legitimized by the Act. As was said by Mr. Justice Estey in Stubart:

Income tax legislation, such as the federal Act in our country, is no longer a simple device to raise revenue to meet the cost of governing the community. Income taxation is also employed by government to attain selected economic policy objectives. Thus, the statute is a mix of fiscal and economic policy. The economic policy element of the Act sometimes takes the form of an inducement to the taxpayer to undertake or redirect a specific activity. Without the inducement offered by the statute, the activity may not be undertaken by the taxpayer for whom the induced action would otherwise have no bona fide business purpose....[31]

The Act does more than set out deductions, it is a means of advancing government policy. In determining whether the deductions were within the object and spirit of the successor rules, it was necessary to examine the seeding transaction. Once the seeding transaction was found to be within the object and spirit of those rules, the deductions it gave rise to cannot be said to have artificially reduced the taxpayer’s income:

... 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.[32]

If a section creates a complex means by which a taxpayer can receive a specific benefit, and if the taxpayer’s actions in so doing have been found to be in keeping with both the plain meaning and the object and spirit of the relevant sections, then subsection 245(1) cannot operate to disallow the deductions which arose.

I would dismiss the appeal with costs.

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