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.
* * *
MACKAY D.J. concurred.
* * *
BASTIN D.J. concurred.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.