Farmers Mutual Petroleums Limited v. Minister of National Revenue, 67 DTC 5277, [1967] CTC 396, [1968] S.C.R. 59

MARTLAND, J. (all concur) :—These are appeals from judgments of the Exchequer Court which refused to permit the appellant, in computing its income, in the years 1959 and 1960, to deduct, in respect of legal expenses, the respective amounts of $80.10 and $10,623.43, and in respect of expenses claimed by the appellant as exploration and drilling expenses, the respective amounts of $53,273.38 and $143,581.10.

The facts involved in respect of these two matters are distinct from each other, so I will deal with each of the items separately.

Legal Expenses :

The appellant was incorporated under the laws of the Province of Saskatchewan on December 1, 1949, for the object, inter alia, of acquiring mineral rights and exploring for petroleum and natural gas.

Following its incorporation the appellant began a vigorous and successful campaign to acquire mineral rights from land owners. The system followed by the appellant was to acquire the fee simple title to minerals from land owners who had previously granted leases of their petroleum and natural gas rights to major oil producing companies. Those leases were uniform and standard. They were for a period of ten years providing to the land owner an annual rent of ten cents per acre and re- serving a royalty of 1214 per cent to the land owner in the event of a producing well or wells being brought into existence.

The land owner transferred to the appellant his entire estate and interest in the mineral rights, including all benefits from the existing lease. In return, he received one share of the capital stock of the appellant for each acre transferred and a trust certificate as evidence that the appellant thereafter held in trust for him one-fifth of the mines and minerals and the benefits therefrom.

In this manner the appellant acquired the mineral rights in approximately 750,000 acres in Saskatchewan and issued approximately 2,500 trust certificates. The appellant received as income four-fifths of the rentals payable thereon and four-fifths of any royalties from producing lands.

In 1955 when oil was discovered in south eastern Saskatchewan many of the land owners instituted actions in the Court of Queen’s Bench of Saskatchewan for declarations that the agreements between them and the appellant were induced by fraudulent misrepresentation and were accordingly void, and for orders revesting in the land owners the mineral rights and the interest in the leases which had been transferred and assigned to the appellant. In all about 250 such actions were begun, the pleadings being virtually identical in all cases.

The appellant successfully defended such of those actions as came to trial so that it remained possessed of the mineral rights and benefits under the contracts above described. None of the lands involved nor any of the actions commenced were lost by the appellant nor did the appellant lose any of the income which it was receiving from the lands. The legal expenses so incurred by the appellant constitute part of the amounts that were claimed by it as a deduction from income and that were disallowed by the Minister.

After the appellant had succeeded in some cases in the courts, many of the land owners formed a mineral owners’ protective association to advocate and obtain legislative relief. A Royal Commission on Certain Mineral Transactions’’ was appointed by the Saskatchewan Government to inquire into allegations that many owners of freehold mineral rights in Saskatchewan had been deprived of such rights by means of fraud or misrepresentation. This Commission recommended that a Board be constituted for the purpose of achieving, if possible, the voluntary re-negotiation of contracts whereby the owners were deprived of their freehold mineral rights through misrepresentation, whether innocent or fraudulent.

The Mineral Contracts Re-negotiation Act, 1959 was enacted to implement the recommendations of the Commission. Further legislation of a similar tenor was proposed in 1960.

The appellant employed counsel to make representations on its behalf opposing the proposed legislation, suggesting variations in the terms thereof and making representations to the Board later established pursuant to legislation enacted with respect to contracts entered into by it which were sought to be renegotiated.

The learned trial judge confirmed the Minister’s position and held that the legal expenses incurred were a ‘ payment on account of capital” made ‘‘with a view of preserving an asset or advantage for the enduring benefit of a trade’’.

The decision of the learned trial Judge was based upon the judgment of this Court in M.N.R. v. Dominion Natural Gas Company Limited, [1941] S.C.R. 19; [1940-41] C.T.C. 155. Counsel for the appellant sought to distinguish the Dominion case and also contended, in the alternative, that that case would have been decided differently today on the same facts in view of changes which have since occurred in the relevant provisions of the Income Tax Act.

The relevant provisions of the Income Tax Act, R.S.C. 1952, e. 148, are as follows:

12. (1) In computing income, no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from property or a business of the taxpayer,

(b) an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part,

Section 12(1) (a) and (b) were derived from Section 6(1) (a) and (b) of the Income War Tax Act, R.S.C. 1927, ce. 97, which provided as follows:

6. (1) In computing the amount of the profits or gains to be assessed, a deduction shall not be allowed in respect of

(a) disbursements or expenses not wholly, exclusively and necessarily laid out or expended for the purpose of earning the income;

(b) any outlay, loss or replacement of capital or any payment on account of capital or any depreciation, depletion or obsolescence, except as otherwise provided in this Act.

Counsel for the appellant advanced the proposition that legal expenses incurred to protect a right to income are deductible regardless of whether the protection of that right also involves preserving a capital asset. The appellant, he said, immediately upon its acquisition of title to the mineral rights from a land owner had the right to receive and retain as its income four- fifths of the acreage rental payable by the lessee of the mineral rights. The legal expenses incurred were to protect that income. In the Dominion case, that which was protected was a franchise which, in itself, did not produce income.

In my opinion, this proposition is not valid, because it is directly contrary to the intent of paragraphs (a) and (b) of Section 12 when read together. To be deductible for tax purposes an outlay must satisfy at least two basic tests:

(1) It must be made for the purpose of gaining or producing income (Section 12(1) (a)).

(2) It must not be a payment on account of capital (Section 12(1)(b)).

Both of these tests must be satisfied concurrently to justify deductibility. In British Columbia Electric Railway Company v. M.N.R., [1958] S.C.R. 133; [1958] C.T.C. 21, Abbott, J. said, at pp. 137, 31 :

Since the main purpose of every business undertaking is presumably to make a profit, any expenditure made “for the purpose of gaining or producing income” comes: within the terms of Section 12(1) (a) whether it be classified as an income expense or a capital outlay.

Once it is determined that a particular expenditure is one made for the purpose of gaining or producing income, in order to compute income tax liability it must next be determined whether such disbursement is an income expense or a capital outlay.

It can certainly be said that the appellant, in resisting the lawsuits launched against it, was seeking to protect its income, because it was seeking to protect the assets from which its income was derived. It can, therefore, be argued that the expenses were properly deductible under Section 12(1) (a). This is not contested by the respondent. The object and purpose of the lawsuits, however, was to compel the restoration to the land owners of the mineral rights which the appellant had purchased. The learned trial judge has found, and the evidence establishes, that those rights were items of fixed capital, and were so regarded by the appellant. At the time the litigation occurred, the sum total of the mineral rights acquired by the appellant, all of which were of the kind involved in the litigation, represented all of the appellant’s capital assets. The appellant did not trade in them, but intended to retain them perpetually.

It was to protect those capital assets from attack that the legal costs of the litigation were incurred, and, to quote the words of Dixon, J. (later Chief Justice) in Hallstroms Pty. Lid. v. Federal Commissioner of Taxation (1946), 72 C.L.R. 634 at 650, referring the costs of defending title to land:

Next to the outlay of purchase money and conveyancing expense in acquiring the title to land, it would be hard to find a form of expenditure in relation to property more characteristically of a capital nature.

The fact that the leases acquired by the appellant, along with the mineral rights, were more immediately connected with the production of income than was the franchise involved in the Dominion case does not affect the matter in principle. It is relevant in relation to the application of Section 12(1) (a), but in relation to Section 12(1) (b) we must ask the question, was this outlay for the purpose of preserving a capital asset? In my opinion it clearly was and, if that is so, Section 12(1) (b) prevents its deduction.

With respect to the second submission respecting the Dominion case, while Section 12(1) (a) of the present Act is less restrictive than was Section 6(1) (a) of the Income War Tax Act, Section 12(1) (b) of the Income Tax Act is essentially the same as was Section 6(1) (b) of the Income War Tax Act. In my opinion, for the reasons which I gave in the recent case of British Columbia Power Corporation Limited v. M.N.R., the Dominion case has established the proposition that legal expense incurred with a view of preserving an asset or advantage for the enduring benefit of the trade is a capital expenditure that is not deductible.

I agree with the learned trial judge that the legal expenses involved in opposing the proposed legislation and in appearing before the Board created by such legislation are subject to the same considerations. They are not different in kind from the costs of the litigation in the courts.

Exploration and Drilling Expense

Scurry-Rainbow Oil Limited, hereinafter referred to as “Scurry”, became a major shareholder in the appellant. Scurry was the successor in title to Canadian Pipe Line Producers Ltd. in respect of an agreement, dated May 19, 1954, to which the latter company was a party along with Canada Southern Petroleum Ltd., West Canadian Petroleum Ltd., Trans Empire Oils Ltd. and British Empire Oil Co. Ltd. Under the terms of that agreement the entire legal and beneficial interest in certain Crown petroleum and natural gas permits covering approximately 1,500,000 acres in British Columbia would be held jointly by the parties. The beneficial interest acquired by Scurry was 22 per cent of the reservations covered by the agreement.

Canada Southern Petroleum Ltd. had been named as manageroperator under the terms of the agreement, but it was succeeded by Phillips Petroleum Corporation, hereinafter referred to as “Phillips”. Under the agreement the parties agreed to conduct a seismic program, and, contingent upon its results, to drill a well for the joint account and at the joint expense of the parties in proportion to their interests. The manager-operator was given sole and exclusive management and control of the exploration, drilling and production operations on the land.

The parties had the right to receive progress information and to inspect and examine the books and records of the manageroperator. There was also provision for meetings and consultation and for surrender, sale or assignment of all or part of a party’s interest in the lands.

Paragraph 11 of the agreement governed the matter of costs and expenses:

11. COSTS AND EXPENSES

The parties hereto mutually covenant and agree with one another that all exploration costs, drilling costs, completion costs, abandonment costs, production costs, and all other costs and expenses of every nature and kind chargeable to the joint account hereunder incurred in respect to any and all operations carried on hereunder in respect to any of the lands described in the Permits set out in Schedule “A” shall be borne and paid by the parties hereto in proportion to their respective interest in the lands and Permits upon which such exploration, drilling or producing operations are carried on, as such interests appear in Schedule “B” hereof. Subject to the further provisions of this Agreement, Manager-Operator shall initially advance and pay all costs and expenses incurred in connection with the said lands and shall charge the Joint-Operators with their proportionate share thereof upon the cost and expense basis provided for in the attached Accounting Procedure. Joint-Operators agree that they will promptly reimburse the Manager-Operator for Joint-Operators’ proportionate share of all such costs and expenses within the time limited by the said Accounting Procedure.

On January 2, 1959, Scurry and the appellant entered into an agreement, which, after certain preliminary recitals referring to the agreement of May 19, 1954, read as follows:

AND WHEREAS the parties hereto desire to enter into this Agreement whereby Farmers Mutual shall have the right to ac- quire certain interests in the said lands subject to the terms and conditions as hereinafter provided.

NOW THEREFORE THIS AGREEMENT WITNESSETH that Farmers Mutual hereby agreed to pay all costs which may be incurred by Scurry-Rainbow in the performance of its obligations with respect to the seismic program referred to herein. Scurry- Rainbow agrees that upon the completion of the said seismic program on the said lands and the payment by Farmers Mutual of all costs which would have been incurred by Scurry-Rainbow on this seismic program, Farmers Mutual shall have earned an undivided Three (3%) Percent interest in the said lands and the interests owned by Scurry-Rainbow and Farmers Mutual shall thereafter be:

SCURRY-RAINBOW OIL LIMITED	19% interest
FARMERS MUTUAL PETROLEUMS LTD.	3% interest

Scurry-Rainbow agrees to execute any and all further documents required in order to vest the interest aforesaid in Farmers Mutual in the event that the seismic program herein is completed. After Farmers Mutual shall have earned the Three (8%) Percent interest referred to herein, Scurry-Rainbow agrees to grant and hereby grants to Farmers Mutual the option to earn an additional Eight (8%) Percent interest in the said lands on the condition that Farmers Mutual agrees to pay and pays Scurry-Rainbow’s entire cost of drilling the well referred to herein. After the said well shall have been drilled and Scurry-Rainbow’s share of the costs paid by Farmers Mutual, Scurry-Rainbow agrees to execute any and all further documents required in order to vest the Eight

(8%) Percent interest in Farmers Mutual.

Under the terms of the 1954 agreement, Phillips, as manageroperator, conducted a seismic program and carried on a drilling program. Phillips invoiced Scurry for its proportionate share of these expenses. On receipt of an invoice, Scurry would usually send an invoice to the appellant for the amount Scurry was required to pay to Phillips, and Scurry would pay Phillips. On two occasions Scurry sent the Phillips’ invoice to the appellant, which paid Phillips directly.

On October 5, 1959, the appellant elected to exercise its option, under its agreement with Scurry, to earn the additional 8 per cent interest in the lands by paying Scurry’s entire cost of drilling the well.

Section 83A(3) of the Income Tax Act, at the relevant times, provided as follows :

83A. (3) A corporation whose principal business is

(a) production, refining or marketing of petroleum, petroleum products or natural gas, or exploring or drilling for petroleum or natural gas, or

(b) mining or exploring for minerals,

may deduct, in computing its income under this Part for a taxation year, the lesser of

(c) the aggregate of such of

(i) the drilling and exploration expenses, including all general geological and geophysical expenses, incurred by it on or in respect of exploring or drilling for petroleum or natural gas in Canada, and

(ii) the prospecting, exploration and development expenses incurred by it in searching for minerals in Canada,

as were incurred after the calendar year 1952 and before the end of the taxation year, to the extent that they were not deductible in computing income for a previous taxation year, or

(d) of that aggregate, an amount equal to its income for the taxation year

(i) if no deduction were allowed under paragraph (b) of subsection (1) of section 11, and

(ii) if no deduction were allowed under this section,

minus the deductions allowed for the year by subsections

(1), (2) and (8a) of this section and by section 28.

The question in issue is as to whether the moneys paid by the appellant pursuant to its agreement with Scurry were deductible in computing the appellant’s income tax, as being ‘‘drilling and exploration expenses . . . incurred by it on or in respect of exploring or drilling for petroleum or natural gas in Canada’’. The learned trial judge held that they were not deductible by the appellant. His reasons for so holding are summarized in his judgment as follows:

The submission on behalf of the appellant, as I understand it, is that by the agreement between Scurry and the appellant dated January 2, 1959 the appellant reimbursed Scurry for its outlay for exploration and drilling expenses. Since an expense cannot be incurred by a party who is truly reimbursed, therefore it cannot be said that the expenses were incurred by Scurry but rather they must have been incurred by the appellant which was out of pocket in the precise amount of the expenses and that Scurry was merely the conduit between the appellant and the manager-operator.

In my opinion the agreement between Scurry and the appellant is not susceptible of such interpretation. The substance of that transaction, as I see it, was that the appellant purchased an interest in lands from Scurry and that the price to be paid therefor was determined and measured by the cost of the exploration and drilling expenses incurred by Scurry. It was a condition precedent to any payment to Scurry by the appellant that Scurry should have incurred exploration and drilling expenses and I can entertain no doubt that the money paid by the appellant to Scurry was in consideration for a transfer of an interest in land from Scurry to the appellant although that consideration was measured by the yardstick of the costs incurred by Scurry. What Scurry received was payment for an asset sold by it to the appellant and accordingly Scurry was not reimbursed for the exploration ex- penses incurred by it. Conversely what the appellant paid for and received was the transfer of an interest in lands and therefore did not pay for exploration and drilling expenses.

I am in agreement with these conclusions. Exploration and drilling expenses were incurred in respect of the work carried on by Phillips as manager-operator under the 1954 agreement. This work was done by Phillips on behalf of all the parties to that agreement as well as on behalf of itself, and a portion of the expense was incurred by Phillips, as agent for Seurry.

The 1954 agreement contained provision for an assignment of interest by the parties to it, but there was no assignment of interest effected by Scurry in favour of the appellant. The appellant did not acquire any contractual rights under that agreement, and Phillips had no right to require the appellant to assume any obligation to pay any part of the exploration and drilling expenses which, as manager-operator, Phillips had incurred.

The 1959 agreement between Scurry and the appellant, after referring to the 1954 agreement, recites that the parties desire to enter this agreement whereby Farmers Mutual shall have the right to acquire certain interests in the said lands’’. The obligation of the appellant was to pay ‘all costs which may be incurred by Scurry in the performance of its obligations with respect to the seismic program referred to herein’’. The appellant was thereby to acquire a 3 per cent interest in the lands. It also obtained an option to earn an additional 8 per cent interest by paying Scurry’s entire cost of drilling the well.

The position is, therefore, that the appellant did not itself incur exploration or drilling costs in respect of land in which it had an interest. What it did do was to pay for a contractual right to acquire an interest in lands on which exploration and drilling had taken place by paying expenses already incurred by Seurry in connection therewith. The payments made by the appellant were not in respect of expenses which it had incurred in respect of exploration or drilling. They were payments of expenses which had been incurred by another and were made, not to meet a liability of the appellant for the cost of exploration or drilling, but made for the acquisition of an interest in the lands.

In these circumstances, in my opinion, the payments made by the appellant cannot be deducted, under Section 83A(3), in computing its income for tax purposes.

In my opinion, both appeals should be dismissed with costs. BRITISH COLUMBIA POWER CORPORATION LIMITED, Appellant,

and

MINISTER OF NATIONAL REVENUE, Respondent.

Supreme Court of Canada (Abbott, Martland, Ritchie, Hall and Spence, JJ.), October 3, 1967, on appeal from a judgment of the Exchequer Court, reported [1966] C.T.C. 454.

Income tax—Federal—Income Tax Act, R.S.C. 1952, c. 148—Section 12(1)(a), (b)—Legal expenses—Income expenditure vs. capital expenditure—Whether legal expense incurred by holding company in resisting expropriation of shares of subsidiary a deductible expense— Communications of corporation to shareholders—Whether cost of making communications to shareholders a deductible expense of corporation—Awarding of costs.

The appellant’s principal asset consisted of the common shares of the British Columbia Electric Company. In August 1961 the British Columbia Government expropriated those shares at a price of $110,- 985,045, whereupon the appellant, in a move designed to obtain greater compensation, began a series of legal steps to have the expropriation set aside. In July 1963 the B.C. Supreme Court held the expropriation to be ultra vires of the B.C. legislature but at this point the appellant informed the Government that its principal concern was to obtain fair compensation. The transfer of the shares was then completed for a consideration of $197,114,358, as fixed by the Court. In issue was whether legal expenses amounting to some $1,156,223 incurred by the appellant in this connection met the test of deductibility in Section 12(1) (a), and, if so, whether Section 12(1) (b) then operated to preclude their deduction.

Also in issue was the deductibility of the cost of communications to shareholders made to inform them of the expropriation and ensuing developments.

HELD (per curiam) :

As to the first issue, the legal action was brought, and the expenses were incurred, in order to preserve the appellant’s title to the shares. It followed from the principle established in the Dominion Natural Gas case that the appellant’s outlay was a non-deductible capital expenditure within the meaning of Section 12(1) (b).

As to the second issue, the reasonable furnishing of information from time to time to shareholders by a company respecting its affairs was a part of the carrying on of the company’s business of earning income and was properly deductible.

Appeal allowed in part.

CASES REFERRED TO:

M.N.R. v. Dominion Natural Gas Co. Ltd., [1941] S.C.R. 19;

[1940-41] C.T.C. 155;

United Gas and Fuel Co. of Hamilton, Ltd. v. Dominion Natural

Gas Co. Ltd., [1934] A.C. 485;

British Insulated and Helsby Cables Ltd. v. Atherton, [1926]

A.C, 205:

M.N.R. v. The Kellogg Co. of Canada Ltd., [1948] S.C.R. 58;

[1943] C.T.C. 1;

M.N.R. v. Goldsmith Bros. Smelting & Refining Co. Ltd., [1954]

S.C.R. 55; [1954] C.T.C. 28;

Evans v. M.N.R., [1960] 8.C.R. 391; [1960] C.T.C. 69;

Premium Iron Ores Lid. v. M.N.R., [1966] S.C.R. 685; [1966]

C.T.C. 391;

British Columbia Electric Railway Co. Ltd. v. M.N.R., [1958]

S.C.R. 133; [1958] C.T.C. 21;

Southern v. Borax Consolidated, Lid., [1941] 1 K.B. 111;

Associated Portland Cement Manufacturers Ltd. v. C.I.R.,

[1946] 1 All E.R. 68;

Morgan v. Tate cfa Lyle Ltd., [1955] A.C. 21 ;

Ward & Co., Ltd. v. Commissioner of Taxes, [1923] A.C. 145;

IIallstroms Pty. Ltd. v. Federal Commissioner of Taxation

(1946), 72 C.L.R. 634;

Broken Hill Theatres Pty. Ltd. v. Federal Commissioner of

Taxation (1952), 85 C.L.R. 423.

D. McK. Brown, Q.C., H. H. Stikeman, Q.C., and D. M. M. Goldie, for the Appellant.

P. N. Thorsteinsson and D. G. H. Bowman, for the Respondent.

MARTLAND, J. (all concur) :—This is an appeal from a judgment of the Exchequer Court which decided that the appellant was not entitled, in computing, for the purposes of tax, its income for the years 1962 and 1963, to deduct certain litigation costs, or to deduct certain expenses incurred for communications to its shareholders. The amounts involved for litigation costs were $742,623.89 in the year 1962 and $414,199.81 in 1963. The expense for communications to shareholders was $6,020.31 in 1962 and $3,126.27 in 1963.

The appellant was incorporated under the Companies Act of Canada on May 19, 1928, and was empowered to own, control and manage companies and enterprises in the public utility field. It owned all of the issued common shares of British Columbia Electric Company Limited, hereinafter referred to as ‘‘the Electric Company’’, a public utility company incorporated under the Companies Act of British Columbia in 1926. The income of the appellant was mainly derived from dividends paid to it by the Electric Company.

With effect on August 1, 1961, the British Columbia Legislature enacted the Power Development Act, 1961. This statute, inter alia, provided that:

1. Each share, issued or unissued, of the capital stock of the Electric Company vested in Her Majesty the Queen, in right of the Province.

2. The term of office of each director of the Electric Company holding office when the Act came into force was terminated.

3. The Lieutenant-Governor in Council should appoint the directors of the Electric Company.

4. Holders of common shares of the Electric Company at the time the Act came into force were to receive as compensation for their shares $110,985,045.

5. Upon the request of the appellant, the Electric Company would purchase all the undertaking and property of the appellant at a price equivalent to $38 for each issued share of the appellant’s capital stock less the amount paid for the Electric Company shares, referred to in paragraph 4 above. This worked out at approximately $68,500,000 for assets worth about $11,000,000.

Directors of the Electric Company were subsequently appointed by the Lieutenant-Governor in Council, who took possession of the undertaking and who paid to the appellant the sum of $110,985,045.

On September 21, 1961, the appellant submitted for fiat a petition of right asking that full and complete compensation for the Electric Company shares be determined by the Court. This was refused by the Provincial Secretary.

On November 13, 1961, the appellant commenced an action against the Attorney-General of British Columbia, the Electric Company and others, and asked for a declaration that the Act was ultra vires of the British Columbia Legislature.

In December 1961, the appellant reduced its capital and paid to its shareholders $18.70 per share, in a total amount of $89,236,605.70.

On March 29, 1962, two further Acts were passed. The Power Development Act, 1961, Amendment Act, 1962, increased the compensation for the Electric Company shares to $171,833,052. It vacated the appellant’s option for the sale of its undertaking and property. The sum of $60,848,007 was thereafter paid to the appellant.

The British Columbia Hydro and Power Authority Act amalgamated the Electric Company and the British Columbia Power Commission under the name of British Columbia Hydro and Power Authority.

The appellant amended its pleadings to allege the invalidity of these two statutes.

The trial of the action commenced on May 1, 1962, and was completed on February 25, 1963. Chief Justice Lett delivered judgment on July 29, 1963, holding that all three statutes were ultra vires of the British Columbia Legislature. A considerable part of the 144-day trial was occupied with evidence as to the value of the Electric Company shares, and a value was determined in the judgment of $192,828,125.

On the day the judgment was delivered, the appellant informed the Premier of British Columbia, by telegram, that its principal concern was to obtain fair compensation. He replied on August 1, 1963, accepting the amount found due by the Chief Justice. By agreement a reference was made to the Chief Justice to determine what amount should be paid to the appellant for its shares in the Electric Company. He fixed a figure of $197,114,358 and the appellant, on September 27, 1963, sold those shares to Her Majesty in right of the Province of British Columbia, for that amount, crediting the two payments of $110,985,045 and $60,848,007 already received.

On November 1, 1963, the shareholders of the appellant resolved to wind up the company, and on November 6, 1963, an order was made appointing a liquidator.

The first issue on this appeal is as to whether the appellant, in the determination of its income tax, is legally entitled to deduct its outlays for the litigation costs. Its right to do so depends upon whether it can establish that such outlays fall within the exception to paragraph (a) and do not fall within paragraph

(b) of Section 12(1) of the Income Tax Act, R.S.C. 1952, c. 148, which provide:

12. (1) In computing income, no deduction shall be made in respect of

(a) an outlay or expense except to the extent that it was made or incurred by the taxpayer for the purpose of gaining or producing income from a property or business of the taxpayer,

(b) an outlay, loss or replacement of capital, a payment on account of capital or an allowance in respect of depreciation, obsolescence or depletion except as expressly permitted by this Part.

I have reached the conclusion that the outlays in question do fall within Section 12(1) (b) and for that reason are not deductible. This makes it unnecessary to determine whether or not, apart from Section 12(1) (b), they fall within the exception to Section 12(1) (a).

In my opinion this case is governed by the judgment of this Court in M .N .R. v. Dominion Natural Gas Company Limited, [1941] S.C.R. 19; [1940-41] C.T.C. 155.

The question in that case was as to whether Dominion Natural Gas Company Limited could properly deduct from its income legal expenses incurred by it for litigation, concerning its franchise rights in the City of Hamilton. The case ultimately reached the Privy Council (United Gas and Fuel Company of Hamilton, Limited v. Dominion Natural Gas Company Limited, [1934]

A.C. 435). In brief, in 1904, Dominion had been granted a franchise by the Township of Barton enabling it to lay its pipe lines and distribute gas in the township. In the same year, United Company had been granted a franchise from the City of Hamilton. Later, portions of the township became annexed to the City Of Hamilton. The United Company, which in 1931 had been granted an exclusive franchise in the city, sued Dominion for a declaration that Dominion was wrongfully maintaining its mains in the streets of the city, an injunction to restrain such use of the streets and the distribution of gas in Hamilton, and a mandatory injunction to compel the removal of its mains from such streets.

The position in which Dominion was then placed was that it faced a challenge to its legal right to continue the use of its mains and to distribute gas in the Hamilton area. It defended the action successfully, and incurred legal expense in so doing.

It was held in this Court that those expenses were not deductible for income tax purposes. Chief Justice Duff and Davis, J. held that they did not fall within the category of “disbursements or expenses wholly, exclusively and necessarily laid out or expended for the purpose of earning the income’’ within Section 6(a) of the Income War Tax Act, R.S.C. 1927, ce. 97, as they were not working expenses incurred in the process of earning ‘‘the income’’. They also held that the expense was a capital expense, incurred “once and for all” and for the purpose of procuring ‘‘the advantage of an enduring benefit’’ within the sense of the language of Lord Cave in British Insulated and Helsby Cables Ltd. v. Atherton, [1926] A.C. 205 at 213. That well-known statement is as follows:

But when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.

Kerwin, J. (as he then was) and Hudson, J., at p. 31, held that the legal costs were a “payment on account of capital” (quoting the words of Section 6(1) (b) of the Income War Tax Act) because “it was made (to use Viscount Cave’s words) with a view of preserving an asset or advantage for the enduring benefit of a trade”.

Crockett, J. held that the expenses were excluded under Section 6(1)(a).

Referring to this case, in his judgment in M.N.R. v. The Kellogg Company of Canada Limited, [1943] S.C.R. 58; [1943] C.T.C. 1, Chief Justice Duff, at pp. 60, 3, said:

It was held by this Court that the payment of these costs was not an expenditure “laid out as part of the process of profit earning” but was an expenditure made “with a view of preserving an asset or advantage for the enduring benefit of the trade” and, therefore, capital expenditure.

In the Kellogg case the taxpayer was held entitled to deduct the legal expenses there involved, which had been incurred in defending a suit brought for alleged infringement of a registered trade mark. Chief Justice Duff, at pp. 60, 3, in distinguishing that case from the Dominion case, said:

The right upon which the respondent relied was not a right of property, or an exclusive right of any description, but the right (in common with all other members of the public) to describe their goods in the manner in which they were describing them.

The Dominion case was distinguished in M.N.R. v. Goldsmith. Bros. Smelting & Refining Company Limited, [1954] S.C.R. 55; [1954] C.T.C. 28, in which the taxpayer was held to be entitled to deduct the legal expense involved in defending successfully a charge of participating in an illegal combine, on the basis that the Dominion case was concerned with money paid to preserve a capital asset.

The facts in Evans v. M.N.R., [1960] S.S.R. 391; [1960] C.T.C. 69, were distinguished from those in the Dominion case because the issue in relation to which legal expense had been incurred did not relate to an item of fixed capital, but to a right to receive income.

In Premium Iron Ores Ltd. v. M.N.R., [1966] S.C.R. 685; [1966] C.T.C. 391, the legal expenses had been incurred in resisting the claim of a foreign government to collect income tax. The preservation of a capital asset was not in issue.

The authority of the Dominion case is not weakened by subsequent alterations in the statute, in so far as it deals with the question as to what constitutes a payment on account of capital. The definition of what constitutes an allowable deduction under Section 12(1) (a) of the Income Tax Act is broader in its terms than that contained in Section 6(1) (a) of the Income War Taz Act, as was pointed out by Abbott, J. in British Columbia Electric Railway Company Limited v. M.N.R., [1958] S.C.R. 133 at 136; [1958] C.T.C. 21 at 29. However, there is no material difference between Section 12(1) (b) of the Income Tax Act and Section 6(1) (b) of the Income War Tax Act dealing with payments on account of capital.

The appellant’s submission was that the purpose of the action in which its costs were incurred was to test the validity of provincial legislation which, if valid, would have had the effect of divesting the appellant of its shares in the Electric Company. The action was not for the purpose of bringing into existence an asset or advantage of enduring benefit to the appellant or for the purpose of recovering a capital asset.

Reliance was placed on the decision of Lawrence, J. in Southern v. Borax Consolidated, Limited, [1941] 1 K.B. 111. In that case the taxpayer had incurred legal expense in resisting an action brought by the City of Los Angeles claiming the invalidity of its title to land in California on which its subsidiary had erected wharves and buildings. It claimed the right to deduct these expenses in computing its income tax, the issue being as to whether they were wholly and exclusively laid out for the purposes of the trade, within the provisions of the English Act.

Lawrence, J., holding that these expenses were properly deductible, said, at p. 120 :

It appears to me that the legal expenses which were incurred by the respondent company did not create any new asset at all, but were expenses which were incurred in the ordinary course of maintaining the assets of the company and the fact that it was maintaining the title and not the value of the company’s business does not, in my opinion, make it any different.

At p. 117 he had said :

The title of the company, which must be assumed in my opinion, to have been a good title, remains the same; there is nothing added to the title or taken away, and the title has simply been maintained by this payment.

This decision was cited with approval by Lord Greene, M.R. in Associated Portland Cement Manufacturers Ltd. v. C'.I.R., [1946] 1 All E.R. 68 at 72, where he said:

The money that you spend in defending your title to a capital asset, which is assailed unjustly, is obviously a revenue expenditure.

It may be noted, however, that this was not the issue actually before the Court in that case. What was actually decided was that payments made to two retiring directors, in order to prevent competition with the company’s business, were in the nature of capital expenditure and not deductible.

Favourable reference was also made to the case of Southern v. Borax in some of the judgments in the House of Lords in Morgan v. Tate & Lyle Lid., [1955] A.C. 21, in which the taxpayer was permitted to deduct from income the cost of a campaign to oppose the threatened nationalization of the sugar industry.

In that case the question of whether the expenses were of a capital nature was not raised, and so the only issue was as to whether, under rule 3(a), the expenses represented money “wholly and exclusively laid out or expended for the purposes of the trade’’.

This case may be contrasted with the earlier decision of the Privy Council in Ward & Company, Limited v. Commissioner of Taxes, [1923] A.C. 145, which decided that expenses incurred by a New Zealand brewery in distributing anti-prohibition literature prior to a poll of the electors upon the possible introduction of legislation prohibiting intoxicants, was not a deductible expense for income tax purposes. The relevant statutory provision in that case precluded deduction of expenditure ‘ not exclusively incurred in the production of the assessable income’’.

The Ward case was distinguished in Morgan v. Tate & Lyle Ltd., as it was by Kerwin, J. in the Dominion case because of the difference in wording between the New Zealand statute and the relevant provisions under the consideration in each of those cases.

The reasoning in Southern v. Borax was critically analyzed by Dixon, J. (as he then was) in his dissenting reasons in Hall- stroms Pty. Ltd. v. Federal Commissioner of Taxation (1946), 72 C.L.R. 634 at 650, when he said:

Upon the facts as they appear from the case stated set out in the report [1941] 1 K.B., at pp. 111-114; 23 Tax Cas., at pp. 597- 599, I do not think that this decision can be supported. The costs were incurred in order to retain a capital asset of the company employed in the business as fixed capital and to avoid the payment, in consequence of its loss, of a charge upon revenue of indefinite duration. Next to the outlay of purchase money and conveyancing expenses in acquiring the title to the land, it would be hard to find a form of expenditure in relation to property more characteristically of a capital nature.

The basis of the decision of Lawrence, J. may be seen from two passages in his judgment. In the first, his Lordship said: “In my opinion the principle which is to be deduced from the cases is that where a sum of money is laid out for the acquisition or the improvement of a fixed capital asset it is attributable to capital, but that if no alteration is made in the fixed capital asset by the payment, then it is properly attributable to revenue, being in substance a matter of maintenance, the maintenance of the capital structure or the capital assets of the company”, [1941] 1 K.B., at pp. 116, 117; 23 Tax Cas., at p. 602. The first or positive statement contained in this passage is open to no substantial objection, but the second, the converse and negative proposition that if no alteration is made in the capital asset by the payment it is a revenue expenditure, appears to me to have no foundation in principle or authority. No alteration in a fixed capital asset was effected by the outlay that was in question in what has become the leading case upon the subject (British Insulated and Helsby Cables Ltd. v. Atherton, [1926] A.C. 205; 10 Tax Cas. 155) and there was none, to take one or two examples only, in English Crown Spelter Co. Ltd. v. Baker (1908), 5 Tax Cas. 327; 99 L.T. 353; in Countess Warwick Steamship Co. Ltd. v. Ogg, [1924] 2 K.B. 292; 8 Tax Cas. 652; in Collins v. Joseph Adamson & Co., [1938] 1 K.B. 477 (at all events as to one of the two payments) and in Henderson v. Meade- King Robinson & Co. Ltd. (1938), 22 Tax Cas. 97, at p. 105. The New Zealand decision in Commissioner of Taxes v. Ballinger & Co. Ltd. (1903), 23 N.Z.L.R. 188 seems much in point and is quite opposed to the view of Lawrence, J.

The second passage in the judgment of Lawrence, J. reads thus:

“It appears to me that the legal expenses which were incurred by the respondent company did not create any new asset at all, but were expenses which were incurred in the ordinary course of maintaining the assets of the company and the fact that it was maintaining the title and not the value of the company’s business does not, in my opinion, make it any different. [1941] 1 K.B., at p. 120; 23 Tax Cas., at p. 605.”

It is possible to find in this statement two reasons not necessarily interdependent. One is the lack of any fresh acquisition of assets. That, in my view, does no more than put aside one possible state of facts in which the payment would have certainly been of a capital nature. The other is that the defence of the title against impeachment amounted to maintenance, the costs forming part of the business expenditure in the ordinary course upon maintaining the company’s assets. An analogy which suggests itself is the cost of restoring the front door of the business premises after an attempted entrance by bandits. No ground was disclosed in the case stated, as set out in the reports, and none exists in the known customs or propensities of Californian city authorities, for sup- posing that the company was exposed to regular or recurrent attacks upon the validity of its title. His Lordship probably did not doubt that the purpose of the litigation was to decide once and for all whether the taxpayer had or had not a valid title; but, as appears from the first of the foregoing passages cited from his judgment, his Lordship regarded outlays making no alteration in a fixed capital asset as amounting in substance to a matter of maintenance. I should have thought that the decided cases illustrated the fact that these are not exhaustive alternatives. A decision of the Canadian Supreme Court that is entirely at variance with the view of Lawrence, J. is the Minister of National Revenue v. Dominion Natural Gas Co. Ltd., [1941] S.C.R. (Can.) 19.

This view of Southern v. Borax was affirmed by the High Court of Australia in Broken Hill Theatres Proprietary Ltd. v. Federal Commissioner of Taxation (1952), 85 C.L.R. 425, where it is stated, at p. 434 :

We would add that we all think, as Dixon, J. thought in Hall- stroms’ case, that, on the facts as stated, the decision of Lawrence, J. in Southern v. Borax Consolidated cannot be supported.

It must be borne in mind that the only issue which had to be determined in Southern v. Borax was whether the expense there involved was wholly and exclusively laid out for the purposes of the trade, under the relevant English statutory provision somewhat equivalent to, but not identical with, our Section 12(1) (a). The existence in our Act of both paragraphs (a) and

(b) of Section 12 shows that Parliament contemplated that there might be expenses made for the purpose of gaining or producing income, which were of a capital nature, and which, under paragraph (a) taken alone, might be deducted, but, by virtue of paragraph (b), notwithstanding the fact that they so qualified under paragraph (a), could not be deducted. There was no equivalent to paragraph (b) under consideration in that case.

To the extent that Southern v. Borax is authority for the proposition that a legal expense which is incurred to protect from attack a taxpayer’s title to a capital asset is not a capital but a revenue expenditure, it cannot be reconciled with the decision of this Court in the Dominion case. Dominion’s gas franchise was a capital asset. The attempt by United to establish that such franchise was non-existent within the boundaries of the City of Hamilton was an attack upon its title to that asset. The attack was found to be unwarranted and Dominion’s franchise remained a valid franchise as it had always been. Nothing was added to or taken away from it as a result of the proceedings. But the proposition established by this Court was that legal expense incurred in order to preserve an existing capital asset was a payment on account of capital. A payment of that kind falls within Section 12(1) (b).

In the present case, the appellant was faced with legislation the effect of which was to vest title to the shares which it had owned, in the Crown, at a price fixed by the statute. These shares constituted the appellant’s principal capital asset. In the opinion of the appellant the compensation fixed was not adequate. In order to obtain what it considered to be a fair compensation (which the learned trial judge has found, on ample evidence, to have been the appellant’s primary purpose) it was necessary to seek to set the legislation aside. The action was brought and the legal expenses incurred in order to preserve the appellant’s title to the shares. Thereafter, the appellant was able to dispose of the shares to the Crown at a more favourable price. In essence, the main purpose and the result of the litigation was to improve the consideration received for the disposition of a capital asset.

In my opinion the principle established in the Dominion case must apply to the facts in the present case, and, consequently, the appeal on this point fails.

The second, and relatively minor item relates to the claim for deduction of the cost of communications to shareholders. The purpose of these letters was to inform shareholders, first, as to the situation which faced the appellant when the legislation was passed, and later, as to developments which had occurred from time to time.

The learned trial judge refused to allow a deduction in respect of these expenses, holding that they related to capital and not to earning income within Section 12(1) (a).

With respect, I am of the opinion that these expenses should be viewed differently from the legal expenses previously discussed. Those expenses represented payments to preserve a capital asset. The expenses now under discussion did not, and I do not regard them as falling within Section 12(1)(b). Are they properly deductible under Section 12(1) (a)?

The ultimate control in law of a limited company rests with its shareholders and it is they who have the legal power to determine its policy. This power cannot be properly exercised unless the shareholders are informed periodically with respect to the company’s affairs. A public company incorporated under the Companies Act, R.S.C. 1952, c. 53, is required, by Section 121, to furnish its shareholders with copies of its balance sheet, statement of income and expenditure and statement of surplus prior to its annual meeting.

In my opinion, the reasonable furnishing of information from time to time to shareholders by a company respecting its affairs is properly a part of the carrying on of the company’s business of earning income and a corporate taxpayer should be entitled to deduct the reasonable expense involved as an expense of doing business.

I am, therefore, of the opinion that this expense was properly deductible.

The appellant also urged that the judgment of the learned trial judge, which awarded to the respondent two-thirds of his taxed costs against the appellant and to the appellant one-third of its taxed costs against the respondent, should be varied by awarding to the appellant all its costs and by depriving the respondent of any costs. It was submitted that, as the appellant had succeeded in part at the trial, thus justifying its resort to the Court for relief, it should be entitled to all its costs.

In my opinion the matter of costs was at the discretion of the learned trial judge and the appellant has failed to establish that the discretion was not properly exercised according to law.

In the result, I would allow the appeal in part and refer the assessment in question back to the Minister of National Revenue for reconsideration and re-assessment in accordance with the reasons for judgment herein. As the appellant has failed in respect of the major part of its appeal, I would award costs of the appeal to this Court to the respondent.