Cullen, J.: — This is an appeal by way of an action pursuant to subsection 172(2) of the Income Tax Act, S.C. 1970-71-72, c. 63 as amended, from an income tax reassessment made by the Minister of National Revenue respecting the plaintiff’s 1973 taxation year.
In computing its 1973 income tax, the plaintiff corporation claimed an amount of $2,850,000 as a gift to the Manitoba Hydro-Electric Board as a “donation to the Crown” pursuant to paragraph 110(1)(b) of the Income Tax Act. This deduction was disallowed by the Minister who reassessed the plaintiffs income for the 1973 taxation year by including in the plaintiffs income for tax purposes the amount of $2,850,000 which had been deducted by the plaintiff as a gift to the Crown in the right of the Province of Manitoba. In addition, the Minister assessed a penalty of $279,136.13 pursuant to subsection 163(2) of the Act.
The main issue here is whether or not the amount of $2,850,000 represents a gift to the Crown. There is a secondary issue, i.e. the penalty, whose disposition is dependant upon the disposition of the primary issue.
The facts of this case are quite straightforward, with much that occurred written down either in letters, minutes of meetings or memos to file. The characterization of what occurred is the enigma here. In May of 1973 (Exhibit P203), Manitoba Hydro and the plaintiff signed a letter of intent which provided inter alia that Manitoba Hydro would acquire from Churchill River Power Co. Ltd. (a wholly-owned subsidiary of the plaintiff) all the outstanding shares of Northern Manitoba Power Co. Ltd. (a wholly-owned subsidiary of Churchill River Power Co. Ltd.) together with the total indebtedness of Northern Manitoba to Churchill for the price of $3,375,000 and that Manitoba Hydro would acquire from Northern Power Ltd. (a wholly-owned subsidiary of Northern Manitoba Power Co. Ltd.) all of its electric distribution facilities located in Saskatchewan for the price of $225,000. The letter of intent also contained the provision that the plaintiff would make a non-refundable gift to Manitoba Hydro in the amount of $2,850,000.
That, indeed, is the very subject of the dispute between the parties in this case.
On behalf of the plaintiff, it is contended that the donation of $2,850,000 by the plaintiff to Manitoba Hydro on September 28, 1973 was a gift to Her Majesty in the right of the Province of Manitoba and consequently deducti- ble by the plaintiff under paragraph 110(1)(b) of the Income Tax Act. It is asserted that the donation was voluntary, made freely and was without consideration. There were, in the plaintiffs words, no restrictions on the use which Manitoba Hydro could make of the funds. It was categorized by counsel for the plaintiff as two separate albeit related transactions where Manitoba Hydro agreed to pay $3.6 million for the shares and assets and Hudbay agreed to give back a non-refundable gift of $2.85 million.
On behalf of the defendant, it is pleaded that the payment by the plaintiff of $2.85 million was not in the nature of a gift, but rather was part of the consideration paid by the plaintiff for the payment to Churchill by Manitoba Hydro of $3.6 million.
What is clear is that Manitoba Hydro in the end only disbursed $750,000 for the shares and assets of Northern Manitoba. True, it paid $3.6 million to Churchill but received $2.85 million from the plaintiff which amounted to a net disbursement of $750,000. Is this transaction involving three entities indicative of a scheme to reduce “artificially” the plaintiff's income? Obviously, where something is given in return for some benefit or advantage it is not a true gift.
In Bert Kay Litchfield v. M.N.R., 7 Tax A.B.C. 196 at 198, it was held that:
For there to be a gift, there must be a transfer of property, there must be a donor who gives something gratuitously and there must be a donee who received the property given.
[Emphasis is mine.]
Background
The first paragraph of the statement of claim, the facts of which are agreed to by the defendant, reads as follows:
The Plaintiff (herein called “Hudbay”) is a corporation incorporated under the laws of Canada and in 1973 inter alia operated a mining complex in the Flin Flon area, in the Provinces of Manitoba and Saskatchewan. In 1973, Churchill River Power Company Limited (herein called “Churchill”), a corporation incorporated under the laws of Canada, was a wholly owned subsidiary of Hudbay and supplied power generated from its power plant at Island Falls on the Churchill River in Saskatchewan to the Hudbay mining operations. In 1973, Northern Manitoba Power Company Limited (herein called “Northern Manitoba’’), a corporation incorporated under the laws of Manitoba, was a wholly owned subsidiary of Churchill and purchased power from Churchill for distribution to residents of the communities of Flin Flon and Snow Lake in Manitoba. Prior to September 30, 1973 Northern Power Limited (herein called “Northern”), a corporation incorporated under the laws of Saskatchewan, was a wholly owned subsidiary of Northern Manitoba and purchased power from Northern Manitoba for distribution to the residents of Flin Flon in Saskatchewan and to the communities of Creighton and Denare Beach also in Saskatchewan. The electrical transmission and distribution systems operated by Hudbay and its subsidiaries are hereinafter called “the Hudbay System.”
Hudbay, through its subsidiary, Churchill, held a licence from the Saskatchewan government to generate power in Saskatchewan at Island Falls which are fed by water from Reindeer Lake. The licence had been in existence since 1931 and was to expire in 1981. Hudbay had constructed generating facilities at Island Falls which had the capability of generating 96 megawatts of power.
The electricity generated at Island Falls was transmitted by a steel tower double transmission line southeasterly to a point in Saskatchewan near the Manitoba-Saskatchewan border where another single transmission line supported by wooden poles interconnected with the main line and extended easterly to the community of Snow Lake in Manitoba and beyond. The main line continued to Flin Flon. The capacity of the main line was about 104 megawatts. The capacity of the line to Snow Lake was 20 megawatts. Subsequently after interconnection with the Manitoba Hydro system, the capacity became 48 megawatts.
The electricity generated at Island Falls was used by Hudbay to supply power to its mine sites in both the Flin Flon and Snow Lake areas, its smelter in Flin Flon, its zinc plant in Flin Flon and other plant facilities. It also was used to supply electricity for sale for domestic purposes to residents of, inter alia, the towns of Flin Flon and Snow Lake which were basically communities comprised of employees of Hudbay. The power used by Flin Flon in 1973 at peak was about seven and one-half megawatts and by Snow Lake about one megawatt. The power consumed by Hudbay in its own operations was in excess of 80 megawatts at peak.
The generating station and the power generated at Island Falls and the double transmission line to Flin Flon were owned by Churchill. The transmission line to Snow Lake was owned by Hudbay. The distribution systems in the Manitoba part of Flin Flon and in Snow Lake were owned by Northern Manitoba Power. Northern Power owned the distribution systems which supplied power generated at Island Falls to certain communities in Saskatchewan including an area known as the boundary area which was that portion of Flin Flon located in Saskatchewan. Northern Manitoba Power and Northern Power purchased power from Churchill for resale to their residential customers.
The Hudbay system was an isolated system because it was not connected with either the system of Manitoba Hydro or the system of Saskatchewan Power which served most of the power consumed in the provinces of Manitoba and Saskatchewan.
Through the use of steam turbines, Hudbay could generate seven more megawatts, and by 1973 Hudbay had developed a plan to instal a 15 megawatt steam turbine. Hudbay also had to obtain an oil-fired boiler to supplement the steam from the smelter to drive this turbine which eventually gave the Hudbay system a total generating capacity of 117 megawatts. With the exception of an operation in Winnipeg, Hudbay was the only private electric utility company operating in Manitoba.
It can be said that the generation and sale of power to the residents was really incidental to Hudbay's main business — a mining and metallurgical operation. The residents were primarily employees of Hudbay, and these residents had power supplied to them at very low rates because the cost of producing power at Island Falls was 0.2¢ per KWH as compared with Manitoba Hydro's cost of 0.5¢ in 1973. Although incidental to its mining operation, the Hudbay system made on average before taxes a profit of approximately $460,000. In 1973 we are told that figure was $540,000.
Despite some concerns in late 1968 and early 1969 about low water levels due to reduced precipitation, and also concerns about its single wooden pole transmission line which led to earlier negotiations with Hydro, it’s fair to say the evidence of the plaintiff's witnesses indicated the Hudbay system was able to generate sufficient electric power to meet its requirements and the requirements of residents both private and commercial. If any difficulty arose, Hudbay had “considerable flexibility because of large consumption of electricity by its zinc plant.”
Why Any Deal?
On the face of it, one might wonder why Hudbay would wish to sell its electric power system given that the average annual profit of the Hudbay system was $400,000 ($540,000 in 1973), and an ability to supply all the power needed for its operations and that of the residents. And why would Manitoba Hydro wish to buy when it could foresee the day, i.e. 1981, when Hudbay's franchise would probably end and electric power in Saskatchewan would be generated by the system of Saskatchewan Power? The Snow Lake agreement provided that it could be acquired through a 12-months notice to Hudbay.
The first set of negotiations resulted from Hudbay’s concern that small amounts of precipitation had lowered lake levels in Reindeer Lake, thereby limiting the amount of power that could be generated at Island Falls and therefore the need for standby power. However, over the time frame of these negotiations water levels rose, sufficient power could be generated and the need for standby power abated, although still a plus if available. When Hudbay made its "offer" to Manitoba Hydro the figure was clearly set very high to discourage any possibility of acceptance and it had its desired effect. Later negotiations on the part of Hudbay came about as a result of political pressure from the mayor and council in Flin Flon and an MLA who felt the "system" should be sold to Manitoba Hydro so his constituents would have the same access to electrical power as others in the province. Mr. McKenzie, a senior management official, also stressed in evidence that Hudbay did not want to be in the public utility business.
For its part, Manitoba Hydro wanted to supply all electric power in Manitoba to fulfil its mandate, and here again the reason for the immediacy of its preparedness to negotiate was political pressure.
It is clear on the facts that we have two corporations, dealing at arm's length endeavouring to find common ground to facilitate a contract of sale. There is no question that they were acting independently and had individual priorities and concerns. There is almost a textbook beginning with an overpriced offer to sell and an underpriced offer to purchase, wherein both sides were testing the waters about the possibilities of a sale. We heard evidence that the high offer was made to discourage the sale after concern about lake levels no longer existed. Also the construction by Manitoba Hydro at its own cost of the Ponton-Stall Lake line in 1970-71 really gave Hudbay the standby power it wanted. Although not interconnected, and no agreement at that time to do so, Hudbay felt that in an emergency a public utility could hardly refuse power and a connection was a comparatively easy task. One witness for Hudbay, I believe Mr. McKenzie, indicated they were winners all round because they had standby power at no cost to them, installed in the region they had hoped for and lake levels were rising enabling maximum generating capacity at Island Falls.
This happy state of affairs, however, did not obviate the necessity of dealing with political pressure, and of course Hudbay's wish to get out of the public utility business.
Although independent in their dealings, the parties were not free to do exactly as they pleased. Manitoba Hydro had embarked on a monumental capital construction program and “could not” go above $750,000 whatever their views on the value of the assets they wanted to acquire. Hudbay faced different problems, namely: the franchise from Saskatchewan would end in 1981 and probably not be renewed; the contract at Snow Lake could be terminated on twelve months’ notice by Manitoba Hydro; the company’s wish not to be in the utility business, and not to have to deal with the ever-present political problems it entailed.
Some reference was made about the authority vested in Manitoba Hydro to expropriate. Both parties conceded it was there but neither really seems to have given it much thought. For Manitoba Hydro it was a last resort, and Mr. Arnasson was quite clear that it had never been used as a lever, and doubted it had any bearing on the negotiations. He was satisfied they would find an agreement as reasonable people. Hudbay concedes they were never threatened with expropriation and really saw that route as bad public relations for both sides. Counsel for the plaintiff suggested Hudbay could get its price from expropriation which in my view is highly speculative. If they really believed that, why not back off from negotiation and wait? Also, Manitoba Hydro was not in a position where it had to expropriate, and could point out it had already embarked on a $62 million capital expansion in Manitoba, that they had a limited amount of money available and would prefer to wait until 1980 when one year’s notice could be given re Snow Lake, and when quite probably Hudbay's franchise from the Saskatchewan government would end, making that period a better time to consider expropriation. I am satisfied that Manitoba Hydro's power to expropriate played no significant role in the negotiations.
One further fact should be noted here. Hudbay had made it quite clear that it would not supply electric power to the residents of Flin Flon for heating purposes, seeing it as an economic waste of cheap power which could be more productively used in its mining and metallurgical operations. In fact it was buying concentrates for its zinc plant and could make a profit because of the cheap power. The mayor and council wanted its residents to have this right to use electric power for heating, and I gather the MLA wanted the residents of his constituency to have it too.
Negotiations
The following negotiations lead to no other interpretation that the fact that we have one deal and not two deals albeit related.
At the outset, Hudbay wanted to sell for the reasons given, which reasons later abated, but it was clearly prepared to sell the Hudbay system. The reasons for approaching Manitoba Hydro having faded, we have (after a series of meetings and exchanges of letters which made no mention of price, (Exhibit D93)), Mr. Arnasson's comments to file indicating, "after considerable discussion we received a copy of a brief statement prepared based on the principles contained in their letter which indicated their evaluation of the distribution system at Flin Flon and Snow Lake to be $4,248,565 ... We immediately indicated to them that their proposal was completely unacceptable as revenues in no way would support this kind of expenditure." One witness, I believe Mr. McKenzie, said, "we were highballing it" and Mr. Arnasson said the offer was received with "shock and disbelief."
A counter offer of $250,000 left no room for doubt that negotiations were at an end, but clearly from the outset it was intended as one transaction — a sale to Manitoba Hydro. In this early negotiation Mr. Arnasson on March 14, 1972 (Exhibit P113) set forth the position of Manitoba Hydro upon which they "would be agreeable to consummate an agreement", and this formed the basis for later negotiation.
On August 22, 1972 a meeting was held between the Mayor and his councillors plus two representatives of Hudbay. A report was made on the breakdown of negotiations. Despite comments in Exhibit P151, Mr. McKenzie in evidence said they could have supplied power for heat but didn't want to.
On January 9, 1972 a meeting was held in Toronto between officials for Hudbay and Manitoba Hydro, which had been initiated by Mr. Morrice, president of Hudbay, and Mr. Bateman, president of Manitoba Hydro, to reopen negotiations. Positions were established, and it was agreed “to start with five conditions to which both parties had previously agreed". See Exhibit P102 (and Exhibit P113 for conditions). Thus, we have a continuation of the first attempt to deal.
It still boiled down to a matter of price. A committee of two was appointed “to negotiate the price to be paid by Manitoba Hydro". Mr. Dalton, treasurer of Hudbay, and Mr. Arnasson, assistant general manager, operations, were named. On January 16, 1973 Mr. Arnasson wrote to Mr. Dalton setting forth objectives, namely, five conditions plus two — one providing for Manitoba Hydro to purchase a block of power for a limited period of time and the other an agreement to assist each other with a supply of standby power for emergencies and the interconnection was essential and beneficial to both. Mr. Dalton’s position was if Hudbay sold they got an intertie but it was not the real reason for the sale; however, they were clearly aware of the advantage.
The meeting between Mr. Dalton and Mr. Arnasson indicates they were getting closer to a deal. Manitoba Hydro provided four formulas, sample calculations for cash flow purposes and an approximate $1.5 million increasing to $1.68 million if item 4 included (Exhibit D109). In Mr. Arnasson's memo re. meeting February 19,1973 (Exhibit D109) we have the first expression by Hudbay to Manitoba Hydro of their concern “with respect to the cash flow situation as they are in a 50% tax bracket for his kind of transaction" (emphasis is mine). Later, “Mr. Dalton indicated his present position was a total cash flow of $2.5 million whereas I [Mr. Arnasson] indicated my position was $1.5 million. Although he suggested a $2 million figure, I indicated that the maximum that I would intend to attempt to sell to the Executive Committee or to the Board would be $1.75 million.”
It was clear to Hudbay from this meeting that Manitoba Hydro would not supply power to Hudbay for distribution to Hudbay’s customers.
Although Manitoba Hydro were prepared for a cash flow of $1.5 million, it would be, as indicated earlier, their intention to sell to the United States at a profit and remained adamant about and never deviated from the $750,000 figure. As counsel for the defendant argued, “To Arnasson these were separate components."
In Exhibit P184 Mr. Arnasson writes to Mr. Dalton an offer arising out of their February 19, 1973 meeting. Part A is the offer of $750,000 for the purchase of the distribution systems at Flin Flon and Snow Lake. The other “component" provides for $1,008,500 payable over a five-year period for the purchase of firm capacity, standby power and wheeling charges according to “the following cash flow" which cash flow is spelled out. Mr. Dalton did not like the second component because it was all “taxable", and after taxes by his calculation worth less than $1 million. These negotiations clearly show that Manitoba Hydro was aware the system they were purchasing was worth more than $750,000 but they could not go above that price. To reach a fair price they were prepared to accommodate Hudbay with a purchase of power they really didn't need but would sell as surplus.
The two gentlemen met on March 23, 1973, where Manitoba Hydro was advised that the submission did not solve their tax problem, and an alternative was offered by Mr. Dalton (See Exhibit D113):
... retain $750,000 net cost distribution
(A) This figure be expanded as an all inclusive figure with non refundable contribution by Hudbay to net $750,000.
[Emphasis is mine.]
Here we have Hudbay endeavouring to get Manitoba Hydro to accommodate them in a different way. This alternative envisaged Manitoba Hydro making a total payment of $4 million during 1973 and Hudbay making a non-refundable contribution in January 1974 of $3.25 million. There then followed discussions about what the contribution would cover, the benefit to Hudbay through contribution being tax deductible of approximately $1,625,000 and net figure of $750,000 for a total of $2,375,000. Can this really be said to be giving something gratuitously?
This meeting clearly indicates the benefit to Hudbay, albeit the numbers were later changed when an agreement was reached. Mr. Arnasson echoed the sentiments for Manitoba Hydro that they could call it what they wanted but $750,000 was the net out figure. The letter from Mr. Dalton and his write up proposal (Exhibit P192) leave very little room for doubt that we have one and one only transaction here. $750,000 is the linchpin and whatever “price" is arrived at it must net out to $750,000.
In Exhibit P193 we have a letter of April 13, 1973 to Mr. Arnasson from Mr. Dalton which he hopes will serve as the basis for a letter of intent, and attached is “pertinent points for inclusion in letter of intent” whereby item 6 deals with “non-refundable gift", and what construction the money is to be applied to. There was therefore a suggestion of a form of restriction about the manner in which the money should be used so that at the outset, the money paid could hardly be said to be totally free of any restrictions. In the final analysis the $2.85 million was not applied as suggested for construction but to purchase the shares involved in the deal. Manitoba Hydro was certainly free to choose but the deal only went through if documents included a reference to a non-refundable gift.
Finally, Exhibit P203 is the letter of intent from Mr. Dalton to Mr. Arnasson dated May 2, 1973 and signed by the two gentlemen. Paragraph 7 provides for the non-refundable gift of $2.85 million, and again “towards the cost of electrical facilities provided or to be provided by Manitoba Hydro related to the distribution of electric power in the City of Flin Flon and the Local Government District of Snow Lake".
Mr. Arnasson, in evidence, speaking about Exhibit P203, said they were not prepared to pay $3.6 million, would only pay $750,000 and would not tender a cheque for $3.6 million unless a cheque for $2.85 million was paid back immediately and not at some date in the future. Mr. Arnasson also makes the point that they never requested a contribution. If no $2.85 million paid then no $3.6 million cheque. It is really like the boy scout trying to help the lady across the street who doesn't want to go.
Why would Manitoba Hydro be concerned with the value of the assets at all, once convinced that they were only going to pay $750,000 and the value was Clearly in excess of that figure — which they acknowledged in one of their offers to pay $1.5 million over five years for power? Once Mr. Dalton raised the question of concern about a 50 per cent tax bracket, and the possibility of Manitoba Hydro agreeing to accept a non-refundable gift, Manitoba Hydro did not want to participate in anything immoral or illegal. The price had to be approximately correct on the question of morality and the legal and auditing opinion must have satisfied Manitoba Hydro that it was legal. Suppose, as an example, Hudbay wanted to donate a painting of Hudbay’s facilities to Manitoba Hydro. Manitoba Hydro, knowing it was a gift, would also need an indication that the price or value of the painting approximated the figure Hudbay said it was worth. The concern about value, therefore, had to do with Manitoba Hydro's concern about legality and morality, and not about a second deal/transaction.
The Premier's press release in Exhibit P209 mentions only the $750,000 which he stated was $1.25 million less than was at first requested, and about $500,000 more than first offered. This Premier's news conference makes the point, "I would also like to announce that jointly — in fact with the President of Hudson Bay Mining and Smelting — agreement has been reached in principle for purchase by Manitoba Hydro of the Hudson Bay Mining and Smelting Company's hydro electric facilities in Flin Flon and Snow Lake.”
If Hudbay really felt they had made a “gift” to Manitoba Hydro, and did so to benefit its employees, residents and customers — wasn't this the place to announce it as an excellent public relations gesture? But they were silent then and, I suspect, silent always about this gift. I daresay the good citizens, the Mayor, the councillors, nor for that matter anyone, were told about a so-called gift to Manitoba Hydro. Only Hudbay officials, Manitoba Hydro officials and ultimately the tax department ever really had any information on the $2.85 million. We had no evidence of any public announcement by Hudbay of this "gift", I suspect because there was in fact no announcement.
In Exhibit P247 Mr. Carpenter, vice-president, secretary and general counsel of Hudbay, writing to Mr. Purdy Crawford, partner of the law firm of Osler, Hoskin & Harcourt, writes: “It was thought better to handle these items separately so as to give them the appearance at least of being independent transactions." (Emphasis is mine.)
It is quite clear that all of these negotiations can be characterized as one deal, one transaction with no "gift" pursuant to paragraph 110(1)(b) of the Act, and so this portion of the appeal is dismissed with costs.
With the penalty, I have considerable difficulty in acceding to the defendant's position. Here is a reputable firm given an opinion by its auditors and a legal opinion from its outside counsel that it is possible to give a non-refundable gift to a provincial Crown corporation and that the circumstances in this instance warrant such an interpretation. Further, no attempt was made to hide it from the Minister of National Revenue. The “gift” is found in the income tax return, and the tax benefit is claimed. There is no obligation to seek a tax ruling from the Department and failure to do so is hardly an attempt to hide the matter. The Manitoba Hydro Board made it clear they would not proceed if the transaction was immoral or illegal. The Board didn't care what Hudbay called it — their only interest was $750,000 but I expect they were satisfied that it was all right to proceed in this way due to reasons given by Mr. Dalton, the Treasurer.
Whether a gift or partial consideration, is really a legal characterization to be determined by the Court. As counsel for the plaintiff put it, “The Ministry would have a distinct advantage if he could levy a penalty everytime it disagrees with a taxpayer?' Each case must be looked at carefully to determine if there is an omission or a false statement upon which to base a penalty. That is not the case here.
Something more than mere disagreement must be determined: a false statement by a taxpayer, as an example, or gross negligence, or a finding by the tax department that an error was made deliberately. I do not believe there is the criminal onus of proving beyond a reasonable doubt, however. One cannot fault the plaintiff for putting the best possible light on the situation, including the suggested two deals, as long as the main feature is not hidden. I cannot find gross negligence here, or any attempt to bury information from the prying look of the Ministry. Even on a “balance of probabilities" burden, the defendant's case fails.
The appeal with respect to the imposition of a penalty is allowed with costs to the plaintiff.
Appeal allowed in part.