Hamilton v. The Queen, 97 DTC 787, [1997] 1 CTC 2446 (TCC)

McArthur J.T.C.C.: - These appeals are from reassessments for the Appellant’s 1987, 1988 and 1989 taxation years. The issue is the deductibility of $32,312.00 paid in each of the two years 1987 and 1988 by the Appellant to the Province of British Columbia to renew the coal licence fee of Norco Resources Ltd. (Norco) a public Company. This Court is asked to determine in what manner, if any, Alvin Hamilton may deduct these expenses. Counsel for the Appellant submitted that the expenditure could be classified as:

..expenses that Alvin Hamilton may deduct through the flow-through share provision of the Act or as Canadian exploration or development expenses; capital losses as claimed by Revenue Canada; allowable business investment losses; or ordinary business losses.

The Appellant was represented by his Power of Attorney and son William Hamilton.

Mr. Alvin Hamilton is now 84 years of age. He suffers from significant short-term memory loss. His capacity to make decisions, respond to questions and deal with his business affairs are markedly restricted. Evidence was presented by his son William and long time friend David Robertson Sinclair.

William Hamilton had personal knowledge of Norco, having personally bought and sold shares of the Company, adopting his father’s interest in the Company. During the six month period prior to trial he obtained further information about Norco upon reviewing the Appellant’s considerable business records.

Mr. Sinclair is a highly knowledgeable and impressive witness. He is a retired British Columbia chartered account and presently, amongst other activities, is a member of the Board of Directors of Cominco Mining Corporation. He shared investment interests with the Appellant over a period of 30 years and was well acquainted with Norco and the Appellant’s interests in that Company and other Mining ventures. He did not do the Appellant’s accounting requirements and he was not personally involved in Norco.

The following is an attempt to summarize my findings of relevant facts.

Having retired from a distinguished career in Federal Politics, the Appellant devoted his skills to the private business world. He developed a keen interest in developing the natural resources in Western Canada. His interest appeared to be both philosophical and practical. Prior to Norco he actively and profitably participated in similar ventures. He had used his ingenuity, connections and enthusiasm to form syndicates and raise necessary capital.

The Appellant invested in Norco during the 1980s. It had proven coal reserves in Northern British Columbia. Although several million dollars were expended on exploration, it never went into production and the company was dissolved in 1990. What interested the Appellant primarily, was Norco’s amber resin deposits. He saw these as potentially valuable for use as synthetic high temperature plastic. He personally pursued the possibilities for the use of Norco’s amber resins. He was advised in a letter to him in 1987 from the Ford Motor Company U.S.A., that the amber resin had good potential for application for automotive parts.

Experiencing financial difficulties, Norco became inactive in 1986. Convinced that the exploitation of Norco’s amber resins could be highly profitable, the Appellant paid Norco’s annual coal licence fee in 1987 and 1988. These licences were issued to Norco. In 1989, the Appellant attempted to have the licences issued to him personally, but this was refused. The licences granted to Norco, “... the right to do exploratory and development work of every kind for all coal in the location ... described...”. In 1990 Norco was struck off the Register of Companies in British Columbia presumably for its failure to file requisite annual returns.

Filed as one of a number of documents making up A-10 is the following letter:

December 18, 1987

Mr. David Manning, President,

Norco Resources Ltd.,

9807 - 196 A Street,

Langley, B.C. V3A 4P8.

Dear Dave:

I have just issued a cheque to Minister of Energy and Petroleum Licenses for the sum of $33,312.00 dollars for payment of license fees for Norco Resources Ltd. It had to be paid before December 31st, 1987. It was a cheque from Richardson- Greenshields charged to my account.

I request that you acknowledge this investment in Norco in 1987 for the purpose of exploration and\or development of the natural resins in the Norco claims before February 1988 so I can use the Section 66 of the Income Tax Return.

It is understood that I will receive “flow-thru” shares at the price per share decided by the Directors.

Witness: SIGNED:

Marilyn H. Riley: Alvin Hamilton

Position of the Appellant

The payments made by the Appellant were properly deductible through the flow-through share provisions contained in subsections 66(12.6) and 66(12.62) of the Income Tax Act (the “Act”).

He also made four alternative submissions. The first was that to the extent that the flow-through share deduction is not allowed, the payments will qualify as Canadian Development Expense (CDE) which are properly deductible pursuant to subsection 66(3) of the Act. Secondly, to the extent that the flow-through share deduction is not allowed, the payments will qualify as a Canadian Exploration Expense (CEE) which are also properly deductible pursuant to subsection 66(3) of the Act. Thirdly, the payments are properly deductible as allowable business investment losses pursuant to paragraph 39(1)(c) of the Act. Finally, the payments are properly deductible pursuant to sections 9 and 18(l)(a) of the Act as ordinary business losses.

Position of the Respondent

The payments made by the Appellant were properly deductible as capital losses pursuant to paragraph 38(1 )(b) of the Act and that the payments were not deductible under those sections of the Act presented by the Appellant.

Analysis

I will attempt to deal with the Appellant’s arguments in the order submitted.

(1) Flow-through shares

To encourage investment in mining exploration in Canada, the Act permits an investor taxable deductions that are not otherwise permitted. This is done through complex interconnection subsections of section 66 of the Act.

The term flow-through shares is used to describe shares acquired by a taxpayer pursuant to an agreement with a corporation, whereby the corporation agrees to incur CEE and/or CDE in an amount equal to the consideration given by the taxpayer for the shares and to “renounce” the expenses in favour of the taxpayer. The relevant exploration and/or development expenses are considered, for income tax purposes, to be CEE and CDE of the taxpayer and not of the corporation. The consideration given by the Appellant for the flow-through shares was the payment of $32,312 paid on behalf of Norco for the renewal of coal licences, with the Province of British Columbia during each of the 1987 and 1988 taxation years.

In order to qualify as a “flow-through shares” and for the tax treatment applicable to such shares, all shares issued pursuant to an agreement must meet the definition of flow-through shares as provided for in paragraph 66(15)(d.l) of the Act.

In order for a taxpayer to obtain the “flow-through” of CEE and/or CDE all of the applicable requirements of subsections 66(12.6) to 66(12.73) must also be observed, which is in addition to the requirements contained in paragraph 66(15)(d. 1). The renunciation provisions for flowthrough shares deal separately with CDE and CEE. Subsections 66(12.6) and 66(12.61) outline the provisions whereby a principal-business corporation will be allowed to renounce CEE that it incurs to a taxpayer who has acquired flow-through shares of the corporation. Subsections 66(12.62) and 66(12.63) outline the provisions whereby a principal-business corporation will be allowed to renounce CDE that it incurs to a taxpayer who has acquired flow-through shares of the corporation.

In order to implement the renunciation provisions, certain filing requirements must be met. Firstly, under subsection 66(12.68) a corporation which enters into an agreement to issue flow-through shares or that prepares a selling instrument [1] must file a prescribed form (Form T100) with Revenue Canada together with a copy of the agreement. The form must be filed by the end of the month following the earlier of the month in which the agreement to issue the shares is entered into and the month in which the selling instrument is first delivered to a potential investor. Upon receipt of Form T100, an identification number will be assigned by the Minister with respect to the offering of flow-through shares and the corporation will be notified of this number.

I agree with counsel for the Respondent that the Appellant is not entitled to the benefits provided by the renunciation of expenses via the flow-through shares mechanism, because the various filing requirements were not observed. The factual evidence or lack thereof supports this position. The filing requirements provided in the Act are conditions precedent to the availability of the flow-through share mechanism. Unfortunately for the Appellant these filing requirements were not completed and the Appellant’s first argument fails.

(2) CDE and CEE Preliminary Comments

The deduction of mining related expenses vary according to the nature of the expense and when it was incurred. Prior to May 7, 1974 expenses were classified as “Canadian Exploration and Development Expenses (CEDE). Similar expenses incurred after May 6, 1974 were defined as CEE and CDE in subsection 66.1(6) and 66.2(5).

While not determinative of the merits of his submissions, I disagree with the Appellant’s position that a properly qualified CEE or CDE is deductible pursuant to subsection 66(3) of the Act. Subsection 66(3) allows taxpayers who do not meet the principal-business test to deduct an amount in respect of their CEDE in computing income. By reason of the definition of CEDE contained in subsection 66(15), only expenses incurred after 1971 and before May 7, 1974 are deductible under subsection 66(3). Since the Appellant made the payments during the 1987 and 1988 taxation years, subsection 66(3) is of no application. If the payments are properly classified as either a CEE or CDE, their deductibility will have to be pursuant to some other provision in the Act. A taxpayer’s right to a deduction is contained in subsection 66.2(2) for a CDE or 66.1(3) for a CEE of the Act and not in subsection 66(3).

The definitions of a CDE and a CEE are important provisions relating to the taxation of the mining industry. However, a CDE or a CEE are not in themselves deductible. The amount of the CDE is added to the taxpayer’s cumulative Canadian development expense (CCDE) account which is defined in paragraph 66.2(5)(b) of the Act. Conversely, the amount of the CEE is added to the taxpayer’s cumulative Canadian exploration expense (CCEE) account which is defined in paragraph 66.1(6)(b) of the Act. The concept of cumulative expense pools requires in effect, that a taxpayer net his CDE or CEE against various amounts in the general nature of recoveries of such expenses. The pool of CCDE and the pool of CCEE are examined at each year end and depending on whether the balance is negative or positive, the taxpayer is entitled to a deduction in computing income or must include an amount in income.

(a) CDE

The Appellant’s first alternative submission was, that to the extent that a flow-through share deduction is not allowed, the payments will qualify as a CDE and are properly deductible pursuant to section 66(3) of the Act. In order to determine whether the payments qualify as a CDE it is necessary to refer to definitions in paragraph 66.2(5)(a).

In that paragraph CDE are basically grouped into two general categories: post-production development costs and the costs of acquiring and maintaining an interest in a mineral property.

Counsel for the Appellant submitted that the licence payments are properly classified as a CDE under subparagraph 66.2(5)(a)(ii) or 66.2(5)(a)(iii). The subject payments are not properly classified as a CDE under subparagraph 66.2(5)(a)(ii) which deals only with post- production development costs incurred between May 6, 1974 and November 17, 1978. Since the payments were made in the 1987 and 1988 taxation years, subparagraph (ii) is not applicable.

Subparagraph 66.2(5)(a)(iii) deals with the costs of acquiring and maintaining an interest in a mineral property and more specifically a “Canadian resource property”. A Canadian resource property is defined in paragraph 66(15)(c) of the Act as

(ii) any right, licence or privilege to

(B) prospect, explore, drill or mine for minerals in a mineral resource in Canada,

By subsection 248(1) a “mineral resource” is defined to include a coal deposit. The Appellant’s annual payments made for the renewal of coal licences fall within the definition of subparagraph 66.2(5)(a)(iii). Unfortunately for the Appellant, this in itself is not determinative of whether the coal licence payments are properly “deductible” as CDE. Subparagraph (iii) contains a limitation by reference to paragraph 18(l)(m) of the Act.

For the purpose of this decision paragraph 18(l)(m) may be paraphrased as follows: No deduction shall be made for any amount paid to a province that may reasonably be regarded as a lease rental or an amount in lieu thereof in relation to development or ownership of a Canadian resource property.

The Federal Court of Appeal in Gulf Canada Ltd. v. R., (sub nom. Gulf Canada Ltd. v. The Queen) [1992] 1 C.T.C. 183, (sub nom. R. v. Gulf Canada Ltd.) 92 D.T.C. 6123 addressing how licence payments would be treated in the context of paragraph 18(l)(m) stated at pages 188-89 (D.T.C. 6128):

annual rental or other payments to provincial governments made for the purpose of keeping leases or licences to subsurface rights current are “not included” in Canadian development expenses. The trial judge so found and he was correct.

From this passage it is clear that paragraph 18(l)(m) is applicable to licence payments as well as lease payments made for the purpose of development or ownership of an interest in a mineral property. Accordingly, the licence payments in the present case are not properly deductible as a CDE.

(b) CEE

The Appellant’s second alternative submission was that to the extent that a flow-through share deduction is not allowed, the payments will qualify as a CEE and are properly deductible pursuant to section 66(3) of the Act. To determine whether the payments qualify as a CEE it is necessary to refer to subparagraph 66.1(6)(a) wherein.

CEE is narrowly defined and includes only the expenditures listed. For our purposes, CEE are basically grouped into two general categories: grassroots mining expenses and pre-production development costs.

Counsel for the Appellant submitted that the licence payments are properly classified as a CEE under subparagraph 66.1 (6)(a)(iii). It deals with the expenses incurred in the course of prospecting, surveying, drilling, trenching, digging test pits and preliminary sampling. Specifically excluded from the definition of CEE in subparagraph (iii) are any CDE.

In determining whether the lease rental payments qualified as a CEE on page 188 (D.T.C. 6127) in Gulf Canada (supra) the Federal Court of Appeal concluded that payments made to maintain an acreage inventory upon which development and production may take place in the future are not within the definition of clause 66.1(6)(a)(i)

In order for an expense to be incurred there has to be some connection between that expense and the work actually done on the ground. I agree with this reasoning. The licence payments are “payments for the right to drill and explore” which as Hugesson, J.A. in Gulf Canada (supra) indicates are not included in exploration expenses. I conclude that the licence payments are not properly deductible as a CEE.

(3) Allowable Business Investment Losses

The Appellant’s third alternative argument was that the payments are properly deductible as allowable business investment losses (ABIL) pursuant to paragraph 39(1 )(c) of the Act. This submission is an extension of the Respondent’s submission that the payments are capital losses pursuant to paragraph 39(1 )(b). The payments must first qualify as a capital loss, before they can be qualify as ABIL.

Paragraph 39(1 )(b) defines a capital loss to be a loss from the disposition of property to the extent that the loss is not otherwise included in computing income for the year under section 3 of the Act. A capital property is the term used to describe property the disposition of which will give rise to a capital gains or losses.

The Appellant stated that he is not entitled to claim a capital loss because they were for coal licences which are a Canadian resource property and as such specifically excluded from the definition of capital losses pursuant to paragraph 39(1)(b). The Respondent takes the position that the payments are shareholder loans. I do not accept either position and find that the Appellant’s payments were capital payments.

The Appellant paid the coal licence fees for Norco with the understanding that he would receive flow-through shares at a price per share as decided by the directors of Norco. This did not come to pass. Norco did not satisfy the legislative requirements. In 1990 Norco was dissolved. This effectively eliminated the Appellant’s opportunity to benefit from section 66 benefits in the Act. Given that the Act did not deem the payment otherwise, it is a capital loss unless it could be classified as an ordinary business loss. I find that the payments cannot be classified as Allowable Business Losses (ABIL) pursuant to 39(1 )(c) of the Act. It does not serve a purpose to review the legislation with respect to an ABIL. Norco was a publicly traded corporation rather than a small business corporation as required to come within the requirements of the relevant legislation.

(4) Ordinary Business Losses

The Appellant’s fourth alternative submission was that the payments are properly deductible pursuant to section 9 and paragraph 18(1 )(a) of the Act as ordinary business losses. The question is whether or not the Appellant was in the coal mining business. I think he was not.

The concept of business is defined in subsection 248(1) to include a profession, calling, trade, manufacture or undertaking of any kind whatever and, for most purposes, includes an adventure or concern in the nature of trade. Business implies some level of economic activity, with such activity being undertaken for the purpose of realizing a profit.

Since traders and investors are both in search of profit, profit motive by itself is not sufficient to distinguish between business income and capital gains or losses. The Court must determine the taxpayer’s operative intention at the time the property is acquired. There are certain factors or aids that the Courts have often considered in determining whether a taxpayer’s intention was to realize an investment or to carry on a business when engaging in a particular transaction. These factors include the number and frequency of similar transactions, the relation of the transaction to the taxpayer’s regular business and the type of assets being disposed of.

Can the coal licence payments be classified as ordinary business losses? The Appellant is listed as owning 30,600 shares of Norco as of August 24, 1983 and owning 50,900 shares as of May 21, 1985. The Appellant stayed with the Norco venture when everyone else had jumped ship. The intention of the Appellant in making the licence payments in 1987 and 1988 must be analyzed in the context of all the circumstances surrounding the transactions including the Appellant’s previous investment in Norco.

In determining the Appellant’s intention in making the licence payments, one must examine the Appellant’s course of conduct surrounding the payments. The Appellant’s entire course of conduct in making the licence payments was consistent with the intention to invest. The licence payments were made to preserve the Appellant’s original investment in Norco.

As mentioned above, one factor that the Courts will use as an aid in determining a taxpayer’s intention at the time of the transaction is the frequency of similar transactions. Counsel for the Appellant made refer- ence to the Appellant’s participation in the Brenda Mines and Baker Trading ventures. In both instances the Appellant made a profit. No details were given as to how these profits were treated for tax purposes no details of the Appellant’s personal activity in these ventures were offered. Had these profits been treated as business income it would have assisted the Appellant’s position. No evidence to this end was given. The burden is on the Appellant to show that the Respondent’s assessments were incorrect. The Appellant has not achieved that standard.

It is unfortunate that the Appellant could not have testified personally. There is no doubt that Mr. Hamilton was a remarkable person who had a keen interest in the development of Canada’s natural resources. Without a detailed structure of the Appellant’s business activities, I cannot conclude, on the generalities presented in evidence, that he was in the business of coal mining.

In conclusion, the licence payments are properly classified as capital losses. The capital loss result from the disposition of capital property which arose upon the cancellation of the Appellant’s right to receive flow-through shares from Norco.

The appeals are dismissed.

Appeal dismissed.