Aluminium Co. of Canada Ltd. v. The Queen, 74 DTC 6408, [1974] CTC 471 (FCTD)

Heald, J:—The plaintiff carries on, inter alia, the business of manufacturing and selling aluminum and aluminum products. It is a fully Integrated aluminum company. Aluminum is made from alumina (the oxide of aluminum) by means of a smelting process. Alumina is a refined mineral ore derived from ore which is found in the ground and known as bauxite.

One of the major world sources of bauxite is Jamaica, West Indies. In order to investigate the commercial potential of Jamaican bauxite, Alcan Jamaica Limited (hereafter Aljam) was formed under Jamaican law in 1943. Since 1958, Aljam has been a wholly owned subsidiary of the plaintiff. Aljam subsequently explored for and acquired by lease substantial ore deposits in Jamaica containing a commercial grade of bauxite. Aljam also operates two processing plants in Jamaica, for the conversion of bauxite to alumina.

In April 1954 the plaintiff and Aljam entered into an agreement under which it was agreed that the plaintiff would acquire alumina from Aljam in exchange for aluminum which aluminum would be sold by the plaintiff for Aliam’s account. By the 1960’s Aljam had become a very important source of alumina for the plaintiff.

In January 1957 the plaintiff entered into an agreement with Canadian British Aluminum Company Ltd (hereafter Canbaco) whereby plaintiff agreed to supply alumina to Canbaco in exchange for aluminum at a ratio of 6.285 units of weight of alumina to 1 unit of weight of aluminum. Canbaco was a wholly owned subsidiary of the British Aluminum Company and had just established a plant in Quebec. The plaintiff and Canbaco are competitors, there is no common ownership of shares. Accordingly, this transaction was an arm’s length transaction. The two agreements above described were barter agreements. Barter agreements in the aluminum industry came into use in the late 1950’s and early 1960’s because, at that time, there was no established market price for alumina. The purchasers of alumina could only relate its value to the value of the finished product, aluminum. As a result, barter contracts were utilized. Barter contracts at this point in time generally provided for a ratio of 6% to 7 tons of alumina to 1 ton of finished aluminum product.

The Canbaco agreement was for a term of 20 years commencing in 1958. Under the agreement, the plaintiff was obliged to supply and Canbaco was obliged to take, for the year 1958, 47,500 long tons (2,240 lbs) of alumina and, for each of the years 1959-1977, 120,000 long tons of alumina. In case of cancellation of the agreement or in the case of a decrease in the quantity of alumina required by Canbaco, Canbaco was obliged to pay the plaintiff $6 for each long ton per year by which the quantity of alumina was decreased, said payment to be made on January 1 in each of the five years beginning with that in which cancellation took effect.

The agreement was cancelled by Canbaco in 1961 who paid to the plaintiff, as per the agreement, as compensation during the years 1962-1966 inclusive, equal instalments of $720,000 (calculated as described in the next preceding paragraph). In computing its income for its 1962-1966 taxation years inclusive, the plaintiff included the amounts so received by it from Canbaco, and, in particular, in 1966, it included the said instalment of $720,000 in its income.

In letters written to Aljam on September 18 and September 25, 1964, Government officials in Jamaica made known to Aljam their view that Aljam was entitled to share in the $3,600,000 compensation being paid by Canbaco to the plaintiff following cancellation of the contract above referred to and that the Jamaican Government was entitled to include in Aljam’s income, and thus tax under Jamaican income tax laws, some portion of the said: $3,600,000 being paid by Canbaco to the plaintiff in the years 1962-1966 inclusive. In both letters, the Jamaican officials also referred to the disparity between the price at which Aljam contracted to barter its alumina to Alcan and the price at which the plaintiff sold Jamaican alumina to independent contractors in arm’s length transactions. In the letter of September 25, 1964 the opinion is also expressed that the commission paid by Aljam on the sale of the aluminum received by it under the barter contract with the plaintiff appeared to be excessive. This commission was paid to companies associated both with the plaintiff and with Aljam. This letter goes on to comment that the problems above referred to adversely affected the Jamaican revenue and said further that the Government of Jamaica intended to apply the provisions of subsection 32(3) of the Income Tax Law of Jamaica to rectify the situation. Said subsection 32(3) appears on page 35 of the Book of Documents tendered in evidence with the consent of both counsel. It reads as follows:

32-(3) Where a non-resident person carries on business with a resident person, and it appears to the Commissioner that owing to the close connection between the resident person and the non-resident person the course of business between those persons can be so arranged and is so arranged, that the business done by the resident person in pursuance of his connection with the non-resident person produces to the resident person either no profits or less than the ordinary profits which might be expected to arise from that business, the non-resident person shall be assessable and chargeable to tax in the name of the resident person as if the resident person were an agent of the non-resident person.

The said letter of September 25, 1964 (a lengthy letter containing some 9 pages in all) then proceeds to detail the reasons why the Government of Jamaica felt justified in applying said subsection 32(3) to the circumstances of this case. In summary, the position of Jamaica was, that while Aljam was not a party to the Canbaco agreement, that because Aljam was a wholly owned subsidiary of the plaintiff and because Aljam contributed substantially to the performance of the Canbaco agreement before cancellation, that by virtue of said subsection 32(3), Jamaica was empowered to, in effect, “look through” the contract, to see what profits, if any, arising from the Canbaco cancellation were applicable to Jamaica. On page 4 of the letter of September 25, 1964 the Jamaican Commissioner of Income Tax said:

. . . I would not be fettered by a contract between a company and its wholly owned subsidiary. In the first place it is the right hand contracting with the left. . . .

The letter then proceeds to consider the extent to which Jamaica has suffered from the cancellation of the Canbaco contract and to project and estimate the portion of the Canbaco contract which would have been filled from plaintiff’s supply of Jamaican alumina and concludes by stating that said portion would have risen to at least 75%. Accordingly, the letter advises Aljam of the intention of the Government of Jamaica to assess and charge income tax on 75% of the $3,600,000 cancellation payments, ie the sum of $2,700,000 was going to be deemed the portion of the profits applicable to Aljam and thus taxable in the hands of Aljam under Jamaican law.

Following receipt of this letter, Aljam’s officials consulted their lawyers who advised them that the Income Tax Commissioner did indeed have the powers claimed by him in his letter of September 25, 1964; that, additionally, he had power to subpoena the books and records of the foreign parent of a Jamaica corporation. Further meetings and discussions ensued between officials of the Jamaican Government and officials of Aljam. The Jamaican tax problem was, of course, reported to the senior officers of the plaintiff in Montreal. In August of 1965 Mr J G Stark, who had been the treasurer of Aljam, resident in Jamaica, returned to Montreal to take up new duties with the plaintiff. At that time, he reported to his superiors that, in his opinion, while the initial Jamaican claim was based on specific and individual technical tax claims, as the negotiations and discussions continued, it became clear to him that, in reality, the claim of the Jamaican authorities was a persistent claim for more tax revenues generally. He said that each year the scope of their demands broadened and increased. After discussions with the other senior management personnel of the plaintiff in Montreal, Mr Stark was sent back to Jamaica to attempt a settlement of Aljam’s tax problems with the Jamaican Government. As a result, a settlement was effected in February of 1966, covering the taxation years 1963-1966 inclusive. Under the terms of the settlement, Aljam was assessed an additional 735,000 Jamaican pounds in income tax. Mr Stark, in his evidence gave these reasons for settlement:

1. To preserve a supply of vital raw material. It was his view that the dispute might well become quite acrimonious, thus jeopardizing the plaintiff’s interests in Jamaica. It was his view that if Aljam took a legalistic position, and resisted the proposed assessment, the Jamaican Government had other avenues of approach open to it. Thus, taking a pragmatic approach, on the basis of sound business judgment, he recommended the settlement.

2. From an accounting and a commercial point of view, he observed that the contingent tax liability to Jamaica had to be shown in the company’s annual financial statements. He said that this contingent liability seemed to be growing each year as the tax demands of Jamaica escalated. He feared that if this contingent tax liability continued to grow, the point would soon be reached where it might well impair the plaintiff’s ability to carry on its foreign business operations.

Mr Robert J Moyse, the plaintiff’s treasurer until January 1, 1966, said he approved this settlement because, firstly, he felt the Government of Jamaica had a strong moral, if not a strong legal position because the Jamaican alumina represented a large portion of plaintiff’s alumina supply at that time. It seemed to him “that the Jamaican authorities were determined to get the price of alumina increased” after participating in some of the meetings there. It was his impression that while the Canbaco matter and the four other specific income tax matters discussed played a part in the position taken by Jamaica, the situation really crystallized to the point where one fact emerged, ie Jamaica was determined, one way or the other, that Aljam was going to have higher taxable income. He felt that the Canbaco compensation and the other specific matters were simply devices to obtain a higher price for Jamaican alumina. Mr Moyse also expressed the view that if the supply contract between the plaintiff and Aljam had been an arm’s length transaction, it was quite likely that said contract would have contained a compensation clause similar to the one in the arm’s length agreement between Canbaco and the plaintiff. He accordingly felt that Jamaica’s claim to a portion of the Canbaco compensation was well founded.

On March 31, 1966 Aljam wrote to the plaintiff reporting the settlement with the Jamaican tax authorities above referred to and invoicing the plaintiff for “your pro rata portion of the said additional selling price of alumina and the portion of the Canbaco cancellation payment deemed payable to us, as determined by the Jamaican authorities and accepted by us for purposes of the setitement”. The attached invoice thus contained two items. The second itefh of the invoice reads as follows:

Portion of Canbaco cancellation payment payable to Aljam as determined by the Income Tax Appeal Board of Jamaica £480,055.

(The reference to the Income Tax Appeal Board of Jamaica is because said Board, in effect, ratified the settlement between the parties by a letter dated March 9, 1966 to Aljam’s counsel thus disposing of the appeal to said Board launched earlier by Aljam.)

The said sum of 480,055 Jamaican pounds amounted to $1,447,078 in Canadian dollars which sum the plaintiff promptly reimbursed to Aljam. Mr Nathaniel B Davis, the plaintiff’s Chief Executive Officer at the time, described the plaintiff’s action in reimbursing Aljam as being “an act to make whole the income of Aljam”. He described the plaintiff’s decision as a pragmatic decision. He felt it was in the plaintiff’s best long-term interests to settle the dispute, that a protracted dispute in the Courts would have “tended to harden the relationships” between the Jamaican Government and the plaintiff. Other officials of the plaintiff confirmed his view that it was perfectly proper for the plaintiff to reimburse Aljam. Mr William J Reid, plaintiff’s treasurer after January 1, 1966, said that the plaintiff’s management looked on this charge as a pricing adjustment more than anything. He said similar retrospective adjustments were not uncommon. He gave two examples of contracts which plaintiff had with other firms for the supply of petroleum coke. In those cases, the contracts were re-negotiated because the contract price subsequently differed markedly from the fair market value. He said that viewed as an adjustment to alumina prices, the $1,447,078 payment had the effect of increasing the alumina price to $59.46 per short ton from $58.81 per short ton and that the said price of $59.46 per short ton was well within the fair market value of alumina during the period in question. He added that said price was well below prices paid by the plaintiff for alumina in arm’s length transactions.

The plaintiff, in its records, included the said sum of $1,447,078 as a cost of sales which procedure was concurred in by its auditors.

The defendant, in assessing the plaintiff for its 1966 taxation year, disallowed the said expenditure of $1,447,078.

lt is the defendant’s position that subject expenditure constitutes a payment on account of capital. In support of this position, the defendant refers to the evidence of the plaintiff’s officials to the effect that said expenditure was made to preserve a supply of vital raw material, thus it was expended to maintain and continue in existence a capital asset and is thus an outlay on account of capital. The cases of British Insulated and Helsby Cables Ltd v Atherton, [1926] AC 205, and Associated Investors of Canada Ltd v MNR, [1967] CTC 138; 67 DTC 5096,. are cited in support of this submission. I do not so interpret the effect of either of said cases. In the Associated Investors case (supra) President Jackett (as he then was) said at page 144 [p 5099}:

. . . The general concept is that a transaction whereby an enduring asset or advantage is acquired for the business is a capital transaction. (See British Insulated and Helsby Cables, Ltd v Atherton, [1926] AC 205.)

Both of these cases define a capital transaction as one whereby an enduring asset or advantage is acquired for the business (italics mine). Thus, in my view, the above authorities are not authorities in support of a submission that moneys expended for the maintenance and continuation of a capital asset are outlays on account of capital. Furthermore, on all of the evidence adduced, I have concluded that the true nature of subject expenditure was a pricing adjustment to the cost of raw material purchased by the plaintiff and required by it in its business of manufacturing aluminum. This was not uncommon in this type of business. Even after said adjustment, plaintiff’s cost of raw product was well within the fair market value range. As a pricing adjustment to the cost of raw material, it did not involve any addition to or withdrawal from fixed capital and was, thus, in my view purely a working expense.

The distinction between outlays on revenue account and on capital account was succinctly stated by President Jackett (as he then was) in the case of Canada Starch Co Ltd v MNR, [1968] CTC 466 at 472: 68 DTC 5320 at 5323, where he said:

in other words, as I understand it, generally speaking,

(a) on the one hand, an expenditure for the acquisition or creation of a business entity, structure or organization, for the earning of profit, or for an addition to such an entity, structure or organization, is an expenditure on account of capital, and

(b) on the other hand, an expenditure in the process of operation of a profit-making entity, structure or organization is an expenditure on revenue account.

Applying those tests to the circumstances in the case at bar, I am satisfied that subject expenditure was incurred in the process of operating a profit-making organization and, as such, was an expendi- ture on revenue account. Plaintiff is an integrated aluminum company extensively involved in aluminum production from the beginning where the raw ore (bauxite) is mined to the final stages where the finished product, aluminum, is produced, marketed and sold. Its Jamaican subsidiary was faced with demands from the Jamaican Government which result in an upward adjustment of the price of raw product required by the plaintiff for the satisfactory operation of its entire profit-making organization. Thus, the plaintiff and its subsidiary, Aljam, made a business decision to acquiesce in said upward price adjustment in the cost of its raw material.

As was stated in Hallstrom’s Pty Ltd v Federal Commissioner of Taxation, 8 ATD 190 at 196, the solution “depends on what the expenditure is calculated to effect from a practical and business point of view rather than upon the juristic classification of the legal rights, if any, secured, employed or exhausted in the process”.

In this case, the plaintiff made a “practical and business decision” because the Jamaican request was reasonable and justified in all the circumstances and because it desired to ensure a continuance of its friendly relations with a host country.

The situation here is not unlike that considered by Noël, ACJ in Pigott Investments Limited v The Queen, [1973] CTC 693; 73 DTC 5507, where it was held that the amounts expended by the plaintiff were one facet of a commercial transaction the object of which was to earn income from its construction business. The subsidiary in effect became the mere agent of the plaintiff and the expenses of the agent were those of the principal.

Defendant’s counsel further submitted that since there was no legal Obligation on the plaintiff to turn over to Aljam a portion of the Canbaco compensation, it was accordingly not a properly chargeable expenditure against the plaintiff’s income. The jurisprudence does not support this submission. The authorities clearly indicate that an expenditure made as a “gift” or as a matter of commercial morality will be allowed as a deduction in computing income.* [1] Subject expenditure was made in the interests of commercial morality (because of the strong entitlement of Jamaica) and to preserve the image of the plaintiff as a good corporate citizen of Jamaica through its Jamaican subsidiary, Aljam.

For all of the above reasons, I have concluded that subject expenditure of $1,447,078 was properly deducted from income by the plaintiff in the taxation year 1966, the year of payment.

The appeal will therefore be allowed with costs. The plaintiff’s assessment for the taxation year 1966 will be referred back to the Minister for reassessment not inconsistent with these Reasons.