The Queen v. Gulf Canada Resources Ltd., 96 DTC 6065, [1996] 2 CTC 55 (FCA)

Linden J.: - I have read the reasons of my colleague Pratte J.A. and I agree with him that the Moldowan decision has no application to the circumstances of this case. The Syncrude operation is currently a commercial enterprise and was so during the year 1978. Recourse to the notion of reasonable expectation of profit in this regard is therefore wholly unnecessary. See generally on this issue, Tonn v. R., [1996] 1 C.T.C. 205, 96 D.T.C. 6001 (F.C.A.).]. I am also in agreement that there is no basis for prorating or attribution in this case. Like Pratte J.A., I also consider the key question to be resolved in this case to be the meaning of section 1204 of the Income Tax Regulations.

I respectfully disagree, however, with the result reached by Pratte J.A., based on a different interpretation of section 1204 than I have arrived at. I, therefore, offer these reasons for coming to a different conclusion.

The issue in this case is to determine the proper income source from which two deductions should be taken. The deductions in question are a $45,656,563 capital cost allowance (CCA) and a $9,504,816 interest expense.

Counsel for the Crown argues that the proper income source from which these amounts should be deducted is one of the “resource” income sources described in section 1204 of the Regulations. Specifically, he argues that one of the sources, described in subparagraph 1204(l)(b)(ii) applies to the activities at Syncrude, so that these costs must be treated pursuant to paragraph 1204(l)(f) as “deductions for the y ear...reasonably regarded as applicable to the sources of income described in paragraph (b)”. Counsel for Gulf argues that the proper source is its world-wide income, the source described in section 3 of the Income Tax Act.

The Crown’s position is maintained in order to reduce the “resource profits” amount earned by Gulf. This reduction would in turn diminish the amount of two allowances permitted Gulf against its world-wide income, the “resource allowance” under paragraph 20(1)(v.1), and the “earned depletion allowance under section 65. Gulf’s overall tax payable would, accordingly, be higher under the Crown’s interpretation. Naturally, Gulf’s position reflects its wish to take advantage of these two allowances and to reduce its liability correspondingly.

The legislative background is the resource taxation scheme of the Act and Regulations. Resource industries have for a number of years been subject to favourable taxation. Canada possesses a vast quantity of natural resources. [1] It has been felt that the national interest is served by encouraging the development of the resource sector. But resource activities are risky and expensive. Recognizing this, Parliament has developed a series of tax incentives for the resource sector. A number of special provisions relating to the treatment of various expenditures and of income, including incentives available in computing that income, have been made available to certain businesses that qualify as resource activities. Included among these is paragraph 1204(l)(b) of the Regulations, which sets out five resource income “sources”. Qualifying under any of these source descriptions allows the particular industry access to special income-side resource treatment. This regulation reads as follows:

1204(1) For the purposes of this Part, “resource profits” of a taxpayer for a taxation year means the amount, if any, by which the aggregate of

(a) the amounts, if any, included in computing his income for the year by virtue of subsection 59(2.1) of the Act and paragraphs 59(3.2)(b) and (c) and 59.1(b) of the Act, less the aggregate of the deductions, if any, allowed in computing his income for the year by virtue of paragraph 59.1(a) and subsection 64(1.1) of the Act and

(b) the amount, if any, of the aggregate of his incomes for the year from

(i) the production of petroleum, natural gas or related hydrocarbons from oil or gas wells in Canada operated by him,

(ii) the production in Canada of

(A) petroleum, natural gas or related hydrocarbons, or

(B) metals or minerals to any stage that is not beyond the prime metal stage or its equivalent,

from mineral resources in Canada operated by him,

(iii) the processing in Canada of ore from mineral resources in Canada not operated by him to any stage that is not beyond the prime metal stage or its equivalent,

(iv) the processing in Canada of ore from mineral resources outside Canada to any stage that is not beyond the prime metal stage or its equivalent, and

(v) rentals or royalties, the amounts of which are computed by reference to the amount or value of production from oil or gas wells in Canada or from mineral resources in Canada

exceeds

(c) the aggregate of his losses for the year from the sources described in paragraph (b),

computed in accordance with the Act, on the assumption that he had during the year no incomes or losses except from those sources and was allowed no deductions in computing his income for the year other than

(d) amounts deductible under section 66 of the Act (other than amounts in respect of foreign exploration and development expenses) or subsection 17(2) or (6) or section 29 of the Income Tax Application Rules, 1971, for the year;

(e) the amounts deductible or deducted, as the case may be, under section 66.1 or section 66.2 of the Act for the year; and

(f) such other deductions for the year as may reasonably be regarded as applicable to the sources of income described in paragraph (b), other than a deduction under section 1201 or subsection 1202(2) or (3), 1207(1) or 1212(1).

(2) ...

(3) Income or loss from a source described in paragraph (1)(b) does not include income or loss derived from transporting, transmitting or processing petroleum, natural gas or related hydrocarbons.

This case specifically concerns the interpretation of section 1204, the resource “income source” provision. Essentially, section 1204 is a provision which regulates the computation of “resource profits” for the resource income sources it describes. As a provision triggering resource income treatment, section 1204 plays an important part in the larger scheme applicable to resource operations generally. It is better understood against this larger backdrop, and it is advisable, if possible, for its interpretation to be consistent with the scheme as a whole. Hence, a contextual approach to statutory interpretation is vital when any one provision of a complicated scheme becomes the focal point of an analysis. This is the situation in this appeal. My analysis will, therefore, consider the broader resource taxing scheme to ensure that the particular interpretation of paragraph 1204 is in harmony with the rest of the Act and its Regulations.

To qualify for resource income treatment, a taxpayer must be able to come within one of the five income source descriptions contained in paragraph 1204(1 )(b) of the Regulations. Briefly, this means that amounts under (a) from the disposition of Canadian resource properties are added to the income, if any, from any of the sources listed in (b). Five sources are listed: income from (i) oil and gas well production, (ii) mineral resource production, (iii) third-party processing of Canadian ore, (iv) Canadian processing of foreign-source ore, and (v) rent or royalties. Losses from any of these sources are then subtracted under (c). The only deductions allowed in the computation are those listed in (d), (e), and (f). Subsection 1204(3), finally, states that any income derived from the transporting, transmitting or processing, of petroleum, etc. is to be treated as manufacturing and processing income, and cannot be a factor in computing resource profits. [2]

The first question to be decided is whether any of the five sources listed in paragraph (b) describes the Syncrude operation. In my view, Syncrude is covered by the language in both clauses 1204(l)(b)(ii)(A) and (B).

Syncrude is an open pit mine. Mineral ore is taken from the mine. The ore is sent to an extractor. The mineral component is separated from the sand, and, finally, it is upgraded into marketable petroleum.

I am of the opinion that 1204(l)(b)(ii)(A) covers Syncrude. Syncrude produces “petroleum” from a mineral resource. In my view, petroleum means crude oil in this context at least. The interpretation of the word “petroleum” as crude oil is supported by a number of factors and is, in my opinion, the most reasonable interpretation. I Ido not agree with counsel for Gulf that the word should be broadly defined. To begin with, the ordinary and common meaning of “petroleum” is crude oil. Second, this interpretation recognizes that the Act is designed to deal with commercial realities. It also respects the important reference to crude oil in subsection 1104(5), the CCA property definition which triggers the resource treatment of capital assets. Finally, it is in harmony with the immediate statutory context in which the word is found. The word “petroleum” also occurs in subparagraph 1204(1 )(b)(i) and subsection 1204(3). In the former, the reference is clearly a reference to crude oil. So, too, in my mind, is the reference in the latter, for only crude oil is “transported” (by truck or train), or “transmitted” (by pipeline), and then “processed.” As Hugessen J.A. stated in Gulf Canada Ltd. v. R.:

[T]here is a strong, indeed overwhelming, presumption that Parliament, having used the same word three times in the same subsection, intended to bear the same meaning each time. Gulf Canada Ltd. v. R., [1992] 1 C.T.C. 183, (sub nom. R. v. Gulf Canada Ltd.) 92 D.T.C. 6123, (sub nom. Gulf Canada Ltd. v. Minister of National Revenue), 136 N.R. 187, leave to appeal S.C.C. refused (sub nom. Gulf Canada Ltd. v. Minister of National Revenue) (1994), 141 N.R. 393 (S.C.C.) at page 186 (D.T.C. 6126, N.R. 191), per Hugessen J.A.

In my view, all these activities are also included in clause 1204(1 )(b)(ii)(B). First, the Syncrude mine is a bituminous sands deposit, and a bituminous sands deposit is a “mineral resource” as defined in subsection 248(1) which reads:

“mineral resource” means

(c) a bituminous sands deposit, oil sands deposit or oil shale deposit....

Subparagraph 1203(l)(b)(ii) applies to activities comprising the “production ... from a mineral resource.” It, therefore, applies to Syncrude.

Second, clause 1204(l)(b)(ii)(B) applies to Syncrude because bituminous sand is a “mineral.” The definition of this term in subsection 248(1) reads:

“minerals” do not include petroleum, natural gas or related hydrocarbons (except coal, bituminous sands, oil sands or oil shale).

The proper interpretation of this definition is quite clear. For the purposes of the Act, any reference to “minerals” is not to be read as including any “petroleum, natural gas or related hydrocarbon” except (among others) bituminous sands. Bituminous sand, therefore, is a mineral. Minerals are not petroleum. Bituminous sand, being a mineral, is, therefore, not a petroleum.

I do not agree that the “petroleums” referred to in the exception clause of the definition are, by that reference, defined as petroleums. They may be petroleums in fact, as any geological engineer might testify. Nevertheless, for this reason, they are specifically included in the exception clause. But their inclusion makes them “minerals.” And, because minerals are not petroleums, bituminous sand, as one of the excluded “petroleums,” is not a petroleum for the purposes of the Act.

Clause 1204(l)(b)(ii)(B), therefore, includes the Syncrude operation because Syncrude produces a mineral (bitumen) from a mineral resource (bituminous sand).

But is every aspect of the Syncrude operation contemplated by clause 1204(l)(b)(ii)(B)? In my view, the answer is yes. Clause 1204(l)(b)(ii)(B) speaks not only of the production of a mineral from a mineral resource, a description that might apply only to the mining component of Syncrude. It also speaks of “the production ... of .... minerals to any stage that is not beyond the prime metal stage ... equivalent.” Syncrude mines a mineral (bituminous sand) and not a metal. These specific words, therefore, apply to Syncrude and the income source is the production of a mineral resource to the equivalent of the prime metal stage. The question that follows, then, is to determine, in the context of Syncrude’s operations, what is meant by the “equivalent of the prime metal stage.”

The meaning of the phrase “equivalent of the prime metal stage” was considered in Canadian National Railway Co. v. Canada, Canadian National Railway v. Canada, (1994), 171 N.R. 64 (F.C.A.), leave to appeal to S.C.C. refused (sub nom. Canadian National Railway v. Canada) (1995), 185 N.R. 399 (S.C.C.) where this Court had to decide its meaning in the context of a coal mining operation. Mahoney J.A., speaking for the Court, stated:

In my opinion, when metallurgical and thermal coal has been processed to the condition in which it meets the specifications of its consumers and they buy and take delivery of it as coal in that condition, it has certainly reached the equivalent of the prime metal stage within the contemplation of the definition of “mining” in subsection 49.01(1) of the Excise Tax Act. [3]

Even though this quotation dealt with the phrase as it appeared in a different statute, I see no reason to depart from the interpretation given above in the present context. In my view, the equivalent of the prime metal stage for mineral production is that point where the production processes have produced a marketable, saleable commodity which meets the specification of its consumers.

According to this meaning, the equivalent of the prime metal stage for bituminous sand is crude oil. The only marketable product created by the Syncrude plant is synthetic crude oil. This was confirmed by the evidence, which was accepted by the Trial Judge, who stated:

All three production components of the plant were needed to make a product that could be transported (pipelined) to market (distant refineries). Mined ore itself had no value because there was no market for it. Similarly, bitumen had no value because there was no way of moving it from the Syncrude site to market. Upgrading was needed to convert the bitumen to a pipelineable product.

Therefore, the only marketable product created by the Syncrude mine is crude oil. The complete Syncrude operation is geared toward the produc tion of marketable crude oil. All aspects of the Syncrude operation, then, are contemplated by clause 1204(l)(b)(ii)(B). They are all resource activities. The two deductions at issue in this case, therefore, are properly related to the resource profits computation. They fall specifically under paragraph 1204(l)(f) as “deductions for the year ... reasonably be regarded as applicable to the sources of income described in paragraph (b).”

I might note that the Trial Judge understood clause 1204(l)(b)(ii)(B), and its application to Syncrude, quite differently. He stated:

Clause (B) covers the activities done to get materials to the equivalent of the prime metal stage, that is, in the case of Syncrude, to the prime mineral stage. By definition under the Act, the mineral is the bituminous sands. Therefore Syncrude has already achieved the prime mineral stage with mining. That is, the material entering the extraction plant, bituminous sands, is already to the prime mineral stage. Consequently, Syncrude is not processing to the prime mineral stage, because the material had already arrived as that stage at the start of the processing.

With respect, this conclusion is in error. First, the Act does not talk of the “prime mineral stage.” Rather, it speaks of an “equivalent” stage, that is, “the equivalent of the prime metal stage.” Second, this equivalence, as stated in the CPCN case, is not of a “technical” nature, but of an economic one. It is that point in the work where the mining operation has produced a product to sell. In the present context, the equivalent of the prime metal stage is that point where bituminous sands are turned into marketable crude oil. I am, therefore, satisfied that the production process contemplated by both clause 1204(l)(b)(ii)(A) and (B), for the purposes of this appeal, is production to the point of crude oil.

This interpretation is supported by a number of contextual items. First, and perhaps most importantly, it reconciles, with no inconsistency, the income and capital sides of the resource tax scheme. The income and capital sides of the resource tax scheme are designed to work in a coordinated fashion. The incentives and allowances at the core of the scheme are calculated with reference to both income and capital cost figures. Understandably, the income and capital sides are, therefore, highly interdependent.

Central to capital-side resource taxation is the classification of properties for CCA purposes. Resource mining assets are either Class 10 or Class 28 assets. These are the Classes applicable to resource properties. Inclusion in these Classes is controlled by subsection 1104(5) of the Regulations, which reads:

1104(5) For the purposes of paragraphs 1100(1)(w) and (x), subsections 1101 (4a) and (4b) and Classes 10 and 28 in Schedule II, “income from a mine”, or any expression referring to income from a mine, includes income reasonably attributable to

(b) the production (other than production from a well) of crude oil from bituminous sand, oil sand or oil shale....

Class 10 and 28 CCA classification, as indicated above, triggers generous tax treatment. Depreciation percentages for the assets included in the Classes are set at 30%, and accelerated to a maximum 100% for Class 28 assets when there is “income from a mine (from crude oil).” The costs of the class 10 and 28 assets factor in the calculation of the earned depletion and supplementary depletion incentives, which in turn affect the calculation of net resource income. The asset costs also trigger an investment tax credit.

These generous capital-side resource provisions create significant opportunities for tax reduction. None of these opportunities went unnoticed by Gulf. All, in fact, were claimed, for Syncrude’s assets quite indisputably fall within the subsection 1104(5) definition. The assets were used for the purpose of generating “income from a mine” through the “production of crude oil from bituminous sand.” Gulf quite properly used subsection 1104(5) to advantage and claimed the assets as Class 10 and 28 resource assets on its tax return.

Gulf also claimed the CCA depreciation rate for those classes. It claimed the investment tax credit triggered by Class 10 and 28 inclusion. It factored the costs of the assets so classified in the earned depletion and supplementary depletion bases, and claimed the incentives accordingly. It also factored these costs into the frontier exploration allowance, which it claimed. Gulf furthermore characterized the properties as “resource properties” to claim Canadian development expense (CDE). It also classified the properties as “mining” or “mineral resource” properties to claim the very generous Canadian exploration expense (CEE).

It is at this juncture that Gulf’s position becomes rather inconsistent. Gulf claimed the incentives and deductions accorded to resource properties: the CEE, the CDE, the frontier exploration incentive, the earned depletion incentive, the supplementary depletion incentive, and the investment tax credit [4] . But then Gulf argues that the CCA depreciation amount applicable to those “resource” assets should not be factored into a “resource” profits computation. Hence, when it was to its advantage, Gulf claimed that the Syncrude assets were mining assets used to produce income from crude oil. Then, in an attempt to squeeze two further tax advantages out of the Act, it seeks to opt out of the resource scheme, which it had previously relied on to its benefit. Gulf now claims, through an income-side interpretation, that the same assets were not mining assets and that they were not used to produce income from crude oil. They were, for this single income- side purpose, it is argued, manufacturing and processing assets. This cannot be a reasonable interpretation of the statute, and does not accord with the contextual approach to statutory interpreta tion.

A second observation that supports the conclusion that all of Syncrude’s operations are resource activities concerns the need to view the Income Tax Act as specifically designed for commercial realities. The Act is replete with references to practical, commercial concepts. The resource provisions themselves talk of “production in reasonable commercial quantities,” of “property acquired for the purpose of gaining or producing income from a mine,” of “carrying on an active business,” of “the production of crude oil from bituminous sands,” of “resource profits,” of “incomes and losses from production from mineral resources,” of “bituminous sands deposits coming into production in reasonable commercial quantities,” of “the development of a mine for the purpose of gaining or producing income from the extraction of material from a bituminous sands deposit.” Each of these references imports practical commercial concepts.

The resource scheme is written with an eye to commercial realities.

This is significant presently for the following reason. Parliament has clearly contemplated Syncrude-type operations through the “mineral resource” definition. Such bituminous sands operations are very few and far between in Canada. Notwithstanding their scarcity, they receive specific mention in the Act. They are described in paragraph 1204(1 )(b). But I note that in this description they are called income “sources.” By naming bituminous sands activities “sources,” Parliament seems to have assumed that they comprise commercial operations. This assumption is consistent with the commercial underpinning of the resource taxation scheme.

One indispensable part of any commercial operation is a sales component. Income, the goal of all commercial activity, can only arise through sales. The argument suggested by the taxpayer, however, would divide the Syncrude operation into two types of taxable activities: (1) a resource activity, and (2) a manufacturing and processing activity. Yet the taxpayer suggests that the resource activity is mining bituminous sand; this cannot be, because bituminous sand cannot be sold for it is a practically worthless product. Hence, it cannot be an income source. The taxpayer seems not to have realized the implication of its argument that no component of the Syncrude operation could qualify for income-side resource treatment because the mining activity is not properly an income source.

Beyond this, however, the argument of Gulf creates a number of taxation anomalies. First, the extraction and upgrading assets used to by Syncrude to derive crude oil from bitumen would, if the taxpayer’s argument is correct, be expected to be Class 29 assets (manufacturing and processing assets). According to the Act however, such assets are necessarily Class 28 (resource assets) because they are assets, according to subsection 1104(5), used to produce “crude oil” from bituminous sand. I note that the taxpayer claimed Class 28 for its extraction and upgrading assets on filing its tax return.

Second, the earned depletion base includes a portion of the cost of assets acquired to process ore not beyond the prime metal stage. If extraction and upgrading are manufacturing and processing activities, none of the assets used by Syncrude in these operations should be included in this base, for the taxpayer would be earning depletion on non-resource activities. I note that the taxpayer claimed earned depletion on such assets in its tax return.

Third, the supplementary depletion base includes a portion of the cost of bituminous sands equipment, that is, equipment used to earn income from a mine in a bituminous sands deposit. Assets used for extraction and upgrading qualify as bituminous sands equipment. But, if extraction and upgrading are manufacturing and processing activities, these assets should not earn supplementary depletion, which is a resource incentive. I note that, in its return, the taxpayer claimed supplementary depletion on these assets.

Fourth, the expenses incurred in bringing a mineral resource into production in reasonable commercial quantities were treated as CDE prior to November 16, 1978 and CEE after that date, and these were added to the earned depletion base. If extraction and upgrading are manufacturing and processing activities, expenses incurred in respect of extraction and upgrading would not qualify as CEE or CDE or would they be eligible for earned depletion. I note that the Respondent claimed CEE and CDE treatment of these expenses on filing its tax return, and claimed the earned depletion resulting therefrom.

Because these anomalies should be avoided, if possible, the proper interpretation to be adopted is that “petroleum” under clause 1204(l)(b)(ii)(A) means crude oil. Furthermore, the equivalent of the prime metal stage for a bituminous sands operation under clause 1204(l)(b)(ii)(B) is crude oil. In this way, Syncrude is an income source, and the above anomalies disappear.

I turn now to a consideration of subsection 1204(3). Counsel for Gulf suggests that the subsection applies to Syncrude. He contends that bitumen is a petroleum and any processing of bitumen is an activity contemplated by subsection 1204(3). It is further argued that any income or loss from such an activity may not be factored in the resource profits computation. Therefore, it is said, the costs pertaining to extraction and upgrading at Syncrude are excluded.

I do not agree. The word “petroleum,” as it is used in subsection 1204(3) means crude oil. Many factors support this interpretation. They are mentioned above but bear repeating. First, the ordinary and common understanding of the term “petroleum” is crude oil Second, the common understanding of the word seems the intended one within the immediate context of subsection 1204(3), which speaks of transporting, transmitting or processing petroleum. The order in which these words are arrayed seems significant, for only crude oil is first transported or transmitted, then processed. Third, the word “petroleum” as used in subparagraph 1204(l)(b)(i) clearly refers to crude oil. The close proximity of this sub- paragraph to subsection 1204(3) strongly suggests that Parliament intended to convey the same meaning for both uses of the term. Fourth, interpreting the word “petroleum” as crude oil is harmonious with the larger resource taxing scheme, and recognizes that the scheme is written with an eye to commercial realities. Gulfs interpretation of the term creates significant inconsistencies between the income and capital sides of the scheme, and completely erodes the otherwise commercial integrity of the scheme.

I do not agree with the analysis of my brother, Pratte J.A., which treats both bitumen and bituminous sands as “petroleum or ... related hydrocarbons” as those words are used in subsection 1204(3). In my view, such treatment, rather than being invited, is foreclosed by the definition of the word “minerals” in subsection 248(1), which specifically excludes “petroleum ... or related hydrocarbons”, but expressly includes bituminous sands in the definition of mineral. Consequently, the word mineral includes bituminous sands, but does not encompass petroleum or related hydrocarbons and. therefore, the processing of bituminous sands is not caught by subsection 1204(3).

I would, therefore, allow the appeal with costs and confirm the reassessment of the Minister for the year 1978.

Pratte J.T.C.C.: — This is an appeal from a judgment of the Trial Division allowing in part the respondent’s appeal from the reassessment of its income tax for the 1978 taxation year.

The respondent is in the business of selling, refining, producing and exploring for petroleum products. Like other petroleum producers, it is entitled, in computing its income under Part I of the Income Tax Act, to certain special deductions the amount of which depends in part on the amount of its “resource profits”, an expression which is defined by section 1204 of the Income Tax Regulations. [5]

The only issue on this appeal relates to the computation of the respondent’s resource profits for the 1978 taxation year. More precisely, the question to be decided is whether the judge of first instance was right in deciding that the Minister could not reduce the amount of the respondent’s resource profits (and, as a consequence, the amount of the special deductions to which it was entitled in computing its Part I income) by taking into account in the calculation of those profits a deduction of $45,656,563.00 claimed by the respondent as capital cost allowance with respect to assets acquired for the purpose of what was referred to as “the Syncrude project” and another deduction of $9,504,818.00 representing interest paid by the respondent on money borrowed to finance the same project.

In order to understand the problem, it is necessary to know a few things about the Syncrude project.

In 1964, Syncrude Canada Limited (“Syncrude”) became the agent of a group including the respondent for the purpose of building and operating the necessary facilities for producing synthetic crude oil from the bituminous sands deposits in Northern Alberta.

The production of oil from bituminous sands is a much more complex process than the traditional method of production of oil from oil wells. It involves three distinct operations: the mining of the bituminous sands, the extraction of bitumen from the sands, the upgrading or transformation of that bitumen so as to obtain synthetic crude oil. Not surprisingly, the production of oil by that complex method is also very expensive and must, in order to be competitive, be done on a very large scale. This was not impossible for Syncrude whose bituminous sands mine is one of the largest in the world provided that plants and machinery of gigantic size be used. In order to give an idea of the size of the production facilities that were eventually built by Syncrude, suffice it to mention that their cost exceeded $2,500,000,000.00.

The building of these installations commenced in 1974 and was not yet completed in 1977 when the mining operations started. By the end of that year, enough bituminous sands had been stockpiled to produce 4 million barrels of crude oil. In March 1978, the extraction plant came into operation; and, in July 1978, the upgrading plant, so that, at the end of that year, 3.56 million barrels of oil had been produced and sold for approximately $50,000,000.00. This is not to say that those installations were then fully operational. They were not and it was expected that it would be many years before they could be operated on a scale sufficient to generate a profit.

It should also be mentioned that this is not the first time that the respondent’s participation in Syncrude gives rise to litigation concerning the calculation of its resource profits. In assessing the respondent’s income tax for the 1974 taxation year, the Minister had also assumed that, in computing resource profits, certain expenses made in relation to the Syncrude project had to be deducted. [6] That assessment was set aside by the Trial Division Gulf Canada Ltd. v. R. (sub nom. Gulf Canada Ltd. v. Canada) (1991) 1 C.T.C. 99, 90 D.T.C. 6622 (F.C.T.D.). (whose judgment was confirmed on appeal [1992] 1 C.T.C. 183, (sub nom. R. v. Gulf Canada Ltd.) 92 D.T.C. 6123 (F.C.A.), leave to appeal to S.C.C. refused (sub nom. Gulf Canada Ltd. v. Minister of National Revenue) (1992), 141 N.R. 393 (S.C.C.)) for the reason that those deductions could not be said to relate to the actual production of petroleum from a mineral resource, as required by section 124.1 of the Act (now section 1204 of the Regulations), since, in 1974, Syncrude had not yet extracted any mineral from the ground.

This appeal raises the same problem in a very different context since, in 1978, Syncrude had not only commenced its mining operations but also produced and sold a substantial quantity of synthetic crude. In spite of that change in circumstances, the judge of first instance allowed the respondent’s appeal and held that the two deductions here in question were not authorized by section 1204 of the Regulation, because, in his view, as “Syncrude was not capable of being operated on a scale which could be expected to be profitable in 1978 nor the near future”, no oil producing business existed at Syncrude in that year.

The appellant attacks this decision as irreconcilable with the decision of the Supreme Court of Canada in Moldowan v. R. [1978] 1 S.C.R. 480, [1977] C.T.C. 310, 77 D.T.C. 5213. That decision and the jurisprudence that followed it were recently reviewed and analyzed by Linden J.A. in Tonn, supra. which has established that the criterion for determining whether a business exists as a source of income is the existence of a “reasonable expectation of profit”. The respondent, on the other hand, invokes the decision of this Court setting aside its 1974 income tax assessment. It adds that, in any event, the two deductions made by the Minister were prohibited by subsection 1204(3).

I have already said that the issue to be resolved does not relate to the computation of the respondent’s business income under Part I of the Act but to the computation of its resource profit under section 1204 of the Regulations. It is common ground that the respondent properly deducted the two sums in question in computing its business income. The respondent could make these deductions because its participation in Syncrude was participation in a business. The question, therefore, is not whether, according to the Mo Ido wan test, the respondent’s involvement in Syncrude was involvement in a business; it clearly was. The question is whether these two deductions were allowed by section 1204 of the Regulations.

As argued before us, the essential issue is whether the deductions were applicable to the “production of petroleum ... from mineral resources” and, therefore, authorized by subclause 1204(l)(b)(ii)(A). [7] In the first Gulf Oil case relating to its 1974 income tax, it was held that the word “production” in a provision similar to section 1204 was used in the narrow sense of extraction from the ground and that, as a consequence, the only incomes and deductions referred to in that provision were those that were directly related to the actual production of petroleum. It followed that expenses made in respect of an oil producing business which was still many years away from production were not deductible.

As I understand his judgment, the trial judge interpreted the decisions of the Trial Division and of this Court in that other case as requiring that the incomes and deductions referred to in subsection 1204(1) be income from and deductions relating to the business of a viable oil producing undertaking sufficiently well established to be capable of generating a profit in the near future. As he was of opinion, not without good reasons, that the Syncrude project had no prospect of being profitable in the near future, he concluded that the Minister had miscalculated the respondent’s resource profits. That was an error. Neither section 1204 nor the decisions that set aside the respondent’s 1974 income tax assessment impose such a requirement. Clearly, during the whole of 1978, Syncrude actually “produced” petroleum in the narrow sense of the word: it mined bituminous sands, extracted bitumen from those sands and transformed that bitumen into synthetic crude which it sold for some 50 million dollars. That sum was clearly a revenue derived from the production of petroleum within the meaning of subsection 1204(1) of the Regulations as it was interpreted in the decisions relating to the respondent’s 1974 income tax assessment and the deductions here in question were clearly related to that source of revenue.

This is not, however, the end of the matter.

As Syncrude produced its first barrel of synthetic crude at the end of July 1978, the respondent says that it is only at that time that Syncrude commenced to produce oil within the meaning of subsection 1204(1) and that the conditions prescribed by that provision were met. It follows, according to the respondent, that the two deductions here in question should be prorated between the period in 1978 during which oil was actually produced and the period in that year when no oil was produced.

I see no merit in that submission. The oil producing activities of Syncrude commenced before 1978, when it started to mine the oil sands deposits, and continued during the whole of that year. It is therefore incorrect to say that Syncrude commenced to produce oil in July 1978.

The respondent’s final and, in my view, more meritorious contention is that the deductions here in question, in so far as they related to the extraction and the upgrading operations, were specifically prohibited by subsection 1204(3) of the Regulations which prescribes that, in calculating the resource profits of a taxpayer from a source described in paragraph (1 )(b), the “income or loss derived from ... processing petroleum, natural gas or related hydrocarbons” must not be taken into account.

According to the respondent, the extraction of the bitumen from the bituminous sands and the upgrading of that bitumen into crude oil are two operations involving the processing of “petroleum .. or related hydrocarbons” since both bitumen and bituminous sands are “petroleum ... or related hydrocarbons”.

I agree.

Bitumen is essentially a mixture of hydrocarbons that results naturally from the degradation of oil and that can be transformed into crude oil. It is obviously composed of hydrocarbons related to petroleum. It is equally obvious that the operations transforming (or “upgrading”) it into crude oil are operations involving the processing of bitumen.

The extraction of the bitumen from the sands is also a processing operation since it consists essentially in heating the sands and mixing them with solvents so as to liquefy the bitumen and in separating the liquid bitumen from the sand and clay. What, at first sight, is not clear is whether the bituminous sands that are so processed can be said to be “petroleum ... or related hydrocarbons”. Any doubt that one might entertain on that point, however, is dissipated by the definition of the word “minerals” found in subsection 248(1) of the Income Tax Act. That definition supposes that bituminous sands are included in the meaning of the phrase “petroleum ... or related hydrocarbons”. It reads as follows:

248(1) In this Act,

“minerals” do not include petroleum, natural gas or related hydrocarbons (except coal, bituminous sands, oil sands or oil shale)....

It follows, therefore, that, in computing the respondent’s resource profits, the Minister could not deduct that part of the two deductions here in question which may reasonably be regarded as applicable to the extraction and upgrading operations.

I would allow the appeal and modify the judgment of the Trial Division by replacing its first paragraph by the following:

“The appeal is allowed, the reassessment of the plaintiffs income tax for the 1978 taxation year is set aside and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the operations whereby Syncrude Canada Limited extracted bitumen from the bituminous sands and upgraded that bitumen so as to produce synthetic crude oil were operations whereby petroleum or related hydrocarbons were processed within the meaning of subsection 1204(3) of the Income Tax Regulations.”

In view of the divided success, I would make no order as to the costs of the appeal.

The appeal is allowed without costs and the judgment of the Trial Division is modified by replacing its first paragraph by the following:

The appeal is allowed, the reassessment of the plaintiff’s income tax for the 1978 taxation year is set aside and the matter is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the operations whereby Syncrude Canada Limited extracted bitumen from the bituminous sands and upgraded that bitumen so as to produce synthetic crude oil were operations whereby petroleum or related hydrocarbons were processed within the meaning of subsection 1204(3) of the Income Tax Regulations.

Appeal allowed.