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Citation: 2005TCC55
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Date: 20050126
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Docket: 97-3628(IT)G
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BETWEEN:
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ALLAN MCLARTY,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Little J.
A. Facts:
[1] The Appellant is one of a number
of investors who invested in proprietary seismic data (the
"Venture Data").
[2] The Appellant's share of the
purchase price of the Venture Data was $100,000.00. The amount of
$100,000.00 was satisfied by a cash payment of $15,000.00 and a
limited recourse promissory note (the "Note") in the
amount of $85,000.00.
[3] The Appellant added the amount of
$100,000.00 to his Cumulative Canadian Exploration Expenses
("CCEE") and claimed CCEE deductions when he filed his
income tax returns for the 1992 and 1994 taxation years.
[4] The Minister of National Revenue
(the "Minister") reassessed the Appellant's 1992
and 1994 taxation years. The Minister allowed CCEE in the amount
of $32,182.00 and disallowed the remainder of the purchase price
of the Venture Data on the basis that the price that was paid was
in excess of fair market value.
[5] The Appellant filed appeals to the
Notices of Assessment.
[6] During the hearing of the appeals
the parties filed a document referred to as Facts Admitted (see
Exhibit A-5):
1. Western
Geophysical Ltd. ("Western") was engaged in the
business of providing seismic data and other geophysical
services.
Paragraph 18(a) of the Reply to Amended Notice of
Appeal dated August 15, 2003 (the "Reply")
2. On June 26,
1992, Western sold its entire Canadian proprietary data library
(the "Data") to Canadian Hunter Exploration Ltd.
("Hunter").
Paragraph 18(b) of the Reply; Paragraph 4(e) of the
Response to Request to Admit sent September 2,
2003 (the "Response")
3. On June 26,
1992, Hunter sold the Data to Seitel Inc.
("Seitel").
Paragraph 18(h) of the Reply; Paragraph 4(f) of the
Response
5. Pursuant to
a Purchase and Sales Agreement dated December 30, 1992 (the
"Seitel Agreement"), Compton Resource Corporation
("Compton") acquired the "seismic business"
from Seitel for consideration totalling $21,000,000 satisfied by
cash in the amount of $2,375,000 and a debenture in the amount of
$18,625,000 in favour of Seitel due on December 31, 2001 (the
"Compton Debenture"). The "seismic business"
was defined as the seismic business carried on by Seitel in
Canada, consisting of the following three components:
seismographic material, the Data, and the Dyad Agreement.
Paragraph 5 of the Amended Notice of Appeal dated
August 7, 2002 (the "Notice of Appeal") and
paragraph 4, 18(n), 18(o) and 18(p) of the Reply
6. Compton was
in 1992 and still is owned 100% by Ernie Sapieha, who and remains
its sole officer and director.
Paragraph 1 of the Request to Admit and Paragraph 1
of the Response
7. Pursuant to
the Seitel Agreement, the purchase price of $21,000,000 was
allocated as follows: $20,999,998 to the Data; $1.00 to each of
the seismographic material and the Dyad Agreement.
Paragraph 18(m) and 18(p) of the Reply
8. Also
included in the purchase agreement was an obligation for Seitel
to provide one copy of the Data to Compton by February 28,
1993.
Paragraph 18(q) of the Reply
9. The Compton
Debenture required that 60% of the revenues (net of commission)
from the sale of licensed copies of the Data be applied to the
Debenture, first to interest and then to principal.
Paragraph 18(r) of the Reply
10. On December 31, 1992,
Seitel and Compton entered into a Data Management and Sale
Agreement whereby Seitel agreed to act as Compton's agent for
the marketing and licensing of the Data in exchange for a
commission not exceeding 10%.
Paragraph 18(t) of the Reply
11. Compton received three
appraisals of the Western Data Base which purported to estimate
the fair market value of the data as follows:
(a) Curts Seismic
Consultants
Ltd.
$41,930,760
(b) Jaskella
(sic) Resources Consulting
Ltd.
$39,787,800
(c) Citadel Engineering
Ltd.
$34,405,000
Paragraph 6 of the Notice of Appeal and paragraph 5
of the Reply
12. On December 31, 1992,
the Appellant entered into a Subscription Agreement (the
"Subscription Agreement") with Compton, pursuant to
which the Appellant acquired an undivided interest in the Compton
Resource Corporation 1992/1993 Oil and Gas Investment Fund (the
"Joint Venture").
Paragraph 7 of the Notice of Appeal and paragraph 7
of the Reply
13. The Appellant and
other individuals (collectively the "Individual Joint
Venturers") entered into a joint venture agreement dated
December 31, 1992 (the "Joint Venture Agreement") with
Compton.
Paragraph 10 of the Notice of Appeal and paragraph 8
of the Reply
14. Under the Joint
Venture Agreement, the Individual Joint Venturers appointed
Compton as their agent to purchase seismic data for the use of
the Joint Venture from Compton. On December 31, 1992, pursuant to
a Technical Data Base Purchase Agreement, the Individual Joint
Venturers, through their agent Compton, purchased a 30.35%
undivided interest in the propriety interest in the "Venture
Data", being the Data, excluding the Nova Scotia data, from
Compton.
Paragraph 11 of the Notice of Appeal and paragraphs
9 and 18(dd) of the Reply
15. The total
consideration given by the Individual Joint Venturers for the
Venture Data was $6,373,335 satisfied by $956,002 in cash and
$5,417,333 by way of promissory notes in favour of Compton (the
"Promissory Notes"). This consideration was the same
amount as the consideration given by Compton to Seitel in
proportion to the percentage interest in the Western Data Base
(i.e. 30.35%).
Paragraph 12 of the Notice of Appeal and paragraph
1 of the Reply
16. The Appellant's
Promissory Note is one of the Promissory Notes referred to in
paragraph 15 above.
Paragraph 13 of the Notice of Appeal and paragraph
1 of the Reply
17. The terms of the
Promissory Notes include the following items:
(a) the Promissory
Notes bear interest at a rate of 8% per annum on any unpaid
portion of the principal sum;
(b) pursuant to the
Joint Venture Agreement which is incorporated by reference into
the terms of the Promissory Notes, the Individual Joint Venturers
assigned to Compton sixty percent (60%) of the proceeds of the
sales of licensed copies of the Venture Data and twenty percent
(20%) of the cash flow from the drilling programs (the
"Drilling Program") carried on by the Joint Venture as
repayment of the Promissory Notes, first to interest then to
principal;
(c) the Promissory
Notes are secured by sixty percent (60%) of the sale proceeds
from the disposition of the proprietary interest in the Venture
Data and an undivided twenty percent (20%) of the rights acquired
by the Individual Joint Venturers pursuant to the Drilling
Program (collectively, the "Security"), with no further
recourse against other assets of the Individual Joint Venturers;
and
(d) in the event
that any portion of the Promissory Notes remain unpaid on the due
date, Compton will appoint an independent trustee to sell the
Individual Joint Venturers' interests in the Security, with
such proceeds being applied to the unpaid portion of the
Promissory Notes and any shortfall would be forgiven.
Paragraph 14 of the Notice of Appeal and paragraphs 1, 18(ee) and
18(kk) of the Reply
18. Pursuant to the
Exploration Agreement, a portion of the Appellant's
Consideration was used by the Joint Venture to acquire an
undivided share of the Venture Data. The portion of the
Consideration used to acquire the Appellant's individual
interest in the Venture Data is equal to $100,000 and was
satisfied by cash in the amount of $15,000 and the Promissory
Note referred to in paragraphs 15-17 above.
Paragraph 15 of the Notice of Appeal and paragraph
1 of the Reply
19. The Appellant also
provided cash in the amount of $8,000 and a promissory note for
$7,000 to the Joint Venture.
Paragraph 17 of the Notice of Appeal and paragraphs
12 and 18(jj) of the Reply
20. Compton also sold
percentage interests in the Western Data Base through three other
agreements as follows:
(a) on December 31,
1992, a 28.5714% undivided interest in Ricinus Resources
Ltd.;
(b) on December 31,
1992, a 14.38571% undivided interest to RFM Capital Corporation
Ltd.;
(c) on January 1,
1993, a 26.7936% undivided interest in Ricinus Resources
Ltd.;
Paragraph 18(gg) of the Reply
21. Carl Ringdahl reviewed
the paper copy of the Western Data Base.
Paragraph 10 of the Request and paragraph 1 of the
Response
22. On December 31, 1994,
the Appellant transferred his interest in the assets of the Joint
Venture, excluding the Venture Data, to Compton Petroleum
Corporation.
Paragraph 22 of the Notice of Appeal and paragraph
13 of the Reply
23. The Appellant added
accrued interest expense to his Cumulative Canadian Exploration
Expense ("CCEE") pool.
Paragraph 24 of the Notice of Appeal and paragraph
14 of the Reply
24. Pursuant to the
definition of CCEE in subsection 66.1(6) of the Income Tax
Act and paragraph 66(12.1)(a) thereof, the taxpayer deducted
amounts from his CCEE pool to the extent that these amounts
became receivable by him as a result of sales of the Venture
Data.
Paragraph 25 of the Notice of Appeal and paragraph
1 of the Reply
25. The Appellant filed
his 1992 return of income claiming an addition of $100,000 to his
CCEE pool in respect of his expenditure of funds for the
acquisition of his share of the Venture Data and an additional
$1,000 in respect of the associated set-up costs.
Paragraph 26 of the Notice of Appeal and paragraph
1 of the Reply
26. The Appellant claimed
an addition of $7,718 to his CCEE pool in the 1993 taxation year
and a reduction of $6,396 to his CCEE pool in the 1994 taxation
year.
Paragraph 27 of the Notice of Appeal and paragraph
15 of the Reply
27. In his 1992 and 1994
returns of income, the Appellant claimed deductions as a result
of drawing down his CCEE pool. In particular, the Appellant
claimed Canadian Exploration Expense ("CEE") of $81,655
in 1992 and $14,854 in 1994.
Paragraph 28 of the Notice of Appeal and paragraph
16 of the Reply
28. By letter dated
January 6, 1997, the Minister of National Revenue (the
"Minister") proposed to reassess the taxpayer on the
basis that the Venture Data had a value of $2,050,142 (the
"Minister's Value") and the Appellant's share
of the Venture Data had a value of $32,182, with the result that
$78,676 of the additions to his CCEE account would be disallowed
as follows:
CCEE Pool 1992-1994 in Respect of the Joint Venture
As
Proposed
Filed
Reassessment
1992 (Purchase of Venture
Data)
100,000
32,182
(Set-up
Costs)
1,000
1,000
1993
7,718
2,293
1994
(6,396)
(11,829)
Total
102,322
23,646
Paragraph 29 of the Notice of Appeal and paragraph
1 of the Reply
29. In the Minister's
letter of January 6, 1997, the Minister also proposed to disallow
interest expenses such that only the interest on the
Minister's Value would be allowed, calculated as follows:
Minister's Value of Venture
Data
$2,050,142
Less: Cash
Component
(955,414)
Minister Recognized Value of
Notes
$1,094,728
Interest expense
allowed
= Minister's Value of Notes x interest
expense
claimed
Total Face Value of Notes
= $1,094,728 x interest expense claimed
$5,417,333
Paragraph 30 of the Notice of Appeal and paragraph
1 of the Reply
30. As a result of the
calculation referred to in paragraph 29 above, the Minister
reassessed to disallow the Appellant interest expense in the
amounts of $5,429 for each of the 1993 and 1994 taxation years.
The Minister instead allowed interest expenses on the
Appellant's Promissory Note of $1,375 for each of the 1993
and 1994 taxation years, being the Appellant's proportionate
share of the interest expense relating to the Minister's
perceived value of the Promissory Notes.
Paragraph 31 of the Notice of Appeal and paragraph
1 of the Reply
31. As a result of the
above, the Minister reassessed the Appellant so as to disallow
the deductions described in paragraph 25 to the extent of $78,676
as follows:
1992:
$48,523
CEE deduction disallowed
1994:
$30,153
CEE deduction disallowed
Paragraph 32 of the Notice of Appeal and paragraph
1 of the Reply
32. The balance of the
Compton Debenture of $18,625,000 was $22,775,419 as set at the
end of November 20, 2001.
Paragraph 7 of the Request and paragraph 1 of the
Response
33. The balance of the
Appellant's Promissory Note of $85,000 was $93,242 as at the
end of 2001.
Paragraph 6 of the Request and paragraph 1 of the
Response
34. The Appellant was an
investor in the Petroleum Capital 1987 Partnership, which
purchased 13,795 kilometres of proprietary seismic data. The
partnership financed the $20,524,799 purchase of the proprietary
seismic database by payment of cash in the amount of $2,932,114
and payment by granting an 8% demand convertible debenture in the
amount of $17,592,685 payable to Petroleum Capital Operations
Ltd., a subsidiary of the general partner, Petroleum Capital
Management Ltd. The debenture was converted into Class B
Partnership Units on January 1, 1990, as a result of a demand for
repayment made by Petroleum Capital Operations Ltd. prior to
December 31, 1989.
Paragraph 8 of the Request and paragraph 2 of the
Response
35. The Appellant claimed
CEE in excess of the cash he invested in the Petroleum Capital
1987 Partnership.
Paragraph 9 of the Request and paragraph 1 of the
Response
[7] The facts that were established
may be summarized as follows. In the fall of 1992, Mr. Sapieha,
the President and sole shareholder of Compton Resource
Corporation ("CRC"), was in the midst of building an
oil and gas exploration and development corporation. He
envisioned that an interest in a proprietary seismic database
would be the cornerstone of the company and attempted to gather
investors to join CRC in the purchase of a seismic database.
[8] Mr. Sapieha contacted the
Appellant as one of the potential investors in a joint venture
(the "Joint Venture"). The Appellant was presented
with and reviewed the offering memorandum (the
"Memorandum") which outlined the actions of the
proposed Joint Venture.
[9] The Memorandum outlined the
purposes for which the Joint Venture would purchase an interest
in the technical Venture Data. The Memorandum stated:
(a) [t]he principle objectives
of this offering are to provide subscribers with an opportunity
to participate in the acquisition of, exploration for and
development of Petroleum Rights while at the same time enabling
investors to avail themselves of the income tax deductions and
federal incentive programs which have been proposed to encourage
petroleum and natural gas exploration developments; and
(b) [t]he primary purpose of the
purchase of the Technical Data Base will be to analyze the data
with a view to determining development and exploration prospects
of the Joint Venture and to assist with the identification of
producing PNG Properties for the Joint Venture to purchase.
However, after a review and analysis of the Technical Data Base,
some portion of the data may be licensed or sold to the industry
in a manner and under circumstances consistent with industry
practice.
[10] The Memorandum also stated:
[t]he Joint Venture will re-invest the Investor's
uncommitted Production Cash Flow from the Drilling Program for up
to two years in further exploration and development based on its
analysis of the Technical Data Base.
[11] In the fall of 1992 Mr. Sapieha was
introduced to Mr. Talbot who was the president of Seitel, the
company that owned the proprietary rights of the Western
Geophysical seismic database. After completing his own due
diligence, which included determining a value for the Venture
Data and hiring three independent appraisers, Mr. Sapieha was
satisfied with the quality of the Venture Data and began
negotiations with Mr. Talbot for the purchase of the Venture
Data.
[12] On December 30, 1992, Seitel sold the
seismic business (which included the Venture Data) to CRC for
$21,000,000.00 payable by $2,375,000.00 cash and a debenture of
$18,625,000.00. In its financial statements Seitel recorded the
amount of the promissory note as a contingent liability.
[13] The Appellant testified that he had
been involved in previous investments involving seismic data
because he wanted to be "in on the ground floor" of an
oil and gas exploration and development company and that the tax
deduction was a factor. I accept the testimony of the Appellant
on this point.
[14] On December 31, 1992, the following
day, the Appellant entered into a subscription agreement
and executed a Joint Venture Agreement with CRC (the "Joint
Venture Agreement").
[15] On that day, pursuant to the Joint
Venture Agreement, CRC − as agent, and on behalf of the
Joint Venture participants - acquired a 30.35% undivided interest
in all of the Venture Data, excluding that relating to Nova
Scotia. The Nova Scotia data and the Venture Data combined is
referred to as the "Data". The Appellant's
proportion was a 1.57% undivided interest in the Venture
Data.
[16] Mr. Sapieha then established an office
for CRC. The office included mapping services, a facility for the
storing of well logs, geophysical software and other technical
services. He then began to put together an exploration team for
CRC that was to analyze and review the Venture Data for the Joint
Venture.
[17] Mr. Carl Ringdahl, an experienced
geophysicist, was hired as part of the exploration team. Mr.
Ringdahl testified that the team began reviewing the Venture Data
in the south and "worked up the play" using all of the
information available (including the existing wells and the
Venture Data). Mr. Ringdahl further testified that over a
period of time, he reviewed every seismic line systematically
from south to north in order to ascertain whether there was an
opportunity to develop a trend or play, and to decide whether to
buy into a land sale.
[18] Mr. Sapieha testified that he believed
that by owning the proprietary rights of the Venture Data
(instead of only a copy), the Joint Venture would obtain a number
of benefits. In particular, he planned to reinvest sales of the
Venture Data back into CRC to pay for exploration expenses and to
use the Venture Data in negotiations with other companies to swap
portions of the Venture Data for petroleum rights and interests
in land.
[19] Mr. Sapieha testified that after two
years, the investors would review the progress of the Joint
Venture and determine whether to continue exploration; however,
the Venture Data licensing revenues were reinvested into
exploration for less than two years. On December 31, 1994, the
properties of the Joint Venture were rolled over to Compton
Petroleum Corporation and $375,000.00 was paid on the promissory
notes.
B. Issues:
[20] The issues in these appeals may be
summarized as follows:
(i)
Did the Appellant purchase the Venture Data for the purpose of
exploration for petroleum or natural gas as required in
paragraph 66.1(6)(a) of the Income Tax Act
(the "Act")?
(ii) Does the debenture provided
by the Appellant constitute an expense as required by paragraph
66.1(6)(a)?
(iii) Was the purchase by the
Appellant of the 1.57% interest in the Venture Data a
non-arm's length transaction?
(iv) If the purchase by the Appellant
was an arm's length transaction did the Appellant pay a
reasonable price for his interest?
(v) If so, what is the fair market
value of the Appellant's share of the Venture Data?
C. Analysis
[21] Subsection 66.1(6) of the Act
reads as follows:
66.1 (6) "Canadian exploration expense" of a
taxpayer means any expense incurred after May 6, 1974 that is
(a) any expense including a geological, geophysical or
geochemical expense incurred by the taxpayer (other than an
expense incurred in drilling or completing an oil or gas well or
in building a temporary access road to, or preparing a site in
respect of, any such well) for the purpose of determining the
existence, location, extent or quality of an accumulation of
petroleum or natural gas (other than a mineral resource) in
Canada.
[22] This provision has two requirements -
(1) the outlay must be an expense incurred, and (2) the expense
must be for the purpose of determining the existence, location,
extent or quality of an accumulation of petroleum or natural gas
in Canada.
The Purpose Test
(i) Did the Appellant purchase
the Venture Data for the purpose of exploration as required in
paragraph 66.1(6)(a) of the Act?
[23] The courts have generally held that it
is not necessary that the statutory purpose within a provision be
the taxpayer's primary motive.[1] It is sufficient that the statutory
purpose be an ancillary purpose, even if the primary purpose is a
tax benefit.[2]
This principle was followed with respect to the application of
subsection 66.1(6) in Petro-Canada v. The Queen.[3] At paragraph 34,
Sharlow J.A. said:
... the statutory purpose test in the definition of
"Canadian exploration expense" may be met by an
expenditure that is made for more than one purpose. However, one
of the purposes of the expenditure must be the determination of
the existence, location, extent or quality of an accumulation of
petroleum or natural gas.
[24] Sharlow J.A. then confirmed that in
Global Communications Limited v. The Queen[4] and Gulf Canada
Ltd. v. Canada[5] the courts asserted that "the purpose test in the
definition of 'Canadian Exploration Expense'
("CEE") requires at least some connection between the
purchase of seismic data and actual exploration work". At
paragraph 35 Sharlow J.A. noted that such a test may be too
strict:
Evidence of the actual use of the seismic data for exploration
could provide that connection. However, in the absence of such
evidence, there must be at least a credible plan for the use of
the seismic data in an exploration program within a reasonable
time after its acquisition. A hypothetical connection to
exploration work that might be done in the future cannot
suffice.
[25] In determining whether a taxpayer has
the requisite intention to satisfy the purpose tests, the courts
have looked at both the taxpayer's subjective intention and a
variety of objective factors. (See Moldowan v. The Queen[6] and Stewart v.
The Queen.[7])
This approach was applied to section 66 in Mickelborough v.
The Queen.[8]
It is not sufficient to look at the Appellant's subjective
intention without determining - whether considering all the
circumstances - the taxpayer had a reasonable expectation that
the Venture Data would be used for the purpose of
exploration.
[26] As noted above, the Appellant testified
that when he acquired his interest in the Joint Venture his
primary purpose was to get in on the ground floor of an oil and
gas exploration company. His subjective primary intention is
corroborated by the objective evidence of his acceptance of the
terms in the Memorandum. It might be that these actions alone are
sufficient to meet the purpose test: because the Appellant bought
his 1.57% interest in the Venture Data on the "good
faith" belief that the Joint Venture would follow through on
its planned exploration.
[27] The fact that there was only a two-year
time frame for the Joint Venture does not change my conclusions.
Two years was sufficient to process and review the Venture Data
to determine the possible exploration and development
opportunities.
[28] Although, in previous cases involving
subsection 66.1(6), courts have looked at what was actually done
to the land or with the seismic data, in this case it is not
necessary to look beyond the Appellant's purpose in obtaining
the Venture Data.
[29] Unlike in Global Communications
and Petro-Canada here, the Appellant is an individual who
entered an agreement that stipulated that exploration for oil and
gas would occur. As a consequence, the purpose test should be
applied in relation to the Appellant's purchase. The
Appellant had no control over what would be done and relied on
the stated purpose in the Memorandum. There was no indication
that the Appellant's reliance on the Memorandum was
unreasonable.
[30] It should be noted that CRC took a
number of steps to use the Venture Data for the purpose of
determining the existence, location, extent or quality of
petroleum or natural gas. These steps included setting up an
office, organizing an exploration team and systematically
reviewing all of the Venture Data. In addition, the Venture Data
was re-examined when land became available. In my opinion, such a
systematic use of data is sufficient to meet the purpose test in
subsection 66.1(6).
[31] Counsel for the Respondent exerted much
energy arguing that there were minimal drillings in the areas
where the Venture Data was shot. Based on the evidence that was
presented to me, I cannot accept the general proposition that if
no drilling occurs that seismic data was not purchased for the
purpose articulated in subsection 66.1(6). Seismic data is
used to reduce the risk in drilling, and can be used to determine
both where to drill and where not to drill.
Here, I find that, the Venture Data was used for both purposes;
however mainly to determine where not to drill.
[32] The Appellant's case should be
distinguished from Petro-Canada and Global
Communications. In Global Communications, the
Federal Court of Appeal determined that "Global failed to
establish that it was carrying on the business of oil and gas
exploration" or that Four Star was carrying out exploration
on Global's behalf. In addition, Global failed to show
"its data was being used in an organized and systematic
manner in the search for oil and gas reserves with a view to a
reasonable expectation of profit". In short, the Court
determined that none of the seismic data was actually used in
exploration.
[33] In the trial decision of
Petro-Canada v. The Queen,[9] Justice Bowie determined that only a small
portion (6.5%) of the seismic data was used for the purposes of
exploration. He concluded that the real purpose of acquiring the
data was to transfer CEE. The Federal Court of Appeal upheld
Justice Bowie's decision and determined that it is not
necessary that there is actual use of the data for exploration:
"a credible plan" for the use of the Venture Data,
"within a reasonable period of time after its
acquisition," could be sufficient.[10]
The Debenture
(ii) Does the debenture provided
by the Appellant constitute an expense as required by paragraph
66.1(6)(a)?
[34] Subsection 66(1) precludes the
deduction of an amount that was not an expense. Justice Pratte,
speaking for the Federal Court of Appeal in The Queen v.
Burnco Industries Ltd. et al.[11] held:
In our opinion, an expense, within the meaning of paragraph
18(1)(a) of the Income Tax Act, is an obligation to
pay a sum of money. An expense cannot be said to be incurred by a
taxpayer who is under no obligation to pay money to anyone.
[35] This definition of an incurred expense
has been used to distinguish between situations where money is
owing and when it is contingent on another event. The courts have
held that when the amount is contingent on whether or not
something is to occur the amount is not an expense but a
contingent liability. The Respondent submits that the
Appellant's Note is a contingent liability.
[36] In order to answer this question we
must carefully consider the wording of the Note. The Note reads
as follows:
The undersigned, FOR VALUE RECEIVED, hereby promises to pay to
COMPTON RESOURCE CORPORATION (the "Noteholder") on the
31st day of December 1999, the sum of Eighty-five Thousand
($85,000) in lawful money of Canada together with any accrued and
unpaid interest on any unpaid portion of the said principal sum,
which interest shall accrue from and after December 31, 1992, at
the rate of eight percent (8%) per annum calculated annually and
not in advance.
The terms of repayment of this promissory note to the Noteholder
shall be limited to those terms set out herein and no other
action shall lie against the undersigned in respect of any
covenant for payment.
The indebtedness of the undersigned shall be reduced only in
accordance with the provisions set forth in Schedule 1
attached hereto, which schedule is incorporated into and forms
part of this promissory note.
This promissory note shall be non-negotiable and non-assignable
by the Noteholder without the prior written consent of the
undersigned and the assignee first agreeing in writing with the
undersigned to be bound by the terms hereof. The Noteholder shall
have no right of recourse against any legal person other than the
undersigned in respect of the covenants contained herein and
shall further have no greater rights hereunder than as are
conferred hereunder and in Schedule 1 attached hereto.
DATED this 30th day of December, 1992.
[37] Sections 2 and 3 of Schedule 1 to the
Note stipulate that the interest and principal shall be paid
through the proceeds of the sales of the licensed copies of the
Venture Data and through the cash flow from the drilling program.
If the amount is not paid in full by December 31, 1999 - that is
in the event of default - section 7 provides as follows:
7. If the
indebtedness created hereby either with respect to principal or
interest remains in whole or in part unpaid as of December 31,
1999, the Noteholder will appoint an independent trustee to sell
for cash only:
a. the Technical
Assets; and
b. an
undivided 20% of the undersigned's Participating Interest in
Petroleum Rights acquired by the Joint Venture pursuant to the
Drilling Program.
The proceeds of the sale will be allocated as follows:
a. Technical
Assets:
i. 60%
(net of commissions, if any) to the Noteholder as a reduction of
amounts owing by the undersigned under this promissory note;
and
ii. 40%
(net commissions, if any) to the undersigned;
b. an
undivided 20% of the undersigned's Participating Interest in
Petroleum Rights acquired by the Joint Venture pursuant to the
Drilling Program:[12]
100% to the Noteholder as a reduction of amounts owing by the
undersigned under this promissory note, allocated firstly as to
interest and the remainder as to principal.
Any balance owing by the undersigned on this note after the
allocation of the proceeds of the sale as described above will be
forgiven by the Noteholder and the undersigned will have no
further liability under this promissory note.
The actual terms of the Note require payment of 60% of the
profits from the sale of the Venture Data and 20% of the
Appellant's drilling rights acquired by the Joint Venture
pursuant to drilling. Thus, if no profits were made the
noteholder would, at a minimum, receive 60% of the proceeds of
sale of the Venture Data.
[38] Black's Law Dictionary, 8th
Edition, defines "contingent liability" as:
a liability that will occur only if a specific event happens;
a liability that depends on the occurrence of a future and
uncertain event.
[39] The Oxford English Dictionary defines
"contingent" as "liable to happen or not; of
uncertain occurrence or incidence".
[40] There have been several occasions where
the courts have been called upon to determine whether there is a
contingent liability.
[41] In Canadian Pacific Limited v. The
Minister of Revenue (Ontario)[13] the Ontario Court of Appeal
determined that not knowing what the liability will be does not
make it contingent. In determining there was not a contingent
account the Court stated, "... where a taxpayer has incurred
liability in a taxation year, and has placed money into an
account to enable it to fulfil the liability, uncertainties
surrounding the amount which will ultimately be paid will not
per se result in the liabilities being classed as a
contingent account".[14]
[42] In Wawang Forest Products Limited
and Nerak Contractors Inc. v. The Queen[15] the Federal Court of Appeal
considered whether the taxpayer was entitled to deduct the full
cost of work completed by the subcontractors that year even
though a portion of the payments were held back until the workers
produced clearance certificates from the Workers'
Compensation Board.
[43] Justice Sharlow held that the payments
were not contingent liabilities. In reaching this conclusion,
Justice Sharlow noted that the three uncertainties in Samuel
F. Investments Limited v. M.N.R.[16] do not by themselves establish a
test to determine whether a liability is contingent.[17] Instead, Sharlow
J.A. reaffirmed that the generally accepted test was set down by
Lord Guest in Winter and Others (Executors of Sir Arthur
Munro Sutherland deceased) v. Inland Revenue Commissioners.[18] At page 262
Lord Guest said:
I should define a contingency as an event which may or may not
occur and a contingent liability as a liability which depends for
its existence upon an event which may or may not happen.
[44] At paragraph 15 Sharlow J.A. further
stated: "nor does a legal obligation to pay an amount become
contingent merely because payment may be postponed in certain
events or no date is stipulated for payment."
[45] In Frederick W. Hill v. The
Queen,[19]
Justice Miller determined that there was no contingency
where the mortgagee could not seek any deficiency but could take
possession or sell the land. In reaching this conclusion Miller,
J. said, "To deny interest deductibility on the basis that a
limited recourse mortgage creates a contingent liability, creates
the possibility of every such mortgagor being denied any interest
deductibility."[20]
[46] When we look strictly at the terms of
the Note there are a number of apparent uncertainties. However,
in the light of Wawang and Canadian Pacific
Limited, I find that the Note is not a contingent liability
simply because we do not know how much or at what time the
promissory note will be paid. However, although there is a
provision that requires the noteholder to appoint a trustee to
sell the Venture Data the actual sale of the Venture Data could
be contingent if there was some uncertainty if the Venture Data
can be sold.
[47] It is in this instance where the terms
of the contract may not be enough to determine whether or not a
liability is contingent. In Webster et al. v. The Queen[21] Bowman A.C.J.
determined that despite the fact that the seismic data in
question was purchased from the same parties under substantially
similar terms as those in Global Communications the matter
should proceed to trial.
[48] Associate Chief Justice Bowman's
decision was upheld by the Federal Court of Appeal where
Rothstein J.A. wrote for the majority:
In Wawang, supra, the question of contingency was
dependent on the terms of certain contracts. In my opinion, the
fact that the terms of the contracts were the relevant
considerations in Wawang, supra, does not necessarily mean
that, in every case, it will only be the terms of the contracts
that will be determinative of whether a liability is contingent
or absolute. Each case will depend on its own facts.
Referring to the observation in Wawang, supra, that the
risk of non-payment does not render a liability contingent,
Strayer J.A. says that the realization of revenues or sales
proceeds, even if highly probable, would not make a liability
absolute. However, as I understand it, it was the Minister's
concern that the revenues and proceeds of sale of the seismic
assets would be insufficient to satisfy the tax appellant's
liability that gave rise to the reassessment. By adducing
valuation evidence, they apparently wish to dispel this concern.
It may be that whether the liability is contingent or absolute
will not turn on valuation evidence and will be based on whether
the seismic assets is or is (sic) not within the
discretion of the tax appellants if revenues are insufficient to
pay their liability. However, I would, at this stage, prefer to
leave these considerations to the Trial Judge.[22]
[49] Ultimately, to determine whether the
Appellant's Note is a contingent liability it is necessary to
look at the surrounding facts. The ongoing market for quality
seismic data, and relative rarity of such quality (especially at
the time the Venture Data was purchased) leads me to the
determination that the Venture Data could be sold. I find that at
the time the Appellant purchased his interest in the Venture Data
there was no contingent liability because the Venture Data was
required to be and could be sold upon default.
[50] The fact that the noteholder has not
yet appointed an independent trustee does not make the Note
contingent. To determine otherwise would create an unnecessary
ambiguity within our tax system and encourage a system where a
transaction that is originally certain could become contingent
due to someone's failure to comply with a contract or some
other uncertain event.
Arm's Length Transaction
(iii) Was the Appellant's purchase
of the 1.57% interest in the Venture Data a non-arm's length
transaction?
[51] This was not an issue in the
Minister's original assessing position. As a consequence, the
Respondent has the burden of proving that this is a non-arm's
length transaction.
[52] Subsection 251(1) of the Act
provides:
251. (1) For the purposes of this Act,
(a) related
persons shall be deemed not to deal with each other at arm's
length; and
(b) it is a
question of fact whether persons not related to each other were
at a particular time dealing with each other at arm's
length.
[53] The parties are in agreement that it is
not an issue of whether the Appellant and Mr. Sapieha are
"related persons".
[54] The Appellant's counsel submits
that Mr. Sapieha was strictly an agent and that the Court has to
look through the agency to see if the Appellant was dealing at
arm's length with CRC. The Appellant's counsel submits
that the issue is the Appellant's relationship to CRC.
[55] The Respondent's counsel submits
that the Court should only look at Mr. Sapieha's
relationship to CRC and find that because Mr. Sapieha was the
sole director and shareholder of CRC the transaction was
non-arm's length.
[56] In Peter Cundill & Associates
Ltd. v. The Queen[23] McArthur J. discussed the factors to
be considered in determining whether there is an arm's length
transaction. He stated that the parties are not at arm's length:
(1) if there is the existence of a common mind that dictates the
terms of the bargain on both sides of the transaction; (2) if the
parties to the transaction are acting in concert and without
separate interests; or (3) if there is de facto
control.
[57] In the case at bar, the Appellant chose
to accept the terms within the Memorandum specifying that CRC
would be the operator of the Joint Venture and purchase an
undivided interest in the Venture Data for the investors. The
Memorandum indicated that the exploration was to occur in Western
Canada. Thus, although Mr. Sapieha devised the plan and
introduced the Appellant to the Memorandum, it was ultimately the
Appellant's decision to invest. No evidence was presented at
trial that indicated that Mr. Sapieha influenced the decision of
the Appellant or any of the Joint Venture participants. The
appropriate relationship to assess is that between CRC and the
Appellant.
[58] The Appellant chose to subscribe to the
Joint Venture and executed the subscription agreement, confirming
his agreement to be bound by the Joint Venture Agreement and the
Memorandum.
[59] In H.T. Hoy Holdings Limited v. The
Queen[24] McArthur J. addressed the significance of
choice in arm's length transactions:
Of importance in establishing that the vendor and the
purchaser dealt with each other at arm's length is of course
the fact that Mr. Cloutier did not have to purchase Plaza nor did
Mr. Hoy have to sell to him. Each party had his or its own
individual needs [...] No one was obliged to act. Each
participant was looking after his or its own interest while
having a common goal.
[60] There is no evidence to indicate the
Appellant and CRC, through Mr. Sapieha, acted in concert
without separate interests. Nor was there any evidence that
Mr. Sapieha unilaterally imposed the purchase of the Venture
Data on the Appellant or had the power to do so. There was no
collusion to inflate the price of the Venture Data because the
Appellant had accepted the terms of the Memorandum which limited
the purchase price to not higher than the lowest valuation. Here,
there is no party in a position to impose its will on others and
the parties cannot be said to be acting in concert without
separate interests.[25] I have therefore concluded that the purchase by the
Appellant of the 1.57% interest in the Venture Data was an
arm's length transaction.
The Reasonableness of the Expense
(iv) If the purchase by the Appellant
was an arm's length transaction did the Appellant pay a
reasonable price for his interest?
[61] Section 67 of the Act
provides:
67. In computing income, no deduction shall be made in respect
of an outlay or expense in respect of which any amount that is
otherwise deductible under this Act, except to the extent that
the outlay or expense was reasonable in the circumstances.
[62] Section 67 requires that the expense be
reasonable in the circumstances. In this situation, the Appellant
paid $100,000.00 in return for an undivided interest in the
Venture Data. Pursuant to the Joint Venture Agreement, dated
December 31, 1992, this undivided interest gave the
Appellant the ability to use the Venture Data for independent
exploration and to receive a percentage of any proceeds and
income from the PNG properties, Drilling Program and sales of
copies of the Venture Data.
[63] In deciding to make an investment in
the Joint Venture, the Appellant relied on the terms of the
Memorandum which stated, "The purchase price of the
Technical Data Base will not be higher than the lowest appraised
value received from three experienced, independent
valuators".
[64] Before the Venture Data was purchased,
on behalf of the Joint Venture participants, Mr. Sapieha took
several steps to determine an appropriate purchase price. He
reviewed the Data (which included the Nova Scotia data) and
looked at it on an area-by-area basis. In arriving at a
valuation, in consultation with Mr. Fairs and
Mr. McCombs, he looked at the replacement cost of the Data
and considered the fact that it was likely he could have the Data
shot at a reduced price because the market was depressed and
crews were looking for business. Mr. Sapieha was unaware of
previous sales of the Data and believed it was valued at
$30,300,000.00.
[65] As indicated in the Memorandum, Mr.
Sapieha obtained three appraisals from Mr. Jaskela, Mr. Curts and
Mr. Webb. Messr. Jaskela, Curts and Webb were individuals who
regularly valued seismic data. These independent appraisals
of the Venture Data came back significantly higher than the
amount of the purchase price.
[66] Mr. Jaskela, a professional
geophysicist, appraised the Venture Data at $39,787,800.00. He
testified that in doing so, he determined the cost to acquire or
shoot the Venture Data and then applied a discount of 25%- 50%
per kilometre. The discount varied by area and was based on the
quality of the Venture Data. There was no reduction based on the
age of the Venture Data as he opined that seismic data retains
its value for over 30 years.
[67] Mr. Brian Curts, a geophysicist from
Curts Seismic Ltd. testified that in determining the value of
seismic data he primarily looks at the exploration value. Mr.
Curts first looked at the cost related to the location of the
Venture Data and then at the "source effort". Once he
determined the cost to re-shoot the Venture Data in 1992, he
added costs such as permits. He then applied a discount to the
total based on lack of quality, age and the need to reprocess
some of the Venture Data. He applied a separate price for the 3-D
data. He estimated the Venture Data was worth $41,930,760.00.
[68] Mr. Webb, a professional Engineer from
Citadel Engineering Ltd., testified that they verified the data
length and looked to see if there were any existing reserve
accumulations that would enhance or reduce the price/value per
kilometre per program. He established the sales value of a
licensed copy by calling five or more brokerage firms and then
used a multiple of the replacement value to arrive at fair market
value. He determined the replacement of the Venture Data value
was $ 56,285,000.00 dollars, the estimated resale value was
$32,866,000.00 and the fair market value was $31,912,000.00. Mr.
Webb also valued the Nova Scotia data.
[69] In my opinion, it is relevant that on a
previous occasion, Mr. Jaskela and Mr. Webb had been asked by Mr.
McCombs (a former business partner of Mr. Sapieha) to value
the seismic data that the Petroleum Capital Partnership was to
purchase. During the period that Mr. Sapieha was creating his
business plan he was in discussions with Revenue Canada (as it
then was) about the valuations of the seismic data used in that
partnership. The purchase price was approximately $20,500,000.00
and was based on those valuations. The investors were assessed
because Revenue Canada determined the purchase price of the data
was in excess of the fair market value. By a letter dated
September 30, 1992, Revenue Canada advised Mr. Sapieha that the
settlement offer relating to "The Petroleum Capital 1987-1
Partnership", which reduced the tax deduction by
approximately one-third, was accepted. Mr. Webb and Mr.
Jaskela used a similar method in appraising that seismic data
(i.e. the seismic data in the Petroleum Capital 1987-1
Partnership) as they used in determining a value for the Venture
Data.
[70] The purchase price of the Data
(including the Venture Data) was less than two-thirds of Mr.
Webb's appraisal. Mr. Webb's appraisal was the lowest for
the Venture Data.
[71] Although in the trial decision of
Petro-Canada Bowie J. discredited the replacement cost
methodology in determining the fair market value of seismic data,
I was advised that at the time of the transaction in question it
was the standard approach of businessmen in Calgary. Canadian
Hunter used that method in obtaining a value of $27,000,000.00
for the Data and Mr. Webb testified that he did not know of
anyone in the oil business with the designation of valuator. Thus
while it may be that relying on the replacement cost methodology
is inappropriate for determining the fair market value of seismic
data, I find it is not unreasonable for such valuations to be
relied upon for this transaction.
[72] In Petro-Canada Sharlow J.A.
reconfirmed the applicability of the test for reasonableness as
articulated in Gabco Limited v. M.N.R.[26] At page 5216 of Gabco
Cattanach J. articulated the test for determining whether
something was reasonable:
It is not a question of the Minister or this Court
substituting its judgment for what is a reasonable amount to pay,
but rather a case of the Minister or the Court coming to the
conclusion that no reasonable businessman would have contracted
to pay such an amount having only the business consideration the
appellant had in mind.
[73] Given the highly speculative nature of
the oil and gas exploration industry, the fact that seismic data
is very difficult to value as well as the experience of Mr.
Sapieha in the oil and gas exploration industry, this is not an
appropriate case to question the participants' business
judgment. This is not a situation where paying more than the fair
market value would be unreasonable. However, I find that a
reasonable businessman in the Appellant's position would have
paid at least $100,000.00 in return for the undivided interest in
the Venture Data and the unlimited access that the Appellant
obtained.
[74] Since this was an arm's length
transaction, and the expense was reasonable this is not an issue
of fair market value. That being said, I will briefly address the
evidence relating to the fair market value. It is significant
that there has been no qualified opinion relating to the specific
value of the Appellant's 1.57% undivided interest. Mr
Siebert, the only expert qualified to opine on the fair market
value of the Venture Data, was not instructed by the Respondent
to value the Appellant's interest. Mr. Siebert's opinion
was that the fair market value of the Venture Data would not
exceed $6,000,000.00. As a consequence, I find that it does not
address the issue at hand.
[75] Moreover, I have trouble accepting much
of Mr. Siebert's opinion related to the value of the entire
Venture Data for several reasons. Mr. Siebert failed to take into
account the exploration value of the Venture Data and the fact
that there might have been a special purchaser. He was also
conservative in his cash flow projections and discount rates.
[76] For the reasons as outlined above I
have concluded that the appeals should be allowed, with
costs.
Signed at Vancouver, British Columbia, this 26th day of
January 2005.
Little J.
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