Noranda Mines Ltd. v. MNR, 87 DTC 379, [1987] 2 CTC 2089 (TCC)

Bonner, T.C.J.: —Noranda Mines Limited appeals from a reassessment of income tax for the 1972 taxation year of its predecessor, Orchan Mines Limited. The appellant is an amalgamated company formed by the merger on December 31, 1978, of Noranda Mines Limited (hereinafter "Noranda") and Orchan Mines Limited (hereinafter "Orchan"). Both Noranda and Orchan were public companies whose shares were listed on stock exchanges. Both were part of what was sometimes called "the Noranda group".

Pursuant to an Agreement dated December 28,1972, Orchan purchased from Noranda a 75 per cent interest in a resource property known as "the Norita property". The consideration was $500,000 plus a share of future net profits. The respondent, in making the reassessment now in question, proceeded on the basis that Noranda and Orchan were not dealing with each other at arm's length with the consequence that the cost to Orchan is, by virtue of subparagraph 59(3)(d)(i) of the Income Tax Act, deemed to be the amount included in Noranda's income by virtue of paragraph 59(3)(c) of the Act. The parties agreed that Noranda and Orchan were not "related persons" within the meaning of paragraph 251(1)(a) of the Act and thus were not, by virtue of that provision, deemed to deal with each other at arm's length. Thus, they agreed, the issue is whether, in point of fact, Noranda and Orchan were persons who were, on December 28, 1972, dealing with each other at arm's length.

Although Noranda did not have de jure control over Orchan there existed at the relevant time a close relationship between the two companies. In December of 1972 Noranda owned 45.3 per cent of the common shares of Orchan. Kerr Addison Mines Limited (hereinafter "Kerr Addison”), 41 per cent of the shares of which were owned by Noranda, and Pamour Porcupine Mines, Limited (hereinafter "Pamour"), 45 per cent of the shares of which were owned by Noranda, together held a further 5.53 per cent of the common shares of Orchan. The information circular dated March 15, 1973, which accompanied the Notice of the Annual Meeting of Shareholders of Orchan named only Noranda as principal shareholder. The shares of both Pamour and Kerr Addison not owned by Noranda were broadly distributed among the public.

At the relevant time two of the five directors of Orchan were linked to Noranda. They were Donald Earl Schmitt, who was vice-president — Mines of Noranda and also a director of Pamour, and W.S. Row, a director and executive vice-president of Noranda who served as well on the boards of both Kerr Addison and Pamour. Other officers of Noranda served as officers of Orchan, Kerr Addison and Pamour. The position is set forth on Exhibits A-2 and A-3, copies of which are schedules I and Il to these reasons.

The only witness called at the hearing of this appeal was Mr. Schmitt. He graduated in 1937 from the University of Toronto as a mining engineer. Since then his entire career has been in mining. He retired in 1981 from a senior position in the Noranda group. Mr. Schmitt impressed me as a careful and candid witness and as one to be believed on matters which he was able to clearly recall.

Mr. Schmitt outlined Orchan's historical background. He became associated with Orchan in 1962. It had acquired claims in the Matagami area of the Province of Quebec. A Mr. J.P. Dolan of Orchan approached Noranda with a view to securing the assistance of Noranda in bringing the property into production. Mr. Schmitt, who had previously served as manager of Pamour, was assigned by Noranda to work on the project. After exploration of the property it was concluded that Orchan had a good grade of ore, but that the deposit was of limited size. Noranda decided to provide the money required to bring the property into production. In consequence it became a shareholder in Orchan to the extent of 45.3 per cent.

The Orchan mine utilized work force, mining equipment and a mill transferred to it from the Waite Amulet mine. The latter operation had run out of ore.

At about the same time as the Orchan mine was being brought into production Noranda was approached by a Mr. Hosking of New Hosco Mines. That company was interested in securing financing for the development of its mineral deposit located some 25 miles from the Orchan property. An agreement was reached and the financing was provided. An arrangement was made whereby Orchan included a circuit in its mill capable of treating the New Hosco ore at a rate of 900 tons a day.

Notwithstanding the arrangement with New Hosco, the mill which Orchan had acquired from Waite Amulet had surplus capacity. Accordingly, ore from other sources was sought. An open pit mine was developed to the south on the Bell Allard property acquired by Orchan. It served as a source of feed for the Orchan mill. Yet another ore body known as the Geron Lake deposit was acquired and mined by Orchan.

Mr. Schmitt stated that during a period of a few months in 1971-72 he was "dickering" with one J.J. Byrne of Norita Quebec Mines Limited (hereinafter "Norita") with regard to an indicated mineral deposit (hereinafter "the Norita property") in the Matagami area. At the time Orchan was, he said, “straining to keep its mill filled". Mr. Schmitt, then president of Orchan, was interested in the Norita property as a potential source of ore. He therefore sought to secure for Orchan the right to test and explore Norita's indicated deposit. According to Mr. Schmitt, it was as a result of a chance meeting with a Mr. Brown, head of Noranda Exploration Company Limited (hereinafter "Norex"), that he learned for the first time that Norex had an option on the Norita property. Norex was a wholly-owned subsidiary of Noranda. It acted as Noranda's agent. The Option Agreement required Norex to spend $50,000 on the Norita property on or before December 31, 1971, and a further $100,000 on or before December 31, 1972, in order to keep the option alive. It provided further that in the event of the exercise of the option a new company would be formed whose shares would be held as to 25 per cent by Norita and as to 75 per cent by Norex.

Mr. Schmitt stated that Noranda had no interest in the Norita property "per se". He explained that Noranda's agent, Norex, did have a general mandate to option and explore mineral deposits in the area, but that there were only two companies which had mills which could treat any ore which might be produced from the Norita property. One was the Orchan mill and the other belonged to a company called Matagami Lake which, Mr. Schmitt said, had plenty of ore.

In 1972 J.M. Slack, an employee of one of the companies the Noranda group, made a study of the Norita project. Mr. Slack was described by Mr. Schmitt as “his right-hand man". A memo outlining the results of his work was sent on October 24th of that year to Mr. Schmitt. That memo stated in part as follows:

The optimum and only satisfactory after-tax rate of return is achieved when Orchan owns the resource. Capital costs are written off against current Orchan income and earned depletion for the period after 1976 is claimed faster. Also as an Orchan resource the concentrate can be sold in the preferred (old) pool providing a 1¢ per pound premium over the new concentrate pool. A satisfactory return requires that only incremental operating costs be charged against the project.

The new company as proposed in the Norita option appears to be an unsatisfactory vehicle in several respects (capital cost allowances depletion claimed, price received and operating costs). A third alternative, Noranda purchasing the resource outright achieves equal return from capital cost allowances and depletion but receives a lower “new pool” price and to achieve any return would require that Orchan dramatically lower the custom milling and management charges. These charges are reasonable and lowering them would be a poor precedent for Orchan's current and future negotiations with other parties in the area.

The project would be sure to proceed and Norita Quebec's interests would be equivalent to those set out in the option, plus their investment would be returned immediately and a higher price received for the concentrate. They would continue to participate in any further mineral occurrence on the property. Any advantage from capital appreciation would still accrue to Norita Quebec — perhaps more directly.

Orchan's purchase of Noranda's Norita interest raises the question of who should be paying for exploration on the substantial target outlined in the Matagami area. The tidiest and best arrangement would be to use Orchan as the corporate vehicle for acquiring ore reserves in the area. It follows that they would be responsible for all exploration expense and that this expense, generally, would be determined by Orchan's long-term ore reserve requirements.

On October 27, 1972, Mr. Schmitt sent a memo to J.O. Hinds, executive assistant to the president of Noranda, and W.L. Brown, head of Norex, to which was attached Mr. Slack's memorandum. In it he recited that Mr. Slack had reported that he had discussed his conclusions with a number of persons therein named. Those persons all appear to have been officers or employees of companies in the Noranda group. They included persons who had responsibility in the tax and legal departments of Noranda. The purpose of the memo was to enquire whether Noranda was interested in a costsharing exploration program.

Minutes of a meeting of the board of Orchan on October 31, 1972, read in part as follows:

The Chairman reported that a feasibility study of the Norita property had been made by the Orchan staff in June, 1970 and the indicated tonnage was found to be insufficient for a viable mining operation. Shortly thereafter, (July 1970) Noranda Exploration had entered into an option agreement with Norita and their work had increased the indicated ore to 1,662,000 tons grading 6.6% zinc, 0.65% copper and 0.95 ounces of silver per ton including 20% dilution. A recent study indicated that the optimum after tax return could be achieved only if Orchan owned the resource. After discussion, on motion by Mr. Dolan, seconded by Mr. Dumas and unanimously carried, the President was authorized to continue studies of the Norita property and negotiations with Noranda Exploration to take over the Norita ground or to participate with Noranda, any agreement to be subject to the approval of a Committee of at least three members of the Board with information to be sent to all Members of the Board.

In November of 1972 a Mr. Beggs prepared a review and revision of Mr. Slack's study. This work was done for Norex.

On November 30, 1972, a proposal was submitted to Norita by Norex and Orchan. It recited that a study had indicated that if a new company were formed to put the Norita property into production, as envisaged by the Option Agreement,

. . .a total operating profit of $4,465,817 for a capital expenditure of $5,256,610, resulting in a loss of $790,793 might be expected.

The proposal proceeded with a review of the choices open to Norex. That section of the document reads in part as follows:

(c) Norex has been approached by Orchan Mines Limited who has indicated its willingness to participate in exploiting the Norita Property on the strength of its evaluation based on the present ore reserves. In light of this, Norex could seek to amend its agreement with Norita to allow Orchan to participate in a manner acceptable to Orchan.

Norex considers alternative (c) to be the most attractive at this time and proposes that Norita agree to allow Orchan to participate. This would allow immediate exploitation of known ore and would enable further exploration of the Norita Property to continue.

In the result Norex and Norita amended the Option Agreement to enable Norex, upon the exercise of its option, to acquire a 75 per cent undivided interest in the Norita property. Orchan then purchased Norita's 25 per cent undivided interest in the property and the 75 per cent interest of Norex, all as contemplated by the proposal.

Mr. Schmitt testified that his only interest in the Norita property was for Orchan. The property did not fall within his area of responsibility as vice- president of Noranda. That responsibility related only to operating mines. Noranda's agreement to sell followed consultation with a number of people, approval by Mr. Powis, president of Noranda, and, Mr. Schmitt assumed, formal approval by the Noranda board. Mr. Schmitt stated that as president of Orchan he did report quarterly to the Noranda board on the operations of Orchan. That report was, he said, of an informational nature. Major expenditures of Orchan were approved by the Orchan board and not the Noranda board.

There existed a Management Agreement whereby Noranda provided the management of the operations of Orchan and other companies in the Noranda goup in consideration of a fee. Mr. Slack, the author of the October 24, 1972 memorandum to Mr. Schmitt, and the persons who worked with him in putting together that report all, according to Mr. Schmitt, got their pay cheques as part of a centralized service rendered by Noranda. I infer that they worked as required from time to time for any company within the Noranda group which then required their talents. Mr. Schmitt stated that under the Management Agreement charges against Orchan were levied on the basis of the proportion of time spent in the central office for each account which they serviced. The following explanation is given in a document filed as part of Exhibit A-1:

In prorating and billing corporate costs incurred on behalf of subsidiary companies, Noranda Mines Ltd. uses a fixed annual fee rather than a direct billing method for services provided. This annual Corporate Service Fee is established and agreed to at the commencement of the calendar year; the fee being an allocation from estimated Corporate Departmental Costs for the year.

The same method of allocation is used for all wholly or partially-owned consolidated subsidiaries and associated companies which Noranda manages for the owners.

The consideration given by Orchan in exchange for Noranda's interest in the Norita property was, the parties agreed, equivalent to the fair market value of that interest.

In at least one respect Mr. Schmitt's memory appears to have failed him. It would seem that he did not, as he suggested, proceed on behalf of Orchan to negotiate with J.J. Byrne for the acquisition of the Norita property and learn only by chance that Norex had already acquired an option on it. That testimony is impossible to reconcile with the following statement made by Mr. Schmitt in his memorandum of October 27, 1972, when events were fresh in his mind:

It may be appropriate to recall that Orchan did a feasibility study on Norita in May of 1970, and following discussions with Dr. Brown in July 1970, joint negotiations with Mr. J.J. Byrne resulted in an option agreement between Noranda Exploration and Norita . . .

It seems clear that the acquisition by Norex, acting as Noranda's agent, resulted from the joint efforts of Norex and Orchan. Thus, the acquisition now in question should be viewed as the culmination of (a) joint efforts by Norex and Orchan to secure the property; (b) the optioning of the property by Norex; (c) work by Norex on the property supporting a conclusion that there was more ore than previously thought; (d) consideration of the questions by whom and how the resource might be exploited in order to yield the maximum after-tax return; and (e) a conclusion that such return could be achieved only if Orchan owned the resource.

The process just described, especially step (d), is not typical of what one might expect of parties dealing with each other at arm's length.

The question of the presence or absence in fact of an arm's length relationship has been explored by the courts in many cases. The Supreme Court of Canada dealt first with the matter in M.N.R. v. Sheldon's Engineering, Ltd., [1955] C.T.C. 174; 55 D.T.C. 1110. At page 180 (D.T.C. 1113) Locke, J., speaking for the Court, said the following:

Where corporations are controlled directly or indirectly by the same person, whether that person be an individual or a corporation, they are not by virtue of that section deemed to be dealing with each other at arm's length. Apart alto- gether from the provisions of that section, it could not, in my opinion, be fairly contended that, where depreciable assets were sold by a taxpayer to an entity wholly controlled by him or by a corporation controlled by the taxpayer to another corporation controlled by him, the taxpayer as the controlling shareholder dictating the terms of the bargain, the parties were dealing with each other at arm's length and that Section 20(2) was inapplicable.

The decision of Cattanach, J. in M.N.R. v. T.R. Merritt Estate, [1969] C.T.C. 207; 69 D.T.C. 5159, is also helpful. At page 217 (D.T.C. 5165) he said:

In my view, the basic premise on which this analysis is based is that, where the “mind” by which the bargaining is directed on behalf of one party to a contract is the same “mind” that directs the bargaining on behalf of the other party, it cannot be said that the parties were dealing at arm's length. In other words where the evidence reveals that the same person was "dictating" the "terms of the bargain” on behalf of both parties, it cannot be said that the parties were dealing at arm's length.

A few years later the importance of bargaining between separate parties, each seeking to protect his own independent interest, was again emphasized in the decision of the Exchequer Court in Swiss Bank v. M.N.R., [1971] C.T.C. 427; 71 D.T.C. 5235. At page 437 (D.T.C. 5241) Thurlow, J. (as he then was) said:

To this I would add that where several parties — whether natural persons or corporations or a combination of the two — act in concert, and in the same interest, to direct or dictate the conduct of another, in my opinion the "mind" that directs may be that of the combination as a whole acting in concert or that of any of them in carrying out particular parts or functions of what the common object involves. Moreover as I see it no distinction is to made for this purpose between persons who act for themselves in exercising control over another and those who, however numerous, act through a representative. On the other hand if one of several parties involved in a transaction acts in or represents a different interest from the others the fact that the common purpose may be to so direct the acts of another as to achieve a particular result will not by itself serve to disqualify the transaction as one between parties dealing at arm's length. The Sheldon's Engineering case (supra), as I see it, is an instance of this.

Finally, it may be noted that the existence of an arm's length relationship is excluded when one of the parties to the transaction under review is in a position in which he has de facto control of both parties. In this regard reference may be made to the decision of the Federal Court of Appeal in Robson Leather Company Ltd. v. M.N.R., [1977] C.T.C. 132; 77 D.T.C. 5106.

The issue in this appeal is essentially one of fact. The onus rests on the appellant to establish on the balance of probabilities that Noranda and Orchan did in fact deal with each other at arm's length. That onus has not been discharged.

From a practical standpoint Noranda controlled Orchan. It would be unrealistic to suppose, in light of the shareholdings outlined earlier, that Orchan was in a position to act exclusively on the basis of its own perception of its own best interest. It is unlikely that Noranda could ever have been prevented from having its way with Orchan. Anyone seeking to stop Noranda from doing so would have needed to marshall the votes of the 49 per cent of the shares of Orchan in the hands of the general public and, as well, the votes attached to some at least of the shares held by Kerr Addison and Pamour. That person, in seeking to influence the voting of the Orchan shares held by Kerr Addison and Pamour, would be obliged to contend with the fact that Noranda held substantial blocks of shares in each of those two companies and was tied to those companies as well, at least to some extent, by interconnecting directors and officers. The fact that Noranda, from a practical standpoint, controlled Orchan is one which, though not determinative, nevertheless weighs heavily against the appellant's position.

The second important consideration in this case is what I might describe as the "group approach" utilized in managing the operations of Orchan and Noranda. Orchan and Noranda were both managed at the staff level by persons who worked interchangeably for other companies in the Noranda group. Furthermore, the presence in various companies of the group of common directors and officers served to foster a group approach at senior management levels. The memorandum of October 24, 1972, prepared by Mr. Slack reflects the approach. It is an effort to determine not what is best for Orchan alone but, rather, what is best for the group. That approach, coupled with the co-operative approach which led to the acquisition of the option in the first place, militates against a conclusion that separate "minds" directed the bargaining on behalf of Orchan and Noranda. I have not overlooked the fact that minutes of the October 31, 1972, meeting of the Orchan Board tend to suggest a measure of independence. However, having regard (a) to the linkages with Noranda already outlined; and (b) to the repeated emphasis on the choice of Orchan on the basis that exploitation of the resource by it (as opposed to others in the group) was the method of yielding the best return, I am not satisfied that the overall interests of the group were not at all times the predominant consideration.

Counsel for the appellant argued that Noranda and Orchan were public companies the directors and officers of which were under a fiduciary duty to their corporations. He said that to suggest that an officer or director of Orchan could be guided in such a way to prefer one interest over another would be to suggest that he was failing to discharge the fiduciary duty he owed to Orchan. A finding that the same mind directed the actions of both parties to the transaction does not, in my view, involve a finding that the mind was not, as regards both corporations, acting honestly, in good faith and with the best interests of both corporations in view.

On behalf of the appellant stress was also laid on the admitted fact that the consideration flowing from Orchan represented fair market value. The arm's length test looks to the presence or absence of the power to influence or control. An unusual result may well be indicative of the absence of an arm's length relationship, but the fact that a result is typical of what might be expected between parties who do deal at arm's length does not negative the existence of a non-arm's length relationship.

For the foregoing reasons the appeal will be dismissed.

Appeal dismissed.

SCHEDULE I

1972 DIRECTORS OF NORANDA MINES LIMITED AND OTHER COMPANIES

SOURCE — 1972 ANNUAL REPORTS

•Neither a Director nor an Officer of Noranda Mines Limited

			PAMOUR
NORANDA MINES	ORCHAN MINES	KERR ADDISON	PORCUPINE
LIMITED	LIMITED	MINES LIMITED	MINES LIMITED
J. R. Bradfield		J. R. Bradfield
	J. P. Dolan*
J. C. Dudley
	M. C. Dumas*
		A. Findlay
G. B. Foster
			K. C. Gray
			P.D.P. Hamilton
L. Hebert
W. James
		P. M. Kavanagh
L. G. Lumbers
A. Monast
		J.P.W. Ostiguy
R. V. Porritt		R. V. Porritt	R. V. Porritt
A. Powis		A. Powis
		W. H. Rea
W. S. Row	W. S. Row	W. S. Row	W. S. Row
	D.E.G. Schmitt		D.E.G. Schmitt
J. D. Simpson
		W. D. Smith
			A. W. Stollery
	J. H. Stovel*	J. H. Stovel	J. H. Stovel
W. P. Wilder

1972 OFFICERS OF NORANDA MINES LIMITED AND OTHER COMPANIES

SOURCE — 1972 ANNUAL REPORTS

			PAMOUR
NORANDA MINES	ORCHAN MINES	KERR ADDISON	PORCUPINE
LIMITED	LIMITED	MINES LIMITED	MINES LIMITED
Chairman,
J. R. Bradfield	J. P. Dolan	W. S. Row
Vice-Chairman,
R. V. Porritt
President,
A. Powis	D.E.G. Schmitt	J. H. Stovel	D.E.G. Schmitt
Exec. Vice-President
W. S. Row	—	—	—
Vice President,
J. M. Anderson
W. G. Brissenden
J. A. Hall
K. C. Hendrick
		P. M. Kavanagh
L. G.Lumbers
R. P. Riggin
			W. S. Row
D.E.G. Schmitt
	J. H. Stovel
A. H. Zimmerman
Secretary,
R. C. Ashenhurst	R. C. Ashenhurst	R. D. Stewart	B. H. Grose
Treasurer,
E. K. Cork	E. K. Cork	I. D. Bayer	E. K. Cork
Asst. Treasurer,
—	B. C. Bone	—	—
General Manager,
—	—	M. D. Rowswell	J. A. Graham
Exec. Asst, to Pres.,
J. O. Hinds	—	—	—
General Counsel,
R. L. Pepall	—	—	—
Comptroller,
	V.H.K. Scott