DeLuca v. The Queen, 87 DTC 5202, [1987] 1 CTC 305 (FCTD), aff'd 91 DTC 5540 (FCA)

Rouleau, J.:—This is an appeal commenced by way of statement of claim pursuant to section 172 of the Income Tax Act, S.C. 1970-71-72, c. 63, as amended, against a decision of the Tax Court of Canada dated October 30, 1984 dismissing the plaintiff's appeal of a notice of reassessment issued by the defendant on October 29, 1981 with respect to the plaintiff’s 1977 taxation year.

This appeal was heard on common evidence with the appeal of The Estate of Vans H. Hulbert (Deceased) v. The Queen (Court No. T-328-85) and the reasons contained herein apply equally to that case.

The facts in this case are straightforward. The plaintiff together with the late Vans H. Hulbert entered an Exploration Option Agreement dated February 28, 1968 whereby certain coal licences were acquired by the plaintiff and Mr. Hulbert from the Province of British Columbia. On May 16, 1969 the plaintiff and Mr. Hulbert (the vendors) transferred their interest in these coal licences to a federally incorporated company, Crow's Nest Industries Limited (C.N.I.) for $200,000. The agreement between the parties also provided that the plaintiff and Mr. Hulbert would receive as further consideration for the licences the sum of $600,000 out of C.N.I.'s first revenues from the sale of any coal or coal products from operations of the licences. The agreement also made the following provisions:

5. Likewise, if C.N.I. disposes of the licences or leases other than by surrender to the government of British Columbia, then any proceeds of sale or disposal received by C.N.I. up to $600,000 shall be paid to the Vendors as the same are received.

7. This agreement shall be deemed to be concluded and fully satisfied at any time that the $600,000 has been paid to the Vendors out of revenues or proceeds by C.N.I.

On January 19, 1976, C.N.I. transferred the coal licences to a wholly- owned subsidiary, The Crow's Nest Pass Oil and Gas Company, Limited. An agreement was entered into between this wholly owned subsidiary as assignee and the plaintiff and Mr. Hulbert as assignors on September 19, 1977. That agreement provided, in part, as follows:

1. In consideration of the sum of SIX HUNDRED THOUSAND DOLLARS ($600,000) in Canadian Funds by certified cheques payable to each of Hulbert and De Luca respectively as follows:

HULBERT — THREE HUNDRED AND SIXTY THOUSAND DOLLARS ($360,000.00) DELUCA — TWO HUNDRED AND FORTY THOUSAND DOLLARS ($240,000.00)

the receipt whereof Hulbert and De Luca respectively hereby acknowledge, the Assignors hereby assign to the Assignee all of their rights, title and interest in and to the May, 1969 Agreement, including all rights of action or other rights accruing to them, or which might hereafter accrue to them under the said May, 1969 Agreement.

On October 29, 1981 the Minister of National Revenue issued a notice of reassessment to the plaintiff for his 1977 taxation year. The Minister added to the income of the plaintiff for that year the amount of $204,000 which, as a result of general averaging calculations, increased the income tax payable by the plaintiff for his 1978 and 1979 taxation years. By notice of objection dated October 29, 1981 the plaintiff objected to the said reassessments and, pursuant to subsection 165(3) of the Income Tax Act, requested that the notice of objection be referred directly to the Tax Review Board with reconsideration of the matter by the Appeals Section of the Department of National Revenue being waived. The defendant consented to this request by a consent dated January 5, 1982 and filed a copy of the notices of objection with the Registrar of the Tax Review Board. The appeal was heard by the Tax Court of Canada in October 1983 and by judgment dated October 30, 1984 the Tax Court dismissed the plaintiff’s appeal.

The plaintiff’s position is that the proceeds received by him were received pursuant to his activities as a prospector and were therefore exempt from income tax. Alternatively, the plaintiff maintains that the proceeds received by him were received pursuant to a settlement of a potential legal action and were for the purpose of giving up the legal rights which the plaintiff had pursuant to the aforesaid agreements and were therefore not subject to tax.

The defendant maintains that the coal licences were rights or privileges to prospect, drill or mine for minerals in a mineral resource in Canada as set out in subparagraph 66(15)(c)(ii) of the Income Tax Act. The plaintiff disposed of the coal licences in May 1969 but retained a right or interest in the said licences, namely the right to receive proceeds of disposition in respect of a disposition as set out in subparagraph 66(15)(c)(vii) of the Income Tax Act and that the plaintiff continued to retain this interest until September 19, 1977 at which time the plaintiff assigned that right to The Crow's Nest Pass Oil and Gas Company, Limited in consideration for the sum of $240,000. Accordingly, the defendant argues that the plaintiff received on disposition of the coal licences $240,000 and that the Minister of National Revenue properly applied the provisions of subsection 59(4), clause 66.2(5)(b)(v)(A) and subsections 66.2(1) and 59(3.2) of the Income Tax Act by adding to the plaintiff's income for his 1977 taxation year the sum of $204,000.

The relevant provisions of the Income Tax Act provide as follows:

59. (1.1) Where a taxpayer disposes of

(a) a Canadian property, or

(b) any right, licence or privilege described in subsection 83A(5a) of this Act as it read in its application to the 1971 taxation year, that was acquired by the taxpayer,

(i) in the case of

(A) a corporation that is a principal-business corporation within the meaning assigned by subsection 66(15) or that was, at the time it acquired the property, such a principal-business corporation, or

(B) an association, partnership or syndicate described in subsection 83A(4) of this Act as it read in its application to the 1971 taxation year,

before 1972, and

(ii) in any other case, after April 10, 1962 and before 1972, under an agreement or other contract or arrangement described therein,

the taxpayer's proceeds of disposition therefrom shall be included in the amount referred to in subparagraph 66.2(5)(b)(v) to the extent that the proceeds become receivable.

59. (3.1) Where a taxpayer has made a disposition of property owned, or deemed to have been owned, by him on December 31, 1971 and thereafter without interruption until the date of disposition that is property described in any of subparagraphs 66(15)(c)(i) to (vi) and is not property described in paragraph (1.1)(b), the following rules apply:

(a) the relevant percentage of the taxpayer's proceeds of disposition therefrom shall be included in the amount referred to in subparagraph 66.2(b)(v) to the extent that the proceeds become receivable; and

(b) where the taxpayer and the person who acquired the property were not dealing with each other at arm's length for the purposes of this section and sections 66 and 66.2

(i) the cost to that person of the property shall be deemed to be the amount included in the amount referred to in paragraph (a) in respect of the disposition by the taxpayer of the property, and

(ii) when that person subsequently disposes of the property or any right or interest therein, that person shall be deemed to have owned the property on December 31, 1971 and thereafter without interruption until the disposition thereof.

59. (3.2) Recovery of exploration and development expenses. There shall be included in computing a taxpayer’s income for a taxation year

(a) any amount referred to in paragraph 66(12.4)(b);

(b) any amount referred to in subsection 66.1(1); or

(c) any amount referred to in subsection 66.2(1).

59. (4) Determination of “relevant percentage”. For the purposes of this section, the “relevant percentage” of proceeds of disposition of property is 60% plus the percentage (not exceeding 40%) obtained when 5% is multiplied by the number of full calendar years in the period commencing at the end of 1972 and ending with the end of the calendar year in which the disposition was made.

66. (15)(c) “Canadian resource property”. “Canadian resource property” of a taxpayer means any property acquired by him after 1971 that is,

(i) any right, licence or privilege to explore for, drill for, or take petroleum, natural gas or other related hydrocarbons in Canada,

(ii) any right, licence or privilege to prospect, explore, drill, or mine for minerals in a mineral resource in Canada,

(iii) any oil or gas well situated in Canada,

(iv) any rental or royalty computed by reference to the amount or value of production from an oil or gas well, or a mineral resource, situated in Canada,

(v) any real property situated in Canada the principal value of which depends upon its mineral resource content (but not including any depreciable property situated on the surface of the property or used or to be used in connection with the extraction or removal of minerals therefrom), or

(vi) any right to or interest in any property (other than property of a trust) described in any of subparagraphs (i) to (v) (including a right to receive proceeds of disposition in respect of a disposition thereof);

66.2 (1) A taxpayer shall include, in computing the amount referred to in paragraph 59(3.2)(c), the amount, if any, by which

(a) the aggregate of all amounts referred to in subparagraphs (5)(b)(iv) to(ix) that would be taken into account in computing his cumulative Canadian development expense at the end of the year

exceeds

(b) the aggregate of all amounts referred to in subparagraphs (5)(b)(i) to (iii) that would be taken into account in computing his cumulative Canadian development expense at the end of the year

Generally, these provisions of the Income Tax Act reflect the special tax treatment accorded to resource properties under the Act. Section 59 sets forth the tax treatment of the proceeds of disposition of resource property with the proceeds of disposition of Canadian resource property being applied to reduce cumulative Canadian development expense, an account set up under section 66.2 of the Act.

In 1972 major tax reforms abandoned the capital treatment generally afforded to resource properties. Pursuant to subsection 59(1.1) of the Income Tax Act dispositions of Canadian Resource Properties are credited to the Cumulative Canadian Development Expense account established by subparagraph 66.2(5)(b)(v) of the Act. Any excess, or credit balance, is included in computing the taxpayer's income for the year [subsections 66.2(1) and 59(3.2)].

To ascertain the fiscal treatment of any disposition of resource property the following four issues must be determined:

1. The nature of the resource property. It must be established whether the property in question is a Canadian resource property, a foreign resource property, a property described in subsection 83A(5a) of the former Act, or property that would have been a Canadian or foreign resource property had those terms been applicable prior to the 1972 taxation year.

2. The class of taxpayer disposing of the property. The taxpayer may be a “principal-business corporation , a taxpayer other than a principal-business corporation, an association, a partnership or syndicate described in subsection 83A(5a) of the former Act, a special product corporation, or a dealer or trader.

3. The date on which the property was acquired. This date will determine which of the successive sets of legislative rules will apply.

4. The date on which the property was disposed of. Again this date will determine which of the successive sets of legislative rules will apply.

In the present case, it is only the last question which is in dispute. Both sides agree that if the disposition of the coal licences in fact took place in 1969 the provisions of the Income Tax Act, as they then read, would have rendered the proceeds of the disposition tax free. The plaintiff argues that all disposition of the property occurred in May of 1969 when the plaintiff and Mr. Hulbert entered into the agreement with Crow's Nest Industries Limited whereby $200,000 was received by the taxpayers with a balance of $600,000 to be paid from revenues from the sale of coal or coal products from the operations of the licences or from the proceeds of sale of disposal of the licences. Accordingly, the plaintiff argues that it was in 1969 that the deal was made, that the price was fixed and that the plaintiff and Mr. Hulbert sold all their interests in the coal licences and the mining property. If that is in fact the case, the plaintiff maintains that there was then no property left to dispose of after December 31, 1971 as required by subsection 59(3.1) of the Act if the amount is to be brought into the taxpayer's income.

I do not agree with the plaintiff's argument. The agreement entered into between the plaintiff and Mr. Hulbert and Crow's Nest Industries Limited in 1969 was a two-pronged arrangement whereby the plaintiff and Mr. Hulbert received a $200,000 down payment and which also contained a provision that they were to receive the balance of $600,000 to be paid from revenues from the sale of coal or coal products from the operations of the licences or from the proceeds of sale or disposal of the licences. It was not until September 1977 that the plaintiff and Mr. Hulbert received the remainder of the sale price. I am in full agreement with the Tax Court of Canada that the plaintiff retained the right to receive proceeds of disposition from 1969 to 1977 when he actually received his share of the $600,000 on disposition and sale of the licences by Crow's Nest Industries Limited to its wholly owned subsidiary, The Crow's Nest Pass Oil and Gas Company, Limited. I am convinced that the Minister of National Revenue was correct in his determination that the plaintiff fell within the provisions of paragraph 66(15)(c) and subsection 59(3.1) of the Income Tax Act.

For these reasons, the plaintiff's appeal is dismissed with costs.

Appeal dismissed.