Thurlow, C J:—This is an appeal from a judgment of the Trial Division which dismissed the appellant’s appeal from a reassessment of income tax for the year 1975 and upheld the disallowance by the Minister of the appellant’s claim for a deduction in computing income for that year of an amount of $902,200 as a reserve in respect of a debt of $922,825 treated in the appellant’s income tax return as owing to the appellant by Cuisson Lake Mines Ltd (hereafter “Cuisson”) and as doubtful.
In reaching his conclusion, the learned trial judge held that as the amount in respect of which the deduction was claimed did not have its origin in sales of merchandise or services rendered by the appellant it was not a debt for which a reserve might be deducted under subparagraph 20(1 )(l)(i) of the Income Tax Act, that the amount represented expenditures of a mining operation of Cuisson which the appellant had contracted to finance and that it was an outlay of capital by the appellant for that purpose.
The circumstances in which the amount of $922,825 arose were as follows:
Cuisson was the owner of certain mining claims which adjoined claims referred to as “Granite Lake Claims” belonging to the appellant. It was not economically feasible to work the appellant’s claims by themselves but it was considered practical to work them in a single operation with the claims of Cuisson. The appellant had other claims in the general area which were being mined and it also had a concentrator in operation about a mile from the Cuisson claims.
The Cuisson claims had been owned by Gunn Lake Mines Limited (hereafter “Gunn”) and had been transferred to Cuisson under an agreement between its shareholders dated November 23, 1973, and agreed to be effective November 30, 1972. The shareholders were Gunn, the appellant and Canex Placer Limited. The appellant and Canex were related companies, both being subsidiaries of or controlled by the same parent company.
The agreement provided that Gunn should always have 30 per cent of the shares and should have proportionate representation on the board of directors and that income or other moneys of Cuisson available for distribution should not be retained by the company but should be paid out proportionately as dividends or otherwise. It also provided for the making, in proportion to their shareholdings, of interest-free loans by the shareholders to Cuisson to discharge current liabilities which Cuisson might not be able to meet from current income or moneys and that the parties would cause the directors of Cuisson to enter into a mining agreement with the appellant which would “... provide for the management of Cuisson and for the further examination, exploration, development and mining of the Granite Lake Claims of Cuisson in conjunction, concurrently and consecutively, with contiguous and adjacent mineral claims of Gibraltar, in such manner and upon and subject to such terms and conditions and for such consideration, all as the Board of Directors of Cuisson may approve.”
The mining agreement between the appellant and Cuisson was dated September 28, 1973, and it too was expressed as being effective the 30th of November, 1972. The parts of it that are relevant for present purposes are the recitals, and the following portions of articles 1, 2, 3 and 5:
A. Cuisson is the recorded and beneficial owner of those mineral claims located in the Quesnel Mining Division, more particularly known and described in Schedule “A” attached hereto (and hereinafter called the “Claims”).
B. Cuisson represents to Gibraltar that the Claims are in good standing, are free and clear of encumbrances, and, insofar as it is aware, are duly and lawfully staked and recorded.
C. Gibraltar is operating an open pit mine on mineral claims and leases situate in the vicinity of the Claims, and in particular, proposes to mine certain claims set out in Schedule “B” hereto (hereinafter called the “Gibraltar Granite Lake Claims”). D. Gibraltar presently operates a concentrator for the purpose of milling ore from its present open pit mine and from its proposed open pit mine areas including the Gibraltar Granite Lake Claims.
E. The parties acknowledge that the Claims do not, by themselves, contain sufficient mineralization to allow an economic mining operation at the present time unless such operation is carried out in conjunction with contiguous claims of sufficient mineralization to allow an economic recovery of mineralization based on a mining plan encompassing both the Claims and such contiguous claims.
F. Cuisson has agreed to grant to Gibraltar the exclusive possession of the Claims for the purpose of mining the Claims and extracting the ore therefrom upon the terms and conditions herein set out.
G. Cuisson has agreed to grant to Gibraltar, during the term of this Agreement, exclusive management of the day-to-day affairs and undertaking of Cuisson, with the intention that Gibraltar will be entitled to exercise all of the management powers of Cuisson except those powers that would, in the ordinary course of business, be exercised by the Cuisson Directors, or are specifically required by the Companies Act or by Cuisson’s Memorandum or Articles of Association to be exercised by the Directors or the shareholders of Cuisson.
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Article 1 — Grant of Mining Rights
1.01 Cuisson hereby grants to Gibraltar the sole and exclusive right and authority, subject however to the terms hereof, to prospect, explore, develop and mine the Claims, or any one or more of them, and to transport the ore therefrom to the Gibraltar concentrator, and without restricting the generality of the foregoing, to:
(a) develop, mine, work, use, manage, and control the said Claims, and any water, surface, or other rights appurtenant thereto or associated therewith:
(b) mine, extract, remove from the Claims, and mill ores and minerals, and use the Claims for ore storage, pit wall slopes, waste dumps, and/or transportation;
(c) prepare, or cause to be prepared, the Claims, for production, including removal and disposal of timber and the grubbing and burning of stumps, stripping of overburden, and construction of roads, powerlines, and other services required, in the opinion of Gibraltar, to prepare the Claims for production;
(d) erect, construct, maintain, use and operate on the Claims buildings, machinery, plant and equipment;
(e) apply for and take in its own name, or in the name of Cuisson, as Gibraltar in its sole discretion decides, permits, licences, leases, easements and rights- of-way, and other rights required in connection with:
(i) the said preparation of the Claims for production,
(iv) transportation, or
(v) selling of the products of the Claims;
(f) in the name of Cuisson, and as its attorney, and in the sole discretion of Gibraltar, to abandon and restake the Claims or any one or more of them, or to group the Claims, and to charge, assign, mortgage, pledge or encumber:
(i) the Claims or any of them,
(ii) the machinery or equipment used or to be used to mine and transport the ore and waste from the Claims,
(iii) the ore from the said Claims,
(iv) the concentrate arising from the said Claims.
Article 2 — Mining and Sale of Ore
2.01 Gibraltar shall, once in every calendar year, in relation to the Claims, submit to Cuisson the following:
(a) a written estimate of the mineable tonnage of ore, and grade of ore, contained in the Claims, such estimate to be based on calculations made in accordance with Gibraltar’s standard engineering practice;
(b) a written estimate of the Preparation Costs of the Claims and of the Gibraltar Granite Lake Claims;
(c) a tentative schedule for mining of ore in the Claims made in accordance with Gibraltar’s standard engineering practice.
Gibraltar shall at all times, have the sole discretion to change its mining plan, and mining schedule, and shall thereupon forthwith notify Cuisson in writing of any material change to its mining plan or mining schedule.
2.02 The amount of waste removed and the amount of ore delivered to the Gibraltar concentrator from the Claims shall be measured by Gibraltar on the basis of a quarterly engineering survey and an annual aerial survey. Immediately upon completion of such surveys, copies thereof shall be delivered to Cuisson.
2.03 Gibraltar may, in its sole discretion, determine the commencement of its mining of the Claims and may from time to time interrupt, cease, or recommence the mining at a time or times and in such manner as Gibraltar may decide. The parties hereto acknowledge that it is Gibraltar’s present intention to mine the Claims in a natural mining sequence taking into consideration the relevant mineralization of the Claims, the Gibraltar Granite Lake Claims, and all other claims owned or operated by Gibraltar, and dependent at all times on the economic feasibility of mining the Claims.
2.04 Upon mining of ore from the Claims, Gibraltar shall deliver such ore to the Gibraltar concentrator and at the time of such delivery, Cuisson shall sell and Gibraltar shall buy such ore. Title to the said ore shall be deemed to pass from Cuisson to Gibraltar at such time. The price and terms of payment for such ore shall be as hereinafter set out.
Article 3 — Price and Payment
[3.01 contains definitions, for the purposes of the agreement, of “Adjusted Grade of Ore”, “Preparation Costs”, “Average Metallurgical Recovery”, “Contained Copper”, “Gibraltar’s Cost of Production and Marketing”, and “Recoverable Copper”.
3.02 The price that Gibraltar shall pay to Cuisson for ore (inclusive of all minerals contained therein) delivered to the Gibraltar concentrator from the Claims (the “Price”) shall be expressed in Canadian currency per pound of Recoverable Copper and calculated quarterly as a sum equivalent to the average of the price per pound of copper paid or payable to Gibraltar for shipments of copper concentrate (including precious metal credits) during the calendar quarter succeeding the calendar quarter for which the Price is being calculated, minus Gibraltar’s Cost of Production and Marketing. Payment of the Price shall be made in the manner set out in the succeeding paragraph hereof.
3.03 Subject to the provisions of paragraphs 3.04 to 3.07 inclusive, Gibraltar shall pay to Cuisson for all Recoverable Copper delivered in each calendar quarter, the following payments:
(a) Two months plus ten days after the end of each calendar quarter, by way of advance, an amount equivalent to Ninety (90%) Per Cent of estimated Price, multiplied by the number of pounds delivered in such calendar quarter. For the purposes of this paragraph, the estimated Price shall be calculated on the basis of the average price per pound of copper concentrate paid or payable to Gibraltar for shipments of copper concentrate during such two months, minus Gibraltar’s estimate of Gibraltar’s Cost of Production and Marketing.
(b) Five and one-half months after the end of each calendar quarter, an amount equivalent to the Price, multiplied by the number of pounds delivered in such calendar quarter, minus payments made under paragraph 3.03(a), provided however, that should the advance exceed the payment due for such calendar quarter, then such excess shall be paid forthwith to Gibraltar.
3.04 If, in any calendar quarter, the calculation of Price in accordance with paragraph 3.02 hereof results in a negative amount, then for such calendar quarter, the result of applying the negative Price to the Recoverable Copper delivered shall be a debt owed by Cuisson to Gibraltar, and may be deducted by Gibraltar from subsequent payments to Cuisson.
3.05 Gibraltar shall deduct from the payments to Cuisson referred to in paragraphs 3.03 and 3.08 hereof, the amount of actual preparation costs incurred by Gibraltar from time to time.
3.09 All taxes, duties or other charges levied by any government or governmental authority, against, or on account of, the mining, milling, transportation, export, or sale of ore or concentrate from the Claims, if paid in good faith by Gibraltar and not included in Preparation costs or Gibraltar’s Cost of Production and Marketing, shall be charged to Cuisson and deducted from subsequent payments to Cuisson. Provided, however, that such taxes, duties and charges shall be the responsibility of Cuisson and Gibraltar shall not be bound to make any such payments except under the general management powers granted by Cuisson to Gibraltar herein.
Article 5 — General
5.01 This Agreement will be in force for Ninety-Nine (99) years from the date hereof or until such earlier date that Gibraltar shall give notice to Cuisson that the Claims have been mined to their full economic potential and all ore derived from the Claims has been fully paid for. Cuisson hereby grants to Gibraltar the sole and exclusive authority and rght, during the term hereof, to manage the day-to-day affairs and undertaking of Cuisson, granting unto Gibraltar the same powers and authority as the Directors of Cuisson now have, excepting only those powers that would in the ordinary course of business be exercised by the Cuisson Directors, or as are expressly required by the Memorandum or Articles of Association of Cuisson or by the Companies Act to be exercised by the Directors or shareholders of Cuisson.
5.11 Independence of Parties
It is not the purpose nor intention of this Agreement to create or constitute a partnership or other relationship between the parties whereby any party shall be liable for the acts or omissions of any other party. Each party shall maintain a separate status and shall be responsible only for its proportionate share of the risks and costs incurred in connection with the activities contemplated by this Agreement.
What appears to have been contemplated by these two agreements was that whatever profit was to be earned or whatever loss was to be sustained as a result of the appellant carrying on mining operations on the Cuisson property was to accrue to or to be borne by the Cuisson shareholders in accordance with the proportions agreed upon through dividends of Cuisson or necessary interest-free loans by the shareholders to it, that no profit was to be earned directly by the appellant from its mining, processing or sale of Cuisson ore and that any loss on the operation was to be recoverable from Cuisson in one way or another.
Mining operations under the agreement began on the Cuisson claims in 1974 and, by the end of 1975, instead of profit, a shortfall estimated at that time at the amount of $922,825 in question had accumulated. I refer to it as “estimated” because under the agreement the figures so far as based on estimates were subject to subsequent revision in accordance with actual expenses and the evidence shows that adjustments were later made of some items included in the amount.
|The $922,825 was made up of:|
|Royalties and Capital Taxes||$ 75,680|
|Excess of Costs of Production and|
|Marketing over sale price of copper||$392,165|
In keeping the accounts of the operation what the appellant appears to have done was to charge initially in its accounts the whole of its expenditures, of which the amounts mentioned formed a part, then to transfer amounts to Cuisson’s accounts and there show them as if Cuisson were carrying on a mining operation and to treat the amounts so transferred as receivables in the appellant’s accounts.
In doing so, the appellant claims to have reduced its total expenditures by these amounts and thus to have increased by the like amounts the profits from its operations. The evidence given by W K Service, the manager for taxation of the appellant’s parent company, supports that position. An opinion to the contrary was expressed by D Kelsey, a witness called by the respondent, but it appears to be based on an assumption that the mining operations carried on by the appellant on the Cuisson claims were in fact operations of Cuisson carried on by the appellant on Cuisson’s behalf. As will appear from what follows, that assumption, in my view, is not correct. I would conclude therefore that the effect of transferring the expenses to Cuisson’s accounts and thereby reducing to a like extent the expenditures of the appellant is to include the amounts in the appellant’s income.
Turning to the question as to whose mining operation it was that was being carried on on the Cuisson claims, the evidence shows that the mining activities were carried on under the agreement and pursuant to its terms, that Cuisson had no assets other than its interest in the mining claims and its rights under the agreement and that it had no physical plant or equipment, no office and no employees. The only business which Cuisson appears to me to have had at any material time, and thus the only business that the appellant had authority to manage for Cuisson, was that of selling its ore to the appellant at the appellant’s concentrator at the price computed in the manner provided and on the terms set out in the agreement and receiving the proceeds, if any. Nowhere in the agreement is there any foundation for the view that mining or transportation or concentrating or marketing operations were to be carried on under it by Cuisson or by the appellant as a partner of or as agent for or otherwise on behalf of Cuisson. Section 5.11 of Article 5 appears to me to preclude such an operation. Under the terms of the agreement, the whole of the operation of clearing and development of the mining site and the extraction and transportation of ore to the concentrator, where the ore thereupon became the appellant’s property, were, in my opinion, operations of the appellant on its own behalf and for its own account alone. The provisions for calculating the price to be paid for the ore, though including references to the costs of these operations, would not serve to characterize them or the milling, concentration and marketing of the concentrate from ore which at that point belonged to the appellant as operations of anyone but the appellant itself. And nothing in the agreement authorized the appellant to carry on any part of these operations on behalf or for the account of Cuisson. Further, the method adopted by the appellant in keeping its accounts and those of Cuisson and preparing financial statements, which, in my view, were not such as to accurately reflect and represent what was being done for the appellant’s own account and that for Cuisson’s account in accordance with the agreement, can have no effect to change the agreement or the characterization of the mining operations carried on under it as those of the appellant and those of Cuisson. On these points, which, in my view, are fundamental to the decision, I differ, with respect, from the view expressed by the learned trial judge.
It was contended for the respondent that because of the conduct of the appellant in keeping its accounts and those of Cuisson and in allocating and transferring portions of its expenditures to Cuisson as if Cuisson were in fact engaged in a mining operation, it was open to the learned trial judge to find that the operation was that of Cuisson and to determine the matter on that basis. If there were no written agreement such a conclusion might be inferred from such facts but in face of the written agreement, which the evidence shows was the arrangement under which the operations were carried out and under which a system of allocation of expenditures was called for in order to determine the price to be paid by the appellant for Cuisson ore, I do not think evidence of how the bookkeeping was done can prevail to characterize the operation as that of Cuisson when the agreement provides otherwise.
It appears to me that once it is accepted that these amounts represented expenditures by the appellant in connection with its own mining operations, as in my opinion they were, as opposed to mining operations of Cuisson, they would properly appear in the accounts of the appellant’s mining operations, whether as capital or income expenses, and not as mining expenditures in the accounts of Cuisson. On this basis, ih computing the appellant’s income for tax purposes, it seems to be clear, and indeed not in dispute, that the development expenses, though of a capital nature, would be deductible under the special provisions therefor contained in sections 66 and 66.2 of the Income Tax Act, that the royalties and capital taxes would not be deductible because of a special prohibition in paragraph 18(1 )(m) of the Act applicable from May 6, 1974, and that the amount representing excess costs of production and marketing over the sale price of copper, being part of the appellant’s mining, transportation, concentrating and marketing expenses, would be deductible as ordinary business expenses.
It also appears, however, that the appellant had, with respect to these items, the rights of recovery provided by the agreement, that is to say: under article 2, section 3.05, the right to deduct the preparation costs from any amount payable to Cuisson for ore; under article 2, section 3.09, to receive payment from Cuisson of the Royalties and Capital Taxes which it had paid and to deduct them from subsequent payments to Cuisson; and, under article 2, section 3.04, to payment of the Excess of Costs of Production and Marketing over the sale price of copper as a debt owing by Cuisson and to recover it from money payable to Cuisson on the purchase of its ore. As the appellant’s rights to recover these items from Cuisson arose from the mining operations carried on by the appellant and its transactions in purchasing Cuisson ore it seems to me that the appellant’s accounts ought to be so Stated as to reflect its rights to such accrued receivables. The alternative is to not reflect them at all, to omit them until they have been received. But, of the two methods, the one that, in my opinion, would more accurately reflect the results of the appellant’s operations for the year, is to include them as receivables. This the appellant has done by showing them as receivables though at the same time claiming a reserve in respect of them as being doubtful.
The provisions of the Income Tax Act which permit the deduction of a reserve in respect of doubtful debts are paragraph 18(1 )(e) and subparagraph 20(1 )(l)(i). They provide:
18.(1) In computing the income of a taxpayer from a business or property no deduction shall be made in respect of
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(e) an amount transferred or credited to a reserve, contingent account or sinking fund except as expressly permitted by this Part;
20.(1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:
(I) a reasonable amount as a reserve for
(i) doubtful debts that have been included in computing the income of the taxpayer for that year or a previous year, ...
Apart from the question whether a debt has been included in computing a taxpayer’s income for the taxation year or a previous year, as I think has been done in the case at bar, the only questions that appear to arise on these provisions are whether the debt is indeed doubtful and whether the amount claimed as a reserve is reasonable.
An argument was made that as the debt in question was not for the price of merchandise sold or services rendered in the course of business, it was not of a kind falling within the subsection. The debt is, without doubt, one of a different kind from those to which subparagraph 20(1 )(l)(i) ordinarily applies. However, the appellant’s rights against Cuisson in respect of the amounts here in question arose and became receivable in the ordinary course of the appellant’s business upon and from the purchase by the appellant of ore for processing in its concentrator with a view to the sale of the concentrate. In the case of the preparation costs, the amount became a receivable because on the purchase of ore from Cuisson a right to retain the amount from the purchase price arose. In the case of excess production and marketing costs, the right also arose upon the purchase of ore when the prices of such ore, as calculated under the agreement, turned out to be a negative rather than a positive amount. At that point, the excess became a debt arising from the purchase. In the case of royalty payments, the right of the appellant under the agreement to receive them arose when they were paid by the appellant as an incident of the carrying on of its mining operation in the Cuisson claims. Having thus arisen out of the appellant’s income earning operation, all three appear to me to be in the same category as trading debts and thus as debts within the meaning of subparagraph 20(1)(l)(i).
In computing the deduction claimed, the appellant deducted from the total of $922,825 an amount which it considered to be the value of Cuisson’s assets and, having regard to the existing prospects of the operation yielding profit in the future, claimed the rest as a reserve. Plainly, up to that point the operation had not been profitable. With respect to the amount claimed, the witness, Service, said:
Q ... The 902,220 doubtful debt claim is not the same as the total amount of the receivable from Cuisson. What accounted for the difference?
A The reserve that was set up in the financial statements of Cuisson was exactly the same as the deficit on the balance sheet of Cuisson, so there would have been a minor equity in Cuisson and I think it would have been reasonable at the time to actually apply for the full amount, but however $902,000 was provided at that time. Q So what you are telling me is your doubtful debt provision was the deficit shown on Cuisson’s balance sheet and Cuisson happened to have about $20,000 of equity, so the deficit was about $20,000 less than the amount owing net to Gibraltar.
A That’s right.
Q You are saying that you could have just by taking the whole amount but you just took the deficit of $20,000 difference?
Q And then was something done about a doubtful debt provision?
A Yes, there was. At the time that Gibraltar was preparing its financial statements for ‘75 it had to assess the collectibility of that receivable. At that time Cuisson had no money, its only asset was the mining claims on the Granite Lake ore body, and the mining on those claims at that time was not profitable. We could see that there was no probability of Cuisson being able to pay that debt in the foreseeable future, so we prudently provided a reserve for that.
Q And that was the doubtful debt provision that is in issue in this appeal? A That’s right.
Counsel for the respondent pointed to the value of $340,805 assigned to the Cuisson mining claims in the company’s balance sheet but in view of the results of the mining operation and the poor prospects for it I would not regard the value so assigned as anything but a book value having at that point little if any relation to reality.
On the evidence I would conclude that the debt was indeed doubtful and that, but for a further fact which emerged, the amount claimed was not unreasonable. The further fact was that as a result of adjustments made in March and June, 1976, and based on results rather than on estimates, the debt was in fact less at the end of 1975 by some $137,000. Adjusted, as I think it should be, by deducting the $137,000, the amount properly deductible as a reserve should be $765,220.
I would allow the appeal and refer the matter back to the Minister for reconsideration and reassessment on that basis. The appellant should have its costs of the appeal and of the proceedings in the Trial Division.