Citation: 2007TCC685
Date: 20071116
Docket: 2004-1284(IT)G
BETWEEN:
BASELL CANADA INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Lamarre J.
[1] The appellant is
appealing reassessments made by the Minister of National Revenue (“MNR”) with
respect to its taxation years ending December 31, 1995, December 31,
1996, October 28, 1997, December 31, 1997 and December 31, 1998.
[2] In so reassessing
the appellant, the MNR disallowed deductions claimed by the appellant under
subsection 9(1) and paragraph 18(1)(a) of the Income Tax
Act (“ITA”) with respect to supply contracts and instead treated those
amounts as eligible capital expenditures within the meaning of section 14
of the ITA and thus as deductible pursuant to paragraph 20(1)(b)
of the ITA. That is the sole issue before this Court.
[3] A Partial Agreed
Statement of Facts was filed by the parties. It is reproduced hereunder:
Partial Agreed
Statement of Facts
The parties hereto, by their respective
solicitors, admit, for the purposes of this appeal only, the truth of the
following facts; the parties may adduce further evidence at trial that is not
inconsistent with this Partial Agreed Statement of Facts:
Context
1.
The Royal Dutch/Shell
Group of Companies and the Montedison Group were the world’s leading producers
of polypropylene.
2.
In 1995, the Royal
Dutch/Shell Group of Companies and the Montedison Group agreed to form a new
incorporated joint venture, Montell, for their worldwide polypropylene
operation.
See the “Rapport
d’activité” of Montell Polyolefins, the 1995 Annual Report of Royal Dutch
Petroleum Co./Shell Transport and Trading Co. and the 1995 Annual Report of
Montedison (respectively Schedules A, B, and C of the present Statement).
3.
At that time, Shell
Canada Products Limited, member of the Royal Dutch/Shell Group of Companies,
manufactured and commercialized polypropylene in Canada from its production
plant in Sarnia, Ontario.
4.
At that time, Himont
Canada Inc., member of the Montedison Group manufactured and commercialized
polypropylene in Canada from its production plant in Varennes, Quebec.
5.
As part of this
worldwide reorganization, Shell Canada Products Limited agreed to transfer its
Contributed Businesses to Himont Canada Inc.
See the Recitals of the
Asset Purchase Agreement dated March 20, 1995 between Shell Canada Products
Ltd. and the Appellant (Schedule D of the present Statement) and the Minutes of
Regular Meeting of the Board of Directors of Himont Canada Inc. dated March 17,
1995 (Schedule E of the present Statement).
6.
Himont Canada Inc.
was then renamed Montell Canada Inc. on March 31, 1995 and is now known as
Basell Canada Inc. (hereinafter the “Appellant”).
Asset Purchase Agreement
7.
Pursuant to an Asset
Purchase Agreement dated March 20, 1995, the Appellant acquired assets
comprising the Contributed Businesses from Shell Canada Products Limited for a
purchase price of US $164,000,000, detailed as follows:
-
US $144,280,000
corresponding to Can. $202,395,984 (using an exchange rate of
1.4028), for assets;
-
US $19,720,000
corresponding to Can $27,663,216 (using the same exchange rate) for the “net
working capital”, that is for the value of the inventories and the trade
accounts receivable less the value of the trade accounts payable, subject to
adjustment.
See the Asset Purchase
Agreement dated March 20, 1995 between Shell Canada Products Ltd. and the
Appellant (Schedule D of the present Statement) and the General Conveyance
dated March 31, 1995 between Shell Canada Products Ltd. and the Appellant
(Schedule F of the present Statement).
8.
The Appellant added
the assets comprising the Contributed Businesses acquired from Shell Canada
Products Limited to its already existing polypropylene business in Canada.
9.
Prior to the
purchase, Himont Canada Inc. had already over Can. $ 207,000,000 in assets
used in Varennes, Quebec for the manufacturing and commercialization of polypropylene.
Supply Contracts
10.
As part of the
acquisition referred to in paragraph 7 of the present statement, the Appellant,
by way of assignment and in consideration of an amount of US $16,300,000
(corresponding to Can. $22,865,640), became party to certain Supply Contracts.
See the Schedule 3 of the
Asset Purchase Agreement dated March 20, 1995 between Shell Canada Products
Ltd. and the Appellant (Schedule D of the present Statement) and the
Assignment of Contracts and Assumption of Liabilities dated March 31, 1995
between Shell Canada Products Ltd. and the Appellant (Schedule G of the present
Statement).
11.
The Supply Contracts
included mainly a contract signed on September 1st, 1991, between Novacor
Chemicals (Canada) Ltd. (hereinafter “Novacor”) and Shell
Canada Chemical Company, a Division of Shell Canada Products Limited
(hereinafter the “Novacor Agreement”).
See the Propylene Sale
Agreement dated September 1, 1991 between Shell Canada Chemical Company, a
Division of Shell Canada Products Ltd. and Novacor Chemicals (Canada) Ltd. (Schedule H of the
present Statement).
12.
Pursuant to the
Novacor Agreement, Novacor had undertaken to sell for a ten-year period agreed
upon quantities of propylene to Shell Canada Products Limited for a given
price.
13.
Propylene constituted
the principal raw material in the Appellant’s business.
14.
In making the said
payment of US $16,300,000, (Can. $22,865,640), the Appellant thus became
entitled to acquire from Novacor raw material needed in its business for a
given price that was advantageous compared to the price on the spot market at
that time.
Tax Treatment
15.
For both tax and
accounting purposes, the Appellant treated the amount of US $16,300,000,
(Can. $22,865,640) so paid as current expenses which were initially amortized
over the term of the Novacor Agreement because this treatment provided, in the
view of the Appellant, a truer picture of its financial affairs.
16.
In its taxation year
ending on December 31, 1998, the Appellant fully deducted the unamortized
balance in accordance with the impairment of assets accounting rules because
the given price agreed upon with Novacor for the raw material was not
advantageous anymore compared to the price on the spot market:
|
Taxation year
|
Dec. 31, 1995
|
Dec. 31, 1996
|
Oct. 31, 1997
|
Dec. 31, 1997
|
Dec. 31, 1998
|
|
Deduction claimed
Deduction claimed
for write-off
|
$2,540,628
|
$3,387,504
|
$2,822,920
|
$564,584
|
$3,387,504
$10,162,500
|
17.
Considering that the
amount of US $16,300,000, (Can. $22,865,640) paid by the Appellant with
respect to the Supply Contracts were amounts paid on account of capital which
constituted “eligible capital expenditures” within the meaning of Section 14 of
the Income Tax Act, the Minister reassessed the Appellant to allow a
portion of the deductions under paragraph 20(1)b) of the Income Tax Act,
instead of the deductions claimed:
|
Taxation year
|
Dec. 31, 1995
|
Dec. 31, 1996
|
Oct. 31, 1997
|
Dec. 31, 1997
|
Dec. 31, 1998
|
|
Deduction disallowed
Deduction allowed
under 20(1)(b)
|
($2,540,628)
$1,200,446
|
($3,387,504)
$1,116,415
|
($2,822,920)
$1,038,266
|
($564,584)
$965,587
|
($13,550,004)
$897,996
|
18.
The Appellant duly
objected to the reassessments.
19.
The Minister
maintained his decision and the Appellant appealed to this Court with respect
to its taxation years ending December 31, 1995, December 31, 1996, October 28,
1997, December 31, 1997 and December 31, 1998.
Issue
20.
The issue to be
determined is whether the amount of US $16,300,000,
(Can. $22,865,640) paid by the Appellant with respect to the Supply
Contracts was a current expense which can be amortized and written off as was
done by the Appellant or a payment on account of capital which constitutes an
“Eligible capital expenditure” as the Respondent contends.
[4] In 1991,
Mr. Steven Mineer, a leader in the supply of olefins, joined Himont
Canada — whose plant is located in Varennes, Quebec — in the capacity
of raw material purchaser. At trial, he explained that the appellant’s business
consisted in producing polypropylene in the form of pellets (essentially
plastic) that were sold to companies that would then mould them into products
to be ultimately sold on the market (Igloo coolers and yogurt containers, to
give two examples).
[5] The principal raw
material from which the appellant produces the polypropylene is the propylene
itself (that comes in the form of a gas). Propylene is probably 95% of the
finished product that is sold by the appellant, and in terms of value
represents 80% of the product cost. Mr. Mineer explained that the appellant
purchases propylene from different sources, treats it and produces pellets that
it then sells. The pellets constitute its inventory that is sold in the market
place to its customers.
[6] In March 1995, the
appellant purchased the assets of Shell Canada Products Limited
("Shell"), which operated the same kind of business in Sarnia,
Ontario. The Asset Purchase Agreement entered into between Shell and Himont
Canada Inc. (the appellant's predecessor) was filed as Exhibit A‑2, Tab D.
In section 13 of this agreement, each party undertook to enter into, in
particular, a feedstock supply agreement substantially in the form of the
agreement thereto attached as Schedule 13(i). Section 2 of the
Feedstock Supply Agreement states the following:
Independently of this Agreement, SHELL
will assign its interest in the Novacor Propylene Sale Agreement dated
September 1, 1991, as amended (the “Novacor Agreement”) . . . [see Exhibit A‑2,
Tab D, p. 29].
[7] The Propylene Sale
Agreement between Novacor Chemicals (Canada) Ltd. (“Novacor”) and Shell, which came into effect
on September 1, 1991, was filed as Exhibit A‑2, Tab H (“Novacor
Agreement”). This agreement entitled Shell to purchase from 270 million to
330 million pounds of propylene for the supply of its plant in Sarnia and
to do so under a set of pricing conditions that were related to the contract
market for propylene on the US Gulf Coast.
[8] Mr. Mineer
explained that Shell (and subsequently the appellant) was expected to purchase
a minimum of 270 million pounds and Novacor had an obligation to supply up to a
maximum of 330 million pounds.
[9] He said that there
was no obligation for Novacor to provide the raw material (propylene) to the
appellant on an exclusive basis (this is reflected in clauses 4.01 and 4.02 of
the Novacor Agreement).
[10] Mr. Mineer stated
that Novacor’s total production was estimated at 800 million pounds a
year, of which 270 to 330 million pounds were to be allocated to the
appellant. In clause 4.02 of the Novacor Agreement, we can see that
Novacor also had to supply other customers. He said that the contract with
Shell (subsequently assigned to the appellant) constituted roughly 3/8 of
Novacor’s propylene production.
[11] On the other hand,
Shell (and subsequently the appellant) was entitled to source propylene first
from its refineries in Montreal and Sarnia as they existed on the effective
date of the agreement, but thereafter was required to source it from Novacor
under that agreement in preference to all other suppliers of propylene, subject
to the terms of its existing written contracts with third‑party suppliers
as of the effective date of that agreement (September 1, 1991) (see
clause 4.01 of the Novacor Agreement).
[12] The pricing
mechanism in the Novacor Agreement was linked to a monthly price that was set
on the US Gulf Coast, that is, the USGC price referred to in the Contract
Price article (i.e. article V) of the agreement. That price is determined
by market participants on the Gulf Coast, with discounts being dependent upon
volume consumed. In other words, for given volumes of consumption the discount
would vary.
[13] Mr. Mineer stated
that those contract prices are typically advantageous in comparison to the spot
prices on the market. There are no minimum or maximum contract volume
obligations when buying from someone in the marketplace.
[14] In agreeing to the
assignment of the contract to the appellant (under article XIX of the Novacor
Agreement), Novacor was obliged to make the supplies available to the appellant
on a contract price basis.
[15] Mr. Mineer
explained that the determination was made at the time of the assignment in 1995
that this contractual obligation was worth US 16.3 million dollars.
[16] As a matter of fact,
an Assignment of Contracts and Assumption of Liabilities was entered into
between Shell and Himont Canada Inc. (the appellant's predecessor) on
March 31, 1995 (Exhibit A‑2, Tab G). By that agreement,
Shell agreed to assign to the appellant the full benefit of the contracts and
agreements (“contracts”) included in the purchased assets (among which was the
Novacor Agreement) and the appellant agreed to assume liability for the
performance of Shell's obligations under those contracts (clause B).
Consent to the assignment of the contracts was obtained (clause C) and by
that assignment Shell sold, transferred and assigned to the appellant all its
right, title and interest in and to the contracts, and the appellant agreed to
assume, and was to observe and perform, all of Shell’s obligations and
liabilities under the contracts.
[17] According to the
Asset Purchase Agreement, on March 20, 1995 (Exhibit A‑2, Tab D),
Shell sold its contributed businesses to the appellant for a total amount of US
$164,000,000. The price payable for the purchased assets was US $144,280,000.
The allocation of that purchase price is found in Schedule 3 to that Asset
Purchase Agreement (Exhibit A‑2, Tab D, p. 26). The supply
contracts at issue in the present case are identified under the Intangible Assets
heading and are evaluated at US $16.3 million.
[18] The purchase of Shell's
assets and propylene business was approved in the minutes of a regular meeting
of Himont Canada Inc. on March 17, 1995 (Exhibit A‑2, Tab E).
The board of directors approved and authorized the purchase by the appellant of
certain property and assets, including plant and equipment then owned and used
at Sarnia by Shell for the production and sale of polypropylene, for US $164,000,000.
[19] It was resolved
further that the board of directors approved and authorized the entering into
of the Feedstock Supply Agreement by the appellant “in order to ensure, among
other things, the supply to the Company [the appellant] of certain of its
requirements for propylene meeting the specifications described therein”.
[20] According to Mr.
Mineer, this transaction did not put the appellant in a monopolistic position.
He said that the North American polypropylene market has in the order of
18 billion pounds of total capacity. The appellant's share of that market
is approximately 3 billion pounds of capacity, which means that about 15
to 20 per cent of total market capacity is in its production
facilities. The Sarnia site that was purchased by the appellant had in the
order of 350 million pounds of capacity, that is, two per cent of the
total market.
[21] Mr. Mineer acknowledged,
however, in cross-examination that there were only two polypropylene plants in
Canada, which are now both owned by the appellant. When the appellant purchased
the plant in Sarnia, there was no interruption in that plant's operations.
Appellant’s argument
[22] Counsel for the
appellant did not dispute the fact that by acquiring the assets owned by Shell at
its Sarnia operation, the appellant did enlarge the structure of its own
business. What counsel argued, however, was that nothing prevented a current
expense from occurring at the same time as a capital expense was incurred on acquiring
the capital assets of Shell’s Sarnia operation. In counsel’s view, one has to
look at the allocation of the purchase price in order to properly classify each
asset so acquired.
[23] Counsel for the
appellant submitted that the purchase of the supply contracts was not per se
determinative. With respect to the characterization of the payment, counsel
relied on the decision of the Supreme Court of Canada in Johns‑Manville
Canada v. The Queen, [1985] 2 S.C.R. 46, in saying that its nature is to be
determined from a practical and business point of view, and not on the basis of
a juristic classification according to the object of the expenditure.
[24] Here, the
US $16.3 million was the upfront payment for the acquisition of raw
material. The appellant thus acquired supplies at a price which was considered
advantageous at the time. As a matter of fact, the cost of the supplies (the
propylene, i.e. the inventory) was made up of two components: 1) the
payment that was made regularly on acquisition, the appellant being invoiced
monthly at the price fixed under the Novacor Agreement; and 2) a portion of the
upfront payment (the US $16.3 million). The US $16.3 million was
paid to obtain favourable prices. In order to obtain the raw material, the
appellant had to make this advance payment. It contributed to the circulating
capital (as opposed to the fixed capital) the very trading assets (the pellets)
used by the appellant to earn its income (see B.P. Australia, Ltd. v.
Commissioner of Taxation of the Commonwealth of Australia, [1965] 3 All. E.R. 209
(Privy Council), at p. 219). In other words, in order to effect the sales,
the appellant had to acquire the raw material, which it obviously did on a recurring
basis; the raw material was purchased, processed and then sold: that is to say,
it circulated.
[25] Counsel for
appellant further submitted that in acquiring the raw material, it was not
acquiring the means of production, but was using it. The nature of the benefit
sought was to obtain inventory at a reduced price, and this inventory could
then generate higher profits.
[26] Counsel suggested
that the Court should look at the business or commercial reality of what was
sought by the expenditure. In so doing, it should exercise common sense
judicial judgment, analyzing various factors in determining whether the
expenditure is an income or a capital outlay (reference was made to the reasons
of Le Dain J., dissenting, in M.N.R. v. Canadian Glassine Co. Ltd.,
[1976] 2 F.C. 517 (F.C.A.) (QL) at par. 24). According to counsel for
the appellant, a supply contract is not a fixed asset; it is not part of the
profit‑making structure or organization of an enterprise. The payment for
the Novacor Agreement was a payment for the supply and was thus a current
expenditure in the circumstances.
Respondent’s argument
[27] At the outset,
counsel for the respondent stated that the only question to be determined is
whether the amount of US $16.3 millions allocated to the right, title
and interest in and to the supply agreements was an amount paid on account of
income or capital. If it was not on account of capital, as the respondent
submitted it was, the respondent does not take issue with the manner in which
the appellant chose to amortize the expense, which, according to the appellant,
provided a truer picture of its financial affairs.
[28] According to the
respondent, the amount of US $16.3 million was an amount paid on
account of capital because it was part of the total amount of
US $164,000,000 paid by the appellant for the acquisition of Shell’s
polypropylene business, namely, a refining facility located in Sarnia, Ontario,
together with intangible assets, such as an assembled work force, supply agreements,
software and goodwill, in order to enlarge its already existing income‑earning
structure (its polypropylene operations located in Varennes, Quebec). In fact,
the appellant doubled the income‑earning structure it had at the time.
According to the respondent, the entire US $164,000,000 (including the
US $16.3 million) was thus an expenditure on account of capital.
[29] Counsel submitted
that an expenditure made for the purchase of a business as a going concern is
always a capital outlay since it is made to obtain a source of income rather
than being made in the course of earning income (for that statement counsel
relied on City of London Contract Corporation v. Styles (1887), 2 T.C.
239 (C.A.) and John Smith and Son v. Moore, [1921] 2 A.C.
13).
[30] Counsel stated that
for Canadian tax purposes, the amount paid by a buyer upon the purchase of all
or substantially all of the assets of a business is also classified as a
capital expenditure rather than a current expense unless that buyer is in the
business of purchasing and reselling businesses (relied on in this regard were Seaboard
Advertising Co. v. M.N.R., [1966] Ex. C.R. 266 and Southam Business
Publications Ltd. v. M.N.R., [1966] Ex. C.R. 1055).
[31] Counsel for the respondent
therefore submitted that the amount of US $16.3 million was not part
of the cost of carrying on a business but part of the cost of acquiring a
business. In the respondent’s view, although a price tag was placed on the
various assets acquired, the Asset Purchase Agreement clearly stated that the
aggregate amount was the consideration for the transaction. In counsel’s view,
the intent was to sell/purchase as a package the entire polypropylene operation
located in Sarnia. The transaction was the purchase of a profit-making structure
in order to add to an already existing business structure an enduring asset,
and not the purchase of severable disparate parts. In the respondent’s opinion,
the appellant cannot say that the amount of US $16.3 million was a
prepaid expense for its future raw material needs or an expenditure made to
acquire inventory, because the amount at issue was not paid to the supplier and
no raw material was actually purchased and kept in inventory by the appellant
as a result of the payment of that amount. What the appellant obtained, rather,
was a right, title and interest in and to supply agreements which entitled it
to buy agreed upon quantities of raw material for a specific period of time at
a given price that was advantageous compared to the price on the spot market at
the time of acquisition. This took place in the process of purchasing a profit‑making
structure with the consequent procurement of endurable benefits.
Analysis
[32] In my view, an
inference cannot be drawn from the documentation provided in evidence and from
the testimony of Mr. Mineer that the intent was for the appellant to
purchase as a complete package the entire polypropylene operation located in
Sarnia. Although the appellant certainly enlarged its profit‑making
structure in acquiring Shell’s business in Sarnia, I tend to agree with the
appellant that the assignment of the Novacor Agreement was a subject matter
that stood on its own in the negotiations with Shell. Shell was linked to that
agreement and it was wholly in its interest to free itself from it by selling
its business. The same cannot be said for the appellant. The appellant could
very well have purchased Shell’s business without accepting the assignment of
the Novacor Agreement if the contract price of the propylene had not been advantageous
to it at the time of the transaction. The result would have been that Shell
would have had to pay damages to Novacor for not meeting its obligations under
that agreement (clauses 4.05(b) and (c) of the Novacor Agreement, Exhibit A‑2,
Tab H). We can speculate that in that case, Shell would have tried to
negotiate a higher price in selling its assets to the appellant, to cover the cost
of those damages.
[33] On the other hand, Shell
could, for whatever reason, have simply assigned its rights and obligations in
and under the Novacor Agreement to the appellant without necessarily selling
its business. We can speculate that the price attributed to the agreement might
then have been that indicated in the actual transaction, that is, US $16.3 million.
In such a case, the expense might very well have been considered by the
Minister as an expenditure made in the process of gaining income, as it would
not have been incurred in the course of purchasing an income‑earning
business as a whole.
[34] In accepting the
assignment of the Novacor Agreement, the appellant was agreeing to pay for its
raw material a price that seemed advantageous at the time. But the appellant
was also taking a risk in that the spot price on the market might very well
drop below the price fixed in the agreement. As a matter of fact, this happened
in 1998 when the appellant decided to deduct the full unamortized balance in
accordance with the impairment of assets accounting rules, as the price agreed upon
with Novacor was no longer advantageous and the appellant still had to purchase
a minimum amount of propylene from Novacor.
[35] Furthermore, a close
look at the documentation tends to show that the assignment of the Novacor
Agreement was not treated together with the transfer of Shell’s business. First,
in section 2 of the Feedstock Supply Agreement, it is clearly stated that
the assignment of the Novacor Agreement is to be treated independently (see Exhibit A‑2,
Tab D, p. 29). Second, there was a separate agreement, entitled
Assignment of Contracts and Assumption of Liabilities, for, among other things,
the transfer of the Novacor Agreement from Shell to Himont Canada Inc. (Exhibit A‑2,
Tab G). Third, there was a separate resolution of the board of directors
of Himont Canada Inc. approving the entering into of the supply agreement separately
from the purchase of the assets of Shell’s plant (Exhibit A‑2, Tab E).
Fourth, a price was specifically allocated for the supply agreements in the
Asset Purchase Agreement (Exhibit A‑2, Tab D, section 3,
and Schedule 3 to that agreement).
[36] All this is an
indication to me that the assignment of the Novacor Agreement was not
necessarily part of the aggregate price for the acquisition of Shell’s profit‑making
structure. At least, the situation is not as clear‑cut as the respondent claims
it to be.
[37] The respondent
relied largely on the decision of the Privy Council in John Smith and Son v.
Moore, supra. In that case, a taxpayer had acquired his father's
coal merchant’s business, including certain short‑term contracts with
collieries for the supply of coal to the business. In his dissenting reasons,
Le Dain J. in M.N.R. v. Canadian Glassine Co., supra, commented
on the John Smith case as follows at paragraphs 31, 32 and 33:
31 . . . There would appear to be little
or no direct authority on the nature of a lump sum payment to obtain a supply
contract. In John Smith and Son v. Moore [1921] 2 A.C. 13, a taxpayer
who had acquired the coal merchant's business of his father attempted
unsuccessfully to deduct in the determination of profits an amount of £30,000 which
was the value that had been placed in the acquisition on certain short-term
contracts with collieries for the supply of coal to the business. The son had
not actually disbursed this sum but had paid something less as the net value of
the business as a whole. A majority in the House of Lords held that the sum of £30,000 was
not a permissible deduction for the purpose of determining profits. Two of the
members of the majority, Lord Haldane and Lord Sumner, held that it was in the
nature of a capital expenditure — a sum to be employed in fixed capital.
The third member of the majority, Lord Cave,
rested his conclusion on the view that the business was a continuing one, and
that the expenditure for the supply contracts was not made by the business for
its trading purposes but by the son out of his own pocket. It was a payment
that could have no bearing on the profits of the continuing business. Viscount
Finlay, dissenting, held that the sum in question was a payment for coal.
32 There has been considerable judicial
commentary on the Smith case, but the general conclusion would appear to
be that in view of its very special facts and the differing reasons for the
majority opinions there is little, if anything, in the way of general principle
to be drawn from it. See Commissioner of Taxes v. Nchanga Consolidated
Copper Mines Ltd. [1964] A.C. 948, at 962-964; B.P. Australia Ltd. v.
Commissioner of Taxation of the Commonwealth of Australia [1966] A.C. 224, at 268-269; Regent Oil Co. Ltd. v. Strick
(Inspector of Taxes) [1966] A.C. 295, at 322-323 and 353. It cannot be said
to be authority for the proposition that a lump sum payment made to a supplier
to obtain a supply contract is to be considered a capital expenditure. As Lord
Pearce put it in the B.P. Australia case (supra) at page 269:
"One certainly cannot deduce that the result would have been the same if
the son had paid £30,000 to the collieries for the
contracts."
33 In my opinion a supply contract,
whatever its term and however advantageous it may be, is not an asset or
advantage in the nature of fixed capital. It cannot be considered in any sense
a part of the profit-making structure or organization of an enterprise. It is
not productive or generative or distributive of anything. It is what is
supplied under it that is used to make profit. The contract is simply evidence
of legal obligations with respect to operating transactions. No doubt it is
a thing of value to the enterprise but that does not mean that it has the value
of fixed capital. Its value is reflected by and is of the same nature as that
which is to be supplied under it. In my view a payment for the contract must be
considered to be a payment for the supply.
(Emphasis
added.)
[38] The majority in Canadian
Glassine did not disagree on this point. In that case, the taxpayer
corporation was incorporated to manufacture glassine paper. It had an
arrangement with another corporation, Anglo‑Canadian, which supplied the
taxpayer corporation's pulp requirements on a long-term basis at an
advantageous price. That agreement included an undertaking by Anglo‑Canadian
to construct underground pipelines to convey pulp and steam from its plant to
the taxpayer's. The amount paid by the taxpayer to Anglo-Canadian under that
agreement was considered by the majority of the court as being paid in
consideration of the construction of the pipelines and not for the execution of
the supply contracts per se. The majority thus concluded that it was an
outlay of capital. Le Dain J. dissented on the basis that the payment was a
payment made in advance to obtain the raw material and power and accordingly
was an income expense.
[39] The John Smith
decision had previously been discussed and distinguished on the basis of its
own peculiar facts in Commissioner of Taxes v. Nchanga Consolidated Copper
Mines, Ltd., [1964] 1 All. E.R. 208 (Privy Council), at pages 213‑215:
The appellant’s argument
relied largely, as was natural, on the decision of the House of Lords in John
Smith & Son v. Moore (6). It would perhaps be more accurate
to say that it relied on the speeches of Lord Haldane and Lord Sumner in that case, for of the four lords who
took part in the decision Viscount Finlay dissented and Lord Cave took
a line of approach which is not relevant to the present dispute. . . .
It appears clearly from a
close study of the speeches of Lord
Haldane and Lord Sumner that two elements in the case, or rather
the combination of those two elements, determined their decision. First, no sum
of £30,000 had ever been paid. What was acquired was a business consisting of a
variety of assets, among which was the benefit of the contracts, and involving
a number of liabilities; the only money that the son had paid was the sum representing
the net value of that business. Lord Sumner said (8):
“He bought a business and its assets at a
valuation . . . He bought no coals; the business had none, nor any stock in
trade; nor did he acquire any stock in trade in any business sense of the term
. . . He did not pay this sum as the consideration for an assignment
of the benefit of these contracts to himself; he took no assignment.”
It is evident that both the learned lords
felt it to be impossible to say that a sum paid to acquire a business as
representing the net value of that business, but not specifically allocated to
individual assets of the business, was anything but a capital expenditure on a
fixed asset. Lord Sumner regarded the case as being in effect governed by the earlier decisions of City
of London Contract Corpn. v. Styles (9) and Alianza Co., Ltd. v.
Bell (10). And so it was, according to the terms in which he dealt with
it. The second feature that was treated as of importance was the fact, alluded
to by Lord Sumner (8), that
in paying something in respect of the benefit of the contracts the son had not
acquired stock in trade or anything like such stock. It is not difficult to
suppose that in a different context a sum paid by a running concern to a trader
for the right to take over his supply contracts at fixed prices, if limited to
the year of profit ascertainment, might fairly be regarded as part of the cost
of acquiring the commodity to be supplied and, as such, chargeable against the
gross proceeds of its sale. Lord Sumner indeed seems to have visualised this, when he said (11) in explanation of
the Styles decision (9):
“This sum was paid with the rest of the
aggregate price to acquire the business and thereafter profits were made in the
business; the sum was not paid as an outlay in a business already acquired, in
order to carry it on and to earn a profit out of this expense as an expense of
carrying it on.”
The John Smith decision (12) therefore turned on
the combination of two elements as the facts of the case: an aggregate price
paid as the net value of a business taken over, and the inclusion in the assets
of that business of the benefit of short-term supply contracts which were not
in a form allowing them to be treated as analogous to stock in trade. But for
the combination of those elements it is not to be assumed that the decision
would have been the same, for it is difficult to accept as a sound general
proposition that if a man acquires and pays for stock in trade for his own
business on the taking over of another he is not entitled to set off against
the gross proceeds of realising the stock the identifiable cost of acquiring it.
. . .
(Emphasis added.)
(6) [1921] 2 A.C. 13; 12 Tax Cas.
266.
. . .
(8) [1921] 2 A.C. at p. 37;
12 Tax Cas. at p. 295.
(9) (1887), 2 Tax Cas. 239.
(10) [1906] A.C. 18; 5 Tax Cas. 60
and 172.
(11) [1921] 2 A.C. at p. 39;
12 Tax Cas. at p. 296.
(12) [1921] 2 A.C. 13; 12 Tax
Cas. 266.
[40] In the present case,
the appellant paid a sum of US $16.3 million as consideration for the
assignment to it of the benefit of the supply contracts. An amount was
specifically allocated to the transfer of the supply contracts. As Viscount Radcliffe
said in Nchanga, supra, at page 215, it is difficult to
accept as a sound general proposition that if a man (or a corporation) acquires
and pays for stock in trade for his (its) own business on the taking over of
another, he (it) is not entitled to set off against the gross proceeds of
realizing the stock the identifiable cost of acquiring it.
[41] There is no single
test for determining whether a particular expenditure is on income or capital
account. In the final analysis, one must exercise common sense judicial
judgment in the light of the particular circumstances of each case (cf. Canadian
Glassine, supra, at paragraph 24, which refers to B.P.
Australia Ltd., supra, cited with approval by the Supreme Court of
Canada in M.N.R. v. Algoma Central Railway, [1968] S.C.R. 447). The
criterion most frequently referred to as an authoritative test is the concept
of “an asset or an advantage for the enduring benefit of the trade of the
taxpayer” expressed by Viscount Cave in British Insulated and Helsby
Cables, Limited v. Atherton, [1926] A.C. 205. But as stated in Nchanga,
supra, at page 212, it cannot be supposed that that test gives any
warrant for the idea that securing a benefit for the business is prima facie
a capital expenditure. Here, although there appeared to be a contractual
benefit for a certain period of time (the Novacor Agreement expired only in
2001), there was no assurance at all of an enduring benefit, as the spot market
price could at any time drop below the contract price, which, as mentioned
before, did indeed happen in 1998.
[42] Furthermore, the
test of whether amounts were payable out of fixed or circulating capital,
referred to in the John Smith case, was discussed in B.P. Australia,
supra, at page 219: “Fixed capital is prima facie that on which one
looks to get a return by one’s trading operations. Circulating capital is that
which comes back in one’s trading operations.” An expenditure with fixed
capital in mind is viewed as a capital expenditure while an expenditure from
circulating capital is not. Although the Supreme Court of Canada in Johns‑Manville,
supra, said that this vocabulary has changed, it recognized that the
same problem of classification survives (at p. 59). As I said before, it
is my view that the appellant made a deliberate choice in accepting the
assignment of the Novacor Agreement. In doing so, it took the necessary steps
to segregate out of the purchase price to be paid to Shell a specified sum allocated
to the supply contract. It is therefore difficult to imagine, to paraphrase B.P. Australia,
the appellant not accounting for that lump sum as an item in the cost of the
production of the polypropylene. As in B.P. Australia, it was “in the
forefront of the wholesaler’s selling costs” (page 219). When the matter
is considered from the perspective of the appellant’s business, as it must be
(see Pantorama Industries Inc. v. The Queen, 2005 FCA 135, [2005] F.C.J.
No. 635 (QL)), the US $16.3 million expenditure was part of the operating
cost to the appellant of obtaining propylene. As stated by Le Dain J.
in Canadian Glassine, at paragraph 38, the appellant did not obtain
for that sum anything that can be regarded as an asset or advantage in the
nature of fixed capital. Prima facie, therefore, the US $16.3
million was “circulating capital which [was] turned over and in the process of
being turned over yield[ed] a profit or loss; [it was] part of the constant
demand which must be answered out of the returns of the trade” (B.P. Australia,
supra, page 219).
[43] I therefore conclude
that the US $16.3 million was not in itself a capital expenditure even
though it was included in the purchase price of the total assets sold by Shell
to the appellant. That particular expenditure was carefully segregated in
separate agreements (the Asset Purchase Agreement, Exhibit A‑2, Tab D,
Schedule 3; the Assignment of Contracts and Assumption of Liabilities, Exhibit A‑2,
Tab G; and the Feedstock and Return Streams Supply Agreement, Exhibit A‑2,
Tab D, p. 29; there was also a separate resolution of the board of directors,
Exhibit A‑2, Tab E) which, in my view, show what the particular
expenditure was for (see Oxford Shopping Centres Ltd. v. The Queen,
79 DTC 5458, at p. 5464 (F.C.T.D.), confirmed by the Federal Court of
Appeal, at 81 DTC 5065).
[44] The appeals are
allowed, with costs, on the basis that the appellant was entitled to deduct
pursuant to subsection 9(1) and paragraph 18(1)(a) of the ITA
the amount of US $16.3 million (CAN $22,865,640) as a current
expense which could be amortized and written off, as was done by the appellant,
for each of the taxation years at issue.
[45] Upon consent to
judgment, the appeal for the taxation year ending December 31, 1996, with
respect to the double inclusion of an amount of $53,277 related to an
investment tax credit is also allowed.
Signed at Ottawa, Canada,
this 16th day of November 2007.
“Lucie Lamarre”
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