Pacific Northern Gas Ltd. v. The Queen, 90 DTC 6252, [1990] 1 CTC 380 (FCTD), aff'd 91 DTC 5287 (FCA)

Joyal, J.: —This Court faces two issues relating to the plaintiff's tax liability under the Income Tax Act. One issue is with respect to the classification, for capital cost allowance purposes, of certain equipment used in it operations. The other issue is the treatment to be given to certain payments received by the plaintiff from its customers in accordance with the Gas Tariff set by the Public Utilities Commission of British Columbia.

The plaintiff, as its corporate name implies, is in the business of buying, transmitting and distributing gas to its customers in certain areas of British Columbia. It buys its gas from Westcoast Transmission at Summit Lake, north of Prince George, and transports it through its pipeline westward to Prince Rupert. Along the way, it services its customers by way of lateral lines running both north and south from the main line.

As is common knowledge in the gas business, the system requires any number of compressor stations as the gas is transported at high pressure through the main pipeline and along the way, fed into lateral lines and ultimately at a much lower pressure, distributed to its industrial, commercial and residential customers. The classification of this compression equipment for capital cost allowance purposes is one issue before the Court.

When a customer is procured, the plaintiff is obliged to run a small diameter service line from its gas main to the customer's premises. Its obligation in that respect is limited, however, to the first 70 feet of the service line. The costs of any extension to that line beyond that distance is charged to the customer. The amounts thereby received by the plaintiff have not been treated as income but have been used to increase its undepreciated capital cost by an amount equal to the difference between the cost of the service line installation and the total of customer payments for the year. The Crown objects to this and claims that these payments constitute ordinary business income. The categorization of these amounts for tax purposes is the other issue before the Court.

The Capital Cost Allowance Issue

It is conceded by the parties that the plaintiff's compressor equipment is either in Class 2 or Class 8 of Schedule II of the Income Tax Regulations. Under Class 2, property is depreciable at a six per cent rate. Under Class 8, it is depreciable at a 20 per cent rate.

Class 8 is easily defined. It includes machinery or equipment not included, inter alia, in Class 2. Class 2 equipment, however, is categorized in knottier terms. It refers in paragraph (d) to property which is “manufacturing and distributing equipment and plant (including structures) acquired primarily for the production or distribution of gas . . .”.

At first blush, it may be said that the plaintiff's compressors have been acquired primarily for the distribution of gas and would therefore fall into Class

2. The plaintiff, however, adopts another view. It says that its total operation has two components, one being the transmission of gas and the other the distribution of gas. The compression equipment is used in the transmission component, i.e., to increase depleted pressure along the main pipeline. It is not used in the distribution end of the operation where regulating stations, to reduce pressure for customer use, are installed.

The plaintiff relies, in this respect, on a generally-accepted break-down in the gas industry between production, transmission and distribution operations. Mr. Jack Kreut, Vice-president of Operations for the plaintiff and Mr. William Deyell, an expert in the gas industry, testified in support. The industry, they said, gives a very clearly defined meaning to these three stages of operations. One of these stages, as far as the plaintiff is concerned, is the transmission of gas from Summit Lake all along its main pipeline to Prince Rupert. It is along this line that compressor stations are located but they are not linked to the distribution of gas as that term is defined by the plaintiff. The distribution effectively begins where the gas is fed into lateral lines and it is at those points that regulating stations are installed to reduce the pressure of the gas to a safe and manageable level.

Compressors, according to the witnesses, are not needed in the distribution of gas and their association with the transmission of gas is clearly reflected in the literature of the Canadian Standards Association, particularly in C.S.A. Z-184, 1975, where at page 21, a schematic outline of a complete gas system is found and where a clear distinction between the transmission and distribution operation is indicated. There is also reference to page 26 of the publication where in defining certain gas industry terms, “transmission line” is defined as

a pipeline that conveys gas from a gathering line, treatment plant, storage facility or from the field collection point in a gas field to a distribution main, service line, storage facility or another transmission line.

[Emphasis added.]

The publication also provides a concomitant definition of "distribution system" as meaning

the distribution mains and service lines and their associated control components, through which gas is conveyed from transmission lines . . . .

[Emphasis added.]

The plaintiff urges the Court to conclude that when Class 2 of Schedule I! speaks of equipment acquired primarily for the distribution of gas, it must necessarily exclude equipment used in the transmission of gas, the two being adjunctive to each other but obviously involving quite distinct functions. Further, says the plaintiff, if the wording used in Class 2 should be categorized as somewhat ambiguous, any such ambiguity should be resolved in the plaintiff's favour on the strength of the Supreme Court of Canada decision in Johns- Manville Canada Inc. v. The Queen} [1]

Finally, the plaintiff refers to Interpretation Bulletin IT-482 of November 30, 1981, which refers to Classes 2, 8 and 10 of Schedule II of the Regulations. At paragraph 8 of the Bulletin, the following is found:

8. Where a natural gas compressor station is used in conjunction with the main gathering or pipeline system and it is used to either stabilize the varying field pressures for transmission of the gas to a gas processing plant or to compress the gas to a pressure required for its transmission to a gas processing plant, the compressor is not considered to be a component part of the pipeline and its capital cost is included in class 8 . . . .

[Emphasis added.]

Paragraph 8 of IT 482 was amended on June 6, 1983 and now reads as follows:

8. A compressor station that is used in the transmission of natural gas from a gas field or a gas plant to a transmission pipeline, or that is used in conjunction with a main transmission pipeline, is included in Class 8. A compressor station used in conjunction with the distribution of gas is included in Class 2 by virtue of paragraph (d) thereof.

[Emphasis added.]

The plaintiff invites the Court to find in these observations not only an admission by the Crown that gas transmission and gas distribution represent separate and distinct functions but that compression stations, when associated with the transmission function, is a Class 8 property.

The Crown, on the other hand, adopts what it calls a more realistic position on the whole issue. Crown counsel suggests that, for purposes of Class 2, Schedule II, a more generic meaning should be ascribed to the expression “distribution of gas”. Such a meaning was the one given by Madame Justice Reed of this Court in Northern and Central Gas Corporation Limited v. The Queen. [2]

In that case, the taxpayer had built a liquified natural gas plant on its gas transmission line to store gas during periods of low demands and have it available to feed its line during peak periods. The taxpayer was of the view that the plant was not one primarily acquired for the distribution of gas, as specified in Class 2(d) and therefore could not fall within that class.

At page 197 (D.T.C. 5146-47), after remarking that words in a statute should be interpreted in their ordinary sense, Reed, J. had this to say:

It is clear that class 2 of schedule B as a whole does not just relate to the natural gas industry. It relates to the production and distribution of electricity, heat and water as well as to the gas industry generally, not merely that involved with the production and distribution of natural gas. Subparagraph (b) is even more general, referring to pipelines without reference to the commodity they carry. Accordingly, it is difficult to conclude that the word "distribution" in subparagraph (d) was chosen with the specific usage of the natural gas industry in mind. Rather, it seems clear that the subparagraphs of class 2 were intended to encompass the whole process from the production (or manufacture) of the gas (electrical energy water or heat) to its ultimate distribution to customers (with some specific exceptions). I think it would do violence to the word distribution as used in class 2, if one interpreted it as encompassing only the end use distribution system, as contended for by the plaintiff. Such interpretation would bring within the scope of subparagraph (d) gas production facilities and end use distribution facilities but not the intermediate transmission facilities. Such interpretation would render subparagraph (ii) meaningless or would force a reader to conclude that “distribute” in that section was being used in a sense different from the way in which it was used elsewhere in paragraph (d). Subparagraph (ii) refers to the distribution of gas in portable containers—a process radically different from the restricted meaning the plaintiff wishes to give to the word “distribute”. In my view, “distribution” in subparagraph (d) is used in a broad and general way and it was intended to encompass the transmission part of the plaintiff's overall distribution system. Thus, the LNG plant falls within class 2(d) as “plant acquired primarily for the . . . distribution of gas". It is true that the plant is a storage facility but from the evidence led by the plaintiff it is clear that the facility is an integral part of the plaintiff's transmission system. One witness described it as an integral part of moving large quantities of gas from North Bay to Sudbury. Thus, the facility is a plant acquired primarily for the distribution of gas.

Counsel for the plaintiff also argued that the LNG plant should fall outside class 2 because it should be classified as coming within the exception set out in subparagraph (iii):

a property acquired for the purpose of processing natural gas before delivery to a distribution system,

I do not think that this argument is convincing. As noted above, it is my view that the word "distribution" as used in class 2(d) is not used in the restricted sense given to that word by the natural gas industry. It is used in a more general sense and encompasses the transmission phase of the plaintiff's enterprise. Accordingly, the plant could not be said to have been acquired for the purpose of processing gas "before delivery to a distribution system".

[Emphasis added.]

On appeal before the Federal Court of Appeal [3] the trial decision was confirmed and Stone, J.A., after reviewing the reasons below, noted:

It is evident that Class 2(d) is not limited in its application to the production and distribution of natural gas alone. In my view, subject to the exceptions specified, the distinction it draws as applied to this case is between property of the appellant that is manufacturing equipment and plant acquired primarily for the production of gas and property that is distributing equipment and plant acquired primarily for the distribution of gas subsequent to its production.

Stone, J.A. then adds to this:

I agree with the learned trial judge that “distributing” and “distribution” are used in a broad and general sense and, for the reasons she has given on the point, that the LNG plant was acquired primarily for the “distribution of gas”. I find nothing in the context that requires us to give the terms “distributing equipment” and “distribution of gas" a more restrictive construction corresponding to the distinction drawn in the natural gas industry between a transmission and a distribution system [4] .

In the face of both these judgments, I daresay the issue before me would not have been the subject of further argument. However, something else happened. Six or seven months after the Appeal Court decision in the Northern and Central Gas case, supra, the Federal Court of Appeal rendered judgment in the case of Nova, an Alberta Corporation v. The Queen, [5] In that case, the issue was whether or not certain equipment consisting of pipes and valves located between the outlet connection of the taxpayer's main pipeline and its compressor stations were such an integral part of the compressor stations that they should properly be classed as Class 8 property.

At the trial level, [6] Dubé, J. adopted the meaning given to pipeline and pipeline systems by those involved in the gas and oil industry. He found that the pipes and valves were not part of the “pipeline” but part of the pipeline system. He rejected the Crown's argument that it was part of the “distribution” of gas, holding that it was perfectly clear in the commercial usage that "manufacturing" and “distributing” did not include "transmission" or "transporting".

The Federal Court of Appeal upheld Dubé, J.'s judgment. Urie, J.A., on behalf of the majority, said:

There can be no doubt, and the trial judge found as a fact that, the respondent is neither a producer nor manufacturer of gas. It is not disputed that its sole business is to transmit (i.e., to transport) natural gas produced and owned by others through its pipelines for delivery on behalf of the owner to the facilities of other natural gas transmission companies. It does not apportion or allot in portions among a number. Nor is it a distributor, or involved in the distribution of gas, in the sense in which those terms are used in the natural gas industry. Distribution, according to the evidence means conveying gas to individual user lines or to other distribution lines. It is a function entirely different from the transmission or transportation of gas. As observed earlier, the service performed by the respondent is akin to that of common carrier without any relationship with the ultimate user. Therefore, the function performed by the respondent is not distribution within either the dictionary meaning of that word or in the sense in which the term is used in the industry.

On those facts then, this case differs from those involved in Northern and Central Gas Corporation Limited v. The Queen. I. . .] Unlike the respondent here, the appellant in that case purchased natural gas from a gas transmission company for delivery to it near North Bay, Ontario, and from where it was transported on a transmission line owned by it. A liquified natural gas plant also owned by the appellant was used to store the natural gas purchased by the appellant in low- demand periods for sale to the appellant’s customers during high demand months. The gas was stored in liquid form for reconversion and delivery to its customers. In these circumstances, this court found that the liquified natural gas plant there in issue was “acquired primarily for the distribution of gas”. Here, no matter whether the dictionary or industry meaning of “distribution” or "distributing" is utilized, the respondent is not engaged therein. The pipes and valves in issue, consequently, are neither manufacturing nor distributing equipment. Neither were they acquired primarily (or otherwise) for the production or distribution of gas. The two preconditions for the classification of property under Class 2(d) of Schedule B have not, therefore been met. The appellant thus fails on the second ground of its appeal. [7]

Pratte, J.A. in his dissenting judgment, adopted the view taken by the Court in the Northern Central Gas case. He stated:

Let me consider, first, the appellant's alternative argument that the assets here in issue were “manufacturing and distributing equipment . . . acquired primarily for the production or distribution of gas" within the meaning of paragraph (d) of Class 2 of Schedule B of the Income Tax Regulations. I am of [the] opinion that, in view of the recent decision of this Court in Northern and Central Gas Corporation Limited v. The Queen, [. . .] that argument cannot be rejected. Indeed, in that decision, as I read it, the Court held that the word "distribution" in Class 2 is used in a very general sense that encompasses what the jargon of the natural gas industry refers to as the transmission and the distribution of gas. It necessarily follows, in my view, that the assets here in question are assets of the kind described in paragraph (d) of Class 2 of Schedule B. [8]

This curial split results in a fine kettle of fish, or more to the point, creates a confusing mix of judicial pronouncements. One trial judge and two appeal judges have opted for a more restrictive construction to conform with industrial usage and make a distinction between “transmission” and "distribution". One trial judge and four appeal judges have adopted a broad and generic interpretation to the word “distribution”. This makes the score 5-3 and if the parties before me were to make book, I am sure the plaintiff would insist on good odds.

In the Northern and Central Gas case, the factual situation was extensively reviewed by the trial judge. She said at pages 194-95 (D.T.C. 5145):

There is no doubt that this plant takes gas out of, and in winter months feeds the gas back into, what the natural gas industry calls a transmission system, not a distribution system. There is ample evidence that the industry draws a very specific and well defined line between a natural gas transmission system and a natural gas distribution system. A natural gas transmission system carries large quantities of gas over long distances at high pressures (e.g.: 500 p.s.i.g. to 1,000 p.s.i.g.); a transmission pipeline generally has a diameter of 10 inches or more and is made of a material (metal) able to withstand high stress levels; the public is not directly served from a transmission line. A natural gas distribution system on the other hand carries gas at relatively low pressures (e.g.: 30 p.s.i.g. to 125 p.s.i.g.) over shorter distances; it comprises a network of small pipes sometimes made of a non corrosive material such as plastic; and it serves the public directly. The end of a transmission system and the beginning of a distribution system is clearly ascertainable because at that point the gas is piped through a "gate station” (a regulating station) to reduce the transmission pressure to distribution pressure levels.

The learned judge also described the operation of Northern and Central Gas where it buys its gas from TransCanada PipeLines at North Bay and runs from there a lateral line westerly to Sudbury and Espanola in order to service its customers. For peak demand, the gas company leans on its LNG plant located on the Sudbury lateral near Hagar, Ontario. I note specifically in this connection that from the time the system is fed by gas purchased from TransCanada Pipelines, the gas running through is owned by Northern and Central.

In the Nova case, Dubé, J. found that the plaintiff is in neither the manufacturing nor the distributing business. It is solely engaged in transmitting or transporting natural gas. The learned judge faces squarely the decision of his colleague Reed, J. in the other case and distinguishes it on the basis that in that case, the gas company was not limited to transmission operations but operated a plant and distribution system as well.

Urie, J.A. in the Nova appeal, stated at page 169 (D.T.C. 6387) that Nova's principal business is the transmission of natural gas within the boundaries of Alberta and he described its operations as follows:

In effect, the respondent (Nova), by transmitting the natural gas owned by its customers, received from the facilities of the producers, acts as a sort of common carrier for the transportation of gas to the facilities of other natural gas transmission companies.

What I conclude from the facts outlined in both the Northern and Central case and the Nova case, as well as the facts in the case before me, may be summarized as follows:

1. Nova is in the business of transporting gas as a common carrier. It does not distribute gas in the sense understood in the industry. Its role is to gather gas from producers, transmit it through its extensive grid system throughout Alberta and deliver it to the owners at the end of the line. For this transmission service, it charges a fee or a toll.

2. Northern and Central, as well as the plaintiff before me, is not in the business of carrying someone else's gas. Northern and Central buys its gas at North Bay from TransCanada Pipelines and thereafter it owns the gas passing through its system to the ultimate customer. The plaintiff buys its gas from Westcoast Transmission at Summit Lake and thereafter its operations are identical.

Would this be the kind of distinction which would resolve the jurisprudential conflict before me?

It could be argued that Nova is in the business of transmitting gas to various distributors. The plaintiff, as well as Northern and Central, are more in the business of distributing gas to their customers. Using the main purpose approach, it would indicate that the plaintiff's compressor equipment is acquired “primarily for the . . . distribution of gas”. If it is true, in industry parlance, that the plaintiff's operations also have a transmission component, the purpose of that transmission component is nevertheless to feed gas into its distribution system. The converse applies in the case of Nova. Its transmission operations, by reason of its grid system, may also be said to have a distribution component but the purpose of that distribution component is nevertheless to carry gas and not distribute it.

How does that tie in with the scheme of Class 2 regulations? I note that Class 2(d) speaks of equipment acquired primarily for the distribution of gas. Class 2(d)(iii) exempts such property when it is acquired for the purpose of processing natural gas before delivery to a distribution system. The regulation must therefore contemplate that there does exist such a work or undertaking as a distribution system and that, although such a system transmits gas no less than a transmission system, its prime function is the distribution of gas.

This is not to suggest that the reasoning of Dubé, J. and Urie, J.A. in the Nova case is not attractive. On the contrary, it is buttressed by strong evidence from the gas industry as to its approach to the various functions of exploration, production, transmission and distribution. Further, it is consistent with the Canadian Standards Association definitions found in C.S.A. Z-184 and it is not inconsistent with Revenue Canada's own interpretation in IT-482. It has the added attraction of creating homogeneity with respect to capital cost allowances in the gas industry by establishing a dividing line between the transmission and the distribution phase of any particular undertaking. It would not particularly matter if such undertaking were of the Nova kind or of the Northern and Central kind. Furthermore, it would indicate that equipment primarily used in conjunction with the transmission of gas, as is the case for compressor stations, would fall into Class 8 and other equipment, primarily used in the distribution phase of the undertaking, as is the case for regulating stations, would fall into Class 2.

Both Dubé, J. and Urie, J.A. in the Nova case have distinguished the facts before them from those found in the Northern and Central case. They found that Nova operated a transmission system. Its equipment could not be said to be “manufacturing or distributing equipment for the production or distribution of gas” as that expression is found in Class 2. Nova was in the business of transmitting gas and it carried on no distribution function at all.

In the case of Northern and Central, however, both Reed, J. and Stone, J.A found that the taxpayer was operating a gas distribution system and that its LNG storage facility was part of that system. Both disagreed with the taxpayer's argument that the facility was part of its transmission operation, i.e. an operation to carry or transport the gas to the “city gate" where the gas is depressured and fed into small bore, low pressure, distribution lines to customers. Furthermore, both learned judges agreed that on a proper construction of the regulation, it was intended that Class 2 would apply to equipment acquired for all phases of a natural gas system, including production, transmission and distribution.

It is this latter finding which, in my respectful view, makes the two cases irreconcilable. The results in either case could certainly be sustained or justified by reason of different factual situations. Indeed, in the case before me, were I to limit the debate to a more functional test as to what compressor stations are all about, I should have little hesitation in ruling that such equipment is primarily acquired for the transmission of gas and not for its distribution. Compressor stations are no less essential for the transmission of gas than regulating stations might be for its ultimate distribution.

ls there a third approach? Can this Court reconcile the irreconcilable or is the Court limited to endorsing one or the other?

In surveying the field in this respect, I should first find that compressor stations, in industry parlance, are a necessary adjunct to the transmission of gas. Adopting the Nova view of things, compressor stations would fall into Class 8 at a 20 per cent rate. Similarly, the transmission phase of a system, like in the case before me, would also fall within Class 8 at 20 per cent. The consequence would be the adoption of a functional test to the interpretation of the regulation, namely that it matters not if the primary acquisition of such property is for purposes of transmission of gas, with a distribution component, or for purposes of distribution, with a transmission component. In either event, such property would fall into Class 8 and would be excluded from Class 2.

To make such a definitive finding would be tempting indeed. It would reconcile the divergent views adopted by the Federal Court of Appeal in the Northern and Central case and in the Nova case.

A more considered approach, however, should make me resist that temptation. Admittedly, one might shift the balance one way or the other and give both the kind of legitimacy expected of a reasoned judgment. On balance, I find I must favour the approach taken in the Northern and Central case.

In my view, Class 2(a) sets the leitmotif for a proper appraisal of the meaning ascribable to the subsequent paragraphs in that class. Class 2(a) speaks of pipelines which includes, of course, a natural gas pipeline and provides for it a depreciation rate of six per cent. Class 2(d) speaks of equipment primarily acquired for the production or distribution of gas. I should find in that respect that natural gas being ordinarily moved or distributed by pipeline, compression stations are part of its appendage. This would indicate to me a legislative intention to place both the pipeline and its equipment in the same class. It would also indicate to me that by referring in the regulation to the two functions of "production" and “distribution” in paragraph (d), by excluding other property in sub-paragraphs (i), (ii) and (iii) and specifically, by excluding processing equipment before delivery to a distribution system, the legislative intent was to place in Class 2 all pipeline equipment whether used in the production of gas, the transmission of gas or the distribution of gas.

In that sense, the concept of transmission or distribution, for purposes of the enactment, could be said to be interchangeable or co-extensive; the reality of any pipeline system is that the process of transmission involves distribution and the process of distribution involves transmission, the whole notwithstanding the prescriptive norms otherwise applicable in the natural gas industry.

There is another aspect to this whole issue which is deserving of comment. The parties will realize that my conclusions lead to incongruous consequences. On the strength of the Nova decision, compressor equipment, when used in the “transmission” of gas by a party involved "solely" in the "business of transmission”, would enjoy Class 8 category at a 20 per cent rate.

The same equipment, fulfilling the same purpose, when used in the "distribution" of gas by a party involved in the "business of distribution”, would fall into Class 2 at six per cent. This is an anomaly which, unfortunately, cannot be immediately resolved. It is a situation forged through a classic Scylla and Charybdis experience. In the light of Nova the Court cannot, without an insensitive approach to the enactment, resolve the anomaly. In the light of Northern and Central, the Court cannot avoid it.

In conclusion, I must subscribe to the reasons expressed by the learned judges in the Northern and Central case and find that the plaintiff's compressor equipment properly falls within Class 2 of Schedule Il of the Income Tax Regulations.

2. The Categorization of Certain Receipts of the Plaintiff:

I have already described the conditions under which the plaintiff is reimbursed by its customers for that portion of the cost of installing its customer service lines when such lines extend more than 70 feet from the plaintiff's main line. The formula for all this forms part of the Tariff imposed by the Public Utilities Commission of British Columbia.

Over the years, varying amounts were received by the plaintiff in this account averaging some $30,000 per year. The amount involved in 1980 was $22,984.

In each of the years between 1974 to 1980, the plaintiff increased the undepreciated capital cost of its installations by an amount equal to the difference between the cost of the customer services and the total of customer payments received.

On October 23, 1985, the Crown purported to re-assess the plaintiff for those years so as to include in income the customer payments above referred to and to add to its depreciable property the amounts of such customer payments.

The plaintiff states that this is not the proper way of looking at it. By their very nature, these customer contributions are capital. They are a component of the plaintiffs capital structure. The treatment given to the contributions are in accordance with generally-accepted accounting principles. By decreasing the undepreciated capital base by an amount equal to the contribution, the plaintiff is adding to his disposable or taxable income.

A similar situation faced another taxpayer involved in the gas distribution business, namely Consumers' Gas Company Limited. The imbroglio with the Crown over its accounting methods and its tax liability became the subject of judicial determination in 1983-84. Urie, J.A., in delivering the unanimous judgment of the Federal Court of Appeal, [9] set out the following factual base to the issue:

The respondent (the plaintiff, Consumers' Gas) is a public company having its head office in Toronto, Ontario. It is engaged in the business of distribution of natural gas to over 725,000 residential, commercial and industrial customers in Ontario, and, as well, in the production of natural gas, primarily from wells in Lake Erie and in the sale and rental of gas appliances. Its business activities, including its rates and accounting methods and practices, are subject to the approval of the Ontario Energy Board. The vast bulk of its revenue (approximately 95 per cent) in the years in issue, was attributable to its gas distribution business. The gas is mainly received from trunk pipelines at a gate station outside its operating area. From the gate station the respondent distributes the gas through steel gas mains which generally run beneath the surface of streets and roads. The individual customers are provided with gas through pipes leading from the mains.

Various persons and organizations such as government departments, municipalities, utilities, telephone companies and other private companies from time to time require the relocation of portions of the pipeline network in order to do construction work for their own purposes. Usually such relocations are required because of some physical conflict arising from the construction work but they may also be undertaken for safety reasons. The parties requesting the relocations may or may not be customers of the respondent.

Whenever it can the respondent attempts to recover the full cost of the relocations from the party requesting them. However, the amount it can recover may be limited by the provisions of either The Public Service Works on Highways Act (R.S.O. 1970, c. 388) or the Railway Act (R.S.C. 1970, c. R-2). The respondent in all cases carefully calculates all elements of cost associated with the relocations and bills the parties in full for such costs or such part thereof as is permitted by statute.

Upon completion of the relocations the original pipe is usually abandoned and left in the ground although certain above-ground equipment such as parts of regulator stations may be salvaged. In the latter event credit is presumably given for the value of the salvaged equipment.

The average annual number of relocations in the taxation years in question was about 225.

Prior to the decision of the Court in Canadian Pacific Limited v. The Queen, [1978] 2 F.C. 419; [1977] C.T.C. 606; 77 D.T.C. 5388, the respondent treated reimbursements received from the parties for whom relocations were undertaken in essentially the same manner as it did for financial statement purposes, i.e., it reduced the amount of the gross cost of its relocated pipe by the amount of the reimbursements and added the net amount only to the undepreciated capital cost of the class (class 2). In substance, it took capital cost allowance on the net cost only. Incidentally, for rate-fixing purposes that is one of the methods for treating the reimbursements authorized by the Ontario Energy Board. After the Canadian Pacific case the respondent took the position that for tax purposes it (a) was entitled to add the gross cost of the relocations to the undepreciated capital cost of the class and to claim capital cost allowance on the gross amount, and (b) was not obliged to include the reimbursements in the calculation of its revenues for tax purposes. [10]

On the strength of the Canadian Pacific case, the Federal Court of Appeal confirmed that the taxpayer was entitled to add the costs of relocation to the undepreciated capital cost of the pipeline regardless of reimbursements. The Court, however, refused to consider whether these reimbursements constituted income or capital receipts because the issue had not been properly raised in the pleadings.

And so the issue came on again and this time Muldoon, J. in his judgment [11] found that the reimbursements constituted capital receipts. He adopted the reasoning of Walsh, J. at the trial of the earlier case, i.e., the case where the issue was effectively aborted by the Federal Court of Appeal on technical grounds, as follows at page 385 (D.T.C. 6136):

I have concluded that the plaintiff in the present case was justified in considering that contributions received towards the relocation of its pipelines done, not for its benefit, but for the benefit of the parties making the contributions, can be carried to a contributed capital account without passing through income. While this undoubtedly has the result, as the plaintiff readily concedes, of conferring an advantage on its shareholders which the parties making the contributions had no intention of doing, nevertheless this appears to be the correct manner of dealing with these contributions in the light of current jurisprudence. As the plaintiff's counsel argues, if this results in unintended tax advantages for the plaintiff the remedy is in the hands of the defendant by way of amending legislation.

The Crown appealed Muldoon, J.'s decision to the Federal Court of Appeal. The case was now styled The Queen v. Consumers' Gas Co. Ltd,' [12] and in its judgment, the Federal Court of Appeal unanimously dismissed the appeal and confirmed the judgment below.

Speaking for the Court, Hugessen, J.A. said this:

It is common ground on the present appeal that the expenditures made by Consumers' Gas for pipeline relocations in the circumstances described are for capital account. In the judgment now under appeal, Muldoon, J. in the Trial Division held that the partially offsetting receipts from third parties were also for capital account and need not be taken into income for the purposes of the Income Tax Act. In my view, he was right.

There is no dispute, and indeed the expert evidence called on both sides was unanimous on the point, that generally accepted accounting principles require these receipts to be treated in the way that Consumers' Gas in fact treated them for financial statement purposes. In other words, proper accounting practice required that the receipts be offset against the capital expenditure in respect of which they were paid by third parties so that only the net cost of the relocation be carried to the asset side of the balance sheet. It was also not disputed that Consumers' Gas practice of taking straight line depreciation over a period of seventy years calculated on the net cost of pipeline relocations was consistent with generally accepted accounting principles. Finally, the expert accounting evidence was that the receipts should be treated as capital receipts and not as income.

Hugessen, J.A. then went on to say:

The principal argument advanced by counsel for the appellant is disarmingly simple. He urges that the method employed by Consumers' Gas for financial statement purposes, which is, as stated, in accordance with generally accepted accounting principles, results in the disputed receipts being reflected in the income statement. Hence, he argues, the treatment accorded for income tax purposes should also produce this result and the receipts should be treated as revenues.

With respect, it seems to me that this approach is flawed. It attempts to achieve the results produced by generally accepted accounting principles while rejecting the method. Although those principles are a guide to the interpretation and application of the Income Tax Act, they cannot help where the Act itself departs from them. This is particularly so where one is dealing with the treatment to be accordefnd to the reduction over time of the value of fixed assets due to aging, wear and tear, etc. Accounting principles require that a realistic estimate be made of the life of each such asset, which must then be depreciated on a straight line basis over that period. Income tax law, on the other hand, for a variety of reasons many wholly unrelated to sound accounting practice, fires an arbitrary percentage (which can even reach 100 per cent) for various classes of assets which may then be applied on a declining balance basis to the cost of the assets of each class and deducted from income.

Thus while it is true, as appellant argues, that accounting principles require depreciation on the net cost of capital assets always to be reflected in income, that is not the case for purposes of income tax. More particularly, on the facts of the present case, the receipts from third parties in respect of pipeline relocations are reflected in Consumers' Gas’ income for financial statement purposes solely because they go to reduce the cost of the assets upon which straight line depreciation is taken over 70 years. The receipts themselves, however, are not treated as income. They are reflected in income, albeit faintly, because good accounting, unlike income tax law, requires that depreciation be taken. It is common ground here that the cost of pipeline relocations is a capital outlay and that the receipts from third parties in respect thereof need not be taken into account in determining undepreciated capital cost for the purposes of calculating capital cost allowance. The mere fact that this results in such receipts not being reflected in income does not make them income. Absent some provision of the statute specifically bringing them into income, they continue to be treated, as required by generally accepted accounting principles, as capital receipts. The submission therefore fails. [13]

From the evidence presented at trial, I fail to see where any substantial distinctions may be found between the Consumers' Gas experience and the experience of the plaintiff before me. If there are factual distinctions, as indeed there are, they are in my view distinctions which in the context of the applicable provisions of the Income Tax Act, are without a difference. I should therefore allow the plaintiff's appeal on that issue.

There will be an order directed to the Crown, as represented by the Minister of National Revenue to reassess and bring all the issues to a close. In that respect, I would ask counsel for the parties to agree to an appropriate draft of the formal judgment for my endorsement. In the meantime, and for purposes of resolving any possible difference, I remain seized of the case.

As the parties have enjoyed divided success in this matter, I should make no order as to costs.

Appeal allowed in part.