Date: 20000524
Docket: A-576-98
CORAM: DÉCARY J.A.
ROTHSTEIN J.A.
SHARLOW J.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
- and -
RESMAN HOLDINGS LTD. (THE SUCCESSOR AMALGAMATED
CORPORATION TO AIRTEX INDUSTRIES LTD.)
DEX RESOURCES LTD.
RESMAN HOLDINGS LTD. (THE SUCCESSOR AMALGAMATED
CORPORATION TO RESMAN OIL & GAS LTD.)
Respondents
Heard at Calgary, Alberta, on Thursday, May 4, 2000
Judgment delivered at Ottawa, Ontario, on Wednesday, May 24, 2000
REASONS FOR JUDGMENT BY: SHARLOW J.A.
CONCURRED IN BY: DÉCARY J.A
ROTHSTEIN J.A.
Date: 20000524
Docket: A-576-98
A-575-98
A-577-98
CORAM: DÉCARY J.A.
ROTHSTEIN J.A.
SHARLOW J.A.
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
- and -
RESMAN HOLDINGS LTD. (THE SUCCESSOR AMALGAMATED
CORPORATION TO AIRTEX INDUSTRIES LTD.)
DEX RESOURCES LTD.
RESMAN HOLDINGS LTD. (THE SUCCESSOR AMALGAMATED
CORPORATION TO RESMAN OIL & GAS LTD.)
Respondents
REASONS FOR JUDGMENT
SHARLOW J.A.
[1] The issue in these appeals is whether the expenses incurred by the respondents in drilling thirty step-out wells in Alberta are "Canadian exploration expenses" as defined in the Income Tax Act, R.S.C. 1985, C. 1 (5th supp), as amended. If so, they are deductible in full when they are incurred. Otherwise, they are Canadian development expenses, which are included in a cumulative account that is deductible on a declining balance basis at the rate of 30% per year.
[2] The Crown has taken the position that the expenses are not Canadian exploration expenses and has assessed the respondents accordingly. The respondents' appeals to the Tax Court of Canada were successful: (1998), 98 D.T.C. 1999 (T.C.C.), T.C.J. No. 600 (QL). The Crown now appeals the decision of the Tax Court Judge. The appeals were consolidated by Order of Stone, J.A.
Definition of "Canadian exploration expense"
[3] The relevant parts of the definition of "Canadian exploration expense" read as follows:
| 66.1 (6) In this section [...]
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66.1(6) Au présent article [...]
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| (a) "Canadian exploration expense" of a taxpayer means any expense made or incurred after May 6, 1974 that is
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(a) "frais d'exploration au Canada" d'un contribuable s'entend des dépenses suivantes engagées après le 6 mai 1974:
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| (ii) any expense incurred before April 1987 in drilling or completing an oil or gas well in Canada or in building a temporary access road to, or preparing a site in respect of, any such well, |
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| (ii) une dépense d'une part engagée avant avril 1987 pour le forage ou l'achèvement d'un puits de pétrole ou de gaz au Canada, la construction d'une route d'accès temporaire au puits ou la préparation d'un emplacement pour un tel puits, et d'autre part engagée par le contribuable |
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| (A) incurred by him in the year, or |
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| (B) incurred by him in any previous year and included by him in computing his Canadian development expense for a previous taxation year, |
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| (B) soit dans une année antérieure si elle est incluse par le contribuable dans le calcul de ses frais d'aménagement au Canada pour une année d'imposition antérieure, |
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| if, within six months after the end of the year, the drilling of the well is completed and |
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| si, dans les six mois suivant la fin de l'année, le forage du puits est achevé et |
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| (C) it is determined that the well is the first well capable of production in commercial quantities from an accumulation of petroleum or natural gas [...] not previously known to exist, or |
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| (C) qu'il soit établi que le puit est le premier susceptible d'une production en quantités commerciales à partir d'un gisement de pétrole ou de gaz naturel [...] jusque-là inconnu, ou |
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| (D) it is reasonable to expect that the well will not come into production in commercial quantities within twelve months of its completion, |
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| (D) qu'il soit raisonnable de s'attendre à ce que le puits ne produise pas de quantités commerciales dans les douze mois de son achèvement, |
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| (ii.1) any expense incurred by him after March 1987 and in a taxation year of the taxpayer in drilling or completing an oil or gas well in Canada or in building a temporary access road to, or preparing a site in respect of, any such well, if |
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| (ii.1) une dépense engagée par le contribuable après 1987 et dans une année d'imposition du contribuable, pour le forage ou l'achèvement d'un puits de pétrole ou de gaz au Canada, la construction d'une route d'accès temporaire au puits ou la préparation d'un emplacement pour un tel puits, à condition, selon le cas, |
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| (A) the well resulted in the discovery of a natural accumulation of petroleum or natural gas and the discovery occurred at any time before six months after the end of the year, |
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| (A) que le puits soit la cause de la découverte, à une date antérieure à la période de six mois suivant la fin de l'année d'un gisement naturel de pétrole ou de gaz naturel, |
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| (B) the well is abandoned in the year or within six months after the end of the year without ever having produced otherwise than for specified purposes, |
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| (B) que le puit soit abandonné dans l'année sans avoir jamais product de pétrole ou de gaz naturel, |
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| (C) the period of 24 months commencing on the day of completion of the drilling of the well ends in the year, the expense was incurred within that period and in the year and the well has not within that period produced otherwise than for specified purposes, or [...], |
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| (C) que le terme de la période de 24 mois commençant le jour d'achèvement du forage du puits tombe dans l'année, que la dépense soit engagée durant cette période et dans l'année et que le puits n'ait pas produit de pétrole ou de gaz durant cette période sinon à une fin admise [...], |
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| (ii.2) any expense deemed by subsection (9) to be a Canadian exploration expense incurred by him [...]. |
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| (ii.2) une dépense réputée par le paragraphe (9) être des frais d'exploration au Canada engagés par le contribuable [...]. |
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[4] Subsection 66.1(9), referred to in subparagraph 66.1(6)(a)(ii.2), lists a number of expenses that may initially be classified as Canadian development expenses but may be reclassified in a later year as Canadian exploration expenses. Broadly speaking, this reclassification may occur if the well results in the discovery of a natural accumulation of petroleum or natural gas, does not produce within 24 months of the completion of drilling, or is abandoned without having produced.
Relevance of the likelihood of encountering oil or gas
[5] The thirty wells that are the subject of these appeals are step-out wells or delineation wells. That means they were drilled at the edge of a known pool of oil or gas to further exploit that pool.
[6] The evidence of Mr. Gray, who testified for the respondents, is that there is no certainty that a step-out well will encounter oil and gas, no matter how close it is to a known pool. His evidence on that point is not contradicted and indeed is consistent with the evidence of Mr. Fairgrieve, an official with the Alberta Energy Utilities Board (EUB) who gave evidence for the Crown.
[7] Mr. Gray explained that for income tax purposes, the respondents' characterization of the expenses incurred in drilling the step-out wells was based on their understanding of the objective of the income tax provisions in question. The respondents are of the view that Parliament has adopted a more generous system of tax incentives for exploration expenses than for development expenses because exploration is inherently more risky than development. They also believe that, if the legislation is to operate effectively as an incentive, it must be possible for taxpayers to determine, before incurring the expenses required to drill a particular well, what the tax treatment of those expenses will be.
[8] By combining that understanding of the objective of the statutory provisions with the practical knowledge gained by years of drilling experience, Mr. Gray developed a specific methodology to determine, in advance of drilling, whether the drilling expenses would meet the definition of Canadian exploration expense, and thus be fully deductible in the year incurred.
[9] Mr. Gray's methodology was to assess, for each well, the degree of risk being undertaken, based on his experience. If he determined that there was a high degree of certainty (approximately 90%) that a particular well would encounter oil and gas, that well would be characterized as a "development well". Any other well would be characterized as an "exploration well". Expenses incurred in drilling an "exploration well", within Mr. Gray's definition, would be treated for income tax purposes as Canadian exploration expenses.
[10] In determining the degree of certainty, Mr. Gray would refer to publicly available information compiled by the EUB to locate all successful wells in the vicinity. He would then determine whether the proposed well was located within one spacing unit (the minimum permissible distance between wells) of three or more successful wells, and within the polygon formed by those successful wells. If not, he would consider the degree of certainty to be low enough to classify the well as an "exploration well", and the drilling costs would be claimed for income tax purposes as Canadian exploration expenses.
[11] The Crown argues that this methodology resulted in an incorrect classification of drilling expenses. The Crown suggests a number of explanations for the error, but in my view the most important objection to Mr. Gray's methodology is that it assumes that the classification of the expenses must be based on an assessment of the risk undertaken when the decision is made to drill. The Crown argues that this assumption is not consistent with the language of the definition which requires the classification of the drilling expenses to be made retrospectively, based on the result of the drilling. On this point, I agree with the position of the Crown.
[12] The definition of Canadian exploration expense asks a number of questions. For expenses incurred before April 1987, the two key questions are:
| " Within six months after the end of the year, has it been determined that the well is capable of production in reasonable commercial quantities from an accumulation of petroleum or natural gas not previously known to exist? |
| " If not, is it reasonable to expect that the well will not come into production in commercial quantities within twelve months of its completion? |
[13] For expenses incurred after March 1987, two key questions are:
| " Did the well result in the discovery, at any time before six months after the end of the year, of a natural accumulation of petroleum or natural gas? |
| " If not, was the well abandoned in the year or within six months after the end of the year without ever having produced, otherwise than for specified purposes? |
[14] It is obvious that these questions cannot have been intended to elicit information about the state of knowledge prior to drilling. They cannot be answered until the result of the drilling is known. For that reason, I conclude that the Crown's interpretation of the statutory definition is consistent with its language, while the respondents' interpretation is not.
[15] It is argued for the respondents that the Crown's interpretation of the definition frustrates the purpose of the statutory scheme, which is to provide an incentive to taxpayers to invest in resource exploration and development. They say that the incentives are more generous for exploration than development to reflect the relative risks. They argue that if the tax treatment of expenditures cannot be determined in advance, the incentive loses its predictability and therefore its effectiveness as an incentive.
[16] I agree that predictability is of critical importance in fiscal matters and that the statutory provisions in question are part of a legislative scheme that is intended to provide an incentive to exploration and development of natural resources. The jurisprudence establishes that fiscal legislation that is intended to be an incentive to a particular activity is to be interpreted, if possible, in such a way as to give effect to that intention: [1984] 1 S.C.R. 536">Stubart Investments Limited v. The Queen, [1984] 1 S.C.R. 536, Lor-West Contracting Ltd. v. The Queen, [1986] 1 F.C. 346 (F.C.A.).
[17] However, these considerations cannot justify the interpretation of the definition of Canadian exploration expense proposed by the respondents. I reach this conclusion for two reasons. First, I do not accept that the incentive feature of the regime would be frustrated merely because the most generous tax relief is denied for expenditures that are established to be exploiting a known resource. The more important reason, however, is that the statutory language cannot reasonably bear the respondents' interpretation.
[18] The respondents argue that if Parliament had meant to exclude the cost of delineation or step-out wells from the definition of Canadian exploration expense, it could have done so expressly. They refer to an amendment to the Income Tax Act enacted in 1980. That amendment excluded from the definition of Canadian exploration expense any expense incurred in drilling a well for the purpose of delineating or determining the extent or quality of an accumulation of petroleum or natural gas, if the drilling commenced after any production in commercial quantities from that accumulation. The amendment was never proclaimed in force and was finally repealed in 1987. The respondents argue that the 1987 repeal of that unproclaimed legislation signals an intention by Parliament that the cost of delineation wells are not to be excluded from the definition of "Canadian exploration expense." They rely on the implied exclusion exception discussed in Professor Sullivan's edition of Driedger on the Construction of Statutes, 3rd ed. (Toronto: Butterworths, 1984). She says this at page 168:
| An implied exclusion argument lies whenever there is reason to believe that if the legislature had meant to include a particular thing within the ambit of its legislation, it would have referred to that thing expressly. [...] The better the reason for anticipating express reference to a thing, the more telling the silence of the legislature. |
[19] In my view, the implied exclusion exception has little force as an aid to the interpretation of the definition of Canadian exploration expense. I do not find the definitions so ambiguous, or the objective of the 1981 amendments or their 1987 repeal so self-evident, as to justify any application of the implied exclusion principle to the interpretation issue raised in this case. In my view, the initial classification of a well as a step-out well has no bearing on the tax treatment of the drilling expenses.
[20] I conclude that in determining whether the expenses incurred in drilling a particular well meet the definition of Canadian exploration expenses, the likelihood that the drilling will be successful is not relevant. I respectfully disagree with the conclusion of the Tax Court Judge that Mr. Gray's methodology resulted in the correct classification of drilling expenses.
[21] This conclusion, however, does not dispose of the appeal. It is now necessary to consider the results of the drilling of the thirty wells in issue.
The successful wells " meaning of "accumulation" of petroleum or natural gas
[22] Of the thirty wells, twenty-eight were successful, in that they encountered petroleum or natural gas. Of the twenty-eight successful wells, two were drilled before April 1987 and twenty-six were drilled after March 1987. The Crown's position is that:
| (a) the pre-April 1987 wells are not producing from an accumulation of petroleum or natural gas not previously known to exist and therefore the expenses of drilling those two wells do not meet clause 66.1(6)(a)(ii)(C) of the definition of Canadian exploration expense, and |
| (b) the post-March 1987 wells did not result inthe discovery of a natural accumulation of petroleum or natural gas, and therefore the expenses of drilling those wells do not meet clause 66.1(6)(a)(ii.1)(A) of the definition of Canadian exploration expense. |
[23] It is undisputed that an accumulation of petroleum or natural gas is the same thing as a natural accumulation of oil or gas. It is also agreed that there can be only one discovery of an accumulation. The parties disagree on the meaning of "accumulation."
[24] We were referred to only one authority that refers in any way to the meaning of "accumulation". That is the decision of the Tax Court in Wheeler v. The Queen, 97 D.T.C. 1156, which was decided against the Crown. As I read that case, it stands for the principle that, for wells drilled after March 1987, the definition of Canadian exploration expense does not implicitly require that the accumulation of oil or gas discovered be capable of production in reasonable commercial quantities. I do not find the Wheeler decision helpful because it does not deal with the issues raised in this case.
[25] For reasons that will become apparent, the arguments of the parties cannot be assessed without understanding how the EUB derives its determination of the existence of "pools" of oil or gas. For the EUB's purposes, the word "pool" has the meaning stated in paragraph 1.1(q) of the Oil and Gas Conservation Act, R.S.A. 1980, Chap. O-5:
| (q) "pool" means a natural underground reservoir containing or appearing to contain an accumulation of oil or gas or both separated or appearing to be separated from any other such accumulation". |
The "reservoir" referred to in this definition is an area of porous rock in which oil or gas is trapped.
[26] The law of Alberta requires certain technical information to be provided to the EUB for every well, including the date of the commencement and completion of drilling, the date of the commencement of production, the well status, the field in which the well was drilled, the zone down to which it was drilled, and the drilling results.
[27] Every well is indicated on a map marked with north-south and east-west grid lines that are approximately one mile apart. The first time a particular pool of oil or gas is encountered by the drilling of a well, the pool is given a unique designation, and that well is recorded as the "discovery well" for that pool. The part of the grid in which the discovery well is located (generally one quarter of the square), becomes the "designated area" for that pool. If subsequent wells encounter the same pool, the part of the grid in which those wells are located are added to the "designated area" for that pool.
[28] If a well is drilled within or close to the designated area for a known pool and encounters oil and gas, there is no presumption that it has encountered the known pool. For every well that encounters oil and gas, the EUB analyses the technical data to determine whether or not the pool was previously known.
[29] According to Mr. Fairgrieve, the analysis depends primarily but not exclusively on pressure data. He explained that apart from the pressure regime, a determination about a pool must also conform to geological principles. For example, gas would not be considered part of the same pool as oil at a higher elevation, because it is physically impossible for gas to be below oil within a pool. In addition, gas or oil with specific chemical characteristics would not be considered part of a pool where the gas or oil is known to have different chemical characteristics (Appeal Book, Volume II, page 491(14)-492(21)). Mr. Fairgrieve also explained that the EUB's pooling determination is subject to review. An erroneous determination will be revised if required to reflect new technical data (Appeal Book, Volume II, page 494(6 - 16)).
[30] The EUB maintains a publicly accessible record of the location and extent of all pools of oil and gas they have identified. One of the exhibits at trial (Exhibit R-1) illustrates the designated area for a pool discovered in 1984 that initially covered two squares of the grid. By May 1, 1991, it had grown to cover eleven squares. Another exhibit (Exhibit R-2) illustrates the designated area for a pool discovered in 1964 which initially covered an irregularly shaped area that was approximately 29 miles from the most northern to the southern point. By March 1, 1990, that designated area had grown to an area that was approximately 37 miles from north to south.
[31] The Crown argues that an "accumulation" of oil or gas is a pool determined by reference to certain defining characteristics, such as the pressure regime, which is the same as a "pool" of oil or gas as that term is defined in the Oil and Gas Conservation Act of Alberta. It is common ground that the oil or gas encountered in each of the respondents' twenty-eight successful wells was part of a previously known "pool", as that term is used by the EUB.
[32] The respondents say that the word "pool" has a well understood meaning in the oil and gas industry (the same meaning as in the Alberta legislation), but "accumulation" does not, and by using the word "accumulation" Parliament should not be taken to have meant "pool," but something less than a "pool". They say that the word "accumulation" should be given its ordinary meaning so that, in the context of the definition of Canadian exploration expense, it would mean any collection or volume of oil or gas in host rock found by a particular well bore. They say that a pool of oil or gas within a common pressure regime can contain more than one accumulation (Gray, Transcript, Appeal Book, Vol. II, pp. 293-4). This is the meaning the Tax Court Judge accepted.
[33] "Accumulation" is defined in the New Shorter Oxford English Dictionary (1993 edition) as "an accumulated mass; a quantity formed by successive additions." It is a descriptive word that is also very general. Its meaning, therefore, depends upon the context it which it is used.
[34] The Crown argues that the word "accumulation" was intended to be read in the sense it which it would be understood in the industry. In my view, that is the correct approach to a word as general as "accumulation" when it is used in the context of highly detailed statutory provisions that are intended to be of use to a particular industry.
[35] In industry usage, a "pool" of oil or gas generally is defined by reference to an accumulation of oil or gas. The two words convey similar meanings in the sense that either term may be used to describe a quantity of oil or gas defined by reference to its geological characteristics, including the pressure regime. For example, the Glossary of Geology and Related Sciences, 2nd ed. (American Geological Institute) defines "pool" (in the context of oil) as:
| A figurative term for an underground accumulation of oil or gas in a single and separate natural reservoir (ordinarily a porous sandstone or limestone) characterized by a single natural-pressure system and bounded by geologic barriers, such as structural conditions, impermeable strata, changes in porosity, or water in the formations. |
The same work defines "accumulation" as:
| The concentration or gathering of oil or gas in some form of trap. |
A similar definition of "pool" appears in Dictionary of Geological Terms, 3rd ed. (Anchor Books, Doubleday), Dictionary of Geology and Mineralogy (McGraw Hill), Manual of Oil and Gas Terms - Tenth Edition (Mathew Bender, 1997). A similar definition of "accumulation" appears in A Dictionary of Mining, Mineral and Related Terms (U.S. Department of Interior, 1968).
[36] The French version of the definition of Canadian exploration expense uses the word "gisement" for "accumulation". In Les termes pétroliers, dictionnaire anglais-français (Total édition-presse), the English word "accumulation" is equated with "pool", which is defined in French as follows:
| Pool : 1/ gisement m. (accumulation commerciale d'huile ou de gaz occupant un réservoir indépendant et se trouvant sous un régime de pression unique) ; synonymes : oil pool, accumulation ; voir aussi oil field |
The same definition of "pool" appears in Dictionnaire technique du pétrole, 2nd, (Éditions Technip, 1979). In that work, the French word "gisement" is defined as follows:
| gisement m " 1) deposit, field, reservoir, pool. [...] gisement de pétrole : oil accumulation, oil pool, a single accumulation of petroleum whose limits are established by subsurface geologic factors. |
[37] The parties also referred to a number of other provisions in the Income Tax Act and statutory definitions from other statutes. I do not propose to discuss those references in detail. It will suffice to say that having reviewed all of the dictionary definitions and statutory references, I accept the argument of the Crown that the words "accumulation" and "gisement" as used in the definition of Canadian exploration expense are intended to convey a meaning that is synonymous with the word "pool" in the various geological dictionaries referred to above, and that it has the same meaning as "pool" in the Oil and Gas Conservation Act of Alberta.
[38] Given that the correctness of the EUB pooling determination in this case is not disputed, the respondents' twenty-eight successful wells must be taken to have encountered previously known accumulations. For that reason, I conclude that the expenses incurred in drilling those wells are not Canadian exploration expenses.
The unsuccessful wells " meaning of "abandoned"
[39] It remains only to consider the classification of the expenses incurred after March 1987 in drilling the two wells that did not encounter oil or gas. The parties agree that the issue is whether or not those unsuccessful wells were "abandoned" within the meaning of clause 66.1(1)(a)(ii.1)(B). The Tax Court Judge did not reach any conclusion on this issue because, having already concluded that Mr. Gray's methodology was correct, he considered it unnecessary to do so.
[40] The facts are not disputed. The respondents gave up all efforts to produce oil or gas from the unsuccessful wells soon after the completion of drilling. One of the wells was a dry hole. The drilling rig contract for that well was assumed by another operator with lease rights to a shallower location. The other well has been used by the respondents as a water disposal well since July of 1988, when it was determined that no oil would be recovered from it. Neither well has been classified as an "abandoned well" by the EUB.
[41] The Crown argues that abandonment of a well does not occur until the requirements of the relevant provincial law relating to the abandonment have been complied with and the well is classified by the EUB as an abandoned well. That means that the well must be abandoned at the surface. At one meter below the ground elevation, the casing must be cut and the hole filled with cement and a plate welded to the casing. The respondents argue that the EUB classification is irrelevant, and that a well is abandoned when all efforts to produce oil or gas from that well have ceased.
[42] Nothing in the Income Tax Act suggests that the question of abandonment of a well depends upon compliance with provincial regulations. I agree with the respondents that abandonment is a question of fact. Evidence that a well meets the EUB standard for abandonment may be sufficient to establish abandonment, but I see no reason to conclude that it is a necessary condition.
[43] On the other hand, I do not accept that a well is abandoned if it is still capable of being used in connection with the exploitation of the resource (for example, as a water disposal well) or if the contractual obligations relating to the well are assumed by someone else. In my view, the evidence in this case falls short of establishing that the wells were abandoned in fact. It follows that the expenses incurred in drilling those wells are not Canadian exploration expenses.
Conclusion
[44] For the foregoing reasons, the Crown's appeal should be allowed with costs. The judgment of the Tax Court Judge should be varied, and the reassessments referred back to the Minister of National Revenue for reassessment, on the basis that the drilling expenses that are the subject of these appeals do not meet the definition of "Canadian exploration expense".
Karen R. Sharlow
J.A.
"I concur
Robert Décary J.A."
"I concur
Marshall Rothstein J.A."
Date: 20000524
Docket: A-576-98
A-575-98
A-577-98
OTTAWA, ONTARIO, THE 24TH DAY OF MAY 2000
PRESENT: THE HONOURABLE MR. JUSTICE DÉCARY
BETWEEN:
HER MAJESTY THE QUEEN
Appellant
- and -
RESMAN HOLDINGS LTD. (THE SUCCESSOR AMALGAMATED
CORPORATION TO AIRTEX INDUSTRIES LTD.)
DEX RESOURCES LTD.
RESMAN HOLDINGS LTD. (THE SUCCESSOR AMALGAMATED
CORPORATION TO RESMAN OIL & GAS LTD.)
Respondents
JUDGMENT
The Crown's appeal is allowed with costs. The judgment of the Tax Court Judge should be varied, and the reassessments referred back to the Minister of National Revenue for reassessment, on the basis that the drilling expenses that are the subject of these appeals do not meet the definition of "Canadian exploration expense".
"Robert Décary"
J.A.
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