Dubé,
J:—This
case
was
heard
on
common
evidence
with
British
Columbia-Yukon
Railway
Company
v
Her
Majesty
the
Queen,
T-3633-75,
and
these
reasons
for
judgment
apply
to
both
cases.
The
basic
issue
is
the
allocation
of
income
between
two
Canadian
railway
companies
and
one
American
railway
company
for
the
taxation
year
1970.
The
plaintiff
company
(hereinafter
“BYR”)
and
four
other
wholly
owned
subsidiaries
of
the
White
Pass
and
Yukon
Corporation
Limited,
including
the
British
Columbia-Yukon
Railway
Company
(hereinafter
“BCYR”)
and
Pacific
and
Arctic
Railway
and
Navigation
Company
(hereinafter
“PARN”),
an
American
company,
provide
an
integrated
railroad,
ship
and
truck
transportation
system
from
Whitehorse,
Yukon,
through
British
Columbia,
down
to
a
terminal
at
Skagway,
Alaska,
USA.
The
“White
Pass
and
Yukon
Route’’,
as
it
is
known,
is
110.8
miles
long:
90.4
miles
over
Canadian
soil
and
20.4
miles
within
Alaska.
BYR
owns
and
operates
the
Yukon
track,
from
Whitehorse
to
the
British
Columbia
border;
BCYR
owns
and
operates
the
railway
through
the
British
Columbia
section;
and
PARN
owns
and
operates
the
line
from
the
Alaska
border
down
to
its
terminal
facilities
at
Skagway
on
the
Pacific
Coast.
The
maintenance
facilities
for
the
whole
system
are
located
at
Skagway
along
with
a
general
freight
wharf
and
a
bulk
terminal.
For
the
1970
taxation
year
BYR,
BCYR
and
PARN
used
a
method
of
allocation
of
income
between
the
two
Canadian
companies
on
the
one
hand
and
PARN
on
the
other
hand
which
was
described
as
follows
in
the
Agreed
Statement
of
Facts.
4.1
Costs
and
expenses
incurred
were
allocated
by
allocating
each
expense
classification
on
a
specific
identification
basis
where
possible,
or
on
a
pro
rata
basis
where
the
cost
or
expense
item
could
not
be
allocated
on
a
specific
identification
basis;
4.2
Property
used
was
allocated
on
the
basis
of
situs
for
immovable
property
and
time
spent
in
each
country
for
movable
rail
property
(36.4%
for
the
US
Company
and
63.6%
for
the
Canadian
Companies);
4.3
23.6%
of
the
aggregate
working
capital
of
the
group
of
Companies
was
allocated
to
the
transportation
system,
based
on
an
allocation
of
gross
receipts;
this
was
allocated
between
the
Canadian
Companies
and
the
US
Company
on
the
basis
of
the
allocation
of
operating
costs;
4.4
A
rate
of
return
of
8%
was
applied
to
the
amounts
determined
under
4.2
and
4.3,
to
produce
the
following:
|
the
Canadian
|
the
US
|
|
Companies
|
Company
|
|
Operating
Expenses
|
$2,890,553
|
$2,472,701
|
|
Return
on
Property
|
949,980
|
613,640
|
|
Return
on
Working
Capital
|
31,852
|
27,352
|
|
$3,872,385
|
$3,113,693
|
|
Percentages
|
55.4%
|
44.6%
|
4.5
These
percentages
were
used
to
allocate
gross
operating
incomes
between
the
Canadian
Companies
and
the
US
Company,
being
based
on
an
apportionment
of
the
aggregate
of:
1.
Costs
and
expenses
2.
Return
on
property
3.
Return
on
working
capital
By
Notice
of
Reassessment
dated
May
23,
1974,
the
Minister
reassessed
the
incomes
by
using
a
different
allocation
based
upon
an
average
of
the
percentages
of
these
three
items
1.
operating
expenses
as
allocated
by
the
plaintiff
2.
an
8%
return
on
property
3.
equated
track
mileage
The
method
used
by
the
Minister
allocated
65.46%
of
income
to
the
Canadian
group
and
34.54%
to
the
US
company,
whereas
the
method
used
by
the
railway
group
resulted
in
the
allocation
of
55.4%
to
the
Canadian
group
and
44.6%
to
the
US
company.
In
the
case
of
BYR
the
Minister’s
reassessment
resulted
in
an
increase
of
income
tax
of
$41,196.22
plus
interest,
and
in
the
case
of
BCYR
an
increase
of
$8,946.86
and
interest.
The
two
Canadian
railways
are
appealing
the
Minister’s
reassessments.
The
grounds
for
the
appeal
are
stated
in
paragraph
9
of
the
Statement
of
Claim.
The
Plaintiff
claims
that
the
allocation
procedure
used
by
the
Department
of
National
Revenue
was
not
in
accordance
with
any
ordinary
business,
commercial
or
accounting
principles,
was
not
in
accordance
with
the
said
US
Regulation
1.863-4,
and,
by
adding
an
allocation
for
equated
track
mileage,
distorts
the
allocation
in
favour
of
Canada
because
most
of
the
Railway
track
lies
in
Canada.
The
Plaintiff
claims
that
the
logical
allocation
should
be
based
on
(a)
the
investment
in
immovable
property
in
each
of
Canada
and
the
US,
and
(b)
the
level
or
activity
or
cost
of
service
performed
in
each
of
Canada
and
the
US.
The
first
gives
due
weight
to
the
preponderance
of
track
miles
in
Canada
and,
at
the
same
time,
the
preponderance
of
the
maintenance
and
wharf
facilities
in
the
US.
The
second
gives
due
weight
to
the
preponderance
of
track
maintenance
and
running
costs
in
Canada,
and
at
the
same
time,
the
preponderance
of
wharf
costs
and
equipment
maintenance
costs
in
the
US.
To
impose
on
to
these
two
allocations
an
added
weighting
for
equated
track
miles
accentuates
only
the
Canadian
preponderances;
to
then
average
the
percentages
further
accentuates
the
weighting
in
favour
of
Canada.
The
method
used
by
the
Department
of
National
Revenue
therefore
distorts
the
income
allocated
to
Canada
unreasonably
and
without
any
foundation
on
ordinary
business,
commercial
or
accounting
principles,
so
that
the
said
Reassessment
is
not
in
accordance
with
sections
3
and
4.
or
any
other
sections
of
the
(old)
Income
Tax
Act.
The
equated
mileage
formula
used
by
the
Minister,
in
conjunction
with
the
operation
expenses
allocation
and
the
8%
return
on
property,
is
based
on
Income
Tax
Regulations
406(1)
and
406(3)
which
read:
406.
(1)
Notwithstanding
subsections
(3)
and
(4)
of
section
402,
the
amount
of
taxable
income
that
shall
be
deemed
to
have
been
earned
in
a
taxation
year
in
a
particular
province
by
a
railway
corporation
is,
unless
subsection
(2)
applies,
one-half
the
aggregate
of
(a)
that
proportion
of
the
taxable
income
of
the
corporation
for
the
year
that
the
equated
track
miles
of
the
corporation
in
the
province
is
of
the
equated
track
miles
of
the
corporation
in
Canada,
and,
(b)
that
proportion
of
the
taxable
income
of
the
corporation
for
the
year
that
the
gross
ton
miles
of
the
corporation
for
the
year
in
the
province
is
of
the
gross
ton
miles
of
the
corporation
for
the
year
in
Canada.
(3)
For
the
purpose
of
this
section,
‘the
equated
track
miles’’
in
a
specified
place
means
the
aggregate
of
(a)
the
number
of
miles
of
first
main
track,
(b)
80%
of
the
number
of
miles
of
other
main
tracks,
and
(c)
50%
of
the
number
of
miles
of
yard
tracks
and
sidings,
in
that
place.
It
is
agreed
by
both
parties
that
neither
US
Regulation
1.865-4,
nor
Canadian
Regulation
406
is
mandatory,
or
even
directly
applicable,
in
the
instant
case,
since
the
former
deals
with
a
taxpayer
“carrying
on
the
business
of
transportation
service
between
points
in
the
US
and
points
outside
the
US’’,
and
the
latter
deals
with
railway
corporations
operating
between
Canadian
provinces.
The
allocation
in
issue
here
is
between
income
in
Canada
by
two
Canadian
railways,
and
income
in
the
US
by
an
American
railway.
Both
counsel
have
found
no
similar
case
and
neither
the
Income
Tax
Act
nor
the
Regulations
offer
formulae
which
are
directly
applicable
to
the
situation.
In
the
absence
of
any
special
direction
from
the
Act,
then
income
must
be
determined
in
accordance
with
ordinary
business
and
commercial
principles.
The
formula
used
by
the
railway
group
was
proposed
to
them
by
their
accountants
Clarkson,
Gordon
&
Co.
The
partner
of
that
firm
responsible
for
the
railways,
Kenneth
L
Ingo,
a
chartered
accountant,
appeared
as
a
witness.
Some
extracts
from
his
Memorandum
of
Allocation
of
Operating
Income,
filed
as
an
exhibit,
bear
reproduction.
The
method
used
by
the
companies
during
1970
is
based
on
the
formula
for
the
allocation
of
income
of
a
taxpayer
carrying
on
a
transportation
business
between
points
in
the
United
States
and
points
outside
the
United
States,
as
prescribed
in
paragraph
1.863-4
of
the
Regulations
to
the
US
Internal
Revenue
Code.
The
provisions
of
this
Regulation
are
set
out
in
their
entirety
on
Appendix
A
to
this
memorandum
and
are
summarized
briefly
below.
Essentially
the
Regulation
provides
that
income
is
allocated
on
the
basis
of
the
aggregate
of
the
following:
1.
Costs
or
expenses
incurred
in
the
transportation
business,
2.
Return
on
property
used
in
the
transportation
business,
and
3.
Return
on
working
capital
used
in
the
transportation
business.
To
develop
the
allocation
of
income
in
accordance
with
the
provisions
outlined
above,
the
required
information
was
assembled
in
the
following
series
of
steps:
1.
Each
of
the
companies’
expense
classification
has
been
allocated
to
Canada
or
the
United
States
on
either
a
specific
identification
or
a
pro
rata
basis.
As
the
companies’
internal
statement
of
operating
expenses
is
prepared
using
a
mixture
of
US
and
Canadian
funds,
it
was
necessary
to
first
of
all
convert
the
items
to
Canadian
funds.
Appendix
B
contains
the
details
of
these
allocations
and
conversions.
2.
The
property
used
in
the
transportation
business
was
allocated
to
the
two
countries
on
the
basis
of:
(a)
situs,
in
the
case
of
immovable
property,
and
(b)
time
spent
in
each
country,
in
the
case
of
movable
rail
property
(ie
United
States
36.4%
and
Canada
63.6%).
Assets
carried
in
US
funds
in
the
companies’
accounts
were
re-stated
in
Canadian
funds,
using
the
average
rate
of
exchange
prevailing
for
the
year.
3.
A
portion
of
the
companies’
aggregate
working
capital
was
allocated
to
the
railway
transportation
business
on
the
basis
of
gross
receipts,
the
formula
being:
Gross
receipts
from
railway
transportation
business
X
100%
Total
gross
receipts
This
formula
resulted
in
23.6%
of
the
companies’
total
working
capital
being
allocated
to
the
railway
transportation
business.
The
amount
so
determined
was
then
apportioned
between
the
two
countries
on
the
basis
of
operating
costs
previously
allocated
to
the
countries.
4.
The
return
on
property
and
working
capital
used
in
the
railway
transportation
business
was
calculated
by
using
a
rate
of
8%
and
applying
it
to
the
amounts
determined
in
3
and
4
above.
This
is
the
rate
of
return
stipulated
in
the
afore-mentioned
Regulation.
An
American
chartered
accountant,
Karl
H
Loring,
a
partner
with
the
firm
of
Ernst
&
Ernst
based
in
Los
Angeles
and
specialists
in
international
tax
practice,
testified
as
an
expert
on
behalf
of
the
plaintiff.
The
following
two
paragraphs
from
his
affidavit
reflect
his
opinion
on
the
two
different
methods
of
allocation.
I
have
considered
the
method
of
allocation
of
income
and
deductions
set
forth
in
the
memorandum
of
Clarkson,
Gordon
&
Co,
a
copy
of
which
is
attached
hereto,
which
is
also
described
in
the
Agreed
Statement
of
Facts
filed
in
this
case,
and
it
is
a
method
which
conforms
generally
to
the
requirements
of
Regulation
Section
1.863-4,
which
allocation,
in
my
opinion,
would
be
acceptable
to
the
Internal
Revenue
Service.
I
have
considered
the
method
of
allocation
of
income
set
forth
in
the
Agreed
Statement
of
Facts
used
by
the
Minister
of
National
Revenue
in
making
his
reassessment.
It
appears
not
to
be
a
method
which
conforms
to
the
requirements
of
Regulation
Section
1.863-4,
and
in
my
opinion
departs
so
radically
therefrom,
that
it
would
not
be
acceptable
to
the
Internal
Revenue
Service.
In
particular,
it
would
seem
to
me
unlikely
that
the
Internal
Revenue
Service
would
accept
a
formula,
which
apparently
double-counts
physical
assets
by
including
the
immovable
property
both
in
the
expense
allocation
and
return
on
capital
computations,
and
again
as
track
mileage,
particularly
where
the
ratio
of
track
mileage
in
the
two
jurisdictions
is
so
disproportionate.
Of
course
it
is
not
for
the
accountants
to
decide
the
issue.
There
is,
moreover,
a
statutory
presumption
of
validity
in
favour
of
an
assessment
and
the
onus
to
show
that
the
assessment
is
erroneous
lies
on
the
taxpayer
who
attacks
it.
But,
as
stated
by
Thorson
J
in
Mandel
v
The
Queen,
[1976]
CTC
545,
76
DTC
6316,
at
page
565
[6330],
“While
the
Court
must
be
mindful
of
this
principle
it
must
in
its
effort
to
apply
the
law
objectively
keep
a
watchful
eye
on
arbitrary
assumptions
on
the
part
of
the
tax
authority.’’
Where
the
Income
Tax
Act
does
not
provide
a
particular
system
of
accounting,
the
validity
of
a
formula
depends
on
whether
or
not
it
tells
the
truth
about
the
taxpayer’s
income.
Track
mileage,
by
itself,
does
not
reflect
the
true
equation
in
this
case.
The
twenty
miles
through
Alaska
ascend
from
sea
level
to
an
altitude
of
2,885
feet
at
White
Pass
on
the
Alaska-British
Columbia
border.
From
that
point
it
climbs
merely
another
30
feet
in
altitude
and
travels
more
or
less
on
a
plateau
downwards
to
Whitehorse,
2,080
feet
from
sea
level.
The
rail
route
through
Alaska
was
the
most
difficult
to
build
and
remains
the
most
expensive
to
maintain,
with
tunnels,
bridges,
and
heavier
snowfalls.
From
five
to
six
locomotives
are
required
to
pull
the
train
up
the
White
Pass
and
these
locomotives
as
well
as
most
of
the
rolling
stock
and
all
the
maintenance
facilities
are
owned
by
the
American
railway
and
located
in
Alaska.
It
is
therefore
obvious
that
merely
equating
the
track
mileage
would
be
unfair
and
unequitable.
But
the
Minister
is
not
basing
his
allocation
merely
on
track
mileage.
He
is
superimposing
the
track
mileage
equation
upon
the
other
formula
which
already
includes
the
mileage
equation.
That,
of
course,
gives
undue
weight
to
the
preponderance
of
track
mileage
in
Canada.
Moreover,
the
Minister’s
formula
further
distorts
the
income
allocation
by
adding
percentages
instead
of
adding
the
actual
amounts.
That
method
unfairly
allows
the
same
percentage
rating
to
unequal
amounts.
For
instance,
for
the
US
company,
the
costs
and
expenses
($2,472,701)
are
four
times
the
amount
($613,640)
allocated
on
US
immovable
property,
yet
both
items
each
rate
a
percentage.
In
other
words,
the
Minister’s
formula
is
faulty
in
that
firstly
it
double-counts
the
immovable
property
of
the
taxpayer,
and
secondly
it
further
distorts
the
allocation
by
averaging
the
percentages
instead
of
the
actual
amounts
of
expense
and
property
allocation.
On
the
other
hand
the
taxpayer’s
method
of
allocation
is
in
accordance
with
sound
accounting
practice
and
is
an
accurate
reflection
of
the
taxpayer’s
income.
The
appeai
is
allowed
and
plaintiff’s
tax
reassessment
for
1970
is
referred
back
to
the
Minister
for
further
reassessment
in
accordance
with
these
reasons,
with
costs
in
favour
of
plaintiff.
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