Alberta Energy Co. Ltd. v. The Queen, 95 DTC 220, [1995] 1 CTC 2111 (TCC), aff'd 98 DTC 6007 (FCA)

Bonner J.T.C.C.:-This is an appeal from an assessment of income tax for the appellant’s 1984 taxation year. During that year, the appellant entered into an Agreement in writing (the ’’Farmout agreement") with Esso Resources Canada Ltd. ("Esso"). Under the Farmout agreement, the appellant received from Esso the sum of $4.5 million for "...the right, licence and privilege of earning an interest in oil sands rights..." in the Fisher Creek area of the Primrose Lake Air Weapons Range in Alberta. The appellant treated the consideration received as proceeds from the disposition of an eligible capital property. The Minister of National Revenue ("Minister") made the assessment under appeal on the basis that the consideration was the proceeds of disposition of a Canadian resource property and that it was required by subsection 59(1.1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") to be included in the amount referred to in clause 66.2(5)(b)(v)(A) when cumulative Canadian development expense was calculated.

The issue in this appeal is whether the Minister was correct in assessing tax on the basis that the thing sold was a "Canadian resource property" within the meaning of paragraph 66(15)(c) of the Act. A second issue raised by the pleadings was abandoned.

The rights [1] that were sold to Esso were acquired by the appellant under an agreement with the Province of Alberta. That Agreement was formed by the acceptance on April 26, 1978 of an offer made by the appellant on April 20, 1978 (the "acquisition agreement"). By the acquisition agreement, Alberta leased to the appellant all the petroleum and natural gas rights within an area known as the Primrose Lake Air Weapons Range. The offer read in part:

Alberta Energy Company Ltd. (AEC) hereby offers to lease all petroleum and natural gas rights (the "said rights"), excluding oil sands as defined in section 2(1) 20 of the Mines and Minerals Act being Chapter 238 of the Revised Statutes of Alberta, 1970, (Oil Sands), owned by Alberta within, upon or under those lands (the "said lands") in the north-eastern portion of Alberta known as "Primrose Lake Air Weapons Range” generally as outlined on Schedule "A" attached hereto.

It provided as well that the leases to be granted under it were to "..convey no right to crude bitumen". Specifically it said:

The said rights shall be leased to AEC in one or more leases which shall be in the form, and be subject to the royalties, rentals and other provisions, currently prescribed in the Mines and Minerals Act (Alberta) and the Regulations thereunder, but notwithstanding any provision of the Mines and Minerals Act and regulations thereunder the leases convey no right to crude bitumen or to the substances which could be recovered as part of a bitumen recovery scheme.

Crude bitumen is a substance of higher viscosity than crude oil. In the natural state, crude bitumen is often found mixed with sand in deposits called "oil sands" and will not flow into a well bore. It may be recovered through a well only if heated sufficiently to reduce the viscosity, permitting it to flow. Heating may be accomplished by the injection of steam. It is the higher viscosity in the natural state which distinguishes crude bitumen from conventional crude oil. The presence of crude bitumen may however be discovered in the course of drilling for conventional oil and gas. The acquisition agreement, which required the appellant to spend $32 million evaluating and developing the petroleum and natural gas rights, recognized this possibility [2] and provided for it in clause 8:

In the normal course of developing the Petroleum and Natural Gas Rights AEC may encounter crude bitumen. AEC shall thereupon be accorded the right to acquire, without the payment of a cash purchase price, explore for and develop said bitumen under such terms and conditions as the Minister may decide, within 90 days of receiving written notice to that effect from the Minister.

Clause 8 is the source of any rights to bitumen or oil sands that the appellant may have held and have conveyed to Esso by the Farmout agreement.

The Farmout agreement was formed in January of 1984, almost six years after the acquisition agreement. It related to a block of lands, 161,280 acres in area, forming part of the Primrose Lake Air Weapons Range, and known as the Fisher Creek Block. The recitals in the Farmout agreement included:

WHEREAS pursuant to the acquisition agreement, AEC is entitled to become the holder of petroleum and natural gas leases, comprised in the Primrose Lake Air Weapons Range (hereinafter called "Air Weapons Range");

WHEREAS pursuant to the acquisition agreement, if in the course of developing rights under the petroleum and natural gas leases AEC encounters Crude Bitumen, AEC will be accorded the right in the Air Weapons Range to acquire, explore for, and develop Crude Bitumen under such terms and conditions as Alberta may decide.

The provision under which the amount in issue was paid reads:

Esso Resources agrees that, in addition to the earning obligations hereinafter stated, it will pay to AEC a cash consideration of $9 million on execution of this agreement, $4.5 million of which shall be for the right, licence and privilege of earning an interest in and to explore for, drill for, produce or take petroleum and natural gas substances from the lands and $4.5 million of which shall be for the right, license and privilege of earning an interest in oil sands rights.

It is the consideration for which the second $4.5 million was paid, that is to say, "the right, licence and privilege of earning an interest in Oil Sands Rights", which is now in question. The following definition of "Oil Sands Rights" was inserted in the Farmout agreement to identify precisely what the parties agreed that Esso was to have the right to earn:

“Oil Sands Rights" means "oil sands rights" as defined in paragraph 121(c) of the Mines and Minerals Act as of the date of this Farmout agreement but only to the extent that such rights may be available or are granted:

(i) in accordance with Clause 8 of the acquisition agreement or other arrangement in substitution therefor, or

(ii) by any leases, licenses or permits or other documents of title to oil sands rights granted from time to time to AEC in accordance with the provisions of Clause 8 of the acquisition agreement or other arrangement in substitution therefor,

insofar as and to the extent only that the same pertain to Oil Sands;

The term "crude bitumen" was also defined in the Farmout agreement.

"Crude Bitumen" has the meaning set forth in paragraph 1(1 )(d) of the Mines and Minerals Act and amendments thereto as of the date of this agreement;

The paragraph 121(c) definition of "oil sands rights" and the paragraph 1 (l)(d) definition of "crude bitumen", which were incorporated by reference in the Farmout agreement, now follow (R.S.A. 1980 c. M-15):

121 In this Part,

(c) "oil sands rights" means

(i) the right to mine, quarry, work, remove, treat or process oil sands that occur in a zone designated by the Energy Resources Conservation Board, including the right to recover any products therefrom whether above or below the surface, and

(ii) the right to dispose of the oil sands and any products recovered therefrom.

1(1) In this Act,

(d) "crude bitumen" means a naturally occurring viscous mixture, mainly of hydrocarbons heavier than pentane, that may contain sulphur compounds, and that in its naturally occurring viscous state is not recoverable at a commercial rate through a well;

There was introduced evidence of correspondence between the appellant and the Energy and Natural Resources Department of Alberta in which officials of the Department express their views on the meaning of clause 8 of the acquisition agreement. Thus, for example, in a letter of September 6, 1978 an official advised the appellant that:

The company (the appellant) should advise potential "farmees" of P&NG rights to be issued under the terms of the letter agreement between the company and the Department that their acquired interest in the P&NG rights will not automatically provide them with a present or future interest in any oil sands that may be encountered in drilling for oil and gas.

In a subsequent letter the official said that the acquisition agreement:

…€effectively requires AEC’s participation in any program involving oil sands evaluation and development. This means, instead of dealing with the industry at large on proposals for oil sands development within the Primrose Range, the Department is obliged to deal with AEC. Other than that, however, AEC or its partners should prepare their proposals for oil sands evaluation and development in accordance with the guidelines enclosed herein.

The Primrose Lake Range which was the subject of the acquisition agreement included a number of areas of land in addition to the Fisher Creek Block. Neither the appellant nor any of its farmees had carried out any drilling or other exploratory work on the Fisher Creek Block prior to formation of the Farmout agreement. However, before the Farmout agreement was formed, crude bitumen had been encountered in three other areas of the Range, Ipiatik West, Ipiatik East, and Burnt Lake. Oil sands leases had been issued for these areas. Thus clause 8 of the acquisition agreement did in practice work as it was intended to work.

The appellant made an application for an oil sands lease relating to the Fisher Creek Block late in 1985. This application was rejected by the Minister. A subsequent application by the appellant for an oil sands prospecting permit covering a larger area was successful and a permit was granted.

The statutory definition of "Canadian resource property", as it read at the relevant time, is central to the dispute. Paragraph 66(15)(c) of the Act defined the term in part as follows:

"Canadian resource property" of a taxpayer means any property acquired by him after 1971 that is

(ii) any right, licence or privilege to

(B) prospect, explore, drill or mine for minerals in a mineral resource in Canada,

(vii) any right to or interest in any property (other than property of a trust) described in any of subparagraphs (i) to (vi) (including a right to receive proceeds of disposition in respect of a disposition thereof);

It may be useful at this point to note two features of the definition. Firstly subparagraph (vii) provides that a right to or interest in a right or privilege to prospect, explore, drill or mine for minerals falls within the definition. Secondly the definition uses the word "any" three times as in "any property" and "any right" and thereby expresses a legislative intent to cast a wide net.

The word "property" as defined in subsection 248(1) of the Act is also very broad in scope:

"property" means property of any kind whatever whether real or personal or corporeal or incorporeal and, without restricting the generality of the foregoing, includes

(a) a right of any kind whatever, a share or a chose in action,

The appellant contended that the "Oil Sands Rights" sold to Esso could not be a Canadian resource property unless they were "property" of the appellant at the date of the Farmout agreement in January 1984. The appellant argued that while the definition of "property" in subsection 248(1) of the Act included a right of any kind whatever, the expression "Oil Sands Rights" used in the Farmout agreement was a defined term and was not to be regarded as a right referred to in the definition of "property" merely because the same word, "right", was used. I agree this far. It was submitted that the thing sold was a "mere expectation", not a right, and, because it was not a right, it could not be "property" within the meaning of the applicable statutory language.

The appellant argued that the "Oil Sands Rights" were not true rights because the Alberta Minister was under no duty or obligation to issue an oil sands prospecting permit or oil sands lease; the Minister had a discretion under the Mines and Minerals Act either to refuse to grant a lease or exploration permit or to grant the approval subject to prescribed conditions. It was the appellant’s position that the right referred to in clause 8 of the acquisition agreement was a mere right to negotiate with the Minister or a right of first refusal. Clause 8 did not create a right of property or an interest in land but was a mere expectancy. The appellant further contended that clause 8 came into operation only upon an encounter with crude bitumen in the normal course of the exercise of its petroleum and natural gas rights. The appellant submitted that this was a true condition precedent. Since the appellant had not encountered crude bitumen at the time that the Farmout agreement was entered into, the appellant had no right to acquire "Oil Sands Rights".

The respondent argued that the appellant had a legally enforceable option under the acquisition agreement: an option to acquire, explore for, and develop any crude bitumen encountered in the course of developing its petroleum and natural gas rights. It was the respondent’s submission that the only thing the Minister had reserved was the power to determine the terms and conditions under which the bitumen could be developed.

The respondent contended that clause 8 should be interpreted in light of the subsequent conduct of the parties. It was said that the parties to the acquisition agreement themselves had treated clause 8 as having conveyed to the appellant a legal right in the bitumen. The respondent relied on the fact that Alberta had previously granted oil sands leases in three other areas of the Primrose Range. The respondent argued that it was strange for the appellant to assert that clause 8 of the acquisition agreement was unenforceable when it had already been acted on by the parties as if it were enforceable. Furthermore, the appellant and Esso had agreed that the $4.5 million was in respect of the disposition of a right to an interest in oil sands rights. It was the respondent’s submission that this characterization should bind the appellant; the appellant had characterized it as a right and could not now assert that it was not.

The respondent also argued that the appellant had a legally enforceable right against the Minister under clause 8 of the acquisition agreement because the Minister was obliged to accord the rights on reasonable terms and conditions. Counsel referred to the mandatory wording in clause 8: "AEC shall thereupon be accorded the right...."

In the respondent’s submission, there was no condition precedent in clause 8 of the acquisition agreement because clause 8 was to be read as conferring a right to any bitumen encountered, and there was a virtual certainty of encountering bitumen. It was the respondent’s submission that encountering bitumen was simply a term of the acquisition agreement and not a condition precedent to the existence of a contract; the right to acquire a lease or permit was granted when the acquisition agreement was accepted.

The respondent argued, in the alternative, that, if the option fell short of being a right to a right, it was an interest in a right to prospect, explore, drill, and mine for minerals in a mineral resource in Canada and thus within the statutory definition.

Without doubt, rights under paragraph 121(c) of the Mines and Minerals Act fall within the clause 66( 15)(c)(ii)(B) definition of Canadian resource property. They are included in the words... "any right to prospect, explore, drill or mine for minerals in a mineral resource in Canada". The appellant had in fact neither applied for nor received an oil sands prospecting permit or an oil sands lease in respect to the Fisher Creek Block at any time before January 1984. Thus the appellant did not at the time of the Farmout agreement hold or dispose of any such rights. That is not, however, the end of the matter. The 4.5 million dollars was, according to the language of the Farmout agreement, paid not only for existing rights of that description but also for rights which "may be available". The essential question is whether the appellant disposed of property that is a right to any right, licence or privilege to prospect, explore, drill or mine for minerals.

In my view, the appellant, by the Farmout agreement, disposed of a right to a right of the sort described in clause 66(15)(c)(ii)(B). I accept the argument that an encounter with crude bitumen had to occur before the appellant or its farmee could call on the Minister under clause 8 of the acquisition agreement to accord to it "the right to acquire...explore for and develop said bitumen ...." The language of clause 8 is not open to any other reasonable interpretation. Nevertheless, as a consequence of the acquisition agreement, the appellant was singled out as the possessor of the exclusive right to call on the Minister to accord to it, in respect of any bitumen which it encountered, any rights which the Minister, in the exercise of the discretion vested in him by the Mines and Minerals Act, might decide to issue.

I accept the assertion that the Minister was entitled under section 153 of the Mines and Minerals Act, to either refuse to issue an exploration licence or to make any such licence subject to conditions which he might prescribe. I do not accept the argument that the presence of such ministerial discretion leads to a conclusion that the appellant did not have a paragraph 66(15)(c) right. The language of clause 8 of the acquisition agreement is mandatory and provides that the appellant shall be accorded the bitumen rights. It seems clear to me that clause 8 was intended to govern such rights as the Minister in the exercise of his discretion might decide to issue and to impose on the Minister in respect of those rights the obligation to issue them to the appellant.

In my view the appellant’s clause 8 right was not, as suggested at one stage during argument a right to a right to a right and therefore one which falls outside the scope of the definition in paragraph 66(15)(c). The approach suggested was one which would count the rights to be "accorded" after an encounter with bitumen as one right and the right received upon the exercise of the "right to acquire" as another. It is a mechanical approach and quite unrealistic. It is not acceptable in the determination of liability to income tax.

Much of the argument advanced on behalf of the appellant seems to rest on the unstated premise that paragraph 66(15)(c) encompasses only unfettered rights to prospect, explore, drill etc. The context in which rights of the sort described in that provision often arise is described in R. Dussault and

L. Borgeat, Administrative Law: A Treatise, 2d ed., vol. 3 (Toronto: Carswell, 1989) at page 125:

The Crown is the owner of the public domain and may consent to relinquishing all or some of its rights, so long as the domain is not put in jeopardy through improper development. It is for this reason that most often the agreement between the individual and the public authority allows the latter to determine the norms or standards that will apply. Consequently, the licensee is required to make use of the Crown domain under a system of unilateral decisions made by the Administration within the rather wide framework established by statute.

In my view, an intention to confine paragraph 66(15)(c) rights to absolute rights is most unlikely to be present in the factual context addressed by the legislation. The acquisition agreement was entered into by the Alberta Minister and the appellant at a time when little was known about the nature and extent of bitumen deposits within the Primrose Lake Range. It is unlikely that either the appellant or the Alberta Minister would be inclined in such circumstances to attempt to specify in advance of an encounter with bitumen just how the discretion possessed by the Alberta Minister under the Mines and Minerals Act ought to be exercised. No doubt it was for that reason that clause 8 was drafted in general language. In those circumstances it would make sense for the appellant and the Alberta Minister to agree quite simply that the appellant would be the person entitled to receive, as of right, any right which the Alberta Minister might decide to issue permitting the exploration, development or exploita- tion of deposits of bitumen which the appellant might encounter. That, as I see it, was the intention expressed by clause 8. The appellant could not compel the Minister to issue rights of the type contemplated by clause 8 but it could compel him to issue such rights to it if he decided to issue them at all. Accordingly what the appellant had under clause 8 and what was sold to Esso was in my view a Canadian resource property within the meaning of paragraph 66(15)(c) of the Act. If, contrary to my view, what was sold was not a right, it was at least, a "privilege" within the meaning of clause 66(15)(c)(2)(B) of the Act. The ordinary meaning of the word "privilege" as set out in the Oxford English Dictionary is: [3]

2. a A right, advantage, or immunity granted to or enjoyed by a person, or a body or class of persons, beyond the common advantages of others;

3. A privileged position; the possession of an advantage over others or another;

Clearly the appellant acquired under clause 8 and disposed of to Esso a right or advantage with respect to bitumen deposits encountered which the right or advantage was superior to that possessed by others. For the foregoing reasons the appeal will be dismissed with costs.

Appeal dismissed.