Utah Mines Ltd. v. Canada, [1991] 1 CTC 387, [1991] DTC 5245

Walsh, D.J.:—An agreed statement of facts was produced in this action and no witnesses were called but both parties produced written arguments accompanied by extensive references to jurisprudence. The pertinent paragraphs of section 18(1)(m) read as follows:

18. (1) In computing the income of a taxpayer from business or property no deduction shall be made in respect of

(m) royalties etc.—any amount other than the prescribed amount paid or that became payable in the year by virtue of an obligation imposed by statute or a contractual obligation substituted for an obligation imposed by statute to

(i) Her Majesty in right of Canada or a province

as a royalty, tax—or as an amount however described—that may reasonably be regarded as being in relation to

(v) the production in Canada of

(B) metal or minerals to any stage that is not beyond the prime metal stage or its equivalent,

from an oil or gas well or mineral resource situated on property in Canada from which the taxpayer had, at the time of such production, a right to take or remove petroleum, natural gas or related hydrocarbons or a right to take or remove metal or minerals.

This section was added by 1974-75-76 c. 36, subsection 7(1) applicable to amounts paid or payable on the fair market value of any property paid or payable after May 6, 1974 in respect to a period after May 6,1974 except for payments made after May 6,1974 in respect of the period from May 6, 1974 to November 18,1974 for which subsection 7(5), c. 26 of said statute applies.

The said subsection 7(5) deals with payments in the period May 6,1974 to November 18, 1974 and the pertinent portions read:

Any amount paid or payable in the year or the fair market value of any property paid or payable in the year to

(i) Her Majesty in right of Canada or a province

as a royalty or an equivalent amount, tax, rental, levy or otherwise or as an amount however described that may reasonably be regarded as attributable to the production in Canada of

(v) metal or industrial minerals to any stage is not beyond the prime metal stage or its equivalent,

from an oil or gas well or mineral resource situated on property in Canada from which the taxpayer had, at the time of such production, a right to take or remove petroleum, natural gas or related hydrocarbons or a right to take or remove metal or industrial minerals.

Gibraltar Mines v. The Queen, [1985] 1 C.T.C. 116; 85 D.T.C. 5085, dealt with a similar situation of how to calculate the royalty payments for which deduction was Claimed. This is really a secondary issue in the present case since the issue of whether such deductions could be made as a result of the Canada-U.S. Tax Convention was not an issue in the Gibraltar Mines case. The taxpayer had deducted royalty expenses estimated as if the royalty were paid or payable from January 1, 1974 to May 6, 1974 based on the amount of royalties that would have been paid if production had ceased as of that date. Actually, copper prices declined substantially thereafter so higher royalties were paid earlier in the year although the quantity of minerals produced during that period was less. It was held that what must be taken was the average unit price for the year multiplied by the number of units sold before May 6,1974 which represented only 14 per cent of the year's total production. Aside from a minor adjustment on the basis that the principle of matching costs incurred with revenues produced does not permit the utilization of an annual net value of the minerals in allocating these royalties to the period in question and that the allocation should be made by multiplying the royalty rate for the year by the units in each period times the net unit value realized in each period. The Minister's position was otherwise upheld by Justice Muldoon.

Plaintiff's contention as set forth in the statement of claim is that the amount of royalty payable pursuant to the provisions of the Mineral Royalties Act to the Province of British Columbia as of May 6,1974 was $4,834,349 which was an expense incurred for the purpose of gaining or producing income from a business deducted pursuant to paragraph 18(1)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). The Minister's reassessment reduced this to $954,910 on the basis of the apportionment of total royalties paid by plaintiff to December 31,1974 which the number of units of production sold before May 6, 1974 was to the total number of units sold in the calendar year in 1974.

It has now been agreed as a result of the Gibraltar Mines case, supra, that plaintiff's claim for a deduction has been reduced to $3,194,114 and paragraph 11 and the conclusion of the statement of claim was amended accordingly, and plaintiff no longer claims that this calculation is not in accord with generally recognized accounting principles.

Plaintiff's principal contention is, however, that the provisions of the Canada-United States Tax Convention applicable to the 1974 taxation year prevents the Minister from applying paragraph 18(1)(m) of the Act for the computation of income.

Article I of the Tax Convention provides:

An enterprise of one of the contracting States is not subject to taxation by the other contracting State in respect of its industrial and commercial profits except in respect of such profits allocable in accordance with the Articles of this Convention to its permanent establishment in the latter State.

Article 111(1) provides:

If an enterprise of one of the contracting States has a permanent establishment in the other State, there shall be attributed to such permanent establishment the net industrial and commercial profit which it might be expected to derive if it were an independent enterprise engaged in the same or similar activities under the same or similar conditions. Such net profit will, in principle, be determined on the basis of the separate accounts pertaining to such establishment. In the determination of the net industrial and commercial profits of the permanent establishment there shall be allowed as deductions all expenses, wherever incurred, reasonably allocable to the permanent establishment, including executive and general administrative expenses so allocable.

Subparagraph 4 of the Article III reads in part:

In the determination of the net industrial and commercial profits allocable to the permanent establishment, the competent authorities of the contracting States may consult together with a view to the adoption of uniform rules of allocation of such profits.

Section 3 of the Canada-United States Tax Convention Act, 1943, S of C, c. 21 reads as follows:

In the event of any inconsistency between the provisions of this Act or of the said Convention and Protocol and the operation of any other law, the provisions of this Act and of the Convention and Protocol shall, to the extent of such inconsistency, prevail.

Plaintiff submits that if paragraph 18(1)(m) of the Act were applicable to plaintiff, it would deny the deduction of an amount deductible in accordance with generally accepted accounting principles and be inconsistent with the Convention and the Tax Convention Act since neither the treaty nor any other law of Canada applicable in the 1974 taxation year empowers Canada to unilaterally attempt to amend the Convention by means of a change in the domestic law which would preclude the operation of generally accepted accounting principles.

In this connection, the case of The Queen v. Melford Developments Inc., [1982] C.T.C. 330; 82 D.T.C. 6281 was referred to. Although the facts were different, Justice Estey in rendering the judgment of the Supreme Court of Canada stated at page 335 (D.T.C. 6285):

Laws enacted by Canada to redefine taxation procedures and mechanisms with reference to income not subjected to taxation by the Agreement are not, in my view, incorporated in the expression" laws in force” in Canada as employed by the Agreement. To read this section otherwise would be to feed the argument of the appellant, which in my view is without foundation in law, that subsection (2) authorizes Canada or Germany to unilaterally amend the tax Treaty from time to time as their domestic needs may dictate.

On 335-36 (D.T.C. 6285), he states:

. . . section 3 of the ratifying statute of 1956* anticipates at least in part the problem with which the Court is today faced. There is, of course, no room for debate on

* This was the Canada-Germany Income Tax Agreement in issue.

the proposition that Parliament is supreme and can neither bind itself nor any successor of Parliament when acting within its constitutionally-assigned sovereign jurisdiction. obviously it follows that section 3 or any other part of the 1956 statute can be repealed or amended. The question is not that, but whether the collateral legislative action in connection with the Income Tax Act has the effect of amending the 1956 statute. The suggestion that it does have such an effect is startling. There are 26 concluded and 10 proposed tax conventions, treaties or agreements between Canada and other nations of the world. If the submission of the appellant is correct, these agreements are all put in peril by any legislative action taken by Parliament with reference to the revision of the Income Tax Act. For this practical reason one finds it difficult to conclude that Parliament has left its own handiwork of 1956 in such inadvertent jeopardy. That is not to say that before the 1956 Act can be amended in substance it must be done by Parliament in an Act entitled "An Act to Amend the Act of 1956". But neither is the converse true, that is that every tax enactment, adopted for whatever purpose, might have the effect of amending one or more bilateral or multilateral tax conventions without any avowed purpose or intention so to do.

There is no doubt, in my view, that the effect of section 3 is to make the operation of any other law of Parliament, including the Income Tax Act, subject to the terms of the 1956 Act and the incorporated Agreement. The only exception to this result would be where Parliament has expressly set out to amend the 1956 statute. Then, of course, there is no conflict between the 1956 Act and "any other law”.

It dealt with an amendment to the Canadian Income Tax Act whereby guarantee fees paid by plaintiff were deemed to be interest. In rendering the Supreme Court decision, Justice Estey stated that it was in accord with the decision of Justice Mahoney in considering the Canada-U.S. Convention in Associates Corporation of North America v. The Queen, [1980] 2 F.C. 377; [1980] C.T.C. 80; 80 D.T.C. 6049; affd [1980] 2 F.C. 382; [1980] C.T.C. 2115; 80 D.T.C. 6140. At pages 82-83 (D.T.C. 6051; F.C. 381), Justice Mahoney had stated:

The guarantee fees paid to the plaintiff are not interest within the terms of the Canada-U.S. Tax Convention. Paragraph 214(15)(a) of the Income Tax Act deeming them to be interest is inconsistent with the Convention and, by virtue of section 3 of the Act that makes the Convention part of Canada's domestic law, paragraph 214(15)(a) cannot apply to guarantee fees subject to the Convention. The fees in issue were a component of the plaintiff's industrial and commercial profits which were not taxable by Canada since the plaintiff was a United States enterprise having no permanent establishment in Canada.

[Emphasis added.]

Defendant distinguishes this case, however, stating that in the present case the royalty expenses incurred by plaintiff under the Mineral Royalties Act of British Columbia were a component of its industrial and commercial profits allocable to its permanent establishment in Canada, thus were expenses completely within the domestic taxation jurisdiction of Canada unlike the Associates Corporation of North America case, supra, where the plaintiff was a United States enterprise having no permanent establishment in Canada. Justice Estey made this distinction himself at page 335 (D.T.C. 6285) of the Melford case, supra, stating: "The Treaty does not authorize the taxation of industrial and commercial profits of a non-resident where those profits were not earned through a permanent establishment in Canada."

Defendant further argues that in the present case the amendments relating to royalty expense deductions in Canada merely brought about a change in the deduction of a component of plaintiff's industrial and commercial profits which under the Convention were allocable to the plaintiff's permanent establishment in Canada and thus subject to Canadian taxation whereas in the Melford case, supra, the word "interest" not only appeared in the Canada- Germany Income Tax Agreement but as a form of income was dealt with specifically by that treaty so that a change in the meaning of the word in that agreement would necessarily mean a change in the Agreement itself. Furthermore, in Melford, supra, the provisions set out to circumvent a limitation contained in a tax treaty and was directed only at non-residents whereas in the present case, amendments to 18(1)(m) at issue in this appeal were directed at the manner in which all taxpayers calculated income under the Act and affected Canadian residents carrying on similar business activities under the same or similar conditions as it did non-residents protected by the Convention.

Paragraph 11 of the Protocol of the Convention states:

The citizens of one of the contracting States residing within the other contracting State shall not be subject to the payment of more burdensome taxes than the citizens of such other State.

The amendments to the Income Tax Act in question comply with this, a Canadian mining corporation not being treated any differently than the permanent establishment of an American corporation doing the same. work in Canada.

With respect to the argument in plaintiff's statement of claim that the industrial and commercial profits are to be determined in accordance with concepts prevailing at the time of the coming into force of the Tax Convention which allowed at that time full deductibility from mining royalties paid to a province in Canada, defendant submits that in the absence of definition of "industrial and commercial profit” this is not frozen for all time, by what was understood by it at the date of the Convention and that there are no expressed provisions in the Convention so limiting them. Within the jurisdiction of Canada the notion of profits whether industrial, commercial or otherwise both from an accounting and tax legislative perspective has never been established but has been and is still a concept that changes constantly.

It is interesting to note that an extract from Michael Edwardes-Ker, The International Tax Treaties Service, pages 30-32 refers to a decision June 1979, in ” International Tax Treaties O.E.C.D. Income" Article 7, page 30 in which at page 31 the decision states:

It may be argued that since the contracting parties negotiated the Treaty in light of existing internal law, they intended that the terms of the Treaty be construed thereunder; and further, that subsequent amendment of internal law affords the unusual opportunity to one of the signatories to make a unilateral change that will have an impact on the provisions of a bilateral agreement. In fact, a few treaties have expressly limited the application of internal laws to that in force on the date of signature. E.g., United States-Honduras Income Tax Treaty, Article XX(6), now terminated. However, we believe that the better view is that, absent a clear intent to limit the internal law to that in force at the time of a treaty's ratification, subsequent changes in internal laws should be given full effect.

One must keep in mind that the purpose of a treaty is different from that of the Code. A treaty attempts to state certain broad principles upon which the contracting parties agree, necessarily leaving the particulars to be defined by the internal laws of each signatory. The Code, on the other hand, attempts to anticipate and deal with specific problems. The intent of the drafters in taking this approach, we believe, was to allow for a certain amount of "breathing room" in the internal law, even though a change therein might have some impact upon a provision in a treaty. Based upon the fact that the U.S.-U.K. Treaty and Protocol follow the general pattern of other U.S. income tax treaties, we feel that this is sufficient evidence of the intent of the drafters of these documents that this "breathing" concept be used when it is necessary to refer to internal law for purposes of interpretation.

Such a conclusion may be somewhat weakened however, in the present case, by paragraph 2 of the Protocol which states:

In the event of appreciable changes in the fiscal laws of either of the contracting States, the government of the two contracting States will consult together.

Paragraph 18(1)(m) of the Income Tax Act might well be considered as an "appreciable change".

By 14 George 6 Chapter 27 assented to June 30, 1950, Canada-United States Tax Convention Act of 1943 and 1944 were amended inter alia by adding at the end of paragraph 1 of Article III the following new sentence:

In the determination of the net industrial and commercial profits of the permanent establishment there shall be allowed as deductions all expenses wherever incurred, reasonably allocable to the permanent establishment including executive and general administrative expenses so allocable.

Defendant argues that this was added to the Convention to formalize the previous practice of allowing the deduction for administrative purposes of head office expenses were reasonably allocable to the permanent establishments and was not intended to permit the deduction of expenditures otherwise disallowed by the taxing state.

That this was the intent is substantiated by an extract from the United States Senate Foreign Relations Committee Report on Supplemental Income Tax Convention which was taken from 7. Legislative History of the United States Tax Conventions which stated at page 607:

Article l(a) of the pending Convention provides in effect that in determining the net income of a permanent establishment in the taxing country which is a branch or subsidiary of a corporation of the other contracting state, there shall be allowed as deductions so much of the administrative expenses of the head office as are reasonably allocable to such permanent establishment. This agreement is in reality declaratory of the existing practice of both countries.

Defendant therefore argues that there was no intention to allow deductions under the Convention of all expenses regardless of the deductibility of such expenses as permitted under the internal tax laws of the contracting States.

Reference is made to the American case of Handfield v. C.I.R. (1955), 23 T.C. 633 in which [it was] determined that plaintiff had a permanent establishment within the United States within the meaning of the Tax Convention, and that therefore since he was engaged in business within the United States in the year in issue, his operations were subject to taxation under U.S. Internal Revenue Code, so that the deduction he claimed for salary to himself and interest on money borrowed from himself as a business expense were not items deductible under that Code, and hence could not be claimed as deductions.

Defendant has an alternative argument based on subsection 124(2) of the Income Tax Act enacted at the same time as 18(1)(m) which permitted as a deduction from corporate tax 15 per cent of abatement of federal tax on mining profits earned in the province. This provided tax relief to taxpayers who were as a result of the enactment of paragraph 18(1)(m) not thereafter permitted to deduct such royalty payments as a business expense in arriving at their income for Canadian taxation purposes. Defendant's argument is that to allow the plaintiff to benefit from the tax relief provided by subsection 124(2) of the Act while permitting it to deduct the royalty payments, a deduction which is prohibited by paragraph 18(1)(m) of the Act would have the effect of permitting the plaintiff to deduct a statutorily prohibited expense, and at the time same compensating it with a 15 per cent abatement that was substituted therefor, and that such a conclusion is contrary to the clear statutory scheme enacted by Parliament in 1974. It was argued that the scheme of the Act should be looked at as a whole.

In considering this problem, see Highway Sawmills v. M.N.R., [1966] S.C.R. 384; [1966] C.T.C. 150; 66 D.T.C. 5116 at 157-58 (D.T.C. 5120; S.C.R. 393-394), and also Qualico Developments Ltd. v. The Queen, [1984] C.T.C. 122; 84 D.T.C. 6119 at 128 (D.T.C. 6124) in which Chief Justice Thurlow referred to the Highway Sawmills Ltd. case stating:

. . . there is the consideration that to permit the deductions as claimed tends to distort the computation of appellant's income for the years in question, a result which I do not think the language used should be presumed to intend and which should be avoided if the statute can be so interpreted.

On the other hand, defendant's argument that to uphold plaintiff's action to be allowed to continue to deduct royalty payments prohibited by paragraph 18(1)(m) on the basis that this infringes the Tax Convention, unless at the same time the judgment finds that subsection 124(2) cannot be applied to plaintiff, and to allow it to claim the 15 per cent deduction from profits allowed therein, would defeat the purpose of the amendments considered as a whole and the intent of the Act, is considerably weakened by another section of the amended Protocol and by other jurisprudence. Section 10 of the Protocol reads:

The provisions of the present Convention shall not be construed to restrict in any manner any exemption, deduction, credit or other allowance accorded by the laws of one of the contracting States in the determination of the tax imposed by such State.

This would clearly have the effect of meaning that at least insofar as the Convention is concerned, subsection 124(2) constituting a deduction, may be given full force and effect.

In the case of Lor-Wes Contracting Ltd. v. The Queen, [1985] 2 C.T.C. 79; 85 D.T.C. 5310, Justice MacGuigan rendering the judgment of the Court of Appeal referred at page 82 (D.T.C. 5312) to the judgment of the Supreme Court of Canada in The City of Winnipeg v. Morguard Properties Ltd. (1983), 50 N.R. 264 where at 282-83, Justice Estey said for the Court:

In more modern terminology the courts require that, in order to adversely affect a citizen's rights, whether as a taxpayer or otherwise, the Legislature must do so expressly. Truncation of such rights may be legislatively unintended or even accidental, but the courts must look for express language in the statute before concluding that these rights have been reduced. This principle of construction becomes even more important and more generally operative in modern times, because the Legislature is guided and assisted by a well-staffed and ordinarily very articulate Executive. The resources at hand in the preparation and enactment of legislation are such that a court must be slow to presume oversight or inarticulate intentions when the rights of the citizen are involved. The Legislature has complete control of the process of legislation, and when it has not for any reason clearly expressed itself, it has all the resources available to correct that inadequacy of expression. This is more true today than ever before in our history of parliamentary rule.

Reference was also made by him to the case of Stubart Investments Ltd. v. The Queen, [1984] C.T.C. 294; 84 D.T.C. 6305 at 314 (D.T.C. 6322-23).

Similarly, in the case of Canterra Energy Ltd. v. The Queen, [1987] 1 C.T.C 89: 87 D.T.C. 5019, Justice Urie in rendering the judgment of the Court of Appeal stated at 95-96 (D.T.C. 5024):

The words of Lord Reid in Inland Revenue Commissioners v. Hinchy, [1960] A.C. 748; [1960] 1 All E.R. 505 are also apposite in dealing with what may have appeared to be unfortunate results arising from giving to words in a statute their plain meaning. At pages 767 and 768 (All E.R. 512) he had this to say:

Difficulties and extravagant results of this kind caused Diplock J. and the Court of Appeal to search for an interpretation which would yield a more just result. What we must look for is the intention of Parliament, and I also find it difficult to believe that Parliament ever really intended the consequences which flow from the appellants' contention. But we can only take the intention of Parliament from the words which they have used in the Act, and therefore the question is whether these words are capable of a more limited construction. If not, then we must apply them as they stand, however unreasonable or unjust the consequences, and however strongly we may suspect that this was not the real intention of Parliament.

It can be argued therefore that if in drafting subsection 124(2) of the 1974-75-76 amendments to the Canadian Tax Act to alleviate the rigorous consequences of the adoption at the same time of paragraph 18(1)(m) (and 12(1)(o) although this is not applicable in the present case) the problem which might arise if 18(1)(m) were found to be inapplicable because of the Canada- U.S. Tax Convention, and a non-foreseen benefit was therefore conferred on the taxpayer, was not contemplated and legislation was not so drafted as to prevent, then this benefit the taxpayer is perfectly entitled to benefit by it. This, I believe, must result in the rejection of defendant's argument that if the royalty deduction is to be permitted the subsection 124(2) deduction should not be. It does not, however, add any weight to the argument that paragraph 18(1)(m) should be found to be inapplicable to plaintiff because of the Convention,

I conclude that paragraph 18(1)(m) does not contravene the provisions of the Canada-U.S. Tax Convention and Protocol thereto, having been validly enacted and applicable equally to both domestic corporations and permanent establishments in Canada of U.S. corporations.

Plaintiff's appeal from its 1974 income tax assessment is therefore dismissed with costs. The provisions of subsection 124(2) of the Income Tax Act in effect for that year will apply to it. The assessment is referred to the Minister for such reassessment as may be necessary in accordance with these reasons.

Appeal dismissed.