Supreme Court of Canada
Western
Minerals Ltd. v. Minister of National Revenue, [1960] S.C.R. 24
Date:
1959-11-30
Western Minerals Limited Appellant;
and
The Minister of National Revenue Respondent.
1959: June 17, 18; 1959: November 30.
Present: Taschereau, Locke, Martland, Judson and Ritchie JJ.
ON APPEAL FROM THE EXCHEQUER COURT OF CANADA.
Taxation—Income tax—Capital gain or
income—Company—Powers under memorandum of assosiation—Money received under oil
leasing agreement—The Income Tax Act, 1948(Can.), c. 52, ss. 3, 4.
In 1944, the appellant company and Western Leaseholds Ltd.
(see ante p. 10) were incorporated and were at all relevant times owned
and controlled by the same shareholders and directors. The declared objects of
each company included, inter alia, the carrying on of the business of
drilling for, producing and marketing oil, and the acquiring by purchase,
lease, concession or licence mineral properties or any interest therein and
selling and disposing of or otherwise dealing with the same or any interest
therein. The appellant acquired the freehold mineral rights in some 496,000
acres, and Western Leaseholds Ltd. acquired the right to lease or sublease
these rights on a 10 per cent, royalty basis.
In 1950, the appellant company, at the request of Western
Leaseholds Ltd., leased certain acreage to Imperial Oil Ltd. on a 9 per cent,
royalty basis. The money for the lease was paid by Imperial Oil Ltd. to Western
Leaseholds Ltd., which in turn paid to the appellant
[Page 25]
in the years 1949 and 1950 a sum of over $234,000. The
Minister treated this amount as taxable income, and this assessment was upheld
by the Exchequer Court.
Held: The money in question was taxable income.
Western Leaseholds Ltd. was under no liability to pay any
royalty to the appellant except in respect of leases granted to it. It was
under no legal obligation to pay these moneys. The receipt of these moneys by
the appellant should be treated as moneys paid to it in the ordinary course of
its business of dealing in mineral rights with a view to profit, and as such,
part of its income for the purposes of taxation. Even if Western Leaseholds
Ltd. had been under any legal liability for the payment of royalty in respect
of the mineral rights leased in this case, the moneys received formed part of
the appellant's taxable income.
APPEAL from a judgment of Cameron J. of the Exchequer
Court of Canada, affirming an assessment made by the
Minister of National Revenue. Appeal dismissed.
A. S. Pattillo, Q.C., and J. B.
Tinker, for the appellant.
D. W. Mundel, Q.C., A. L. DeWolf and K. E.
Eaton, for the Respondent.
The judgment of the Court was delivered by
Locke J.:—This
is an appeal from a judgment of Cameron J. delivered in the Exchequer Court
which dismissed the appeal of this appellant from assessments under The
Income Tax Act for the taxation years 1949 and 1950. By the consent of the
parties the evidence given on an appeal by Western Leaseholds Limited (referred
to hereafter as "Leaseholds") before the Exchequer Court was made
applicable to the present matter and the judgment delivered by Cameron J.
disposed of both appeals.
In the reasons for judgment in the case of Leaseholds which
will be delivered contemporaneously with the giving of judgment in the present
matter I have stated at length the facts concerning the incorporation of these
two companies, both of which were incorporated at the instance of Mr. Eric L.
Harvie, a barrister practising in Calgary. I refer to the facts as there stated
without repeating them.
The present appeal concerns the liability of the appellant
to taxation on a sum of $34,850.13 received by it in the year 1949 from
Leaseholds and a further sum of $199,544.55 from that company in 1950.
[Page 26]
It is the contention of the appellant that these two amounts
represent moneys received from the realization of what was a capital asset in
its hands, that asset being what is said to have been a right to be paid a
royalty by Leaseholds of 10 per cent. of the value of the production of
petroleum in the area in which the mineral rights were leased to Imperial Oil
Company. The respondent contends that these are simply moneys realized in the
course of the carrying on of the appellant's business of dealing in the mineral
rights acquired by it in 1944 with a view to profit.
The evidence is by no means clear as to the true nature of
the consideration for the making of these payments by Leaseholds.
In the balance sheet of the appellant for the year 1949
prepared by its auditors and filed with the income tax return there appeared an
entry which read:
Realization from the sale of a royalty interest ……$34,850-00
This was treated as a capital gain by the auditors. For
the year 1950 the balance sheet showed a like entry with the amount of
realization stated at $234,395. There are deductions from the latter amount
which reduced the amount in question for the year 1950 to that first above
stated.
The Minister, in making his assessment for these years,
treated the amounts as business receipts of the company for the purpose of
computing its taxable income.
The appellant filed notices of objection to the disallowance
of its claim that these were receipts from the realization of a capital asset
and these notices form part of the record. The objection to the assessment for
the year 1949 claimed that pursuant to the agreement made by the appellant with
Leaseholds on December 31, 1947, whereby it had granted to that company the
right "to purchase up to 7% of the said 10% gross royalty on the lands
included under the Imperial Oil option" at the prices stated, Leaseholds
had purchased 6 per cent, of the aforesaid gross royalty at a purchase price of
$34,850.13 calculated in accordance with the aforesaid agreement. The reason
for the purchase was stated to be that as the royalty payable by Imperial Oil under
the option exercised in that year was merely 4 per
[Page 27]
cent. and since "Western Leaseholds, in turn, was
required to pay a 10% gross royalty to the taxpayer, the purchase had been
necessary."
In respect to the year 1950, the objection stated that when
the Imperial Oil Company exercised its option in 1950 in respect of 190,929.29
acres it had been agreed between Leaseholds and Minerals that the latter should
grant a lease direct to Imperial Oil reserving a 9 per cent. royalty. As this
was 1 per cent. less than Leaseholds was required to pay under the option it
held from the appellant, Leaseholds was required to account to the appellant
for the 1 per cent. difference which it did
by buying a 1% gross royalty from the Apellant at the price
for royalty above set out, being $199,544.55 (after an adjustment to a payment
received in 1949 by the Appellant in connection with the same transaction).
In the Agreement for Leases dated July 7, 1944, made
between the appellant and Leaseholds, the appellant granted to the former
company:
… the sole and exclusive right to acquire a lease and/or
leases of the said minerals in the form and upon the terms and conditions
included in the draft lease attached hereto as Schedule "B", and
subject to the terms and conditions hereinafter set forth.
The Owner will grant the Operator a lease or leases covering
any or all of the said minerals in respect to any or all of the said lands as
may be from time to time requested by the Operator.
* * *
IT IS UNDERSTOOD AND AGREED that the Operator shall be
entitled to operate the said leases on its own behalf or may at its sole
election grant subleases in respect to any or all of the said minerals….
The draft lease which formed Schedule "B" to
the agreement was expressed to be between Minerals as lessor and Leaseholds as
lessee: the consideration expressed was the sum of $1, and in addition it was
provided:
… that the Operator shall and will pay a royalty in cash of
10% of the current market value at the time and place of production of all leased
substances produced, saved and sold from the said leased lands.
As the evidence disclosed, the option dated May 15, 1946,
which was given to the Shell Oil Company was an option to purchase in fee the
mineral rights, and Minerals, as the owner, of necessity joined as a party in
giving it. While that option was dropped and nothing further paid by the
[Page 28]
optionee, the option granted, if exercised, required a
payment of a fixed sum per acre and in addition a royalty which increased from
year to year during the term of the option varying from 2½ per cent, to 6½ per
cent. No lease of the area was then granted to Leaseholds and accordingly no
royalty would have become payable by it under the agreement of July 7, 1944, if
production of oil had been obtained. The parties however, by an agreement made
contemporaneously with the granting of the option to the Shell Company which
recited that the companies considered that it was in their mutual interests to
grant the option, agreed that in the event that Shell purchased any of the
mineral rights, Minerals would accept $2 per acre as settlement for its
interest in the rights so purchased. It does not appear that it occurred to Mr.
Harvie and his associates who directed the policy of both companies that under
this option, if exercised, any liability for royalty would attach to Leaseholds
in respect of any production obtained.
When the Imperial Oil option was given on February 7, 1947,
it gave to the optionee the right to acquire the fee in the mineral rights in consideration
of a fixed price per acre and a royalty which varied from 3 per cent, to 7 per
cent, dependent upon the year in which the option was exercised. On December
31, 1947, after the Imperial Oil Company had paid the $250,000 as payment for
the option for five years, Leaseholds wrote a letter addressed to Minerals
which was approved by the latter, which, after referring to the option granted,
said in part:
You agree that we are entitled to retain the sum of $250,000
option money paid by Imperial and are under no liability to account to you in
respect thereof.
Under our Lease with you, you are entitled to a 10% royalty,
but under the Imperial Option the royalty reserved graduates from 3% to 7%, depending
on the year of purchase, and you hereby grant us the exclusive option of
purchasing from time to time up to 7% of your royalty on the following basis:
Per Acre
On the first 10,000 acres ……………………………………. $2.63 for
each 1%
purchased.
" " second " " ……………………………………. 2.10
for each 1%
purchased.
" " third " " …………………………………………. 1.58
for each 1%
purchased.
" " balance of acreage …………………………………… 1.05
for each 1%
purchased.
[Page 29]
It is to be noted that this letter states that under
Leasehold's lease Minerals was entitled to a 10 per cent, royalty but there was,
in respect to these lands, no such lease and no such liability. The liability
under the agreement of July 7, 1944, was only in respect of leases granted to
Leaseholds. The agreement contained no provision for Minerals granting leases
to others, and accordingly there could be no such liability in the case of the
option to Imperial Oil which was for the sale of the mineral rights outright or
under the lease which was eventually granted unless such liability was imposed
by some further agreement made between the parties.
When, however, the Imperial Oil Company had exercised its
option and paid the consideration, a further agreement was made between the
appellant and Leaseholds dated December 30, 1950, described as an
"Agreement of Settlement and Adjustments". The agreement provided, inter
alia, that the rights of Leaseholds under the agreement of July 7, 1944,
were to be terminated on the completion of the arrangements provided for which
required Minerals to grant a lease in a form which was made a schedule to the
agreement of all of the mineral rights in the area less those in the area in
respect of which a lease had been granted on November 1, 1946, to Imperial Oil
Limited, referred to as the "Leduc Lease" and the 193,137.79 acres
covered by the lease to Imperial Oil dated January 15, 1951. A further term of
the agreement was that Leaseholds should be entitled to retain all moneys paid
by Imperial Oil Limited "as the purchase price for the said lease"
under the terms of the option letter dated February 4, 1947, except the sum of
$234,394.68:
… being the amount paid by Leaseholds to Minerals as
consideration for reducing the royalty payable under the Agreement for Leases
from 10% to 9%, which sum was computed on the basis set forth in letter between
the parties hereto dated the 31st day of December, A.D. 1947.
Mr. Harvie, who, through his majority share interest,
controlled both companies, gave evidence at the trial, but said nothing about
these payments. Mr. Arnold, a director, who was in close touch with the management
of both companies during this period, merely produced the letter of December
31, 1947, signed by the parties without comment.
[Page 30]
Mr. H. W. Meech who was secretary of both companies in
November 1947 and thereafter simply said that the agreement said that the sum
was paid by Leaseholds to Minerals as consideration for reducing the royalty
payable under the Agreement for Leases and that the amounts were computed in
accordance with the schedule set out in the agreement. The agreement was that dated
December 31, 1947.
As the Agreement for Leases dated July 7, 1944, obligated
Leaseholds to pay, inter alia, a royalty of 10 per cent. of the value of
production only upon lands leased to it by Minerals and as the option given to
Imperial Oil on February 7, 1947, was for a sale outright of the mineral rights
upon defined terms and as, when the option was exercised for the balance of the
lands in 1950, a lease of the remaining 190,929.29 acres was, at that company's
request, substituted for a conveyance of the mineral rights, Leaseholds was
under no liability to pay any amount as royalty to Minerals when that
transaction was completed unless some independent agreement was made between
them whereby it assumed such liability. As to this it is sufficient to say that
there is no evidence of any such agreement. The appellant indeed does not
appear to suggest that any such agreement had been made.
It will be seen that the letter of December 31, 1947, above
quoted says that "under our lease with you, you are entitled to a 10%
royalty", but this is inaccurate. There was no such lease of the area
affected by the Imperial Oil option and no liability accordingly under the
Agreement for Leases. Similarly the recital in the Agreement of Settlement of
December 30, 1950, says that the amount in question was paid as consideration
for reducing the royalty payable under the Agreement for Leases when, in truth,
no royalty was payable by Leaseholds under that agreement.
The various positions taken by the appellant in regard to
the making of these payments has not been consistent. In the notice of
objection to the assessment in regard to the payments made in 1949 it was said
that the sum of $134,850.13 was paid to purchase 6 per cent. of the gross
royalty reserved which presumably meant the royalty payable under the Agreement
for Leases. However, for the year 1950, the notice of objection stated that the
moneys had
[Page 31]
been paid to purchase a 1 per cent. gross royalty from the
taxpayer, this apparently referring to the gross royalty payable under the
terms of the Imperial Oil option. The settlement agreement, however, says that
the moneys were paid as the consideration for reducing the royalty payable by
Leaseholds.
In the reasons for judgment delivered by Cameron J. it is said
that counsel for Minerals had contended that "in effect, Leaseholds
purchased 1% of the Imperial Oil royalty from Minerals". The learned judge
rejected this contention since he considered that it was clear that after
December 30, 1950, Minerals was entitled to the full royalty of 9 per cent, and
Leaseholds to no part of it. He considered that the only reasonable
interpretation to put upon that part of the Agreement of Settlement and
Adjustments referred to was that Minerals thereby agreed to cancel that part of
their contract of July 7, 1944, by the terms of which Leaseholds was bound to
pay Minerals 1 per cent. more royalty than Imperial Oil would pay by the terms
of the new agreement of December 30, 1950.
I am unable, with great respect, to agree with this
conclusion since Leaseholds was under no liability to pay any royalty except in
respect of leases granted to it.
The argument addressed to us by counsel for the appellant is
that the amount was paid to Minerals and received by it as the consideration for
commuting its right to receive the larger royalty which is to adopt the finding
made by the learned trial judge. In the absence of any evidence of an agreement
imposing such liability, the receipt of these moneys by the appellant should,
in my opinion, be treated as moneys paid to it in the ordinary course of its
business of dealing in the mineral rights with a view to profit, and as such,
part of its income for the purposes of taxation. Once it is shown that
Leaseholds was under no legal obligation to pay these amounts, the whole basis
of the appellant's argument disappears.
While this is, in my view, fatal to the appeal, I would add
that if Leaseholds had been under any legal liability for the payment of
royalty in respect of the mineral rights
[Page 32]
acquired by conveyance or lease by Imperial Oil Limited, I
would agree with the learned trial judge that the moneys received form part of
its taxable income.
The Memorandum of Association of the appellant declared the
same objects as those stated in that of Leaseholds As the learned trial judge
has pointed out, the evidence makes it clear that Minerals never intended to go
into production on its own account and it could make a profit only by the
disposal in one form or another of such mineral rights as it owned. The source
of these moneys is not in doubt. They form part of the amounts paid by Imperial
Oil Limited—to adopt the language of the Agreement of Settlement of December
30, 1950—as "the purchase price for the said lease". I think it impossible
to distinguish receipts of this nature from rents and royalties received under
the lease when granted in determining whether they are taxable as income.
I would dismiss this appeal with costs.
Appeal dismissed with costs.
Solicitors for the appellant: Stikeman &
Elliott, Montreal.
Solicitor for the respondent: A. A. McGrory,
Ottawa.
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