Date: 20070209
Dockets: A-434-05
A-435-05
Citation: 2007 FCA 38
CORAM: NOËL
J.A.
SHARLOW
J.A.
RYER
J.A.
Docket: A-434-05
BETWEEN:
TRI PACIFIC GAS CORPORATION
Appellant
and
HER MAJESTY THE QUEEN
Respondent
Docket: A-435-05
BETWEEN:
RAY ROTH
Appellant
and
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
RYER J.A.
INTRODUCTION
[1]
These are
appeals from two decisions of Bell J. of the Tax Court of Canada (2005 TCC 484)
in which he disallowed a deduction of $363,552 claimed by the appellant, Tri
Pacific Gas Corporation ("Tri Pacific"), in respect of its taxation
year that ended on March 31, 1998 and upheld the inclusion of $371,726 in the
income of the appellant, Ray Roth ("Roth"), as a shareholder benefit,
in respect of his 1998 taxation year.
[2]
The appeals
were consolidated by order of this Court, dated January 27, 2006, with the
appeal of Tri Pacific (A-434-05) being designated as the lead appeal. These
reasons will be filed in A-434-05 and a copy of them will be filed in A-435-05.
FACTS
[3]
Mr. Roth is an individual of considerable
experience in the petroleum industry. He was employed by a non-resident
corporation that was involved in the construction of a liquefied natural gas
("LNG") facility that was owned by the Indonesian government oil and
gas corporation ("Pertamina"). After the conclusion of that employment in 1978, Mr. Roth
undertook an arrangement with Pertamina for the promotion of another LNG
project in Indonesia (the
"Pertamina LNG Project"), in the course of which he claims to have
incurred costs of various types. He also says that he incurred certain
engineering and design costs that related to another project involving drilling
off the east coast of East Kalimantan, Indonesia (the "East Kalimantan
Drilling Project"). Mr. Roth claims that he incurred costs totalling
$371,726 between April of 1978 and the end of 1981 in relation to those two
projects. He says he would have been reimbursed by the other parties to those
arrangements if those projects had come to fruition, but that did not happen.
In late 1981, Mr. Roth resumed Canadian residence and undertook employment with
an Edmonton based corporation.
[4]
In late
1991, Tri Pacific was incorporated, initially under another name, with Mr. Roth
and another individual, Mr. Ron Cripps, as equal shareholders. Tri Pacific was
set up to exploit a potential interest of an Asian group in a new LNG project
that was to produce LNG on the west coast of Canada, for shipment to Southeast Asia.
[5]
The
financial statements of Tri Pacific as at March 31, 1993 show an asset called
"Pre Development Costs" in the amount of $455,353.60 and a liability
called “Loans Payable” in the amount of $540,000. Included in both amounts is
the $371,726 of costs that Mr. Roth said that he had incurred in relation to
the Pertamina LNG Project and the East Kalimantan Drilling Project. Both
amounts became part of the Tri Pacific financial statements as the result of a
journal entry in June of 1992.
[6]
In
relation to the liability portion of the 1992 journal entry, Mr. Roth testified
that a promissory note was prepared and initialled but not executed, by him.
That document was not produced as evidence. No other documents were produced
to support the journal entry. Mr. Roth testified that he had receipts for all
his costs at one time, but they had been given to the accountants for Tri
Pacific and could not be found after a search.
[7]
In
November of 1994 BAS Ventures Inc., ("BAS Ventures"), a nominee and
agent for a number of persons (including Tri Pacific), and Capital Projects
Group Inc. entered into a joint venture arrangement (the "Pac-Rim
JV") to evaluate the feasibility of building an LNG plant at Kitimat, B.C.
(the "Kitimat LNG Project") for the purpose of exporting LNG to
Southeast Asia. At approximately the same time, the Pac-Rim JV entered into a
Management Agreement with Tri Pacific to obtain management services, and in
particular the full-time services of Mr. Roth, in relation to the feasibility
evaluation segment of the Kitimat LNG Project. The Management Agreement
acknowledged that Tri Pacific had incurred certain "prior period costs of
$371,146.00" and that those costs would be paid to Tri Pacific if the
Kitimat LNG Project reached certain milestones.
[8]
In 1997,
the interest in the Pac-Rim JV that was held by BAS Ventures was sold to
Pac-Rim LNG Inc., Bechtel Enterprises International, Ltd., Phillips Petroleum
Canada Ltd. and Daewoo Corporation. The agreement specified that the
"Purchased Interest" was a 5% equity interest in the Pac-Rim JV,
which related to the Kitimat LNG Project. The purchase price of the
"Purchased Interest" was $4.5 million, of which US $1 million was
paid and the balance, including an amount referred to as representing a
reimbursement of certain development costs incurred by the selling party, was
never paid because it was contingent upon the attainment of a financing
milestone that was never reached. As a consequence of this sale, Tri Pacific
received a payment of $586,601.20 as its share of the purchase price.
[9]
In
computing its income for its 1988 fiscal period, Tri Pacific included, as
ordinary income, the amount of $586,601.20 and claimed a deduction, on account
of "Predevelopment costs" in the amount of $474,326. Of this amount,
the Minister, on reassessment, permitted a deduction of $110,774 and denied the
balance of $363,552 on the basis that this portion of such "Predevelopment
costs" had not been incurred by Tri Pacific.
[10]
Tri-Pacific
made a payment of an amount in excess of $500,000 to Mr. Roth in 1998. He
included no portion of that payment in computing his income for that year on
the basis that the amount received represented a repayment of indebtedness
owing to him by Tri Pacific. On reassessment, the Minister included $371,726
of that payment in his income for 1998 as a shareholder benefit pursuant to
subsection 15(1) of the Income Tax Act, R.S.C. 1985, c.I (5th
Suppl.) (the "ITA").
[11]
Both Tri
Pacific and Mr. Roth appealed their respective reassessments and the matters
came before Bell J. of the Tax Court for adjudication.
TAX COURT DECISION
[12]
Bell J. dismissed
both appeals. He held that Tri Pacific was not permitted to deduct the
$363,552 of "Predevelopment Costs" since that amount represented
costs that had been incurred by Mr. Roth prior to 1982 and had not been
incurred by Tri Pacific. Bell J. went on to hold that the $363,552 amount did
not represent the cost of any property that had been transferred by Mr. Roth to
Tri Pacific at the time of the 1992 journal entry. He found that there was no
documentation in evidence that supported such a transfer and that any knowledge
that Mr. Roth possessed had not been reduced to writing or put into electronic
form. This lead him to conclude that what Mr. Roth possessed was essentially
information, ideas, knowledge or know-how, none of which was exclusive to him.
[13]
Based upon the
decision of this Court in Manrell v. R. 2003 FCA 126, Bell J.
concluded that, as a matter of law, whatever Mr. Roth may have had, it did not
constitute property within the meaning of that term in the ITA. In reaching that
conclusion, Bell J. emphasized that the know-how that Mr. Roth possessed was
not exclusive to him and that it had not been formalized into some marketable
form, in contrast to the know-how that was the subject matter of the sale to
Pac-Rim LNG Inc., Bechtel Enterprises International, Ltd., Phillips Petroleum
Canada Ltd. and Daewoo Corporation that occurred in 1997. In that regard,
counsel to Tri Pacific advised the Court that what had been sold in 1997 was
"Economic studies, models, engineering studies, models, expertise,
know-how".
[14]
Bell J. concluded
that the 1992 journal entry did not give Mr. Roth a legally enforceable right
to receive $371,726 from Tri Pacific because the purported transfer of property
that allegedly gave rise to the liability of Tri Pacific to pay that amount was
a legal nullity. He also held that the promissory note, which was initialed
but unexecuted, was unenforceable. In absence of a legally enforceable right
to repayment of a liability owing by Tri Pacific to Mr. Roth, Bell J. concluded
that the payment of $371,726 by Tri Pacific constituted a shareholder benefit
that validated the reassessment of Mr. Roth, pursuant to subsection 15(1) of
the ITA.
ANALYSIS AND DECISION
[15]
The appellants
contended that Mr. Justice Bell made several errors of law in his decision but
the main issue underlying their contentions was whether or not any property was
transferred by Mr. Roth to Tri Pacific. That issue was further refined when
counsel for the appellants conceded, at the hearing, that the initialed but
unexecuted promissory note was a legal nullity and that only know-how was the
subject of the alleged transfer. According to the appellant, Bell J. erred in
not finding that the 1992 journal entry had the effect of recognizing the
transfer of know-how by Mr. Roth to Tri Pacific and the legal obligation of Tri
Pacific to pay the amount of $371,726 as a consequence of such transfer.
[16]
In my view, Bell J.
was correct when he concluded that, for income tax purposes, Mr. Roth’s
"know-how" was not property that was capable of being transferred by
Mr. Roth or acquired by Tri Pacific and as a result, the liability portion of
the 1992 journal entry could not be treated as having created or established a
legally enforceable right on the part of Mr. Roth to be paid $371,726 as the
cost of property acquired by Tri Pacific.
[17]
The inevitable
results of these findings are:
a.
that Tri Pacific
could not claim a deduction of, or in respect of, the cost of any property
acquired from Mr. Roth, and therefore Bell J.’s decision to deny the $363,522
deduction that was claimed by Tri Pacific in computing income for its 1998
taxation year was correct; and
b.
that Mr. Roth could
not claim that the receipt of $371,726 from Tri Pacific in 1998 constituted the
repayment of a corresponding amount of indebtedness that was owed to him by Tri
Pacific, and therefore Bell J.’s decision to uphold the inclusion of $371,726
in the 1998 income of Mr. Roth, pursuant to subsection 15(1) of the ITA, was
correct.
[18]
The appellants also
advanced a number of other arguments, but none of those arguments need to be
addressed. Given the conclusion that Tri Pacific did not acquire any property
from Mr. Roth and did not become indebted to him, those additional arguments
must fail.
[19]
For these reasons, I
would dismiss both appeals with costs.
"C.
Michael Ryer"
"I
agree.
Marc
Noël, J.A."
"I
agree.
K.
Sharlow, J.A."
Email this Content