Reynolds Ltd. v. R., [1996] 2 CTC 261, 96 DTC 6312

DéCary J. (Stone and McDonald, J J. A., concurring): — These are appeals and cross-appeals from three judgments of the Trial Division dated 2 October 1994 which disposed of Canadian Reynolds Metals Company Limited — Société canadienne de métaux Reynolds Limitée (“Reynolds”)’s appeals instituted against three reassessments for income tax. The first one dated 7 July 1981, was in respect of its 1977 taxation year (Court File No. A-570-94), the second one, dated 9 March 1983, in respect of its 1979 taxation year (Court File No. A-562-94) and the third one, dated 21 February 1985, in respect of its 1980 taxation year (Court File No. A-563-94). The Trial Division disposed of the three appeals in the same set of reasons and we shall do the same. The reasons for judgment rendered in Court File No. A-562-94 shall constitute the reasons for judgment in Court Files Nos. A-563-94 and A-570-94 upon filing a copy hereof in those files.

In the judgments appealed from, Joyal J. overturned in part the Minister’s assessments of the income tax payable by Reynolds. The learned judge found that the cost of replacing the carbon cathode lining the steel pots used in the production of primary aluminium was a capital expenditure and not a current expense as determined by the Minister. He also found, this time against Reynolds, that the following chemicals, namely coke, pitch and anode paste, which constitute the carbon anode and which are used in the electrolytic production process, were not converted into property for sale in the ordinary course of business such that the respondent would be entitled to claim the inventory allowance provided in section 20(l)(gg) of the Income Tax Act, 1970-71-72, S.C., c. 63. That section read as follows at the relevant times:

Section 20(1 )(gg) - Inventory allowance. - an amount in respect of any business carried on by the taxpayer in the year, equal to that portion of 3% of the cost amount to the taxpayer, at the commencement of the year, of the tangible property (other than real property or an interest therein) that was

(i) described in the taxpayer’s inventory in respect of the business,and

(ii) held by him for sale or for the purposes of being processed, fabricated, manufactured, incorporated into, attached to, or otherwise converted into or used in the packaging of, property for sale in the ordinary course of the business

that the number of days in the year is of 365;

With respect to the capitalization issue, we did not need to call upon counsel for Reynolds. There is little to add to the thorough reasons of Mr. Justice Joyal. The distinction between current expenses and capital expenditures arises from the importance of accurately matching income with expenditures over a given finite accounting period. Essentially, expenditures which are expected to confer a benefit of enduring nature to the enterprise are capital in nature. Without resorting to a survey of the ample jurisprudence on this issue, we will borrow from the following oft-cited passage from Viscount Cave L.C. in British Insulated & Helsby Cables v. Atherton (sub nom. Helsby Cables Ltd. v. Atherton), [1926] A.C. 205, 10 Tax Cas. 155 (H.L.) at 213-14:

... when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital.

The characterization of expenditures as current or capital in nature has been complicated by the trend in caselaw to focus on the nature of the asset itself and whether or not it must be replaced on a recurring basis rather than on the benefit which the expenditure is intended to confer upon the enterprise. It is clear, however, that while the recurring nature of an expense may be a relevant factor in distinguishing between capital and current expenses, it is in no way decisive. On the other hand, it is also clear that an asset need not be of a perpetual nature in order to be classified as capital for the purposes of tax treatment (see Commissioner of Taxes v. Nchanga Consolidated Copper Mines Ltd. [1964] A.C. 948 (Rhodesia & Nyasaland) at page 960).

To turn to the case at bar, we are in agreement with the Trial Judge’s characterization of the expenditures related to the replacement of the linings (or cathodes). The expenditures in question are clearly for the purpose of ensuring the uninterrupted and efficient production of primary aluminium at the Reynolds’ Baie Comeau plant. The linings are fundamental to the electrolytic process used and are employed and maintained over several fiscal periods. In fact, due to advances in technology and the concerted efforts of Reynolds, the useful life of the linings increased from an initial 20 months at the plant’s outset, to a period of 4 to 5 years during the taxation years in question and to a period of 7 to 9 years at the time of trial. The record provided insight on the significant value of the linings to the company, as well as the importance of reducing the production costs of aluminium by undertaking measures to increase the longevity of the cathodes. In our opinion, the judge did not err in deciding, as a matter of law and fact, that the expenditures in question were properly characterized as capital assets of an enduring nature.

We reject the Minister’s contention that the replacement of faulty cathodes constitutes a mere repair to the cell. The Trial Judge found as a fact that “a complete reconstruction” of the cell’s contents was required over time. It is indisputable that a receptacle is necessary to contain the electrolytic process, but the process would be impossible without a cathode. The cathode, in both construction and function is much more than a mere “cell lining”, and the judge committed no overriding or palpable error in finding that the cell and the cathode were separate and distinguishable assets. Further, even if it could be said that the cell was the primary capital asset, the expenditures to replace the cathode would effectively restore the cell to new condition. Such expenses are capital in nature and constitute much more than quotidian repairs or periodic maintenance .

The appeals in Files Nos. A-562-94 and A-563-94 will therefore be dismissed.

With respect to the inventory issue, Reynolds argues, essentially, that the Trial Judge having found as a fact that

It appears to me that the basic chemical transformation which takes place is that the carbon anode releases electrons to the alumina and the oxygen ions in the alumina are transmitted to the carbon to form carbon dioxide. This transformation or decomposition is literally at the atomic level of change and according to the evidence, the electrons themselves become incorporated into the aluminium product. (at 30-31 of the reasons)

and that

the anode carbon provides electrons for the reduction of alumina and provides the end product aluminium. The evidence before the Court is that the typically shiny appearance of the metal reflects the optical properties of these electrons that give it such high electrical and thermal conductivity. [Page 33 of the reasons. I

he could not but have concluded that the anode carbon was traceable through its electrons in the end product and essential to the very existence of the end product, thereby qualifying for the inventory allowance as interpreted by Teitelbaum J. in the Mattabi Mines Ltd. v. Minister of National Revenue, [1989] 2 C.T.C. 94, (sub nom. R. v. Mattabi Mines Ltd.) 89 D.T.C. 5357 (F.C.T.D.); affirmed [1992] 2 C.T.C. 8, (sub nom. R. v. Mattabi Mines Ltd.) 92 D.T.C. 6252 (F.C.A.)). Reynolds also relies on the concessions made by the Minister before and at trial to the effect that alumina, cryolite and aluminium fluoride qualify as inventory, as well as on the concessions made by counsel on the appeal to the effect that electrons coming from the anode carbon ended up in the final product and that without these electrons there simply would not be aluminium at the end of the process.

We do not read these findings and concessions as meaning that the electrons which are released from the anode carbon keep the characteristics of the latter when they are captured by the aluminium ions to form the end product nor as implying that chemical processes at the electron level are contemplated by section 20(1 )(gg). We need only deal with that last implication, since the conclusion we reach with respect to it is decisive of the issue before us.

We simply cannot agree with so esoteric a construction as advanced by counsel that resorts to classifying substances at the electron level in order to give effect to the meaning of section 20(1 )(gg).

This Court, in endorsing the reasons of Teitelbaum J. in Mattabi, determined that for property to qualify for the inventory allowance under that section, it must be “actually part of the final product” (at 109 (D.T.C. 5368)). There is, in the wording used by Parliament, an obvious intent to remain within the realm of practicality. A purposive interpretation of the words “inventory”, “tangible property”, “be held”, “processed into”, “property for sale”, “ordinary course of business” [1] mandates that property capable of qualifying for the inventory allowance be at the very least tangible at the atomic level. The atoms are after all “the smallest particles in which the elements combine either with themselves, or with each other, and thus the smallest quantity of matter known to possess the properties of a particular element” [2] . Atoms themselves, constituted of protons, neutrons and electrons, and not electrons alone, define the properties and essential characteristics of a particular element or substance.

Where the “tangible property” at issue for the purposes of the application of section 20(1 )(gg) is the anode carbon and the final product is the aluminium, the section requires that it be the anode carbon itself, and not its subatomic components taken individually, that somehow finds its way into the aluminium at the end of the process. The evidence, as found by the Trial Judge, is that in the end anode carbon does not actually become part of the aluminium.

The concessions by the Minister were made in relation to property at the atomic level, not at the subatomic level. The subject goods all contained aluminium atoms. The Minister does not dispute that section 20(1 )(gg) can be applied to chemical processes and Interpretation Bulletin IT-435R, in force during the relevant period, merely acknowledges that chemical process is not to be excluded from the application of the section. It is one thing to say, as does section 17 of the Bulletin, that a chemical need not be “identifiable in the end product” to qualify; it is another one to say that a chemical which has lost its identity does qualify.

The appeal in Court File No. A-570-94 and the cross-appeals in Court Files Nos. A-562-94 and A-563-94 will therefore be dismissed.

Reynolds shall be entitled to one set of costs in Files Nos. A-562- 94 and A-563-94. The Minister shall be entitled to one set of costs in the appeal File No. A-570-94 together with the cross-appeals in Files Nos. A-562-94 and A-563-94. Any disbursements in any of the appeals or crossappeals shall also be awarded.

Appeals and cross-appeals dismissed.