Fording Coal Limited v. Her Majesty the Queen, [1995] 1 CTC 2734

Rowe D.J.T.C.C.:—The appellant appeals from assessments of income tax with respect to its taxation years 1985-90, inclusive. By an agreement dated December 2, 1985, Elco Mining Limited (Elco) purchased from Fording Coal Limited (Fording) an interest in the Fording River Coal Mine, which entitled Elco to take in kind and separately dispose of coal equivalent in value to its 0.001 per cent interest of each tonne of grade coal shipped from that mine. By agreement dated December 30, 1985, the appellant purchased from Elco all or substantially all of its "Canadian resource properties” (as defined in subsection 248(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63 (the "Act")), including a 50 per cent interest in a joint venture property, owned by Elco and certain other parties under an arrangement known as the "Elk River Coal Joint Venture”, together with Elco’s 0.001 per cent interest in the Fording River Coal Mine. Immediately before the appellant’s purchase of all or substantially all of Elco’s Canadian resource properties, Elco had accumulated a certain cumulative Canadian exploration expense (CCEE) and an amount of cumulative Canadian development expense (CCDE). The appellant and Elco jointly elected in accordance with subsections 66.1(4) and 66.2(3) of the Act (in effect for the 1985 taxation year) in respect of the appellant’s purchase of all or substantially all of Elco’s Canadian resource properties in that taxation year, with the result that the appellant became a "successor corporation" as defined in subsections 66.1(4) and 66.2(3) of the Act. The appellant filed its tax returns for each of its taxation years 1985—1990, inclusive, and in computing income claimed certain deductions as the successor corporation in respect of Elco’s CCEE (total of $7,277,134) and CCDE (total of $5,861,088) determined immediately before the purchase by the appellant of the Elco Canadian resource properties. However, by reassessments for the appellant’s 1985—1990 taxation years, inclusive, the respondent disallowed these CCEE and CCDE deductions. In each of its taxation years 1985 through 1990, the appellant had income from the production of minerals from the Fording River Coal Mine in amounts which exceeded the deductions claimed by the appellant as successor corporation to Elco in respect of CCEE and CCDE for those years. As a consequence, the appellant’s position is that it is entitled to the deductions as claimed on the basis that Elco had an interest in or a right to take or remove minerals from the Fording River Coal Mine immediately prior to the appellant’s purchase of all or substantially all of Elco’s Canadian resource properties. The respondent’s position is that subsections 66.1(4) and 66.2(3) of the Act should be applied to restrict the appellant’s deduction of the Elco Tax Pools to the production income from its interest in the Elk River Coal Joint Venture property. Further, the Minister of National Revenue (the "Minister”) regards the transactions of December 2, 1985 and December 30, 1985 as a tax avoidance scheme falling within the ambit of subsection 245(1) of the Act and that the deduction of CCEE and CCDE amounts acquired by the appellant from Elco would unduly or artificially reduce the appellant’s income as contemplated by that subsection. In the Minister’s view, the transactions of December 2, 1985 and December 30, 1985 were entered into by the appellant in order to circumvent the provisions of subsections 66.1(4) and 66.2(3) of the Act.

As filed, the appellant’s Notice of appeal dealt with various other issues which were resolved by the parties and, whether or not the appellant is successful on the remaining issue as above described, the appeal will be allowed to incorporate the matters agreed upon and counsel will draft a judgment accordingly. The relevant provisions of subsections 66.1(4) and 66.2(3) of the Act as in effect for the 1985 and 1986 taxation years and subsections 66.7(3) and 66.7(4) of the Act as in effect for the appellant’s 1987, 1988, 1989 and 1990 taxation years apply. Filed as Exhibit A-l was an agreed statement of facts and a book of exhibits was filed as Exhibit A-2. The agreed statement of facts is as follows:

For the purposes of this appeal, the parties admit the following facts but reserve the right to adduce evidence not inconsistent with these facts.

1. At all times material to this appeal:

(a) The appellant was a "taxable Canadian corporation" as defined in subsection 248(1) of the Income Tax Act having a taxation year ending on December 31, and

(b) Elco Mining Limited ("Elco") was a "taxable Canadian corporation" as defined in subsection 248(1) of the Act and dealt at "arm’s length" with the appellant as that phrase is used for the purposes of the Act.

Agreed Facts

2. Before 1985 and at all other times material to this appeal, the appellant owned and produced coal from the Fording River Coal Mine located in the Elk River area of British Columbia.

3. Before December 30, 1985, Elco held a 50 per cent joint venture interest in 42 coal leases (the "Elk River Joint Venture") located in close proximity to the Fording River Coal Mine. The remaining 50 per cent interest was held by parties dealing at arm’s length with the appellant and Elco.

4. In June 1985 negotiations commenced between the appellant and Elco with regard to the acquisition by the appellant of Elco’s interest in the Elk River Joint Venture. These negotiations continued throughout the fall of 1985.

5. By agreement dated December 2, 1985 (the "Fording royalty agreement"), Elco, for $10,000, purchased a 0.001 per cent interest in the Fording River Coal Mine. The Fording royalty agreement provided, inter alia, that:

(a) Elco was assigned a 0.001 per cent interest on each tonne of grade coal mined, shipped and marketed from the Fording River Coal Mine.

(b) Elco was entitled to take in kind and separately dispose of coal equivalent in value to its 0.001 per cent interest.

(c) Elco granted to the appellant the irrevocable option to repurchase at any time the 0.001 per cent interest at an amount equivalent to its value at the time of repurchase.

6. By agreement dated December 30, 1985, the appellant purchased from Elco all or substantially all of its "Canadian resource property" (as defined in subsection 248(1) of the Act, including:

(a) its 50 per cent interest in the Elk River Coal Joint Venture property;

and

(b) its 0.001 per cent interest in the Fording River Coal Mine.

One condition precedent to the closing of the December 30, 1985 agreement was that the appellant be reasonably satisfied that Elco had CCEE and CCDE in the approximately amount of $14,000,000 and an earned depletion base ("EDB") of $3,300,000.

7. The income received by Elco under the Fording royalty agreement was $116.49 for the period December 2, 1985 to December 30, 1985.

8. The amount of Elco’s cumulative Canadian exploration expense ("CCEE") (as defined in paragraph 66.1(6)(b) of the Act) determined immediately after the appellant’s purchase of all or substantially all of Elco’s Canadian resource property was $7,277,134, no part of which had been deducted by Elco in computing its income for any taxation year or designated by Elco pursuant to subsection 66(14.1) of the Act for any taxation year.

9. The amount of Elco’s cumulative Canadian development expense ("CCDE") (as defined in paragraph 66.2(5)(b) of the Act) determined immediately after the appellant’s purchase of all or substantially all of Elco’s Canadian resource property was $6,642,581, no part of which had been deducted by Elco in computing its income for any taxation year or designated by Elco pursuant to subsection 66(14.2) of the Act for any taxation year.

10. The appellant and Elco jointly elected in accordance with subsections 66.1(4) and 66.2(3) of the Act (as in effect for the 1985 taxation year) in respect of the appellant’s purchase of all or substantially all of Elco’s Canadian resource property on December 30, 1985.

11. In each of its taxation years 1985 through 1990, the appellant had income from the production of minerals from the Fording River Coal Mine in amounts which exceeded the deductions claimed by the appellant as successor corporation to Elco in respect of Elco’s CCEE and CCDE for those years.

12. There was no production income to Elco from its interest in the Elk River Coal Joint Venture prior to December 30, 1985.

13. There was no production income to the appellant from its interest in the Elk River Coal] Joint Venture for any of the taxation years under appeal.

B. Appellant's Tax Returns and Assessments

14. The appellant filed its tax returns pursuant to paragraph 150( 1 )(a) of the Act for each of its taxation years 1985 through 1990, and in computing its income claimed the following deductions as the successor corporation in respect of Elco’s CCEE and CCDE determined immediately after the purchase by the appellant of all or substantially all of Elco’s Canadian resource property:

	CCEE	CCDE
1985	$7,277,134,00
1985		$1,992,774.00
1986		1,394,942.00
1987		976,460.00
1988		683,522.00
1989		478,465.00
1990		334.925.00
	$7.277.134.00	$5.861.088.00

so that at the end of the appellant’s 1990 taxation year there remained no CCEE and CCDE of $781,493.

15. By reassessments for the 1985, 1986, 1987, 1988, 1989 and 1990 taxation years, the respondent disallowed these CCEE and CCDE deductions.

George Bingleman testified he resides in Calgary, Alberta and is the vice-president, finance, of Fording and has been employed with the appellant for 16 years. He referred to a map (Exhibit A-3) in which the Fording mining property is shown as 493 MTCC and the Elco property as 175 MTCC. The Elco property was operated as a joint venture with Elco owning 50 per cent, Stelco 25 per cent and Home Oil and Scurry-Rainbow together owning the remaining 25 per cent. In June 1985, Mr. Claus Siebel, of Dusseldorf, Germany, on behalf of certain European investors, contacted Fording to see if it was interested in acquiring the Elco stake in the Elk River joint venture property. Elco had a certain contractual arrangement with Morrison-Knudsen Company Inc. (M-K), a construction company, whereby M-K had the right to provide certain planning, design, engineering and construction services on the development of the property. Mr. Bingleman stated that Fording regarded the Elco property as a good prospect and was concerned some other interested parties may acquire it and might not operate it properly during a period of low prices for coal, thereby having a potential effect on Fording which operated a coal mine on the adjacent property. The thinking at Fording was that the Elco property could be opened up before 1995. By paying the sum of $225,000, Fording purchased the 25 per cent interest in the joint venture owned by Stelco but Home Oil and Scurry-Rainbow chose to retain the 25 per cent share which they owned jointly. Pursuant to an agreement between Fording and Elco, dated December 2, 1985, Fording sold to Elco a 0.001 per cent interest in the Fording River Coal Mine. The agreement contained an option in favour of Fording whereby it could reacquire that interest, and Fording had always intended that option be exercised, which occurred on December 30, 1985. Mr. Bingleman stated that Fording spent in excess of $500,000 in carrying costs on the Elco property in addition to its purchase of the Stelco share of the joint venture.

In cross-examination, Mr. Bingleman stated there was no discussion at the outset of any tax pools available to Elco. The property, described as 493 MTCC on Exhibit A-3, had reserves sufficient for 50 years but the German investors apparently believed there were other world suppliers of coal capable of satisfying the needs of the German steel industry and for that reason decided to sell their interest, through Elco, in the Elk River Joint Venture. At Tab 2 of Exhibit A-2, Bingleman agreed that a Fording internal memo, dated September 17, 1985, set forth as one of the conditions of acquisition of Elco’s interest the availability, to Fording, of Elco’s tax pools. In order to accomplish that purchase, Fording wanted to sell Elco a 0.001 per cent interest in the Fording River Coal Mine. As to what Fording would have done had Elco not agreed to purchase the 0.001 per cent royalty interest in the manner carried out by agreements of December 2 and December 30, 1985, Mr. Bingleman stated, "We probably would have purchased it (the joint venture interest) anyway". Mr. Bingleman agreed the transfer of Elco tax pools was an item introduced by Fording into negotiations. Tax advice was obtained from Price Waterhouse (tab 6 of Exhibit A-2) on the subject of the ability of Fording to immediately write off CCEE, as a successor corporation to Elco. Although the advice made mention of an advance ruling from Revenue Canada, that was not pursued by Fording. On October 2, 1985, Fording paid to Elco the sum of $50,000 by way of a non-refundable payment to demonstrate good faith, which sum Elco could retain if negotiations were unsuccessful. M-K had a right to a reversionary interest in the event Fording did not develop the property within ten years and Mr. Bingleman stated Fording has done a feasibility study on plant design and costing of the project. Fording was able to negotiate with M-K some of the more onerous provisions which it inherited from Elco, such as a minimum non-production royalty and the right to undertake construction without tender. Fording, in existence since 1968, had no specific date in mind for opening a mine on the Elk River property. Mr. Bingleman agreed the amount of $116.49 was earned by Elco for its 0.001 per cent royalty interest in the Fording River Coal Mine, for the period December 2—30, 1985. The agreement of December 2, 1985 whereby Elco acquired such interest, contained an irrevocable option in favour of Fording to reacquire that royalty interest, and on December 30, 1985 it did so, paying Elco the sum of $10,000. At tab 17 of Exhibit A-2, Mr. Bingleman identified the agreement dated December 30, 1985 between Elco and Fording, covering the purchase by Fording of Elco’s 50 per cent interest in the Elk River Joint Venture and the 0.001 per cent interest Elco held in Fording River Coal Mine. Elco agreed to sign a joint election to be sent to Revenue Canada. At paragraph 11.01 on page 20 of the asset purchase agreement, Fording wanted to be satisfied that Elco had CCDE and CCEE in the approximate aggregate amount of $14,000,000. Elco also was granted a vendor’s royalty interest from actual production when that property came on stream. The other joint venturers waived the right to exercise first refusal with respect to Elco’s 50 per cent interest. Fording paid to Elco the sum of $10,000 together with other consideration as set forth in paragraph 4.01 on page 11 of the agreement found at tab 17 of Exhibit A-2. Mr. Bingelman agreed that Fording had been appointed agent by Elco to dispose of its share of the coal, 1.e., .001 per cent of production from the Fording River Coal mine for the period December 2 to December 30, 1985.

In re-examination, Mr. Bingleman stated that although Fording has 50 years reserve on its existing property the current plant is near capacity. As a result, there is an alternative to expanding the current facility to twice its present size by building a new plant, at an estimated cost of nearly one-half billion dollars, on the former Elco property. In 1996, without more, the Fording interest in the Elk River property will revert to M-K. The view at Fording is that a price of $80 per ton is required to make the expansion viable and the current price is only $60.

In re-cross-examination, Mr. Bingleman was shown a draft letter to Revenue Canada, dated October 21, 1985, (Exhibit A-4) requesting an advance income tax ruling in respect to the transaction which is the subject of this appeal, but he stated the letter was never sent as Fording chose to proceed with the Elco deal despite the absence of any written advance ruling.

Counsel for the appellant read in the following from the examination for discovery of Stanton Lawless:

Q. Mr. Mitchell: Mr. Lawless, you’re an officer of the Crown in the right of Canada, is that correct?

A. Yes, as I understand.

Q. Mr. Softley:The Crown thinks it’s an Income Tax Act by the Crown’s interpretation of the Act. Again, in my submission, it’s a question of law, not a question of fact.

Mr. Mitchell: We’ll, now, move onto the seeding transactions.

Q. Can I refer you to paragraph 11 of the notice of appeal and paragraph 4 of the reply. I think we’re in agreement and we agree, do we not, that the appellant acquired all or substantially all of Elco’s Canadian resource property on December 30, 1985?

A. Yes, that’s correct.

Q. Okay. Would you turn to paragraph 13 of the appeal and paragraph 5 of the reply. As I read what you’re saying in the reply; that you admit that the appellant and Elco made joint elections, but you deny the result. Do you contest the fact that Fording, or the appellant, became a successor corporation? I’m just trying to narrow down here what you’re denying. Maybe your counsel can answer that.

Mr. Softley: What we’re denying is that within the proper interpretations from our perspective of 66.1(4) and 66.2(4) Fording became a successor corporation so as to be able to utilize the tax pool. Again, an interpretation of law to these facts.

Mr. Mitchell: I’m just trying to narrow down in the pleadings. Are you denying it became a successor corporation or are you denying it could utilize the pools?

Mr. Softley: Both are part and parcel with the issue as to the scope of the application of 66.1 and 66.2.

Mr. Mitchell: Okay. So you’re denying that the appellant became a successor corporation-

Mr. Softley: Yes.

Mr. Mitchell: That’s all I wanted to know.

Q. Am I correct in saying, or does the Crown agree that the resource pools were properly passed from Elco to Fording? Now, let me ask the question and let me follow-up the question. I’m asking here, were the resource pools passed, and I believe that we agreed that the resource pools passed. You may be of the view that they were streamed, and I think we all know what I mean by streamed, but did they pass, that’s the question I would like to get an answer to.

A. Yes, I understand that they did. Yes.

Q. Okay. Do you agree, and I would ask you to turn to paragraph 12 of the notice of appeal. In paragraph 12 it talks about Elco’s cumulative CEE and Elco’s cumulative CDE. Do they agree those pools represent moneys actually spent by Elco for the appropriate purposes?

A. Yes.

Q. Okay. And I take it that the Crown is not taking the position that there was anything artificial or undue with respect to those pool balances in Elco’s hands?

Mr. Softley: If I may, "artificial" and "undue". One wonders what you mean by those words. I think in fairness to the witness that ought to be clarified. I can certainly, on behalf of the Crown, subject to Mr. Lawless adding something if he wants to adopt what I say, say to you that we’re not contesting that the amounts in the pools are inaccurate or improper in the sense that they were validly incurred.

Q. Mr. Mitchell: That’s where I was getting and that’s what I want to know, we agree that Elco expended the amounts said on the pools. We’re not talking about the numbers, we are not quarreling with the fact that Elco expended it; is that right?

A. That’s right.

Q. That’s right. And we agree that if the amounts had remained in Elco and Elco had income, Elco could have deducted the appropriate amounts against that income from those pools?

A. Yes.

Q. Mr. Mitchell: We agree that on December 30, 1985 the appellant bought all or substantially all of the resource properties of Elco; we agree with that? Do you agree with that?

A. Yes, I do.

Q. Okay. And part of what they bought was the 0.001 per cent overriding royalty that Elco had previously bought from Fording; is that correct?

A. Yes, that is.

Q. So part of the properties that they bought when they bought all or substantially all of the property included that 0.001 per cent overriding royalty; is that correct?

A. Yes, I understand that’s in the agreement.

Q. Now, does the Crown dispute in this that the overriding purpose in this transaction was the acquisition by Fording of the Elco property? And what I’m getting at here, just to clarify my question is, as you appreciate, the Appellant takes the position that there was a business reason for acquiring the Elco property entirely apart from the seeding transaction. Does Revenue Canada agree with that fact or do they disagree with those facts?

A. Yes, we agree with that that there was a business purpose in purchasing the property.

Q. You may not wish to answer this one, but in paragraphs 9, 4 and 13 of the reply, you refer to certain judicial antiavoidance rules, judicial doctrines, or judicial antiavoidance rules. Now, what I would ask is, what rules are you relying on? What judicial doctrines and what-there’s the words "relevant judicial doctrines." I’m not asking you to interpret the law, what law are you relying on in you saying there was no reasonable expectation of profit in-what is the certain buzz word?

Mr. Softley: Again, as it’s inquiring with respect to, in my submission, either the framing of the legal issues. And I would advise the wimess not to answer. I leave it to you whether or not you want to go off the record. We can-

Mr. Mitchell: No, I’ll ask it on the record. Let’s be clear what I’m asking. I believe I’m entitled to know the basis of fact in law upon which your assessment was predicated. If you are refusing to answer me the basis of law which the law was predicated, that’s fine, I can’t go further at this point, but I would like to know that that’s what was being refused to me.

Mr. Softley: What’s being refused is to answer that question that you asked.

Q. Mr. Mitchell: Okay. Then, what was the basis of law on which the assessment was predicated relating to the judicial-what’s the buzz word they use? Judicial doctrines?

A. Is that not the same question?

Q. Well, I’m asking the question that way and if you’re refusing it, then that’s fine.

Mr. Softley: I would advise the witness not to answer.

Q. Mr. Mitchell: Okay. We are not able to obtain in this discovery a detail of the basis of judicial doctrines which you’re relying to and on which the assessment is based; is that correct?

Mr. Softley: That’s your conclusion and editorial comment. I don’t know if that’s the question.

Mr. Mitchell: Okay. Now, you are relying on subsection 245(l)-old 245(1); is that correct?

A. Yes, that is included in our-

Q. When going to old subsection 245(1) it refers to a deduction. Now, what is the deduction that is being disallowed in this case?

A. I understand the deduction is the CEE pool and the CDE pool of the predecessor,

Q. Is it the pool or is it our utilization of the pools? Let’s go off the record for a minute.

(Discussion off the record)

Q. Mr. Mitchell: Is the deduction you’re referring to the portion of the CEE and CDE pools that Fording claimed?

A. Yes.

Q. Okay. Now, what is the disbursement or expense that, as I read this, "No deduction may be made in respect of a disbursement or expense." Now, what is the disbursement or expense that you’re referring to here?

A. I understand the disbursement and expense would be the acquisition of the pools from Elco.

Q. I have here a memorandum dated February 11. It’s from you to head office, Jim Pearson, and I’ve marked a page here. It says here-

Mr. Softley: Perhaps we could get our own copy out so we can follow along.

Mr. Mitchell: It’s on page 8. It’s February 11, and it’s a memorandum from Mr. Lawless to Jim Pearson. With the attention to Mr. Kirby and it’s on page 8.

Q. And about a third of the way down the page it says,

The disbursement or expense in respect of the transaction is the acquisi- tion of the assets and attached resource pools of Elco.

Would you agree that that’s the case?

A. Yes, and also included in the next paragraph, I believe, is also-the deduction of the pools themselves in the next paragraph on that page.

Q. Well, we can go back. We can deal with those paragraphs separately because I think one deals with what is the disbursement or expense and that’s my question now, and then the next question is, what’s the deduction of the disbursement or expense? And it’s the Crown’s position that the disbursement or expense is the acquisition of the assets and resource pools of Elco; is that correct?

A. Yes, I agree that’s what is stated there. Yes.

Q. So the disbursement or expense would be the amount that was paid to acquire those resource pools, is that correct?

A. I would have to clarify that.

Q. Let me tell you where I’m having trouble. It seems to me that a disbursement or expense is an outlay, and what I’m trying to find out here is what is the outlay that you’re saying is the disbursement or expense. And it can be a number of things? Can it be the amount that Elco originally spent on properties?

A. Right.

Q. I take it from this that what you’re saying the disbursement or expense is, is the acquisition price that was paid to acquire that from Elco, and I’m just trying to clarify what you’re saying it is.

A. I believe it would be the acquisition cost to acquire from Elco and also include the cost incurred by Elco in incurring the expense, although it doesn’t say that in that specific paragraph.

Q. No, I’m not binding you to this, I’m just trying to find out for this Discovery what we’re talking about, what facts you’re talking about when you say-

A. Yes.

Q. -what is the disbursement or expense? Now, are you saying it was the amount expended by Elco? It was the amount that Fording spent to acquire the pools from Elco or are you saying it’s either or both? I’m just-may be-

A. I would say it’s probably both.

Q. Both the amount that Elco spent and the amount that was spent?

A. Yes.

Q. And so going on to the next paragraph, I’ll read the next paragraph:

The deduction in respect of the disbursement or expense is the deduction by Fording of the resource pools of Elco.

So what we’re saying is the deduction that we’re talking about is not the acquisition cost of those pools, it’s the deduction of the appropriate amount-that you would say inappropriate amount, but the amount in question of those pools by Fording; is that correct?

A. Yes.

Q. All right.

A. There was a subsequent position paper on this issue, I believe, in 1990. I would have to refer to it to see if our position was the same in that—on both these issues. This is a preliminary position paper.

Mr. Mitchell: Can we take a moment here because I think we have that document here.

(Brief Adjournment)

Q. Mr. Mitchell: So if I believe the department’s position on this is, the disbursements or expense that we’re talking about could be either (A) The amount that Elco actually spent on the property historically; (B) The amount that Fording paid to Elco in the transaction to acquire the pools; or (C) The claiming of those pools by Fording against its income. Is that a fair characterization that Revenue says it could be all three of those?

A. Yes, I agree with that.

Q. Okay. And we’re agreed, are we not, that the actual expenses and disbursements that were made to build up the pools were made by Elco; is that correct?

A. Yes.

Q. And we’re agreed that they were made long before this transaction occurred; is that correct?

A. Yes.

Counsel for the respondent read in the following from the examination for discovery of George Bingleman:

Q. Mr. Softley: Mr. Bingleman, would you advise me, please, as to your present position with Fording Coal Limited?

A. I’m the vice-president of finance.

Q. And for how long have you been the vice-president for finance?

A. I would think about 15 years, 16 years.

Q. Could you briefly describe for me the scope of your duties in that position?

A. I’m responsible for the accounting and financial affairs of Fording including taxation and risk management to the extent that these actions, particularly in the areas of financing, require approval of our board.

Q. And I take it that you are familiar with the tax returns that were filed by Fording Coal Limited for the 1985 through the 1990 taxation years and, in particular, claims made with respect to the deductions for the so-called tax pools acquired from Elco Mining Limited?

A. I’m aware of that, yes.

Q. During those years in question, did you have primary responsibility for the gathering of information and submission of information on Fording’s tax returns?

A. No.

Q. Who had that responsibility?

A. Mr. Ron Lepla.

Q. And as I understand it, Mr. Lepla unfortunately passed away very recently?

A. That’s correct.

Q. However, in preparation for this examination for discovery, you would agree with me that you had a duty to inform yourself as best you can with respect to issues involved in these appeals?

A. Yes.

Q. And you’ve reviewed the relevant files in preparing yourself for this examination?

A. I hope so.

Q. And you’ve informed yourself by discussions with those individuals within the Fording Coal Limited organization that you felt you needed to talk to to prepare yourself for this examination?

A. I believe I am prepared.

Q. Okay. With respect to your relationship to these issues prior to Mr. Lepla’s passing away, would he have been reporting to you regularly with respect to these affairs that are in issue in this appeal?

A. Periodically, he reported to me, yes.

Mr. Softley: And I take it, Mr. Mitchell, that Mr. Bingleman is tendered today as a proper officer to be examined for discovery on behalf of Fording Coal Limited?

Mr. Mitchell: That is correct.

Mr. Softley: That would be examined for discovery with respect to Tax Court of Canada Action No. 93-1707(IT)?

Mr. Mitchell: That is correct.

Q. Mr. Softley: Is it agreed, Mr. Bingleman. That your answers will be binding on the appellant, Fording Coal Limited, save all just exceptions under the Rules of Court?

Mr. Mitchell: Yes.

A. Yes.

Q. But in terms of, to use your word, Fording’s objective at that time, it was to proceed in a manner whereby the tax pools were acquired so that it could be written off against current production income?

A. That’s right.

Q. And if at that time in terms of the negotiating position of Fording, Elco were to have said no, we will not do that, would that have ended the matter?

A. No, probably not,

Q. Again when you say probably, I take it you don’t specifically know whether it would have ended the matter?

A. No one knows. We only get to live it once. That’s a speculation.

Mr. Softley: We’ll mark that and then talk about it a little bit, please.

Exhibit R-10: Memo of October 8, 1985 from Mr. Gardiner to the Fording file

Q. Mr. Softley:Mr. Bingleman, if I can refer you to the memo that appears to be analysis to a degree of the potential production from the Elk River Coal Project interest that you would have been acquiring from Elco, and if you look at the top of the second page, the second paragraph, it indicates that 10 years seems a possible time frame for the project to be viable and we should try to get this amendment leaving clause 7.3 intact. I take it as reflected in this memorandum, it was the view of Fording at this time, in any event, that you probably wouldn’t be producing from the Elco property for at least 10 years?

A. No, I don’t think that’s what it says. I think it says that we would be producing within ten years.

Q. When at this point in time did Fording anticipate if it had any anticipation as to when you would bring this property on production?

A. I’m sorry, would you ask that question again, please?

Q. I’m sorry. I’m, in effect, asking the question following your comment that you interpret the memorandum to say that you would be producing within 10 years.

A. Yes.

Q. My question is then, is there some time frame in less than ten years that Fording anticipated that it would be producing?

A. Understanding the situation that it would require something in the order of three years, perhaps in that magnitude to bring a mine to production, I guess I would have to say that perhaps it was in five years away, might have been our thought at the time before we would start construction, development, whatever.

Q. Was it a decision that was in place at this time that you would start production five years as opposed to ten, as opposed to 15 years from now?

A. There was no decision in place. It was a possibility. Certainly it’s not possible to make decisions in advance very wisely, so the decision, if it were taken, would have to be based on the economics at that time.

Q. And certainly the economics at that time as I would understand it, indicate to you that you would not make a plan right then and there to bring it on production immediately?

A. Well, I think the first objective was to acquire the land. So we were not planning to open a mine before we acquired the land.

Q. And in acquiring the lands, you had no specific idea as to when you would open a mine, is that a fair comment?

A. That’s a fair comment.

The submissions of counsel for the appellant are summarized as follows:

The appellant at all material times owned and operated the Fording River Coal Mine located in the Elk River area of British Columbia. In the same vicinity, Elco, together with Home Oil and Stelco, owned 42 coal leases under an arrangement known as the Elk River Coal Joint Venture. Prior to December 30, 1985, Elco had made or incurred certain disbursements or expenses with respect to the Elk River Coal Joint Venture which qualified as Canadian cumulative expenses (CEE) or Canadian development expenses (CDE) as defined by paragraphs 66.1(6)(a) and 66.2(5)(a) respectively of the Act. Pursuant to the provisions of sections 66.1 and 66.2 of the Act, the scheme is such that the disbursements and expenses become one factor in arriving at a balance of cumulative accounts, (referred to as "pools”), called cumulative Canadian exploration expenses (CCEE) and cumulative Canadian development expense (CCDE). Thus, a taxpayer does not deduct disbursements or expenses made or incurred with respect to costs that qualify as CEE or CDE but those amounts form one component of pools known as CCDE and CCEE and the taxpayer’s deduction is then based on the formulae set forth in subsections 66.1(2) and 66.2(2) of the Act, one component of which in each case is the balance of its CCEE and CCDE pools at year end. The acquisition by the appellant of Elco’s interest in the joint venture property was carried out for the purpose of acquiring the mining properties of Elco and, although it was aware that certain resource pools would pass to it as a result of the structure of the overall agreement, that aspect was merely an adjunct to the underlying business transaction. The agreement of December 2, 1985 whereby Elco purchased a 0.001 per cent interest in the Fording River Coal Mine and a right to take in kind and separately dispose of coal therefrom, meant that on December 30, 1985 Elco owned a 50 per cent interest in the Elk River Coal Joint Venture and an interest in and a right to take and remove coal from the Fording River Coal Mine. By agreement dated December 30, 1985, Fording purchased all or substantially all of Elco’s Canadian resource property, as defined by subsection 248(1) of the Act. Elco and the appellant jointly elected in accordance with subsections 66.1(4) and 66.2(3) of the Act in respect of the appellant’s purchase of all or substantially all of Elco’s Canadian resource properties in that taxation year. The result flowing from the transaction was that amounts that were Elco’s CCEE and CCDE prior to the appellant’s acquisition, formed separate pools of potential deductions available to the appellant pursuant to the specific provisions of subsections 66.1(4) and 66.2(3) of the Act. The appellant, upon completing the purchase and filing the election, became a ’’successor corporation" with respect to the CCDE and CCEE pools of Elco, which Elco could no longer claim. Fording then proceeded to claim deductions based on the complex mathematical calculations required under the relevant provisions of the Act. It is an agreed fact that in each of the years 1985 through 1990, the appellant had income from the production of minerals from the Fording River Coal Mine in amounts which exceeded the deductions claimed by the appellant as successor corporation to Elco in respect of Elco’s CCEE and CCDE. Counsel for the appellant made no bones about the fact the sale to Elco and reacquisition of the 0.001 per cent interest in the Fording River Coal Mine had no business purpose whatsoever other than for tax purposes. However, that manoeuvre, referred to as the "seeding transaction" did not disqualify the appellant to the deductions as claimed. From the appellant’s point of view, compliance with the strict, detailed and complex provisions of the relevant provisions of the Act dictate the tax consequences and there is no reason for the Minister to have disallowed them by his reassessments. As for the provisions of subsection 245(1) of the Act, there has been no artificial or undue reduction of income. Also, the deduction of a reserve or a permitted portion of a prescribed pool does not constitute the making or incurring of a disbursement or expense, which disbursement or expense was made by Elco, not Fording. As for the "object and spirit" test of legislation, counsel for the appellant submitted it is not to be used as a means of ignoring the specific wording of the Act.

Counsel for the respondent submitted that subsections 66.1(4) and 66.2(3) of the Act do not contemplate giving effect to a transaction, such as that entered into by the appellant on December 2, 1985, to "seed" a nominal interest in a producing property of a successor corporation to a predecessor corporation in order that the successor corporation can subsequently reacquire that interest and utilize unused resource deductions against all of the income from the successor’s property to which that interest, now inherited from the predecessor, relates. Clearly, that effect is not in keeping with the object and spirit of the provisions and the appellant is entitled only to deductions of CCDE and CCEE to the extent of any production income derived from the Elk River Coal Joint Venture property (which was nonproducing) and cannot claim those deductions as against all production income derived from the Fording River Coal Mine, by virtue of its sale and reacquisition of the 0.001 per cent interest in said property. Counsel for the respondent submitted the transaction was one clearly undertaken for the purpose of tax avoidance and not only violated the object and spirit of the relevant provisions of the Act but did so in a way that ran counter to the wording of subsection 245(1) of the Act. The deductions, even if they did not run afoul of the object and spirit of the legislation, would unduly or artificially reduce the appellant’s income. The particular "seeding transaction" had no purpose other than to avoid taxes and had no connection with commercial reality and therefore the Minister was correct in disallowing the CCEE and CCDE for the years under appeal.

The first issue to be decided is whether the provisions of subsections 66.1(4) and 66.2(3) of the Act, as those subsections applied to the appellant’s 1985 and 1986 taxation years, and subsections 66.7(3) and 66.7(4), as applicable to the appellant’s 1987-1990, inclusive, taxation years permit, or does any other provision or principle of the laws of Canada preclude, the deduction by the appellant of the CCDE and CCEE in the amounts claimed forming part of Elco’s tax pools. The effect of subsections 66.7(3) and 66.7(4) was to "grandfather" the previous rules as it would affect the appellant. Therefore, the provisions of subsections 66.1(4) and 66.2(3) of the Act, set out below, are adequate for this analysis.

66.1 (4) Successor corporation’s Canadian exploration expense.-Where a corporation (in this subsection referred to as the "successor corporation") has, at any time after May 6, 1974, acquired, by purchase or otherwise (including an acquisition as a result of an amalgamation described in section 87), from another person (in this subsection referred to as the "predecessor") all or substantially all of the property of the predecessor used by him in carrying on in Canada such of the businesses described in any of subparagraphs 66(15)(h)(i) to

(vii) as were carried on by him, and (except in the case of an amalgamation or a winding-up) the predecessor and the successor corporation have jointly elected in prescribed form on or before the day that is the earlier of the days on or before which either taxpayer making the election is required to file a return of income pursuant to section 150 for the taxation year in which the transaction to which the election relates occurred, there may be deducted by the successor corporation in computing its income under this Part for a taxation year, such amount as it may claim not exceeding the lesser of

(a) the cumulative Canadian exploration expense of the predecessor, determined at the time immediately after the property so acquired was acquired by the successor corporation, to the extent that it has not been deducted by the successor corporation in computing its income for a previous taxation year and has not been deducted by the predecessor in computing his income for any taxation year; and

(b) the amount that is equal to such part of its income for the year, if no deduction were allowed under this section, section 65 or 66 of the Income Tax Application Rules, 1971 in respect of this paragraph (minus the deductions allowed for the year by subsections (5) and (66(2), (6) and (7), sections 112 and 113 and the provisions of the Income Tax Application Rules, 1971 allowing a deduction for the purposes of this paragraph), as may reasonably be regarded as attributable to

(i) the disposition of any property described in any of subparagraphs 66(15)(c)(i) to (vii) owned by the predecessor immediately before the acquisition by the successor corporation of the property so acquired,

(ii) the production of petroleum or natural gas from wells, or the production of minerals from mines, situated on property in Canada in respect of which the predecessor had, immediately before the acquisition by the successor corporation of the property so acquired, an interest or a right to take or remove petroleum or natural gas or a right to take or remove minerals, and

(iii) the amount, if any, by which the aggregate of all amounts each of which is an amount

(A) required by subsection 59(2) or (2.1) to be included in computing its income for the year, and

(B) in respect of a reserve deducted in computing the predecessor’s income and deemed by paragraph 87(2)(g) or by virtue of that paragraph and paragraph 88(l)(e.2) to have been deducted by the successor corporation as a reserve in computing its income for a preceding year

exceeds the aggregate of amounts, if any, deducted in computing the successor corporation’s income for the year by virtue of subsection 64(1), (1.1) or (1.2) in respect of dispositions of property by the predecessor;

and, in respect of any expense included in the cumulative Canadian exploration expense referred to in paragraph (a), no deduction may be made under this section by the predecessor in computing his income for a taxation year subsequent to his taxation year in which the property so acquired was acquired by the successor corporation.

66.2(3) Successor corporation’s Canadian development expense.-Where a corporation (in this subsection referred to as the "successor corporation") has, at any time after May 6, 1974, acquired, by purchase or otherwise (including an acquisition as a result of an amalgamation described in section 87), from another person (in this subsection referred to as the "predecessor") all or substantially all of the property of the predecessor used by him in carrying on in Canada such of the businesses described in any of subparagraphs 66( 15)(h)(i) to

(vii) as were carried on by him, and (except in the case of an amalgamation or a winding-up) the predecessor and the successor corporation have jointly elected in prescribed form on or before the day that is the earlier of the days on or before which either taxpayer making the election is required to file a return of income pursuant to section 150 for the taxation year in which the transaction to which the election relates occurred, there may be deducted by the successor corporation in computing its income under this Part for a taxation year, such amount as it may claim not exceeding the lesser of

(a) 30 per cent of the amount by which

(i) the cumulative Canadian development expense of the predecessor, determined at the time immediately after the property so acquired was acquired by the successor corporation, to the extent it has not been deducted by the predecessor in computing his income for any taxation year and has not been deducted by the successor corporation in computing its income for a preceding taxation year,

exceeds

(ii) the aggregate of all amounts each of which is an amount that became receivable by the successor corporation in the taxation year or in a preceding taxation year, that is required to be included in the amount determined under clause 66.2(5)(b)(v)(A) by virtue of subsection 59(1.1) or paragraph 59(3. l)(a) and that may reasonably be regarded as attributable to the disposition by the successor corporation of any property owned by the predecessor immediately before the acquisition thereof by the successor corporation, and

(b) the amount that is equal to such part of its income for the year, if no deduction were allowed under this section, section 65, 66 of 66.1 or the Income Tax Application Rules, 1971 in respect of this paragraph (minus the deductions allowed for the year by subsection (4) and sections 112 and 113), as may reasonably be regarded as attributable to

(i) the production of petroleum or natural gas from gas wells, or the production of minerals from mines, situated on property in Canada in respect of which the predecessor had, immediately before the acquisition by the successor corporation of the property so acquired, an interest or a right to take or remove petroleum or natural gas or a right to take or remove minerals, and

(ii) the amount, if any, by which the aggregate of all amounts each of which is an amount

(A) required by subsection 59(2) or (2.1) to be included in computing its income for the year, and

(B) in respect of a reserve deducted in computing the predecessor’s income and deemed by paragraph 87(2)(g) or by virtue of that paragraph and paragraph 88(l)(e.2) to have been deducted by the successor corporation as a reserve in computing its income for a preceding year,

exceeds the aggregate of amounts, if any, deducted in computing the successor corporation’s income for the year by virtue of subsection 64(1), (1.1) or (1.2) in respect of dispositions of property by the predecessor;

and, in respect of any expense included in the cumulative Canadian development expense referred to in subparagraph (a)(i), no deduction may be made under this section by the predecessor in computing his income for a taxation year subsequent to his taxation year in which the property so acquired was acquired by the successor corporation.

The history of the successor rules (capitalized for effect) is that, prior to 1955, a corporation which sold all of its property may have accumulated large amounts of undeducted drilling and exploration expenses while not producing any income against which the expenses could be deducted. A purchaser of that property could not deduct the expenses because it had not incurred them. The concept of the successor rules was to enable a successor corporation that acquired all or substantially all of the Canadian resource properties of a predecessor corporation to access that predecessor’s unused resource pool deductions, including the CCEE and CCDE, and to deduct those pool deductions against future income from the Canadian resource properties acquired from the predecessor, in accordance with a complicated formula set out in other provisions of the Act. Until March 31, 1977, a successor was entitled to deduct expenses inherited from a predecessor only to the extent of income reasonably attributable to the resource production from the property from which the predecessor had the right to take or remove resources immediately before the transfer. On March 31, 1977, applicable to the 1977 and subsequent taxation years, the successor rules were amended to include the words "an interest" in subsection 66.1(4) of the Act. As a result, a predecessor could now pass on to a successor the ability to use certain forms of income, such as royalty income, against expenses incurred by the predecessor. Then, on January 15, 1987, the Minister of Finance issued the Special Release Draft Income Tax Amendments, Acquisitions of Gains and Losses and Department of Finance Technical Notes, which at page iii, stated:

New rules will limit so-called "seeding" and other tax avoidance transactions designed to circumvent the successor corporation rules for resource companies. These rules will be effective for acquisitions of property and changes of control after January 15, 1987.

The Minister of Finance, The Honourable Mr. Wilson, stated:

As a matter of tax fairness, it is necessary to introduce legislation to make it clear that such transactions will not be accepted as a means of avoiding payment of taxes that are properly owing.

At pages 2-3 of the Department of Finance Technical Notes accompanying the Special Release, under the heading, Subclauses 6(1) and (2)-Income Tax Act 66(6)(b)(ii) and (7)(b)(ii), the following explanation was given:

Subsections 66.1(4) and (5) of the Act contain what are generally referred to as the successor and second successor rules for Canadian exploration expenses (CEE). These rules allow the unclaimed Canadian exploration expenses of a taxpayer (the "predecessor") to be deducted by a corporation (the "successor") that acquires all or substantially all of the Canadian resource properties of the predecessor or by another of the Canadian resource properties of the predecessor or by another corporation (the "second successor") that acquires all or substantially all of the Canadian resource properties of the successor. These expenses may generally be deducted by the successor or second successor only against income from the disposition of Canadian resource properties owned by the predecessor and from production income from those Canadian resource properties in which the predecessor had an interest or right.

These restrictions in the deduction of CEE can be circumvented if the successor or second successor transfers a nominal interest in a productive resource property to the predecessor before the acquisition by the successor of all or substantially all of the predecessor’s resource properties-a so-called "seeding" transaction. In that case, the predecessor’s expenses may be deducted by the successor or second successor against all of its income from that resource property rather than just the portion of its income from the property that is attributable to the interest in the property that was acquired from the predecessor. The amendments to subparagraph 66.1 (4)(b)(ii) correct this defect by limiting the production income from the property against which the predecessor’s CEE may be deducted by the successor or second successor to the production income that may reasonably be regarded as attributable to the property interest or right that was owned by the predecessor.

These amendments are applicable with respect to acquisitions of property occurring after January 15, 1987 other than acquisitions of property occurring before 1988 where the persons acquiring the property were obliged on January 15, 1987 to acquire the property pursuant to agreements in writing entered into on or before that date.

There is substantial authority for the proposition that the Court can look to technical notes accompanying an amendment to the Act, a press release of the Minister of Finance and the Department of Finance Technical Notes for the purpose of gaining some insight into the intention and operation of the legislative amendments. (See Maritime Telegraph & Telephone Co. v. The Queen, [1992] 1 C.T.C. 264, 92 D.T.C. 6191 (F.C.A.), Anderson v. M.N.R., [1992] 2 C.T.C. 2405, 92 D.T.C. 2296 (T.C.C.). The question is what, if anything, can be drawn from the fact of the amendment and the manner in which it was announced in the Special Release, replete with comments from the Minister of Finance, and the Department of Finance Technical Notes? Certainly, there is no presumption that a legislative amendment changes the state of the law. In this instance, the wording of the amendment may flow from an exercise in caution, designed to beef up what may have been regarded as an ambiguous piece of legislation, exposing the Minister of National Revenue to unacceptable risk in undertaking his collection duties under that portion of the Act. The passage quoted, above, from the Technical Notes, makes it clear that the Department of Finance was of the opinion restrictions in the deduction of CEE could be circumvented if a successor or even a second successor transferred a nominal interest in a productive resource property to the predecessor prior to the acquisition by the successor of all or substantially all of the predecessor’s resource properties. The use of the term, "seeding transaction" in the Notes indicates that it was known to the Department and viewed as a means of achieving an end the Minister of Finance no longer viewed as desirable. The language of the Technical Notes indicates the amendments will "correct this defect".

In my view, the amendments involved in the present appeal do not fall into the category as found to exist by Joyal J., Federal Court-Trial Division in Woodward Stores Ltd. v. Canada, [1991] 1 C.T.C. 233, 91 D.T.C. 5090, where the amendment was held to constitute a departure from generally accepted accounting principles and, for policy reasons, to have specifically categorized lease inducement payments as income. In arriving at his conclusion, Joyal J. at page 244 (D.T.C. 5099) stated:

Inducements were obviously a matter of concern to the Crown and, if one looks at the legislative history of paragraph 12(1)(x) of the Income Tax Act, the change it brought about certainly had elements of substance in it.

In the present appeal, the amendments are viewed by the Department of Finance as a means to prevent what was asserted positively to be a mechanism to circumvent the prior restrictions on the ability to deduct CEE. However, while interesting, it does not do anything more than state the view of the officials employed by the Minister of Finance. As a policy decision, the introduction of the amendment striving for greater clarity by which future transactions would be governed, is undoubtedly a good one, but it does not have the effect of precluding the respondent from succeeding on the present appeal on the basis that the previous legislation automatically permitted the appellant to have done what is now expressly forbidden.

Counsel for the respondent contends that the "seeding transaction" violated the "object and spirit" of the legislation, notwithstanding the Minister has no quarrel with the appellant’s acquisition of Elco’s 50 per cent interest in the Elk River Coal Joint Venture property, which was part and parcel of the entire contractual agreement between the parties. Although there is a growing body of jurisprudence in this area, generally it has not been concerned with issues where a significant, if not major, part of the overall transaction, legitimate in its intent and execution with a viable business purpose, is inextricably bound up with another part of that transaction which is said to be tainted and beyond the bounds of the legislative scheme. In the present appeal, I am asked to, in effect, "tickle out" a portion of the lengthy contract between Elco and the appellant, and to determine whether the agreement relating to the sale to Elco and reacquisition by Fording of the 0.001 per cent royalty interest in the Fording River Coal Mine, is one which is severable so as to isolate the "seeding" from the remainder of the transaction-about which no fault can be found. There is no question that the "seeding transaction" had no business purpose other than a tax advantage. In modern society, with the taxpayer facing an array of tax collectors from three separate and distinct levels of government, it is not unusual for business decisions to be made bearing in mind tax implications. Some business dealings may hang totally on the particular effect of taxation and others may consign the taxman to the periphery. It is clear that Fording insisted on the availability of Elco’s tax pools as a condition precedent to the contract but it also was a producing coal company, operating a coal mine on a neighbouring property since 1968 and had legitimate reasons for entering into the deal with Elco, apart from the tax pools.

The Federal Court of Appeal in Vaillancourt v. Cannada, [1991] 2 C.T.C. 42, 91 D.T.C. 5408, dealt with the issue whether the word "property", as defined in subsection 248(1) of the Act, was broad enough to encompass a fractional interest in property. In the course of his reasons, allowing the appeal of the taxpayer, Decary J.A., writing for the Court, stated at page 47 (D.T.C. 5411):

When the Court has to interpret the provisions of tax legislation allowing a reduction of the tax burden, the traditional rule was that the taxpayer’s argument clearly fell within the exemption provision and any doubt was resolved in favour of the Government. This strict rule of interpretation was qualified by the Supreme Court of Canada in Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305, at pages 575-76 (C.T.C. 314-315, D.T.C. 6322):

I would therefore reject the proposition that a transaction may be disregarded for tax purposes solely on the basis that it was entered into by a taxpayer without an independent or bona fide business purpose. A strict business purpose test in certain circumstances would run counter to the apparent legislative intent which, in the modern taxing statutes, may have a dual aspect. Income tax legislation, such as the federal Act in our country, is no longer a simple device to raise revenue to meet the cost of governing the community. Income taxation is also employed by government to attain selected economic policy objectives. Thus, the statute is a mix of fiscal and economic policy. The economic policy element of the Act sometimes takes the form of an inducement to the taxpayer to undertake or redirect a specific activity. Without the inducement offered by the statute, the activity may not be undertaken by the taxpayer for whom the induced action would otherwise have no bona fide business purpose. Thus, by imposing a positive requirement that there be such a bona fide business purpose, a taxpayer might be barred from undertaking the very activity Parliament wishes to encourage. At minimum, a business purpose requirement might inhibit the taxpayer from undertaking the specified activity which Parliament has invited in order to attain economic and perhaps social policy goals. Examples of such incentives I have already enumerated.

Indeed, where Parliament is successful and a taxpayer is induced to act in a certain manner by virtue of incentives prescribed in the legislation, it is at least arguable that the taxpayer was attracted to these incentives for the valid business purpose of reducing his cash outlay for taxes to conserve his resources for other business activities. It seems more appropriate to turn to an interpretation test which would provide a means of applying the Act so as to affect only the conduct of a taxpayer which has the designed effect of defeating the express intention of Parliament. In short, the tax statute, by this interpretative technique, is extended to reach conduct of the taxpayer which clearly falls within "the object and spirit" of the taxing provisions. Such an approach would promote rather than interfere with the administration of the Income Tax Act, supra, in both its aspects without interference with the granting and withdrawal, according to the economic climate, of tax incentives. The desired objective is a simple rule which will provide uniformity of application of the Act across the community and at the same time, reduce the attraction of elaborate and intricate tax avoidance plans, and reduce the rewards to those best able to afford the servives of the tax technicians.

Professor Willis, in his article, supra, accurately forecast the demise of the strict interpretation rule for the construction of taxing statutes. Gradually, the role of the tax statute in the community changed, as we have seen, and the application of strict construction to it receded. Courts today apply to this statute the plain meaning rule, but in a substantive sense so that if a taxpayer is within the spirit of the charge, he may be held liable....

While not directing his observations exclusively to taxing statutes, the learned author of Construction of Statutes (2nd ed. 1983), at page 87, E.A. Driedger, put the modern rule succinctly (at S.C.R. 578, C.T.C. 316, D.T.C. 6323):

Today there is only one principle or approach, namely, the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.

This is the new approach which MacGuigan J.A. described in Lor-Wes Contracting Ltd. v. The Queen, [1985] 2 C.T.C. 79, 85 D.T.C. 5310 (F.C.A.) at 83 (D.T.C. 5313) as a "words-in-total-context approach with a view to determining the object and spirit of the taxing provisions".

Additionally, in determining the object of the legislation, this Court no longer hesitates to refer to the parliamentary debates when the latter rise above mere partisanship, and in particular in tax matters to refer to the budget speech made by the Minister of Finance.

The Supreme Court of Canada in Mattabi Mines Ltd. v. Minister of Revenue (Ontario), [1988] 2 S.C.R. 175, [1988] 2 C.T.C. 294, heard an appeal from a decision of the Ontario Court of Appeal which had decided the phrase "for the purpose of earning income" must mean taxable income. The judgment of the Court was delivered by Wilson J., who at page 191 (D.T.C. 302-04) stated:

The crucial phrase here is "net loss”, which is defined in paragraph 106(5)(b):

(5) In this section,

(b) "net loss" means the amount, if any, by which the non- capital losses exceed the incomes of a corporation for the fiscal years ending between April 26, 1971, and April 1, 1973....

This is a definition peculiar to section 106. It requires Mattabi to establish that its "non-capital losses" exceeded its "incomes" in the relevant years, i.e., 1971 and 1972. What do these terms mean? The Court of Appeal thought the word "incomes" should be construed as referring to more than one income in any given year. In its view, it would cover both taxable and exempt income in a particular year. I would attribute a different significance to the use of "incomes" in the plural. It seems to me that the plural was used because the necessary calculation includes more than one fiscal year. This view is supported by the fact that neither "income" nor "non-capital loss" is defined in section 106. One must turn therefore to the Act in general for their meaning.

Income is dealt with in Part II of the Act which covers sections 8-122 and therefore includes section 106. Division B of Part IT entitled "Computation of Income" begins with the formula for determining the income of a corporation in any fiscal year (section 12). The section begins:

The income of a corporation for a fiscal year for purposes of this Part is its income for the year determined by the following rules....

[Emphasis added.]

"This Part” is, as noted above, Part II ana includes section 106. The rules laid out in section 12 are followed by a large number of sections dealing with what must be included, what may be deducted, and so on. Subdivision F of Division B headed "Amounts Not Included in Computing Income" contains paragraph 75(2)(a):

Subject to the prescribed conditions, there shall not be included in computing the income of a corporation income derived from the operation of a mine during the period of 36 months commencing with the day on which the mine came into production.

Two possible ways of interpreting the relationship between paragraph 75(2)(a) and section 106 were advanced by the parties. The Company’s argument was simply that the plain meaning of the Act resulted in Mattabi having no income for the purposes of Part 11 (including section 106) during this period. The Minister implicitly accepted that this correctly represented the plain meaning but urged this Court to hold that the carry forward provisions "could not have been intended to apply to corporations which earned large incomes but which were exempted under other provisions of the Act from paying taxes on those incomes during the qualifying period". To qualify, he submitted, a taxpayer must have incurred a "true net loss". The Minister supported this interpretation by noting that the credit was designed to provide an incentive to purchase equipment and that such incentive would only be effective in the case of a company that actually paid tax. Therefore, it could not in his submission have been intended to apply in the present case.

The Minister, in effect, asks the Court to find, in the absence of a separate definition for the section, that "income" has a different meaning in section 106 from its meaning ‘for the purposes of" Part II of the Act in which the section appears. Robins J.A. in the Court of Appeal seems to have accepted this submission. He concludes that "income" in section 106 is, in effect, a synonym for profit. Accordingly, it does not matter whether the profit is tax exempt or not. The difficulty with this position, as I see it, is that a taxing statute is a highly technical piece of legislation which requires an interpretation that will ensure certainty for the taxpayer. Many of the words used carry a very specific and technical meaning because they identify the fundamental concepts underpinning the legislation. "Income" is one of those fundamental concepts.

"Net loss" is a defined item for purposes of paragraph 106(5)(b). Both "income" and "non-capital loss" are defined for the purposes of the Act. (Non-capital loss is defined in sections 1 (1)(48) and 99(7)(b)). The legislature did not enact a separate definition of "income" for section 106, which it could easily have done, and in my view it should not readily be taken to have intended it to have a different meaning in section 106 from its meaning in Part II generally.

The Minister, however, relies on this Court’s judgment in Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305, and in particular on one of the guidelines to the interpretation of taxing statutes set out by Estey J. at pages 579-80 (C.T.C. 317, D.T.C. 6324):

3. Moreover, the formal validity of the transaction may also be insufficient where:

(c) "the object and spirit" of the allowance or benefit provision is defeated by the procedures blatantly adopted by the taxpayer to synthesize a loss, delay or other tax saving device, although these actions may not attain the heights of "artificiality" in section 137. This may be illustrated where the taxpayer, in order to qualify for an "allowance" or a "benefit", takes steps which the terms of the allowance provisions of the Act may, when taken in isolation and read narrowly, be stretched to support. However, when the allowance provision is read in the context of the whole statute, and with the "object and spirit" and purpose of the allowance provision in mind, the accounting result produced by the taxpayer’s actions would not, by itself, avail him of the benefit of the allowance.

With respect, I do not think Stubart supports the Minister’s interpretation of "income" here. The issue in Stubart was whether a corporate taxpayer, with the avowed purpose of reducing its taxes, can establish an arrangement whereby future profits are routed through a subsidiary in order to avail itself of the latter corporation’s loss carryforward. It was held that it could since:

Neither the loss carryforward provisions, nor any other provision of the Act, have been shown to reveal a parliamentary intent to bar the appellant from entering into such a binding transaction and to make the payments here in question. Once the tax loss concept is included in the statute, the revenue collector is exposed to the chance, if not the inevitability, of the reduction of future tax collections to the extent that a credit is granted for past losses (page 581 (C.T.C. 317, D.T.C. 6324)).

The submission of the Minister is that a reading of the whole statute according to its plain meaning can defeat a narrow, technical interpretation of a particular provision. However, in the present case consideration of the whole statute reveals, if anything, support for the Company’s position. "Income" is a defined term in Part II of the Act and the failure to define income differently for purposes of section 106 which is contained in Part II has to be treated as significant. Interpretation according to the "object and spirit" of the legislation cannot, in my view, overcome a clear statutory definition. This is not a case in which the Court has a choice of the interpretations it may put upon the language used by the legislature. The legislature has specifically addressed the subject. I would therefore conclude that in assessing whether Mattabi had a "net loss" one must start with the finding that for purposes of paragraph 106(5)(b) its "incomes" were "nil".

Paragraph 106(5)(b) requires that "non-capital losses" be deducted from "incomes" in the search for a net loss. "Non-capital loss" is defined in sections 1(1)(48) and 99(7)(b) of the Act. I do not intend to analyze these provisions, however, since it is common ground that Mattabi’s "non-capital losses" for the relevant period were “nil”. Its "net loss" is therefore also "nil" unless it can produce a negative sum for non-capital losses by revising its 1971 or 1972 tax return.

If the sole purpose of the "seeding transaction" was to enable the appellant to gain access to potential deductions from unclaimed pool balances available to be applied against all its income from the Fording properties, and if it had constituted the entire transaction between Fording and Elco, the appellant may have been treading on the edge of violating the object and spirit of the legislation which was designed to assist the Canadian resource industry. However, the fact the 0.001 per cent sale by Fording to Elco and the reacquisition of that interest was egregiously diminutive should not change the legal effect of the contractual arrangements between the parties. Had the interest sold been 2.2 per cent or some other amount not deemed to be offensive by the Minister, this litigation would probably never have arisen. It is a major step for the Court to ignore the legal effects of the form of the transaction between the parties and to undertake a process equivalent to "reading down" or invoking the "blue pencil" doctrine on the basis that some of the substance of the overall purchase agreement is fiscally offensive to the Minister. It is one thing for parties to purport to contract between themselves to give rise to certain tax, or other advantages, or to purport to assign a particular status by contract, such as that of independent contractor, and to have a Court set aside their arrangement on the basis that they have attempted to do what legally cannot be done because the underlying facts do not support the putative categorization. It is another matter for a Court to excise a portion from a legitimate business agreement because it may have given rise to the kind of tax advantage the Minister later sought to have specifically prohibited by securing an amendment. The successor rules had been amended in 1977 so that a successor could acquire "an interest", thereby permitting royalty income to be used against expenses incurred by the predecessor. The legislation could have been designed to prohibit any benefit flowing to a successor if the purchased interest was less than five per cent or some other proportion. It did not do so. The "seeding transaction", therefore, must be regarded in the context of the complexity of the legislation, its history, and avowed intent to make predecessor’s expenses available to be utilized by successor corporations in the Canadian resource industry. The Minister may wish the amendment of 1987 had been brought into effect several years earlier but that does not change the true legal nature of the Fording-Elco transaction nor the tax consequences that flowed from that contractual arrangement in accordance with the plain reading of the provisions of the relevant subsections of the Act, namely subsections 66.1(4) and 66.2(3), as those subsections applied in the 1985 and 1986 taxation years, fundamentally unchanged by the transitional provisions pursuant to subsections 66.7(3) and 66.7(4), applicable to the 1987-1990, inclusive, taxation years. The relevant portion of subsection 66.1(4), set out below, pertained to the ability of a successor corporation to access CCDE, by claiming part of a certain amount as:

may reasonably be regarded as attributable to

(ii) the production of minerals from mines...in respect of which the predecessor had, immediately before the acquisition by the successor corporation of the property so acquired, an interest in...minerals....

The above provision clearly requires a reasonable attribution to the production of minerals from mines in respect of which the predecessor had an interest but not to the limited extent of the precise amount of that interest, fractional or otherwise. Such a limitation was accomplished by the passage of clause 66.7(3)(b)(i)(C), applicable to the acquisition of resource properties after January 15, 1987, by confining the application of the formula to "the production from that property ".(emphasis added) It is an onerous and, in my view, inappropriate task for the Court to quarrel with the precise method in which a taxpayer falls within the literal confines of complex legislation, merely because that strict qualification within the terms of a provision was not what the Minister intended as a possible consequence. By acting in such a manner, in my opinion the Court would be fine-tuning legislation on the basis of some concept of equity or fair play in the milieu of complex and often arcane rules designed to permit, or even encourage, certain activity and to prohibit other actions in an extremely detailed manner. It is like the story of the harried mother who left her children alone for a brief period of time, having posted an exquisitely delineated set of very specific prohibitions designed to govern their behaviour during her absence. Unfortunately, she had neglected to forbid, in writing, the consumption of the daisies in her garden. Not being on the list, the presumption was, naturally enough, that it was permitted within the framework, and by extension, even the object and spirit of the precisely detailed instructions. Similarly, the appellant did not contravene the object and "Spirit of the relevant provisions of the Act by entering into a legal agreement, in accord with the facts, giving rise to real legal rights and obligations between the parties within the context of a valid business purpose. If a transaction structured solely for a tax advantage can be regarded as having a valid business purpose, as was the case in Stubart, referred to in Vaillancourt, supra, then the "seeding transaction" standing alone, without more, could be completely valid. In the facts of the present appeal, it does not stand alone but is a part of a larger, complex, independent and bona fide business purpose.

The second issue to be addressed is whether the provisions of subsection 245(1) of the Act, as that subsection applied to the years under appeal, precludes deduction by the appellant of the CCEE and CCDE. The position taken by counsel for the respondent is that even if the transactions are within the object and spirit of the legislation governing successor rules, thereby permitting the appellant to deduct the tax pools, then if allowed they would contravene the subsection by unduly or artificially reducing its income. The submission is that subsections 66.1(4) and 66.2(3) and subsection 245(1) of the Act are in pari materia with each other and operate to provide a statutory check on the use of the deductions to ensure they are utilized against properties actually producing income. Since it was conceded the transfer of the 0.001 per cent interest to Elco on December 2, 1985 and the reacquisition, by exercise of an irrevocable option, on December 30, 1985 was done solely for the tax advantage, counsel for the respondent urges that the transaction lacked commercial reality and was inconsistent with normal practice. It had the effect of putting the appellant into a position whereby, on the basis of acquiring the 0.001 per cent interest Elco previously held in the Fording River Coal mine, it then had the potential to deduct approximately $17,300,000 against all income from the Fording properties. The extent of these potential deductions and the amount already claimed during the years under appeal was sufficiently large so as to unduly, in a quantitative sense, reduce the appellant’s income.

Counsel for the appellant submitted that Elco, not the appellant, incurred the disbursement or expense. Also, the claiming of a reserve or a specific permitted statutory deduction such as capital cost allowance or the deductions provided in subsections 66.1(4) and 66.2(3) of the Act does not constitute a disbursement or expense within the meaning of subsection 245(1) of the Act. Alternatively, counsel submitted that even if there was a disbursement or expense, the deduction did not artificially or unduly reduce income in that it was done pursuant to specific provisions of the Act designed for that very purpose, and this result obtains even if the sole purpose of a transaction is to save taxes. Further, the Court was urged not to strike down one portion of a transaction as being artificial.

Subsection 245(1 )-identical to the former subsection 137(l)-applies to the transaction under appeal and reads as follows:

Artificial transactions-In computing income for the purposes of this Act, no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

In the case of Mara Properties Ltd. v. Canada, [1993] 2 C.T.C. 3189, 93 D.T.C. 1449 (T.C.C.). The Honourable Judge Kempo, Tax Court of Canada, considered the issue where the Crown sought to apply subsection 245(1) of the Act to disallow to a taxpayer the cost of inventory incurred by a predecessor, Fraserview. At page 3199 (D.T.C. 1457), Judge Kempo stated:

Clearly, the appellant did not make or incur any outlay or expense as these acts had already been done by Fraserview. The deemed cost of the land was no more than an aggregate of the various expenditures previously made; it was representative of a mathematically derived cost amount which the appellant inherited by operation of the Act.

In McKee v. The Queen, [1977] C.T.C. 491, 77 D.T.C. 5345, Addy J. of the Federal Court-Trial Division dealt with the appeal of a taxpayer who claimed capital cost allowance under Class 18 based on the total potential purchase price of certain film rights. The Minister disallowed the claim, alleging, inter alia, that it was an expense which artificially reduced income within the meaning of subsection 137(1) of the Act. At page 493 (D.T.C. 5347), Addy J. stated:

One of the issues raised was whether the capital cost allowance claimed unduly or artificially reduced the plaintiffs income or, more specifically, whether subsection 137(1) applied. That subsection reads as follows:

137. (1) In computing income for the purposes of this Act no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

The case of Harris v. M.N.R., [1966] S.C.R. 489, [1966] C.T.C. 226; 66 D.T.C. 5189, a decision of the Supreme Court of Canada, contains the following passage at page 505 (C.T.C. 241, D.T.C. 5198):

If, contrary to the views I have expressed, we had accepted the appellant’s submission that the transaction embodied in the lease was one to which section 18 applied and that on the true construction of the lease and the terms of that section the appellant was prima facie entitled to make the deduction of the capital cost allowance of $30,425.80 claimed by him, I would have had no hesitation in holding that it was a deduction in respect of an expense incurred in respect of a transaction that if allowed would artificially reduce the income of the appellant and that consequently its allowance was forbidden by the terms of subsection 137(1). The words in the subsection "a disbursement or expense made or incurred” are, in my opinion, apt to include a claim for depreciation or for capital cost allowance, and if the lease were construed as above suggested the arrangement embodied in it would furnish an example of the very sort of ’’transaction or operation" at which subsection 137(1) is aimed.

[Emphasis added. I

The case was decided on other gounds and the statement is, of course, obiter dicta and is therefore not strictly binding upon me. In view of its authorship however and of the fact that the judgment was concurred in by the remainder of the members of the Court who were sitting at that time, that particular interpretation of subsection 137(1) caused me some concern. The question, in my view, must be squarely faced in the case at bar.

I have searched several dictionaries including The Shorter Oxford English Dictionary, 3rd edition revised. Britannica World Language Dictionary, Funk & Wagnail's New Standard Dictionary of the English Language, The Random House Dictionary of the English Language, The Living Webster Dictionary and

Thorndike-Barnhard (American dictionary). It seems abundantly clear that the common ordinary meaning of the word "expense" pertains to a payment, an outlay of money and expenditure or that which has created a liability or which might have necessitated the transfer of some assets in payment therefor. It can also mean the cost of a thing or whatever must be given up or surrendered for it. The word "disbursement" is even more indicative of an immediate outlay or payment and signifies an expenditure. Nowhere could I find that these words are even remotely used to indicate something in the nature of an allowance. On the contrary the sole affinity between the word "allowance" and these two words occurs when the latter is used as a set-off against or to pay for, compensate for, or counterbalance an expense or disbursement. Far from being in any way a synonym of either of these two words it constitutes, if anything, an antonym.

The Crown itself called, on another matter, as an expert accountant, one Mr. Bonham, who apparently possessed considerable academic and professional qualifications and a considerable practical experience in accounting. This witness, in the course of is evidence, referred with approval to several recognized texts and papers in accounting including Terminology for Accountants CICA 1962, Accounting Terminology Bulletin No 4 AICPA 1957 and The Canadian Accountants Handbook 1968. Fom these publications and the definition of costs, expense and expenditure therein contained, including some recommended changes in terminology, it is abundantly clear that in accounting also the distinction is clearly maintained between an "allowance" and an "expense" of'disbursement".

In the Income Tax Act itself the word "expense" is found in numerous sections and nowhere there is it used to indicate an "allowance". It is for instance used in the sense of an outlay or expenditure in sections 5, 11, 12, 12A, 13, 18 and 20 and is used in the sense of something which counterbalances or is offset against or is used to compensate for an expense in such paragraphs as 5(1)(b), 5(2)(b), 11 (6)(b) and others.

I must therefore conclude that not only in their common ordinary meaning, but also in the technical language of accountancy and, more importantly, everywhere else in the Act itself wherever the words are employed, they are never used nor are they intended to be used as being synonymous to the word "allowance" but that, on the contrary, they are often directly used to indicate an expenditure which one may or may not be permitted to compensate for by an allowance according to the particular provisions of the Act.

In subsection 137(1) itself the words "capital cost allowance" themselves describe an allowance themselves describe an allowance to compensate for the cost or expense. Surely, this allowance itself cannot be the cost, expense or expenditure for which it is intended to provide some tax relief.

In view of the above and also in view of the general principle that wherever ambiguity exists, although I can really find no ambiguity here, a taxing statute must be interpreted against the taxing authority, I can find no reason why the words "a disbursement or expense made or incurred" can be taken to include an allowance which a taxpayer is permitted to claim under the Regulations to compensate for the cost or capital expenditure made in acquiring an asset.

Subsection 137(1) is therefore of no assistance to the Crown.

In The Queen v. Esskay Farms Ltd., [1976] C.T.C. 24, 76 D.T.C. 6010, a taxpayer deducted reserves under paragraph 20(1 )(n) of the Act. Cattanach J., of the Federal Court-Trial Division at page 36 (D.T.C. 6017) observed:

In my view the section is not applicable to the present appeals. The section provides that "no deduction may be made...of a disbursement or expense made or incurred...". The word "disbursement" in common parlance means "money paid out, an expenditure" and the word "expense" also in common parlance means "money out of pocket". I see no valid reason for ascribing any other meaning to those words as used in the context of subsection 137(1).

Under the subsections of the Act at issue in the present appeal, 66.1(4) and 66.2(3), there is specific reference to the "cumulative Canadian exploration expense of the predecessor" which obviously cannot be the actual disbursement or expense made or incurred in respect of a transaction by which the successor corporation became entitled to utilize certain expenses previously incurred by another. Indeed, the right of the successor corporation to obtain certain benefits flowing from the fact the predecessor incurred expenses, is the entire rationale for that piece of legislation. Therefore, in my opinion, subsection 245(1) does not apply to the present appeal as there was no disbursement or expense made or incurred from which a deduction was claimed.

In the event that I am wrong in so holding, I will undertake an examination as to whether or not the transaction complained of by the Minister is otherwise caught by the subsection. In Mark Resources Inc. v. The Queen, [1993] 2 C.T.C. 2259, 93 D.T.C. 1004, the taxpayer’s appeal was dismissed on other grounds but on the subject of artificiality under subsection 245(1) the Honourable Judge Bowman of the Tax Court of Canada, in the course of his judgment undertook a review of other judicial pronouncements and stated his own observations, commencing at pages 2264-67 (D.T.C. 1008-10):

Artificiality-Subsection 245(1)

I shall deal first with the argument under subsection 245(1) as it applied to 1985 and 1986. Subsection 245(1) was, prior to the enactment of the so-called general anti-avoidance rule now contained in the present subsection 245(1), sometimes used to counteract what the Minister conceived to be unacceptable tax avoidance. The Minister has been somewhat sparing in his use of the provision, preferring, it would seem, to rely upon other provisions of the Act or upon general broad principles. For example, in Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305 the profitable assets of one company were transferred to a related company to use up the latter’s losses. It was argued that the transactions were incomplete, shams and without business purpose. The Supreme Court of Canada, in allowing the taxpayer’s appeal, held that the absence of business purpose was no impediment to the effectiveness of the scheme, that the transaction was not a sham and that it was complete.

Although the Crown specifically refrained from relying upon section 137 (the predecessor to section 245) Estey J. commented briefly on that section at page 579 (C.T.C. 316, D.T.C. 6323):

Where the facts reveal no bona fide business purpose for the transaction, section 137 may be found to be applicable depending upon all the circumstances of the case. It has no application here.

Since the Crown did not rely on section 137 the court did not elaborate upon the type of circumstances that would justify applying section 137 to a transaction lacking a business purpose. We are afforded, however, some guidance from a number of other decisions of the Supreme Court of Canada and the Federal Court of Appeal. Harris v. M.N.R., [1966] S.C.R. 489, [1966] C.T.C. 226, 66 D.T.C. 5189 involved a scheme under which a service station was leased for 25 years to an oil company and concurrently leased to the taxpayer for 200 years with an option to purchase at the end of the term. The taxpayer relied upon section 18 of the Income Tax Act, as it then read, to claim capital cost allowance on the aggregate of the rental payments over the 200 year term, less the fair market value of the land. The scheme, had it succeeded, would have resulted in the taxpayer, for an investment of $10,000, being able to claim capital cost allowance on a deemed capital cost of over $600,000. Cartwright, J., as he then was, after holding that the option contravened the rule against perpetuities, went on to observe at page ??? (D.T.C. 5198), that the arrangement embodied in the scheme:

...would furnish an example of the very sort of "transaction or operation" at which subsection 137(1) is aimed.

In Shulman v. M.N.R., [1962] S.C.R. vii, 62 D.T.C. 1166, the Supreme Court of Canada, without written reasons, affirmed a decision of Ritchie D.J. ([1961] C.T.C. 385, 61 D.T.C. 1213) which held that the use of a management company to which a lawyer paid management fees to administer his law practice artificially reduced his income. The management fees were disallowed as a deduction under subsection 137(1). Recent jurisprudence, such for example as The Queen v. Parsons, [1984] C.T.C. 352, 84 D.T.C. 6447 (F.C.A.) would not justify placing undue reliance on that decision today.

In Consolidated-Bathurst Ltd. v. The Queen, [1987] 1 C.T.C. 55, 87 D.T.C. 5001, the Federal Court of Appeal held that the deduction of premiums paid to an arm’s length insurer where that insurer reinsured the risks with the insured’s offshore captive insurance company was prohibited under subsection 245(1) where the insured guaranteed the captive’s potential obligations to the primary insurer, but not where it did not. In the former case, subsection 245(1) was held to be applicable because there was no shifting and distribution of risk and therefore no true insurance protection was obtained. Where no such guarantees were given the taxpayer’s insurance arrangements were held not to be tainted by artificiality.

A recent and significant decision of the Federal Court of Appeal on artificiality is Canada v. Irving Oil Ltd., [1991] 1 C.T.C. 350, 91 D.T.C. 5106. In that case, as part of an obvious tax avoidance scheme, an offshore company was inserted between the domestic taxpayer’s suppliers of crude oil and the taxpayer. The offshore company served no commercial purpose whatever. It had but one full-time employee, it never took possession of or insured the oil and its operating expenses were minimal. It took no part in the transportation of the oil and had title thereto only long enough to increase the price from that at which the appellant could buy from its Middle East suppliers to a figure that, it was found, was fair market value.

Although the Federal Court of Appeal disagreed with virtually all of the trial judge’s conclusions, it held that the arrangement was not a sham (cf. Dominion Bridge Co. v. The Queen, [1977] C.T.C. 554, 77 D.T.C. 5367), and that the deduction, in computing the appellant’s income of the amount by which the Bermuda company increased the price to the Canadian parent for the scintilla of time when it had legal title to the oil did not "unduly or artificially" reduce the appellant’s income. Leave to appeal to the Supreme Court of Canada was denied.

I find the observations of Mahoney J., speaking for the Court, at pages 360-61 (D.T.C. 5114) particularly instructive:

In order to come within the terms of subsection 245(1), a transaction or operation must have the effect of unduly or artificially reducing income; the artificiality of the transaction or operation itself does not determine the issue. Heald J.A., speaking for the Court in Spur Oil v. The Queen, [1981] C.T.C. 336, 81 D.T.C. 5168 (F.C.A.) at page 343 (D.T.C. 5173), said:

..the finding of artificiality in the transaction does not, per se, attract the prohibition set out in subsection 245(1) of the Income Tax Act. To be caught by that subsection, the expense or disbursement being impeached must result in an artificial or undue reduction of income. "Undue" when used in this context should be given its dictionary meaning of "excessive". In light of the Crown’s concession...that under the Tepwin contract the appellant would be paying slightly less than fair market value, it cannot be said that the Tepwin contract and the Tepwin charge result in an excessive reduction of income. Turning now to artificial, the dictionary meaning when used in this context is, in my view, "simulated" or "fictitious". On the facts in this case, the reduction in the income of the appellant can, in no way, be said to be fictitious or simulated.

It is likewise here. Since the respondent paid Irvcal fair market value, it cannot be said that payment resulted in an excessive reduction of income. There was nothing fictitious or simulated in the reduction of the respondent’s income as a result of paying Irvcal 66¢ more per barrel of crude than the crude cost Irvcal. It was very real.

The ratio in Spur Oil was reached on the basis that the result of a non-arm’s length transaction was the result that would have been reached at arm’s length. The appellant’s submission that the fact, as found by the trial judge, that the respondent and Irvcal dealt at arm’s length distinguishes this case from Spur Oil is therefore singularly unpersuasive.

Conclusion

The Supreme Court of Canada’s decision in Stubart reaffirmed that it remains the law of Canada that

Every man is entitled if he can to order his affairs so as that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow taxpayers may be of his ingenuity, he cannot be compelled to pay an increased tax (Inland Revenue Commissioners v. Duke of Westminster, [1936] 1 A.C. 1 (H.L.) at pages 19-20).

On the facts as found herein, it is my opinion that the tax avoidance scheme contrived in the present case did not offend the Income Tax Act.

It is fair to say that artificiality is in the eye of the beholder, and where one draws the line between "acceptable" and "unacceptable" tax avoidance schemes is a matter of perception. In that determination the fact that the scheme may have been predominantly or exclusively fiscally motivated plays a minor or even a non-existent role. [1] What is of far greater importance is whether the scheme falls within accepted norms of commercial reality. The 200 year lease option in Harris on the face of it was not within those bounds. Similarly, in Consolidated-Bathurst, a guarantee by the insured of the reinsurer’s obligations to the primary insurer was held not to be within ordinary principles of commercial usage within the insurance industry. In Irving Oil the purchase of crude oil from a subsidiary at a price that was found by the trial judge to be fair market value appeared to the Federal Court of Appeal to offend no principles of commercial normality.

Wherein, then, lies the artificiality in this case? The transactions with the Royal Bank were at arm’s length. The rate of interest charged was not excessive - indeed it may have been somewhat lower than that charged domestically. The income produced by the investment of the funds in a term deposit arose out of a normal commercial act. There was nothing unusual about the payment of dividends. The documentation necessary to accomplish each of the steps was prepared, executed and delivered as required and the transactions were duly completed in accordance with the documents. They were real transactions. The artificiality, if I understand the respondent’s argument correctly, must consist in the overall objective of utilizing the U.S. subsidiary’s losses in Canada and the attainment of that end by borrowing at a rate that was higher than the anticipated return, all in accordance with a prearranged plan.

Considered separately neither of these elements justifies a disallowance of the interest paid under subsection 245(1). The tax considerations that motivated the arrangement by itself do not by themselves bring it within the ambit of subsection 245(1). [2] The borrowing at a rate that does not and cannot yield an economic return as a means of achieving a predetermined economic result is in itself not artificial. To hold that this scheme failed for artificiality would be to ignore the decision of the Federal Court of Appeal in Irving. If the Irving scheme was not artificial this one cannot be.

One final observation must be made. We have here a series of interrelated transactions. The Crown has challenged under subsection 245(1) only one aspect of the entire arrangement, the deduction of interest, on the basis that it results in an artificial or undue reduction of the appellant’s income. Yet it has chosen to leave intact the consequences of all but one of the component parts. Either the whole structure falls or it does not. It cannot be dismembered piecemeal. In any fiscally motivated scheme, if no sham is involved, there must necessarily be legally effective steps that have specific tax consequences. The tax results of each of those steps that forms an integral part of the entire scheme must be respected unless the Minister is prepared to say that the scheme as a whole fails.

I have concluded that the deduction of the interest is not prohibited by subsection 245(1).

In the present appeal, the purchase by Elco of the 0.001 per cent interest in Fording River Coal Mine, with the right to take minerals therefrom, and the reacquisition by Fording of that interest, was part of a larger transaction of considerable magnitude-all factors being considered, including Fording later increasing its stake in the joint venture by buying out Stelco’s interest for the sum of $225,000-between corporations entering into a legitimate business arrangement. The larger part of the overall deal, the purchase by Fording of Elco’s interest in the Elk River Coal Joint Venture was not challenged by the Minister. The agreement in total was a complete and legally effective transaction, accurately reflecting the reality of that which was being bought and sold. It required a significant expenditure of time and capital on the part of the appellant during the years under appeal. The fact that a portion of the entire contract as structured carried with it a significant tax consequence is not extraordinary in modern business dealings and there was no sham, subterfuge or artifice to distort the reality of what took place. In 1985, there was no clear legislative intent to restrict the benefits accruing to a successor corporation in the manner utilized by the appellant, and in fact there had been amendments to earlier legislation to expand the capacity of successor corporations to use certain tax pools flowing from qualified expenses having been incurred by predecessors. Not only is the Minister complaining about one portion of the contractual arrangement between Fording and Elco, but also about the nature of the interest-admittedly minuscule—acquired within the framework of the provisions of the Act. His position basically is: admittedly, most of the deal meets my approval except for a portion of it which, in my opinion, while perhaps technically meeting the complex language of the Act, was never intended to be used in that manner and we have now passed an amendment to ensure it does not happen in the future. And, in any event it smacks of tax avoidance by being an artificial transaction. I cannot accept that proposition.

Since it is extremely rare that intent is a factor, the heart of the issue in most appeals is whether or not there has been compliance with the Act in the sense of the taxpayer having fulfilled the obligation of establishing he is within the ambit of the relevant provisions.

For the reasons stated in this judgment, I find that subsection 245(1) of the Act does not apply to the appellant for the years under appeal and it is not otherwise precluded from claiming the deduction of the CCEE and CCDE.

The appeal is allowed for all of the years under appeal. As noted at the commencement of these reasons, the parties had agreed to certain aspects of the appeal which had been the subject of pleadings to that point. It was agreed that counsel would draft a judgment for my signature which would contain the precise details to incorporate their agreement on certain matters and then, if the appellant were successful on the litigated issue, to further include into the draft the exact language that is required so the Minister can undertake the reconsideration and reassessment necessary to give effect to these reasons for judgment when the reassessments are referred back to him for that purpose, pursuant to the issuance of the formal judgment.

I am indebted to counsel for their oral and written submissions and the accompanying material. The appellant is entitled to costs on a party-and- party basis. There may be some issue surrounding costs as they relate to matters which were consented to prior to the hearing of the appeal and if this cannot be resolved by counsel, they may speak to me.

Appeal allowed.