Gibraltar Mines LTD v. Her Majesty the Queen, [1982] CTC 1, 82 DTC 6031

Gibson, J:—This appeal of Gibraltar Mines Ltd is from an income tax assessment disallowing Gibraltar’s claim to deduct in computing its 1975 income a reserve for a doubtful debt of $902,200.

Gibraltar, in its income tax return, claimed a doubtful debt reserve of $902,200 with respect to an amount owed to it by Cuisson Lake Mines Ltd; and on this appeal submits (1) it is entitled to the $902,200 doubtful debt reserve as claimed; or (2) in the alternative, that mining preparation costs of $454,980 are deductible by it in computing its 1975 income as Canadian development expense pursuant to subsection 66.2(2) and clause 66.2(5)(a) (ii)(A) of the Income Tax Act and/or as Canadian exploration and development expense pursuant to subsection 66(1) and paragraph 66(15)(b) of the Income Tax Act; and (3) also, in the alternative, that net administration, mining and marketing expense of $392,167.30 is deductible by it as ordinary operating expense incurred for the purpose of earning income from the mining and sale of ore from the Cuisson property (which operation ended up with a loss in the year in question) or for the purpose of earning income from its own Granite Lake properties which it was not feasible to mine without mining the Cuisson property at the same time, as part of one overall mining plan.

On this appeal Gibraltar abandoned a further alternative claim with respect to the mineral royalty and capital tax amount of $75,680 set forth in paragraph 14 of the Statement of Claim on the basis that the deduction thereof alternative is prohibited by paragraph 18(1 )(m) of the Income Tax Act with respect to such amounts paid after May 6, 1974, and that the amount in fact paid prior to that date is de minimis.

The defendant, for the Minister, submits: (1) That the primary question for determination is whether or not the reserve claimed by Gibraltar falls within the ambit of the deduction that is statutorily permitted for a reserve for doubtful debts by subparagraph 20(1 )(l)(i) of the Income Tax Act. (2) That there are secondary questions raised by Gibraltar’s statement of claim, namely, whether or not Gibraltar:

(a) Can deduct, as its own costs or expenses, in computing its 1975 income, within the ambit of section 9 and not prohibited by paragraph 18(1 )(a) of the Income Tax Act, the costs or expenses making up the total amount of $922,825 owing by Cuisson to the plaintiff; and

(b) can deduct, as its own Canadian development expenses, in computing its 1975 income, the costs or expenses representing preproduction costs (preparation costs) in the amount of $454,980 within the meaning of paragraph 66.2(5)(a) of the Income Tax Act.

According to the pleadings, in assessing Gibraltar for its 1975 taxation year, the Minister of National Revenue assumed the following:

(a) that Gibraltar and its parent company, Placer Development Limited, owned 70% of the issued shares of Cuisson:

(b) that as of December 31, 1975, Gibraltar had incurred, pursuant to the Agreement of November 30, 1972, qua agent of Cuisson and for and on behalf of Cuisson, expenditures in the net amount of $922,825 for the following:

(c) that no portion of the said net amount of $922,825 was included by Gibraltar in its income for the 1975 taxation year, or a previous year, as income from its business or property in respect of any property sold or services rendered to Cuisson;

(d) that all portions of the amount of $922,825 incurred by Gibraltar for and on behalf of Cuisson, were, pursuant to the Agreement of November 30, 1972, to be deducted by Gibraltar from subsequent payments to be made by Gibraltar to Cuisson, resulting from the sales of ore by Cuisson to the plaintiff;

(e) that Gibraltar recorded in its accounts for the 1975 fiscal period, a receivable due from Cuisson in the amount of $922,825; and

(g) that no portion of the amount of $902,200 claimed by Gibraltar as a reserve for doubtful debts, was a doubtful debt.

Gibraltar Mines Ltd, is a corporation incorporated under the laws of British Columbia and is owned 70% by its parent company Placer Development Limited. Gibraltar is the owner of certain mineral claims called Granite Lake Claims at which location it operates an open-pit mining concentrator.

Gunn Mines Ltd also owned certain mineral claims in the Granite Lake area adjoining Gibraltar’s claims. For economical and practical reasons, a decision was made to mine these mineral claims held by Gunn Mines Ltd, with Gibraltar’s mineral claims. In order to accomplish this, Cuisson Lake Mines Ltd, was incorporated for the purpose of taking over and did take over certain claims in Gunn Mines Limited which were located adjoining Gibraltar’s claim. On organization and at all material times, the issued and outstanding shares of Cuisson were owned by the following:

By contract dated November 23, 1973, Exhibit 2, among Placer (the parent company of Gibraltar) Gibraltar and Gunn, arrangements were made as to how Cuisson was to be financially operated: it gave Cuisson authority to enter into a mineral agreement with Gibraltar in respect to Cuisson’s Granite Lake claims, authority to provide for the management of Cuisson and for the further examination, exploration development and mining of the Granite Lake claims of Cuisson in conjunction with, concurrently and consequently with the continuous and adjacent mineral claims of Gibraltar in such manner and upon and subject to such terms and conditions and for such consideration, all as the Board of Directors of Cuisson may approve. Pursuant to that enabling authority Cuisson entered into a mining agreement with Gibraltar effective November 30, 1972 and executed September 28, 1973 (see Exhibit 1). By that agreement, Gibraltar and Cuisson expressly provided that the expenses and mining were to be expenses of Cuisson and not of Gibraltar although Gibraltar was the vehicle, so to speak, through which these expenses would be funded. And the agreement provided that these expenses would be recouped by Gibraltar from Cuisson from the sale of the ore mined from the Cuisson mine reserve.

Pursuant to that contractual arrangement, Gibraltar, during other years, including the relevant year 1975, carried out mining operations on the Cuisson Lake Mines Property and provided the necessary financing to do that and recouped certain of those financing costs from Cuisson from the sale of ore as envisaged by the agreement. For example, the statement of operations of Cuisson Lake Mines for the taxation year 1975, see Exhibit 4, shows revenues and expenses as follows:

CUISSON LAKE MINES LTD

STATEMENT OF OPERATIONS AND DEFICIT

Year ended December 31

	1975	1974 1974
Revenues:
Ore sales (Note 3)	$3,633,129	$299,361
Interest income	1,077	994
Expenses (Note 3)	3,634,206	300,355
Cost of sales	3,886,590	344,918
Amortization and depletion	305,382	51,222
General and administrative	46,668	4,917
Interest	45,694	294
	4,284,334	401,351
Loss before royalties	650,128	100,996
Mineral royalties	144,468	6,735
Loss for the year	794,596	107,731
Deficit (retained earnings), beginning of year	107,668	(63)
Deficit, end of year	$902,264	$107,668

The shortfall of expenses over receipts was approximately $922,827,30. As to this, the financial statement of Cuisson, Exhibit 4 at Note 3 reads in part as follows:

There is a serious question as to the ability of the Company to continue operations should Gibraltar not continue to mine the Company’s mineral claims and provide the necessary financing for the Company.

In the accounts of Gibraltar in dealing with this shortfall, such shortfall to the extent of $902,264 only was treated as an accounts receivable owing to it from Cuisson. This is a perfectly acceptable accounting record in so far as Gibraltar and Cuisson are concerned. Because of the Agreement Exhibit 1, and the control Gibraltar had as a result over the operations and finances of Cuisson, $902,200 only was set up as an accounts receivable because on the face of it Cuisson at the end of the fiscal year of 1975 had an apparent equity according to its balance sheet of about $20,000.

In addition, according to the evidence, there have been various adjustments during the 21-month period following December 31, 1975 as to the amount of this debt set up in the books of Gibraltar as owing by Cuisson to Gibraltar; for example, the adjustment to June 30, 1976 decreased this amount by about $190,000.

Further, Gibraltar as evidenced by Exhibit 1, had control of the mining Claims which at the end of 1975 were not exhausted; and they are still not exhausted.

Accordingly, it was perfectly proper for Gibraltar and the other parties to so arrange the affairs of each and the affairs of Cuisson so that the subject expenses were the expenses of Cuisson and they did so.

The only question that arises on this appeal is whether or not Gibraltar, by setting up this shortfall of expenses less income as an account receivable on its books is entitled to claim a reserve for such shortfall which it has categorized as an account receivable for the year 1975 so as to be within the statutory meaning and framework of subparagraph 20(1 )(l)(i) of the Income Tax Act and thereby be entitled to a deduction for the amount of such reserve from taxable income.

As has been said so often and which is still the law in Canada, a person is entitled to arrange his or her affairs in any legal way so that his or her liability for income tax is the less; and a taxing statute will be applied to the substance namely, the legal effect of the sum total of all the transactions ascertained upon ordinary legal principles. See eg C/R v The Duke of Westminster, [1936] AC1; Beit v IRC, [1952] Ch. 53 and Amelia Rose v MNR, [1973] FC 65; [1973] CTC 74; 73 DTC 5083.

The corollary of the rule in the Duke of Westminster case (supra) is that when an act or transaction is a “sham” it is not part of the “substance” to which the taxation statute is applied.

In this case, on the facts the relevant parties including Gibraltar and Cuisson arranged their respective affairs so that the subject mining expenses were expenses of Cuisson and not of Gibraltar. As part of this arrangement Gibraltar provided the necessary financing for Cuisson. That is the substance of the transaction which in the circumstances of this case is perfectly legal.

Accordingly, it was quite proper that as between Gibraltar and Cuisson for the shortfall of income less expenses for the year 1975 that such shortfall be set up as an account receivable. Whatever the characterization of the amount due that was adopted by Gibraltar in its books is a matter of indiffer- ence as between Gibraltar and Cuisson. It was consistent with ordinary principles of commercial accounting. But the difficulty in so far as the main issue in this appeal is concerned is that this particular debt called an account receivable on the books of Gibraltar did not have its origin in sales of merchandise or services rendered and accordingly, cannot be set up as a reserve so as to be deductible from income because it does not fit within the Statutory requirements of the Income Tax Act and Regulations. Cf MNR v Anaconda American Brass Ltd, [1956] AC 85; [1955] CTC 311; 55 DTC 1220. On this evidence Gibraltar contracted with Cuisson, see Exhibit 1, pursuant to its enabling authority arising out of the contract, Exhibit 2, to finance the costs or expenses of Cuisson in this mining operation. The amount of shortfall is not an account receivable for a doubtful debt for which a reserve may be set up within the meaning of subparagraph 20(1 )(l)(i) of the Income Tax Act. Instead, this debt characterized as of 1975 as an account receivable on the books of Gibraltar by the arrangement of all relevant parties which includes both Gibraltar and Cuisson was an outlay of capital by Gibraltar for the purpose of financing this mining operation of Cuisson.

Accordingly, the appeal is dismissed with costs.