Canadian General Electric Company Limited v. Her Majesty the Queen, [1982] CTC 288, 82 DTC 6232

Mahoney, J:—The sole issue remaining, after settlement and abandonment of other matters, is whether an amount to provide Atomic Energy of Canada Limited, hereafter “AECL”, with “know-how” and a non-exclusive licence under patents and patent applications relative to the design, con- struction and operation of a heavy water plant and the processes involved in producing heavy water was a capital or income receipt. The defendant’s case is based entirely on the judgment of the Federal Court of Appeal in Canadian Industries Limited v The Queen, [1980] 2 FC 463; [1980] CTC 222; 80 DTC 6163, hereafter CIL. The plaintiff distinguishes this case on its facts from CIL.

The plaintiff is a manufacturing company serving primarily the electrical utility, industrial, commercial and consumer markets. Beginning around 1952, it became actively involved in engineering and manufacturing components for the Candu nuclear reactor.

As far as the evidence extends the generation of electricity by nuclear reactors involves two alternative combinations of essential material: either enriched uranium with ordinary water or natural uranium with heavy water. Heavy water, deuterium oxide (D,0), is a naturally occurring substance. It is found in “ordinary” water in a proportion of about one part in 7000. It occurs in a higher proportion in salt water than in fresh water. Heavy water is not manufactured; it is separated from the ordinary water. That is what a heavy water plant does. The Candu reactor uses natural uranium and heavy water; its economic viability depends upon the availability of substantial quantities of cheap heavy water. “Substantial” and “cheap” are, of course, relative terms.

Atomic energy in Canada is entirely subject, in all its aspects, to the control and supervision of federal authorities under the Atomic Energy Control Act, RSC 1970, c A-19. Canada has elected to base its nuclear energy development exclusively on the Candu reactor. Heavy water is a prescribed substance under the Act. AECL is incorporated under authority of the Act and exercises and performs powers conferred by it. For all material purposes, the production, possession and marketing of heavy water have been fully regulated by AECL and the Atomic Energy Control Board, hereafter the “Board”, at all times.

Under contract with AECL, the plaintiff built a prototype nuclear power plant at Rolphton, Ontario, which became operational early in the 19603. It was successful. The plaintiff developed experience and an organization and expected to be asked to build additional power plants but it was disappointed. The decision to build commercial plants was taken by Ontario Hydro. It decided that there was room for only one builder in the Ontario market and, being unwilling to tie itself to a single contractor, decided to build the plants itself under licence from AECL. Since Rolphton, no nuclear power plants have been built by the private sector. AECL and Ontario Hydro have cooperated closely in the commercial development of the Candu program in Canada. At times material to this action, the president of Ontario Hydro was a director of AECL.

The heavy water for the Rolphton plant was purchased from a plant at Savannah River, South Carolina, the only available source, which could not supply the quantities needed beyond the pilot plant stage. The decision of AECL and Ontario Hydro to proceed with commercial nuclear power plants implied a decision to build heavy water plants. AECL called tenders; the plaintiff did not bid and a contract was entered into with Deuterium Canada Ltd to build a 200 ton per year plant, utilizing salt water, at Glace Bay, NS. It soon appeared that this capacity would be inadequate and the plaintiff was approached and agreed to build a 400 ton per year plant, utilizing fresh water, at Port Hawkesbury, NS. The proposed capacity of the Glace Bay plant was, at the same time, doubled. The contract entered into in early 1966 with AECL obliged the plaintiff to build the plant, own and operate it, and to sell the production to AECL on a long term, firm price contract. Having been disappointed in its plans for building nuclear power plants, the plaintiff obtained a right of first refusal from AECL to build future heavy water plants.

The plaintiff contacted The Lummus Company, which had built and was operating the Savannah River plant for the US Atomic Energy Commission. It and its Canadian subsidiary are collectively hereafter called “Lummus”. Lummus contracted to participate in the design, engineering and construction of the Port Hawkesbury plant. The agreement provided that all technical data generated would become the plaintiff’s property and for the joint promotion oif the use of the processes, know-how and technical information developed and for the licensing of the same to third parties. Any such licence was to carry with it a non-exlusive licence under the plaintiff’s pertinent patents. While it was hoped that any third party would avail itself of the services of both the plaintiff and Lummus, the agreement contemplated the possibility of licensing a third party willing to deal with only one of them. No licences were, in fact, ever granted pursuant to this arrangement; it is relevant only as evidence of the plaintiff’s intentions prior to the transaction in issue.

By the summer of 1968, two crucial events had occurred. Ontario Hydro had determined to further expand its nuclear power capacity and the Glace Bay heavy water plant was recognized as a probable failure. Substantial additional heavy water production was urgently needed. AECL saw the commercial future of the Candu program depending on its supply. At first, Ontario Hydro considered undertaking construction of the additional heavy water production in conjunction with its nuclear power plants but AECL decided to assume that responsibility. The additional heavy water production was, however, to be physically located with the nuclear power plants as their excess steam would provide a power source for the heavy water production much cheaper than any available alternative.

AECL offered the plaintiff the opportunity to build and own the new heavy water facilities as obliged under the first refusal. The Port Hawkesbury plant was nearing completion but had yet to be commissioned. The plaintiff’s investment at Port Hawkesbury represented some 52% of its investment in fixed assets and an amount equal to about a quarter of its equity. Having regard to the investment required, it was out of the question, from a business point of view, for the plaintiff to make the additional commitment before it was certain that the Port Hawkesbury plant would work and be profitable. The plaintiff was not in a position to exercise its right of first refusal within the necessary time frame.

Unknown to the plaintiff, Lummus had been working directly with Ontario Hydro prior to the plaintiff being offered the opportunity to exercise its right of first refusal. While nothing turns on that, it may explain why Lummus was left out of the deal when the plaintiff sold the know-how to AECL. Lummus apparently was going to have the opportunity to cash in on its know-how in any event.

So much for the background to the transaction that gave rise to the receipt in issue. The plaintiff had gone into the Port Hawkesbury project with the clear expectation that heavy water production would prove an expanding business opportunity to someone in on the ground floor. An obvious avenue for realization of the business opportunity was the licensing of the know-how generated; another obvious avenue was the construction and operation of additional production facilities for its own account. As to the first avenue, Lummus was obviously going to possess a good deal of the know how in fact and it was prudent to agree on a basis for a joint exploration of it. The plaintiff’s first opportunity to pursue the latter avenue came too soon and it had, for compelling business reasons, to pass it up.

Ontario Hydro had been, was and remains the plaintiff’s largest single customer. AECL was the sole market for the output of its largest capital investment and, between them, AECL and the Board had complete regulatory authority over any use which might be made of the inventions and know-how. Ontario Hydro and AECL wanted AECL to have use of the inventions and know-how. The evidence is that the licensing agreement permitted AECL to bring its heavy water plant to production two years earlier than would otherwise have been possible. The plaintiff felt, and I am entirely satisfied on the evidence, correctly so, that it had no real choice but to sell it. The plaintiff also felt, and events have proved it correct to date, that the decision of AECL to undertake production of heavy water for its own account marked the end of that business opportunity in Canada, just as the decision of Ontario Hydro to build its own nuclear power plants had marked the end of private sector opportunities in that area. The plaintiff’s traditional market for equipment remained but its opportunity to build, own and operate additional plants in Canada was foreclosed. Some years later, the Port Hawkesbury plant was sold to AECL and the payment in issue was taken into account in determining the price. The Glace Bay plant was also bought by AECL and completely rebuilt to utilize fresh water. The original plant never produced. Today, AECL is the sole producer of heavy water in Canada.

The plaintiff does license its patents to third parties on occasion. In the area of household appliances, there is a great deal of cross licensing between manufacturers. This is not an important revenue consideration but, rather, it is an important measure to avoid constantly suing and being sued. The plaintiff did, prior to the transaction in issue, at the request of AECL, sell certain of its reactor know-how to French and Italian public atomic energy authorities. It was reactor, not heavy water, know-how; the consideration was nominal in the context of the plaintiff’s overall sales revenue, a total of $159,500 for the know-how. The plaintiff’s revenues from fees for licensing patents has, over the past ten years, run between $500,000 and $800,000 per annum, about 0.01% of its revenue. About half of that revenue derived from one license involving a patent for wire wrapping insulation.

By agreement dated as of November 18, 1968, the plaintiff agreed to provide AECL with drawings and specifications, technical information as to the procurement and cost of materials and equipment, and advice and information with respect to commissioning and operating expenses of the Port Hawkesbury plant, herein the “know-how”, and also granted AECL a non- exclusve, worldwide, licence respecting the inventions subject of certain Canadian patent applications pending and proposed, in consideration of the lump sum of $1,500,000, unrelated to the extent of use, payable in prescribed instalments. $750,000 was received in the plaintiff’s 1968 taxation year and is subject of this action. $250,000 was received in its 1971 taxation year and is* [1] subject of action No T-3094-76, which was tried on common evidence with this action. The balance was received in the plaintiff’s 1974 taxation year and is subject of an assessment that remains open pending disposition of the present actions.

It is entirely appropriate to characterize the know-how in issue here as “a capital asset analogous to patent rights”. In that circumstance, it is of no import that the licensing agreement did not allocate the consideration as between know-how and licences under the patents and that there is no evidence upon which such an allocation could be made.

CIL analysed exhaustively the British judgments on this issue including those to which the plaintiff made particular reference: British Dyestuffs v CIR, 12 TC 586; Handley Page v Butterworth, 19 TC 328; Evans Medical Supplies v Moriarty, 37 TC 540; Jeffrey v Rolls-Royce, Ltd, 40 TC 443; and Wolf Electric Tools Ltd v Wilson, 45 TC 326. The analysis confirms the fundamental validity of the principle enunciated by Lord Pearce in BP Australia Ltd v Commissioner of Taxation, [1966] AC 224 at 264ff:

The solution to the problem is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so Clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer. Although the categories of capital and income expenditure are distinct and easily ascertainable in obvious cases that lie far from the boundary, the line of distinction is often hard to draw in border line cases; and conflicting considerations may produce a situation where the answer turns on questions of emphasis and degree. . .. As each new case comes to be argued felicitous phrases from earlier judgments are used in argument by one side and the other. But those phrases are not the deciding factor, nor are they of unlimited application. They merely crystallise particular factors which may incline the scale in a particular case after a balance of all the considerations has been taken.

That principle was cited with approval in MNR v Algoma Central Railway, [1968] SCR 447; [1968] CTC 161; 68 DTC 5096.

The essential question in CIL was identified, at page 486, as being:

Does the evidence show that CIL lost its business for military TNT with the United States Government as a direct and necessary result of entering into the License Agreement?

The essential question here cannot be so stated because, in this case, the effect of the decisions by AECL and Ontario Hydro to demand, when they did, additional heavy water production was to eliminate, de facto, the plaintiff’s opportunity to make further use, in Canada, of the inventions and know-how generated in the design, construction and commissioning of the Port Hawkesbury plant. Those decision antedated the offer to buy the knowhow and licences. The plaintiff had not undertaken the Port Hawkesbury plant with a view to building and operating only it. It had seen a golden opportunity to build and operate other plants if it built the first one and it saw that opportunity disappear with the Ontario Hydro and AECL decisions. The essential question here is not whether the plaintiff lost a particular business as a result of entering into the licensing agreement; it lost none of the business attaching directly to the Port Hawkesbury plant and it had already lost the opportunity to engage in that business elsewhere in Canada.

The facts peculiar to this case distinguish it from CIL and from the other authorities considered in C/L. While the plaintiff does grant licences of its patents in the ordinary course of its business and does, on occasion, sell its know-how, this transaction was not in the ordinary course of its business. Neither was it an adventure in the nature of trade. It was not undertaken with a view to realizing a profit. Rather it was essentially a salvage operation, a realization of a capital asset which, in the circumstances, was of considerable immediate value to AECL and of no apparent future value to the plaintiff in the Canadian market.

The payment in issue was received by the plaintiff on account of capital. Its action succeeds. It is entitled to costs.