Phénix v. R., [1998] 1 CTC 2379, 98 DTC 1524

Archambault T.C.J. :

Robert Phénix is challenging an income tax assessment notice established by the Minister of National Revenue (Minister) for the 1987 taxation year. The Minister disallowed the deduction of part of the amount claimed by Mr. Phénix as Canadian exploration expenses (CEEs) and as the mining exploration depletion deduction (MEDD). As the amount of the MEDD depends entirely here on the amount of the CEEs which Mr. Phénix can deduct, the issue turns solely on the eligibility of the expenses deducted as CEEs.

In support of the Minister’s assessment the respondent argued that the greater part of the disallowed amount represented the cost of purchasing depreciable property which was not CEEs within the meaning of s. 66.1(6)(a) of the Income Tax Act (the Acf) [1] and that the remainder represents fictitious rental or expenses not incurred. In his appeal Mr. Phénix made several arguments. Essentially, he contended that the cost of purchasing equipment necessary for mining exploration constitutes CEEs. Additionally, certain expenses treated as purchase costs by the Minister were actually rental.

Facts

Legal structure of exploration program

On December 31, 1987 Mr. Phénix was a member of the Société en commandite Radisson (the limited partnership). It was registered as a limited partnership under the laws of the province of Quebec on June 15, 1987. The general partner was Ressources minières Radisson Inc. (Radisson), which was created pursuant to the Canada Business Corporations Act on September 23, 1983. Its head office and principal place of business were located at Rouyn-Noranda, Quebec.

On September 1, 1987 the limited partnership entered into a share subscription agreement with Radisson whereby the limited partnership was to subscribe to flow-through shares of Radisson. Under the terms of that agreement Radisson was to incur CEEs in an amount equal to the proceeds of the flow-through share subscription and renounce these CEEs to the limited partnership by March 30, 1988 at the latest. Radisson undertook to renounce CEEs eligible for the MEDD to be incurred by it between September 1, 1987 and February 29, 1988 (the relevant period) in respect of a mining property (the Duquesne property) in which it held an interest. The primary activity of the limited partnership was the financing of Radisson’s exploration and development work on the Duquesne property in accordance with the provisions of the share subscription agreement.

On October 13, 1987 the limited partnership and Radisson made an initial public offering by means of a prospectus (the prospectus). The firm of Lévesque Beaubien acted as the securities broker. In the prospectus it is stated that Radisson’s activities since its creation had been concerned with acquiring mining properties and with mining exploration. For its future plans, Radisson intended to make the mining exploration and development of its properties its primary activities. At the date of the prospectus Radisson owned no mines and held no interest in an operating mine.

The prospectus described the promoters and managers of Radisson. Among the latter were Julien Gadoury, Jean-Marie Dupont, Guy Bourrassa and Gilles Rocheleau. Mr. Gadoury, a geologist, was president and director: he devoted 100 per cent of his time to Radisson’s affairs. Jean-Marie Dupont was vice-president and director, spending about 50 per cent of his time on Radisson’s activities; he was also the president of Pétroles J.-M. Dupont Inc. Guy Bourrassa was secretary and director: he acted as legal counsel both for Radisson and for the limited partnership. As he was a member of the law firm Bourrassa, Provencher, Barrette of Rouyn-Noranda, he spent less than 50 per cent of his time on Radisson’s affairs. Gilles Rocheleau acted as the full-time financial comptroller of Radisson from April 1987 onwards. The prospectus also described Messrs. Gadoury and Dupont as promoters of Radisson as they had taken the initiative in organizing it.

The prospectus indicated that on October 9, 1987 CDS & Co. held 50.9 per cent of the issued shares of Radisson. It has not been shown by the evidence who were the principal shareholders of CDS & Co.

Duquesne property, Duquesne shares and the “surface plant”

Under an agreement (the Radisson agreement) entered into on April 7, 1987 Radisson was entitled to acquire a 25 per cent interest in the Duquesne property owned by Duquesne Gold Mines Ltd. (Duquesne). To obtain this undivided interest Radisson had to invest the sum of $6,000,000 in exploration and development work on this property before May 19, 1989, $3,000,000 of which was to be before May 19, 1988.

Also a party to the Radisson agreement was Mark G. Smerchansky, who as a representative of all the Duquesne shareholders granted Radisson options to purchase 89 per cent of the Duquesne shares for $3 a share. These options were only valid if Radisson exercised its option to acquire a 25 per cent undivided interest in the Duquesne property.

Though it stated that this was a “firm and binding” agreement, the Radisson agreement specified that a formal agreement would be drawn up later. This formal agreement (the Radisson formal agreement) was signed on November 25, 1987.

Reference was also made in the Radisson agreement to another agreement (the Rupert agreement) entered into on the same day, namely April 7, 1987, whereby Exploration Rupert Inc. (Rupert) purchased a “surface plant” from Eldorado Gold Mines Inc. (Eldorado), a company in the Smerchansky group. [2] Eldorado was to install this “surface plant” on the Duquesne property and Rupert was to rent it to Radisson. The terms used to describe this purchase were as follows:

Purchase and sale of Plant:

We hereby sell to you and you hereby purchase from us the Plant, particulars of the constituent parts thereof being described in Schedule II annexed.

The following description of the “surface plant” is found in Schedule II of the Rupert agreement:

Hoist - Ingersoll Rand Size 5 ft.>< 4 ft. double drum with necessary cable.

Wooden head frame with center line of sheave wheel 82 feet above collar of shaft conforming to the shaft size of 4 ft. 6 in. x 5 ft. 8 in. Safety doors at shaft collar.

Compressor - 1050 C.F.M. electric - 100 PSI.

Air receiver 23 ft. x 3 ft. 6 in. diameter connected to the compressor.

All necessary 6 in. piping and valves from receiver to collar of shaft.

ATCO hoist building 40 ft. x 60 ft. with 14 ft. side walls. Concrete floor surrounding hoist area, leaving balance of area for storage of heavy equipment.

Electrical cable and connections not in excess of 100 feet from distribution board.

The Rupert agreement also granted Rupert the right to purchase [TRANSLATION] “a portable mill” with a capacity of 200 tons a day. The price for the “surface plant” and the “mill” was set at $2,510,000, payable in 24 monthly installments calculated as follows:

The Rupert agreement stated that Rupert could cease making the monthly payments after ten payments. Mr. Bourrassa, who negotiated this agreement, confirmed that the first ten payments corresponded to the price of the “surface plant”. The cost of these facilities was thus $750,000. The Rupert agreement also provided that Radisson guaranteed the payment of the purchase price of the “surface plant” acquired by Rupert.

In the case of the Rupert agreement Mr. Smerchansky intervened, as representative of all the Duquesne shareholders, to sell Rupert 11 per cent of the Duquesne shares, that is 166,667 shares, for $500,000 payable as follows: $100,000 on signature of the Rupert agreement, $150,000 at the time the “surface plant” was installed and $250,000 within three months of the date of installation of the “surface plant”. The Radisson agreement defined the installation date as the date on which the head frame was to be installed. That agreement stated that even after the shares had been paid for in full Mr. Smerchansky would still exercise the voting rights attached thereto so long as Radisson had not exercised its options to acquire all the other Duquesne shares. Mr. Smerchansky’s voting rights were conditional, as they were subject to any agreement entered into with Radisson.

On May 12, 1987 the Rupert agreement was amended (the amended Rupert agreement) to change the size of the hoist: 5' x 4’ instead of 4’ x 3’. Additionally, the monthly payments for the first five months were increased to $78,933 a month, making a total of $394,865 for the first five months, which increased the total price of the “surface plant” to $894,665.

A lease (the Rupert-Radisson lease) dated May 18, 1987, whereby Rupert purported to lease the “surface plant” to Radisson for a period of “ten months” beginning on May 19, 1987 and ending on February 19, 1988, was filed at the hearing. There is an error here since there were only nine months between those two dates. The monthly rental was $150,000, which would give a total rental of $1,500,00 if the actual duration was ten months, and $1,350,000 if the duration was nine months. Radisson could renew the lease for further six-month periods at a rental of $10,000 a month. Radisson was responsible for maintaining the “surface plant”. Furthermore, Rupert was responsible for removing the “surface plant” from the Duquesne property within 30 days of termination of the lease, otherwise it became the absolute property of Radisson without compensation of any kind. The lease was only subject to one condition, namely its approval by the Montréal stock exchange. Guy Bourrassa signed this document on behalf of Rupert and Mr. Gadoury did so for Radisson.

A copy of Rupert’s certificate of incorporation dated April 3, 1986 was filed. Mr. Jean-Marie Dupont is described therein as the incorporator and sole director. When Mr. Bourrassa was asked the name of Rupert’s shareholder, he answered that he did not know. He also did not know whether Rupert had prepared financial statements or had filed tax returns with the tax authorities. When he was shown certificate No. 001 issued to Jean- Marie Dupont on April 14, 1986, mentioning the transfer made to Mr. Bourrassa on February 1, 1987, he admitted he had been Rupert’s shareholder from that time onwards. The prospectus also indicated that on October 13, 1987 Mr. Bourrassa was Rupert’s sole shareholder and manager.

Ginette Branchaud, a representative of the Minister, indicated at the hearing that when in December 1990 she asked Jean-Marie Dupont if Rupert would file a tax return for the 1989 taxation year, he told her that the company [TRANSLATION] “had never been in operation nor had any assets”. Ms. Branchaud produced a Rupert tax return dated March 18, 1987 in which Gilles Rocheleau stated that the main activity of the business was mining exploration and that Messrs. Dupont and Gadoury each held 50 per cent of Rupert’s shares. The return indicated that it was for the taxation year ending April 3, 1986, which was the day on which Rupert was incorporated. Attached to this return was an opening balance sheet at April 3, 1986 showing assets and capital stock of $10. In an excerpt from the Gazette officielle du Québec dated December 15, 1990 there is a notice stating that Rupert will be dissolved in 30 days from publication of the notice for failure to file annual reports for 1987 to 1990.

It seems that during the summer of 1987 counsel for Lévesque Beaubien Inc. learned of certain problems regarding the eligibility as CEEs of the alleged rental owed by Radisson to Rupert under the Rupert-Radisson lease. Mr. Bourrassa therefore asked Jacques Lévesque of Maheu Noiseux, Radisson’s chartered accountants, to submit to the Minister a request for an advance ruling on certain tax consequences of the lease. On September 28, 1987 Mr. Bourrassa, as Radisson’s agent, signed a power of attorney authorizing Mr. Lévesque to submit this request. In his letter Mr. Lévesque asked the Minister to confirm inter alia that the monthly rental of $150,000 paid for a period of ten months was CEEs within the meaning of s. 66.1 (6)(a) of the Act, provided Radisson was dealing with Rupert at arm’s length. He also asked the Minister to confirm in particular that the rental was not a “Canadian exploration and development overhead expense” (CEDOE) within the meaning of s. 1206 of the Income Tax Regulations (the Regulations).

A representative of the Minister requested particulars and Mr. Lévesque confirmed in a letter of November 26, 1987 that the Rupert-Radisson lease had not yet been signed but was to be signed on December 15, 1987: the lease was to begin on that date and end on September 15, 1988. [3] Mr. Lévesque said he obtained this information from Mr. Bourrassa.

On the same day, November 26, 1987, Mr. Smerchansky for Duquesne and Mr. Daniels for Eldorado agreed to amend the Rupert agreement to relieve Radisson of its obligations as a guarantee. At that date the sum of $300,000 was still owing to Eldorado for the “surface plant”. The amendment stated the following:

By this modification the parties agree that Radisson is not a party anymore to the plant agreement and Eldorado hereby acknowledges that as of this date no payments by Rupert are due and that Radisson has no obligations of whatever nature in connection with the plant agreement.

In December 1987 there was little reason to hope for favourable decisions from the advance rulings division. On December 10, 1987 it was apparently decided to amend the Rupert-Radisson lease. I note that Eldorado was not a party to this agreement. The following clause was apparently added:

[TRANSLATION]

If Radisson does not obtain an advance ruling clearly establishing that the rental payable to Rupert qualifies as Canadian exploration expenses (CEEs) and so qualifies for the mining exploration depletion deduction (MEDD), Radisson may terminate the agreement and lease the surface plant directly from Eldorado Gold Mines Inc. Rupert hereby undertakes to agree that money paid to it as of that date as rental shall be treated as paid to Eldorado by Radisson.

On December 21, 1987 the issuing of shares in the limited partnership was closed. The Minister’s representative informed Mr. Lévesque the same day by telephone that her Department could not make the rulings requested. In a letter of December 21, 1987 the director of the bilingual services and resource exploitation industries division gave reasons for this decision. The Department was unsure whether the monthly payments of $150,000 were strictly rental, were payment for other services or were payment for the purchase of depreciable capital property. Several questions of fact arose, in particular whether Rupert and Radisson were dealing at arm’s length. It was also mentioned in that letter that certain information had not been provided, such as a full list of Eldorado’s shareholders and the identity of the general partner.

As may well be imagined, this decision by the Department created a serious problem when the issue closed. According to Mr. Lévesque, counsel for the broker told him that the amount subscribed for the flow-through shares would be reduced to take into account the fact that a large expense amount could not be renounced. Contrary to this assertion made to Mr. Lévesque, the amount of the issue was apparently not altered. Moreover, Radisson and Eldorado apparently signed a new lease (the Eldorado-Radisson lease) on February 27, 1988 taking effect as of May 19, 1987. In view of the importance of this contract, I reproduce it in full.

Considering that Rupert has signed an agreement with Eldorado to acquire a surface mining plant (the “surface plant”) as described in schedule “A”;

Considering that Rupert has rented to Radisson the surface plant subject to obtaining a positive advanced tax ruling on the rental by Radisson from Rupert;

Considering that Radisson was not able to obtain such tax ruling;

Considering that Radisson wants to rent the surface plant from Eldorado and that Eldorado is interested to rent the surface plant to Radisson;

The Parties Convene as Follows:

1. Eldorado hereby rents to Radisson the surface plant described in schedule “A” attached hereto for the following considerations:

	1.1	This rental agreement is consented for a period of ten years
		from May 19, 1987 to May 19, 1997.
	1.2	A sum of $125,000 per month for the period beginning on May
		19, 1987 to February 19, 1988.
		A sum of $1,000 per year for the rest of the agreement payable
		every February 19 starting February 19, 1989.
	1.3	Radisson may move or transport the surface plant at its own
		discretion anywhere during this agreement.
	1.4	At the end of this agreement, Eldorado will have to take back
		the surface plant at its own expense in the condition it will be at
		that time.
	1.5	Radisson has the right to sublet the surface plant at its own dis
		cretion during this agreement.
	1.6	Radisson will have the right to review [sic] this agreement for
		another period of ten years for the same conditions.
2.	All payments made by Rupert to Eldorado since May 19, 1987 will be
	considered as payments for the renting of the surface plant for the bene
	fit of Radisson.
3.	Radisson commits itself to take and maintain in force a responsibility
	insurance and will assume all responsibility in relation with the surface
	plant during the term of this agreement.

4. It is understood and agreed by the parties that the present is a rental agreement and should not be interpreted as an option to buy or a purchase agreement or any other kind of agreement.

5. Eldorado can sell the surface plant without Radisson’s consent.

6. This agreement shall be construed and interpreted in accordance with the laws of the Province of Quebec.

Signed at Rouyn-Noranda the 27th of February, 1988.

ELDORADO GOLD MINES INC.

Per:

Radisson Mining Resources Inc.

Exploration Rupert Inc.

On May 15, 1988 Radisson acquired the 166,660 shares of Duquesne from Rupert for $500,000. On April 6, 1989 Radisson acquired from the Duquesne shareholders all the other outstanding shares in Duquesne, that is 1,401,333 shares. Duquesne thus became a wholly-owned subsidiary of Radisson in April 1989.

Exploration program

The Duquesne property is an old mine discovered in the first decade of this century. The mine was abandoned after producing for some years, from 1949 to 1952. The prospectus contained a description of Radisson’s exploration program. The program was in two stages: the first underground and the second on the surface. Costs were estimated as follows: $243,000 for site preparation expenses, $1,512,000 for installing surface infrastructure, described as rental expenses (except for the sum of $202,000), $3,210,000 for underground exploration expenses and $475,000 for surface exploration expenses.

It would appear that installation of the “surface plant” was completed on May 19, 1987 and that the exploration work on the Duquesne property began on that date. [4] Radisson allegedly renounced CEEs totalling $420,000, which allegedly represented rental for use of the “surface plant” for the period beginning May 20, 1987 and ending August 31, 1987, to four other limited partnerships (the CMP group). There is a note in the Radisson financial statements at August 31, 1987 in which it is indicated that it leased equipment for $420,000 [TRANSLATION] “from a company in which the shareholder is one of the Radisson directors”. As to the alleged rental for the “surface plant” for the period from September 1, 1987 to February 29, 1988, Radisson renounced this expense representing the sum of $750,000 to the limited partnership.

Radisson’s exploration activities did not succeed in discovering a large enough deposit to warrant moving on to commercial production. The site where the “surface plant” was installed was abandoned and, at the time of the hearing, Radisson was thinking of dismantling the facilities located there.

Points at Issue

The amount of Mr. Phénix’s CEEs which the Minister refused to recognize as such was only $1,595, that is the share of the CEEs incurred by the limited partnership which accrued to him as limited partner. However, the amount for the limited partnership was $1,529,488. The greater part of the amount disallowed was the cost of acquiring exploration equipment, a cost which the respondent considered did not represent CEEs. So far as the “surface plant” was concerned, the respondent submitted that the sum of $750,000 which Radisson renounced to the limited partnership was not rental but in reality was partly its cost and partly fictitious rental. Finally, the last part of the amount disallowed was expenses not incurred by Radisson and Mr. Phénix’s counsel told the Court that he was not challenging the Minister’s refusal to deduct those expenses.

The following is a breakdown of the total expenses renounced by Radisson to the limited partnership and disallowed by the Minister as CEEs, Mr. Phénix’s position before this Court is also set out:

Notes:

The respondent did not dispute that Radisson’s activities on the Duquesne property constituted exploration work. She admitted that the property the cost of which the Minister disallowed as CEEs was used by Radisson in its exploration program and was necessary to the program; however, she also maintained that a large part of that property could have been used in developing the mine and operating it. She contended that the property was depreciable property the cost of which should be added to the un- depreciated capital cost, and not as CEEs to the cumulative Canadian exploration expenses (CCEE).

Respondent’s Position

The principal legal question raised by this appeal is whether the cost of equipment acquired to do exploration work constitutes CEEs. The relevant provision is s. 66.1(6)(a) of the Act, which reads as follows:

66.1 (6)(a) “Canadian exploration expense” of a taxpayer means any expense incurred after May 6, 1974 that is

(iii) any expense incurred by him (other than an expense incurred in drilling or completing an oil or gas well or in building a temporary access road to, or preparing a site in respect of, any such well) for the purpose of determining the existence, location, extent or quality of a mineral resource in Canada including any expense incurred in the course of

A) prospecting,

(B) carrying out geological, geophysical or geochemical surveys;

(C) drilling by rotary, diamond, percussion or other methods, or

(D) trenching, digging test pits and preliminary sampling,

but not including

(E) any Canadian development expense, or

(F) any expense that may reasonably be considered to be related to a mine that has come into production in reasonable commercial quantities or to be related to a potential or actual extension thereof,

(11.1) any expenses incurred by him after November 16, 1978 for the purpose of bringing a new mine in a mineral resource in Canada into production in reasonable commercial quantities and incurred before the coming into production of the new mine, including

(A) clearing, removing overburden and stripping, and

(B) sinking a mine shaft, constructing an adit or other underground entry,

but, for greater certainty, shall not include

(vi) any consideration given by the taxpayer for any share or any interest therein or right thereto, except as provided by subparagraph (v), or

(vii) any expense described in subparagraph (v) incurred by any other taxpayer to the extent that the expense was,

(A) by virtue of that subparagraph, a Canadian exploration expense of that other taxpayer,

(B) by virtue of subparagraph 66.2(5)(a)(v), a Canadian development expense of that other taxpayer, or

(C) by virtue of subparagraph 66.4(5)(a)(iii), a Canadian oil and gas property expense of that other taxpayer,

but any assistance that a taxpayer has received or is entitled to receive after May 25, 1976 in respect of or related to his Canadian exploration expense shall not reduce the amount of any of the expenses decribed in any of subparagraphs (i) to (v);

66.1(6)a) «frais d’exploration au Canada» d’un contribuable s’entend des dépenses suivantes engagées après le 6 mai 1974:

(iii) une dépense engagée par le contribuable (à l’exception d’une dépense engagée pour le forage ou l’achèvement d’un puits de pétrole ou de gaz, la construction d’une route d’accès temporaire au puits ou la préparation d’un emplacement pour le puits) en vue de déterminer l’existence, la localisation, l’étendue ou la qualité d’une ressource minérale au Canada, y compris

(A) les frais de prospection,

(B) les frais d’études géologiques, géophysiques ou géochimiques,

(C) les frais de forage au moyen d’un appareil rotatif ou à diamant, par battage ou d’autres méthodes, ou

(D) les frais de creusage de tranchées, de creusage de trous d’exploration et d’échantillonnage préliminaire,

à l’exclusion

(E) des frais d’aménagement au Canada, ou

(F) d’une dépense qu’il est raisonnable de considérer comme rattachée soit à une mine qui a commencé à produire des quantités commerciales raisonnables, soit à un prolongement potentiel ou réel de cette mine,

(111.1) une dépense engagée par le contribuable après le 16 novembre 1978 en vue d’amener une nouvelle mine de ressources minérales au Canada au stade de la production en quantités commerciales raisonnables, mais avant que cette nouvelle mine ne commence cette production, y compris

(A) les frais de déblaiement, d’enlèvement des terrains de couverture et de dépouillement,

(B) les frais de creusage d’un puits de mine, la construction d’une galerie à flanc de coteau ou d’une autre entrée souterraine,

il est entendu toutefois que sont exclues

(vi) une contrepartie donnée par le contribuable pour une action ou un droit y afférent, sauf dans le cas prévu au sous-alinéa (v),

(vii) une dépense visée au sous-alinéa (v) et engagée par un autre contribuable dans la mesure ou cette dépense consistait, selon le cas, en

(A) frais d’exploration au Canada engagés par cet autre contribuable, en vertu de ce sous-alinéa,

(B) frais d’aménagement au Canada engagés par cet autre contribuable, en vertu du sous-alinéa 66.2(5)a)(v),

(C) frais à l’égard de biens canadiens relatifs au pétrole et au gaz engagés par cet autre contribuable, en vertu du sous-alinéa 66.4(5)a)(iii);

cependant, aucun montant à titre d’aide qu’un contribuable a reçu ou est en droit de recevoir après le 25 mai 1976 concernant ses frais d’exploration au Canada ou s’y rapportant ne peut réduire une dépense visée à l’un des sous-alinéas (i) à (v);

[My emphasis.]

Counsel for the respondent claimed that the cost of exploration equipment is not CEEs but instead the cost of depreciable capital property covered by s. 20(1)(a) of the Act. In support of her claim she submitted a very detailed analysis. I will summarize her main arguments.

To begin with, she referred to the modern rule of construction adopted by the Supreme Court in Stubart Investments Ltd. v. R., [1984] 1 S.C.R. 536 (S.C.C.), at 578, namely the rule of interpretation stated by Prof. Driedger in his text titled Construction of Statutes (2d ed., 1983, at p. 87), which deals with statutory construction:

[TRANSLATION]

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.

Counsel for the respondent argued that the word “expense” should be construed not literally but in its context, that is, taking into account the provision of which it is a part and [TRANSLATION] “the legislative intent ... indicated by the provisions of the Act authorizing the exploration expense deduction and the provisions of the regulations authorizing the mining exploration depletion deduction”. [5]

Although the list of expenses appearing in s. 66.1 (6)(a)(iii)(A) to (D) and (111.1)(A) and (B) of the Act is not exhaustive, counsel for the respondent noted that these are expenses for [TRANSLATION] “work or surveys”, not for [TRANSLATION] “the acquisition of property”. [6] In accordance with the noscitur a sociis rule, therefore, the word “expense” does not have a broad enough meaning to include the cost of acquiring exploration equipment.

When Parliament intends to allow a deduction for the cost of acquiring property, it says so clearly. She cited in particular the definition of Canadian development expenses (CDEs) and the wording of the definition of “earned depletion base” found in s. 1205( 1 )(a)(vi) of the Regulations. In the definition of CDEs, the reference is not only to expenses but costs as well. However, such costs include only the costs of “Canadian resource property”, that is, the cost of acquiring mining property or mining interests. Section 1205( 1 )(a)(vi)(B. 1 ) and (C) of the Regulations speaks of CEES and of expenses representing the capital cost of tertiary recovery equipment. [7] Counsel for the respondent therefore maintained that the CEEs do not include the capital cost of tangible property.

She argued that the ordinary meaning of the word “expense” is also limited by the type of expense which is part of the CEEs contemplated by the definition of CEDOE. This definition is relevant for the purposes of this appeal in that, under s. 66(12.6)(/?), [8] Radisson could not renounce CEEs which were CEDOEs. The following definition of CEDOEs is found in s. 1206(1) of the Regulations:

“Canadian exploration and development overhead expense” of a taxpayer means a Canadian exploration expense or a Canadian development expense of the taxpayer made or incurred after 1980

(a) that was in respect of the administration, management or financing of the taxpayer,

(b) that was in respect of the salary, wages or other remuneration or related benefits paid in respect of a person employed by the taxpayer whose duties were not all or substantially all directed towards exploration or development activities,

(c) that was in respect of the upkeep or maintenance of, taxes or insurance in respect of, or rental or leasing of, property other than property all or substantially all of the use of which by the taxpayer was for the purposes of exploration or development activities, or

(d) that may reasonably be regarded as having been in respect of

(i) the use of or the right to use any property in which any person who was connected with the taxpayer had an interest,

(ii) compensation for the performance of a service for the benefit of the taxpayer by any person who was connected with the taxpayer, or

(iii) the acquisition of any materials, parts or supplies from any per- . son who was connected with the taxpayer

to the extent that the expense exceeds the least of amounts, each of which was the aggregate of the costs incurred by a person who was connected with the taxpayer

(iv) in respect of the property,

(v) in respect of the performance of the service, or

(vi) in respect of the materials, parts or supplies;

[My emphasis.]

In the submission of counsel for the respondent, it can be inferred from this definition that the CEDOEs include taxes and maintenance, insurance or rental expenses concerning property other than that used solely, or almost solely, for exploration activities, but does not include the cost of acquiring the said property. She recognized that under para. (d)(iii) and (vi) of the definition, the cost of acquiring materials, parts and supplies can form part of CEEs. However, she argued that the property in question is in the nature of property [TRANSLATION] “consumed” in the exploration process. In her submission, only [TRANSLATION] “current” expenses (current expenses), Such as rental expenses, labour costs, maintenance costs and the cost of property “consumed” — and not “capital expenses” (capital expenses), namely those concerning the cost of “unconsumed” property, such as exploration equipment which can be re-used on another site, or on the same site but in putting the mine into production — are taken into account in calculating CEEs.

She argued that under s. 3 of the Act [9] the correct procedure is to determine first the aggregate of business income of a partnership under para. (a) of that section. It is not until the second stage that one must take into ac- count deductions mentioned in s. 3(c), namely those found in subdivision e of the Act, [10] and only if they have not already been taken into account by the application of subdivision b of the Act. [11]

Subdivision b of the Act contains s. 9(1), which authorizes the deduction of expenses in accordance with well-established business principles. According to counsel for the respondent, the accounting practice is that exploration expenses that would otherwise be current expenses are not shown in the income statement because of the principle of matching income and expenditure. [12] They are instead capitalized until the mine is in production or abandoned. In the submission of counsel for the respondent subdivision e of the Act corrects this situation by permitting CEEs to be deducted immedi- ately, as an exception to the principle of matching income and expenditure not only over time but also by income source. [13]

As s. 20(1 )(a) of subdivision b of the Act expressly authorizes a deduction for depreciation on the capital cost of exploration equipment, there is no need to go to subdivision e. The latter only applies to amounts which would not otherwise be deductible in computing income from a business or property. Section 20(1)(a) of the Act thus takes precedence over the provisions of subdivision e.

Furthermore, s. 66.1(2) and (3) of the Act, which provides for the deduction of CEEs, only provides for exceptions to s. 18(1)(b) of the Act for capital expenses which are expressly provided for in the Act. Section 21(2) of the Act is such an express provision, authorizing a taxpayer who elects to do so to include in CEEs interest expenses which would otherwise be deductible under s. 20(1)(c) of the Act. These are interest expenses on money borrowed to finance exploration activities. Parliament does not give mining companies the choice of making a deduction for depreciation under the general provisions of s. 20(1)(a) or making a deduction as a CEE, according to what the mining company considers more beneficial.

According to counsel for the respondent, the Act and Regulations provide a complete code governing the deduction of the capital cost of equipment for mining exploration and production. Among the classes of depreciable property are Class 10(g), applicable to structures and buildings, Class 10(&), applicable to property such as a structure or equipment acquired for the purpose of gaining income from a mine, and Class 10(Z) for property acquired to provide certain services to the mine or to workers in the mine. From 1972 onwards Class 28 has provided accelerated depreciation up to 100 per cent deductible from the mine’s income. This accelerated depreciation applies in particular to property acquired before the mine came into production that would otherwise be included in Classes 10(g), (k) and (/). Finally, there is Class 10(r), covering property that are intended to be used principally to determine the existence, location, extent or quality of a min- eral resource. In counsel for the respondent’s submission, this is why the Regulations should modify s. 66.1 (6)(<a) of the Act:

[TRANSLATION]

159. Including in Canadian exploration expenses the capital cost of property described elsewhere in Schedule II of the Regulations would amount to counteracting the purpose of the tax deduction for depreciation, which is to enable taxpayers to amortize the cost of capital property over a fairly long period, within specific limits, as determined by Parliament...

163. Furthermore, including in Canadian exploration expenses the cost of property also described in Class 10(1) ... would amount to removing any reason for the existence of that class, which could never result in the 30 per cent depreciation as provided.

164. It would also deprive of all meaning Class 28 dealing with property acquired at the exploration stage, before a mine goes into production...

Counsel for the respondent maintained that the object and the scheme of the Act, taken as a whole, also confirms that CEEs do not include the capital cost of depreciable property acquired for exploration purposes. In conceptual terms it is logical for Parliament not to have provided for the same incentives in the case of expenses for renting property as with expenses for acquiring property. A property rental expense is a temporary one. It is consumed in the exploration process. The expense of acquiring physical property, on the other hand, is generally not consumed in the exploration process alone. It relates to property which can continue to be used either on other exploration sites, in “preproduction”, in development and ultimately in putting the mine into production.

After this lengthy analysis of the respondent’s position on the interpretation I should adopt in defining CEEs, I do not intend to describe her position on the fictitious nature of the $750,000 rental. I will instead refer to it where necessary in the course of my analysis.

Analysis

(A) Do CEEs include the cost of exploration equipment?

Despite a learned and well researched submission by counsel for the respondent, I do not think the interpretation advocated by her corresponds to a fair and reasonable reading of s. 66.1(6)(a) of the Act. According to the wording of that provision, the term “CEE” means any expense incurred for the purpose of determining the existence, location, extent or quality of a mineral resource. At first sight it would appear that the word “expense” has a broad enough meaning to take in capital expenses as well. To begin with, the question is whether it is defined in the Act. “Expense” is defined in s. 66(15)(g.2) in the following way:

“outlay” or “expense” made or incurred before a particular time by a taxpayer, for greater certainty, does not include any amount paid or payable

(i) as consideration for services to be rendered after that time, or

(ii) as, On account or in view of payment of, or in satisfaction of, rent in respect of a period after that time;

It may be noted that this definition does not specify either the meaning or the scope of the word. Reference must thus be made to the usual meaning. After consulting several dictionaries, Addy J. of the Federal Court Trial Division adopted this interpretation of the word “expense” in McKee v. R., (1977), 77 D.T.C. 5345 (Fed. T.D.), at 5347 :

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.

This definition throws more light on the incurring of an expense than on its purpose. An expense is incurred once a person makes a payment or hands over property, or undertakes to do so.

In Louis Ménard, Dictionnaire de la comptabilité et de la gestion financière; anglais-français avec index français-anglais, Canadian Institute of Chartered Accountants, Montréal, 1994, the word “dépense” (expense) is defined as follows:

Expenditure

[TRANSLATION]

Expense

General accounting; public administration. Use of funds by an entity, or undertaking which it makes to pay a sum of money later, usually in return for acquiring good or service. Note — Expenses incurred by an entity may be different in nature. Where occasioned by purchase of durable goods, they represent capital expenditure; where incurred for operating requirements, they are charges in the financial year or operating expenses, such as salaries and purchases consumed. In a government body, operating expenses [“dépenses d’exploitation”] are generally called “dépenses de fonctionnement”.

[My emphasis.]

In its ordinary meaning it seems quite clear that the word “expense” may include both a current and a capital expenditure, such as the cost of purchas- ing exploration equipment. Certainly, to a geologist or mining engineer the exploration equipment he has leased or purchased is a necessary expense incurred in the course of work to discover a mineral deposit. Further, in Daniel McMahon et al., Comptabilité intermédiaire, Analyse théorique et pratique, McGraw-Hill, ed., 1993, p. Al.6, “frais d’exploration” (exploration expenses) is defined as follows:

[TRANSLATION]

These include all the costs of labour and equipment and all direct general expenses incurred in locating natural resources. In a Note d’orientation published in 1990 the steering committee of the C.N.C. mentions the components of exploration costs for businesses in the petroleum and natural gas industry. Among other things, exploration costs should include the cost of topographical, geological and geophysical studies, the cost of owning and conserving property and the cost of drilling and of exploratory well equipment.

[My emphasis.]

Is it possible that the context in which the word “expense” occurs in s. 66. l(6)(o) of the Act requires that it be given a limiting interpretation so as to confine it only to current expenses and exclude capital expenditure, as counsel for the respondent argued? She maintained that when Parliament wanted to include the cost of acquiring property in expenses it used the words “cost” or “capital cost”. She cited by analogy, in particular, the wording of the definition of CDEs found in s. 66.2(5)(a) of the Act, where reference is made to the cost of resource property. In my opinion, there is an explanation for the presence of the word “cost” in this definition other than that suggested by counsel. Buying resource property and developing it are not the same activity. In Farmers Mutual Petroleums Ltd. v. Minister of National Revenue (1967), 67 D.T.C. 5277 (S.C.C.), the Supreme Court of Canada held that exploration expenses incurred in exchange of acquiring an interest in lands were not exploration expenses but actually the cost of acquiring such interest. Parliament should therefore have expressly referred to the cost of acquiring resource property if it was to be treated as CDE.

Nevertheless, there are several provisions in the Act where Parliament uses both the words “expense” and “cost”. As an example of this we may mention s. 12(1)(x)(iv) of the Act dealing with incentive payments, requiring a taxpayer to include in his business income any amount received as a reimbursement, contribution or allowance “in respect of the cost of property or in respect of an expense”. At first glance it may be thought that the word “expense” in the Act does not include the cost of property since it seems necessary to refer to the two concepts of “expense” and “cost”. However, a closer analysis indicates that Parliament recognized that the word “expense” also means an expense incurred to purchase property.

First, there is s. 66(12.1 )(a) [14] of the Act, which requires a taxpayer who disposes of “property” the original cost of which was CEEs to reduce his CCEE account by the amount payable for such property. This is a fairly clear indication not only that the word “expense” includes the cost of acquiring property, but also that CEEs include such costs.

There are also other similar examples in the Act where Parliament quite clearly recognizes that the word “expenses” includes the cost of acquiring property. This is true in particular of s. 12(2.2) of the Act, [15] which speaks “of an outlay or expense made or incurred by the taxpayer in the year ... (other than an outlay or expense in respect of the cost of property of the taxpayer)”.

Another example is s. 14(5)(Z?) of the Act, [16] which defines “eligible capital expenditure”. Reference is made in clause (iii)(A) to “any outlay or expense made or incurred ... on account of capital ... other than any such outlay or expense ... (iii) that is the cost of, or any part of the cost of, (A) tangible property of the taxpayer”. It is thus clear that the word “expense” may include an expense relating to the cost of tangible property.

If the word “expense” incurred for the purpose of determining the existence, location, extent or quality of a mineral resource can include the cost of acquiring property, how can we exclude the cost of exploration equipment? Counsel for the respondent claimed that a distinction should be made between current expenses and expenses on account of capital. I consider that the wording of s. 66.1 (6)(a) of the Act does not support adopting such an interpretation for several reasons.

First, not only is there no express exclusion of expenses on account of capital, the subparagraph does not make any distinction between these two types of expense. In any case, all exploration expenses, whether for salary or the cost of purchasing exploration equipment, incurred by a taxpayer for the purpose of discovering a new mineral deposit he wishes to exploit represent expenses on account of capital. According to the tests recognized by the courts, these expenses are intended to confer a lasting benefit on the taxpayer. The case law also contain confirmation that exploration costs represent expenses on account of capital, in particular in Edmonton Liquid Gas Ltd. v. R. (1984), 84 D.T.C. 6526 (Fed. C.A.), at 6529, [17] in which MacGuigan J.A. of the Federal Court of Appeal said the following:

Traditionally, expenses incurred in exploration and development for oil and gas were regarded as expenditures on account of capital and they are therefore deductible in computing a taxpayer’s income only to the extent permitted by the Income Tax Act.

It is also worth comparing the wording of s. 66.1 (6)(a) of the Act with that of s. 37, dealing with scientific research and experimental development costs. Section 37 of the Act distinguishes between expenses which are of a current nature and expenses of a capital nature. Under s. 37, a taxpayer may deduct expenditures of a current nature and expenditures of a capital nature made “in Canada”, but may only deduct expenditures of a current nature made “outside Canada”. In spite of this distinction, all these expenses are expenditures on capital account. The Minister indeed recognized this in his Interpretation Bulletin IT-151R4, where he said in para. 15:

15. ...While all expenditures on SR & ED may be considered expenditures of a capital nature, for the purposes of section 37, current expenditures on SR & ED are considered to be those expenditures that do not result in the acquisition of land, a leasehold interest in land, or property that would otherwise be depreciable property to the taxpayer.

[My emphasis.]

Unlike s. 37, s. 66.1(6) of the Act makes no distinction whatever between current and capital expenses. The respondent would like to take ad- vantage of such a distinction without the appropriate wording being in the Act.

Counsel for the respondent also argued that the scope of the word “expense” should be limited by the list of expenses in clauses (A) to (D) of s. 66.1 (6)(a)(iii) of the Act. In her submission, the effect of applying the nos- citur a sociis rule is that the expenses in question would be limited to those relating to work or surveys and would not include those incurred to purchase property. As I noted earlier, it is clear that the cost of purchasing property can be CEEs. [18] I also do not think that the list of expenses in clauses (A) to (D) of s. 66.1 (6)(a)(iii) is intended to limit expenses solely to current expenses. I feel that this list is actually intended to clarify the scope of the concept of exploration. I am encouraged in this interpretation by the fact that the definition of CEEs was added in 1974 when the Act was amended to limit the deduction of CDEs to 30 per cent and continue allowing the deduction for CEEs at 100 per cent. Previously, CEEs and CDEs were all 100 per cent deductible. It thus became important to distinguish between exploration activities and those involved in developing a mine.

I also feel that this interpretation of CEEs, in keeping with the modern rule of construction, is quite consistent with the scheme of the Act, the object of the Act and the intention of Parliament. When we look at the tax provisions applicable to the mining, petroleum and natural gas industry, it is clear that Parliament wished to encourage activities involving a high degree of risk. [19] In addition to the high probability of failure, exploring for mineral deposits entails very significant cost. It was therefore important to allow companies engaging in activities in this field to deduct all these costs, even if they were on capital account. In his summary of the 1971 tax reform bill Hon. E.J. Benson, then Minister of Finance, said the following:

[TRANSLATION]

The present Act allows a corporation engaged primarily in mining, oil and other related areas to deduct from its overall profit exploration and development expenses incurred in Canada in the current or subsequent years. No tax is payable, therefore, so long as all exploration and development expenses have not been recovered.

Reference was also made in that document to the then existing rule that profits made in the first three years of operating a new mine were exempt from Canadian income tax. This exemption was to end on December 31, 1973. To replace this three-year exemption the new legislation provided for accelerated depreciation on tools and production facilities used in a new mine. Under these provisions taxpayers were entitled to an annual depreciation equal to the higher of the following two amounts: (i) the income from the new mine, or (ii) 30 per cent of the net taxable value of this item. Hon. E.J. Benson added:

[TRANSLATION]

Accelerated depreciation and deductions for exploration and development expenses will have the combined effect of ensuring that profit from a new mine will not be taxed before full recovery of the initial investment.

[My emphasis.]

On reading these summaries of the 1971 tax reform bill, and from reading the Act as it applied in 1987, I feel it is reasonable to conclude that Parliament intended to allow taxpayers engaged in mining exploration projects to deduct not only current expenses, that is expenses consumed in the exploration projects, but also capital expenses, that is expenses which were not consumed. I also note that s. 37 of the Act in 1987 authorized the deduction in their entirety, as scientific research and experimental development expenses, not only of current expenses but also of capital expenses when these had been incurred in Canada. Scientific research activities have features in common with mining exploration. In both cases, the activities are designed to discover an asset and involve a high degree of risk.

I consider that the wording of the CEE definition given in s. 66.1(6)(a) of the Act does not allow me to conclude, as counsel for the respondent would have me do, that CEEs include an expenditure to acquire property consumed on a mining site and exclude expenditure incurred to acquire property which can be re-used on another site. In my view, for the interpretation put forward by the respondent to prevail some provision of the Act excluding the cost of property in the second category would be necessary. Such an exclusion is to be found in s. 6(1)(e) of the Canadian Exploration Incentive Program Regulations (SOR 89-123), [20] which expressly provides that eligible exploration expenses do not include the capital cost of tangible property not consumed in the exploration process. This definition of “eligible exploration expenses” greatly resembles that of CEEs to be found in s. 66.1 (6)(a) of the Act. The interpretation I have accepted thus corresponds to that adopted by the Governor in Council in 1989 in drafting these Regulations. [21]

I consider, therefore, that the word “expense” contained in s. 66.1(6)(a) of the Act covers all exploration expenses: expenses of a current nature as well as capital expenses incurred to acquire tangible property not consumed in the exploration process.

Before applying this interpretation to the facts of this appeal, I should like to comment on some of the other arguments made by counsel for the respondent. To begin with, she maintained that the deduction mentioned in s. 66.1 of the Act was a deduction adopted by Parliament as an exception to the matching principle used by accountants. I do not share this point of view. I think instead that the adoption of s. 66.1 was necessary in view of s. 18(1 )(Z?) of the Act, which prohibits any deduction of expenses on account of capital. [22]

As already mentioned, [23] exploration expenses are expenses on account of capital for a taxpayer who is seeking to discover a mining deposit for the purpose of exploiting it. The deduction provided for in s. 66.1 is thus of the same type as the depreciation deduction provided for in s. 20(1)(a) of the Act. In view of the prohibition in s. 18(1)(b) of the Act, the accounting treatment of such expenses becomes completely irrelevant. It is the Act which governs the conditions for deducting them.

Counsel for the respondent placed great reliance on the fact that the exploration equipment acquired by Radisson was depreciable property covered by s. 20(1 )(a) of the Act and Part XI of the Regulations. As s. 20(1)(a) of the Act is in subdivision b mentioned in s. 3(a) of the Act, she argued that it is the provisions for depreciation deduction which take precedence over the deduction mentioned in s. 66.1 of the Act, deduction which is found in subdivision e. [24] I do not think that this argument of counsel is correct. The answer to this question is found in the comments by Jackett P. in Johnson’s Asbestos Corp. v. Minister of National Revenue, (1966), 65 D.T.C. 5089 (Can. Ex. Ct.), at 5095 :

Subsection (3) of section 83A was obviously intended to permit the deduction of expenses that are not otherwise deductible and would not have been enacted if it were not for the fact that the described expenses are generally speaking incurred in such circumstances that they would not otherwise be deductible. This raises a question in my mind as to whether subsection (3) of section 83A should be interpreted as not applying to expenses that qualify as a current expense of a mining operation. However, the provision is so worded as to include all expenses of the described classes whenever or however occurring and any possibility of the same expense being deducted twice is avoided by the concluding words of paragraph (c) of subsection (3) of section 83A, by which the deduction of the described expenses is permitted only to the extent that they were not deductible in computing income for a previous year. That being so, I see no justification for implying any exclusion of current expenses from the expenses to which the provision applies.

Not only does Jackett P. recognize in this passage that without the existence of the equivalent of 66.1 a taxpayer could not deduct his CEEs, but even if he or she could have done so he saw nothing to prevent the application of this provision to expenses covered by subdivision b. In addition to the reason given by Jackett P., I would say that s. 4(4) of the Act also lays down a rule excluding the possibility of deducting the same expense twice. It should also be noted that s. 18(1)(b) of the Act explicitly contemplates exceptions, not only those mentioned in subdivision b of that section, but also those found elsewhere in Part I of the Act. It is thus not necessary to determine whether one subdivision takes precedence over another.

In any case, this problem did not arise here. Under s. 20(1 )(a) of the Act, for a depreciation deduction to be claimed for exploration equipment it is essential for the amount to be authorized by the Regulations. Under s. 1100( 1 )(a) of the Regulations, the amount that a taxpayer may deduct under s. 20(1 )(a) of the Act is an amount claimed in respect of property contained in one of the “classes” of Schedule II of the Regulations. Section 1102(1 )(<a) of the Regulations provides that the classes of property described in Part XI of the Regulations and in its Schedule II shall be deemed not to include property the cost of which is deductible in computing the taxpayer’s income.

If the interpretation I have adopted is the correct one, the cost of exploration equipment is CEEs and is deductible in computing a taxpayer’s income: the latter therefore cannot claim a depreciation deduction on this property. This result is quite fair, since a taxpayer obviously cannot claim the same expense twice.

Counsel for the respondent maintained that the scope of the word “expense” contained in s. 66.1(6)(a) of the Act must depend on the provisions contained in the Regulations. In particular, she argued that including in CEEs the cost of property described in Class 10(t), namely property that are intended to be used principally for the purpose of determining the existence, location, extent or quality of a mineral resource, amounts to depriving that class of all meaning, so that the 30 per cent depreciation which it makes available could never be obtained. She made a similar argument with regard to Class 28 property. In her submission, such an interpretation would lead to absurdity and be contrary to common sense.

I might have agreed with counsel for the respondent if the provisions of Part XI of the Regulations and Schedule II of the Regulations were contained in the Act. However, all these provisions are in the Regulations, which are subject to the Act. An argument similar to that of counsel for the respondent was made in a case heard by the British Columbia Supreme Court, Geisha Garden Ltd. (1960), 30 W.W.R. 617, 32 C.R. 246, 127 C.C.C. 30 (B.C. S.C.). Collins J. said the following at paras. 7 and 8 of his reasons: [25]

7. ...Counsel for the Crown submitted that I should consider the wording and meaning of the regulations as an aid in determining the meaning of the statute.

8. It is my view that the intention of the legislature is to be found in the words of the statute itself and not in the words of the regulations. The statute was enacted and assented to before the regulations were made. After ascertaining the intention of the legislature by interpreting the words of the statute, that statute will be applied in conjunction with the regulations. Thus the application of the statute to any set of circumstances may be affected by the regulations but the regulations themselves do not affect the meaning of the statute.

[My emphasis.]

Class 10(t) was not added until 1979. [26] It seems to the Court that saying that the scope of s. 66.1 (6)(«) is amended by the description of Class 10(t) has the result of allowing a regulation to amend a statute or to take precedence over it. In G.H.C. Investment Ltd. v. Minister of National Revenue, (1961), 61 D.T.C. 1120 (Can. Ex. Ct.), Thorson P. said at 1125: “The regulation cannot be allowed to override the Act. If the two are in conflict or inconsistent with one another the regulation must give way”. Thorson P. based this conclusion on the observations of Anglin J. of the Supreme Court of Canada in Booth v. R. (1915), 51 S.C.R. 20 (S.C.C.), and Belanger v. R. (1916), 54 S.C.R. 265 (S.C.C.). At p. 280 of the latter judgment Anglin J. said the following:

But no regulation, although passed by the Governor in Council under section 49, can be allowed to override the explicit requirement of section 16 of the statute. If no construction can be placed upon regulation No. 48 which will bring it into harmony with that section, it cannot be regarded has having been made within the authority conferred by section 49, or, if so made, it must be treated as subordinate to the precise and definite prohibition of section 160.

In conclusion, I do not think that the provisions of Regulations adopted by the Governor in Council should be taken into account to define the scope of the Act adopted by Parliament. [27]

This interpretation of CEEs must now be applied to the facts of this appeal. Counsel for the respondent admitted that all the property the cost of which was the subject of a renunciation to the limited partnership was property acquired by Radisson for exploration purposes. Accordingly, all property acquired by Radisson as exploration equipment during the relevant period was CEEs which Radisson could renounce to the limited partnership. The fact that some of this property may have subsequently been used in developing the mine or even in exploiting it does not alter this conclusion. See the decision of my colleague Judge McArthur in Highland Foundry Ltd. v. R, (1994), 94 D.T.C. 1725 (T.C.C.).

(B) Was the $750,000 expense fictitious rental?

The second major point raised by this appeal is as to the true nature of the $750,000 paid to Eldorado by Radisson. Was it rental, as Mr. Phénix argued? He maintained that Radisson paid Eldorado $1,170,000 rental for use of the “surface plant” for the period from May 20, 1987 to February 29, 1988 and that this expense was CEEs which Radisson could renounce under the terms of its flow-through share subscription agreements. Radisson, he submitted, had renounced part of these CEEs to the CMP group, the amount in question being $420,000, and the balance of $750,000 was renounced to the limited partnership.

The respondent contended that this amount of $1,170,000 could not represent rental paid by Radisson because during that period the latter was owner of the “surface plant”. In Paragraph 11 of her Reply to the Notice of Appeal the respondent indicated that, in making his assessment, the Minister relied on certain assumptions of fact, including:

[TRANSLATION]

(i) Ressources minières Radisson Inc. acquired from Eldorado Gold Mines Inc. machinery, equipment and buildings or other structures at a cost of $894,665, and the share of “the partnership” in this property amounts to $573,502.

(i.l) Exploration Rupert Inc., a non-operating company, which signed the purchase contracts for the property mentioned in the preceding paragraph in the amount of $894,665, only acted as nominee or agent or was only a channel for acquiring the property in question.

It is well established that a taxpayer challenging an assessment has the burden of showing that the facts on which the Minister relied were incorrect.

When taxpayers have resort to operations designed primarily to obtain tax benefits the courts must, with greater assiduity, not only determine “what the taxpayer actually did, [and not] what he might have done”, [28] but also ensure that these operations correspond to the actual intent the taxpayers had and that they are legally valid and complete. The first issue needs no comment. For the other two, the courts have developed several judicial tools to assist them in their task, such as the sham transaction principle, the ineffective transaction principle and the principle of the actual nature of a transaction. In Stubart Investments Ltd., supra, at 545, Estey J. suggests the following definition of a sham transaction:

...a transaction conducted with an element of deceit so as to create an illusion calculated to lead the tax collector away from the taxpayer or the true nature of the transaction; or, simple deception whereby the taxpayer creates a facade of reality quite different from the disguised reality.

Application of the second tool is relatively straightforward. The transaction engaged in by the taxpayer, such as a contract, must be carefully scrutinized to see whether it is a valid transaction in formal as well as substantive terms. Urie J. described the application of this tool very clearly in Atinco Paper Products Ltd. v. R., (1978), 78 D.T.C. 6387 (Fed. C.A.), at 6395 :

...It is trite law to say that every taxpayer is entitled to so arrange his affairs as to minimize his tax liability. No one has ever suggested that this is contrary to public policy. It is equally true that this Court is not the watch-dog of the Minister of National Revenue. Nonetheless, it is the duty of the Court to carefully scrutinize everything that a taxpayer has done to ensure that everything which appears to have been done, in fact, has been done in accordance with applicable law. It is not sufficient to employ devices to achieve a desired result without ensuring that those devices are not simply cosmetically correct, that is correct inform, but, in fact, are in all respects legally correct, real transactions. If this Court, or any other Court, were to fail to carry out its elementary duty to examine with care all aspects of the transactions in issue, it would not only be derelict in carrying out its judicial duties, but in its duty to the public at large.

[My emphasis.]

An illustration of the courts’ task is found in Stubart; there the taxpayer met the requirement. In Atinco, on the other hand, the taxpayers were not so successful.

The third tool, the principle of the actual nature, has created and continues to create problems in its application. According to that principle, in assessing a transaction the courts should take the commercial and economic reality of the transaction into account. Dickson C.J. said in Bronfman Trust, supra, at 53:

Assessment of taxpayers’ transactions with an eye to commercial and economic realities, rather than juristic classification of form, may help to avoid the inequity of tax liability being dependent upon the taxpayer’s sophistication at manipulating a sequence of events to achieve a patina of compliance with the apparent prerequisites for a tax deduction.

There are those who think, and I agree with them, that this approach cannot justify the courts disregarding the legal consequences of a transaction. In Continental Bank of Canada v. R., (1994), 94 D.T.C. 1858 (T.C.C.), at 1869, Judge Bowman of this Court qualified the scope of this principle as follows: [29]

So far as the broader question of substance versus form is concerned, we should at least be clear on what we are talking about when we use the elusive expression “substance over form”. Cartwright, J. (as he then was) said in Dominion Taxicab Assn. v. M.N.R., 54 D.T.C. 1020 at p. 1021:

It is well settled that in considering whether a particular transaction brings a party within the terms of the Income Tax Acts [sic] its substance rather than its form is to be regarded.

His Lordship did not elaborate but in light of other authorities 1 do not think that his words can be taken to mean that the legal effect of a transaction is irrelevant or that one is entitled to treat substance as synonymous with economic effect. The true meaning of the expression is, I believe, found in the judgment of Christie, A.C.J.T.C.C. in Purdy v. M.N.R., 85 D.T.C. 254 at p. 256, where he said:

It must be borne in mind that in deciding questions pertaining to liability for income tax the manner in which parties to transactions choose to label them does not necessarily govern. What must be done is to determine what on the evidence ts the substance or true character of the transaction and render judgment accordingly.

[My emphasis.]

It is quite clear from reading all these comments that the courts at the very least have some room for maneuver in assessing the legal consequences of an agreement between two parties.

This approach must be applied to the facts of this appeal. I feel that the Eldorado-Radisson lease had the characteristics of a sham transaction. The contract was created to give the tax authorities the impression that Radisson could incur CEEs which were completely eligible for renunciation, under the terms of the flow-through share subscription agreement. Counsel for Lévesque Beaubien, the broker responsible for distributing the shares of the limited partnership, indicated at the closure of the issue on December 21, 1987 that the rental paid to Rupert by Radisson could not be the subject of a renunciation in its entirety since a large part of the rental was CEDOEs. [30] Contrary to what Mr. Lévesque was told by counsel for the broker, Radisson and the limited partnership did not reduce the amount of the issue and some means had to be found to recover the $750,000 deduction, as the amount represented a significant percentage of the total issue. [31]

The setting up of the Eldorado-Radisson lease was a solution in extremis apparently conceived by some of the Radisson management and accountants. [32] In my opinion the solution adopted, that is the Eldorado-Radisson lease, not only does not correspond to the true commercial and economic nature of the transaction between Radisson and Eldorado but did not have the desired legal consequences. The Eldorado-Radisson lease is not a genuine, valid lease.

To begin with, it may be noted that this was an agreement concluded in all probability after the relevant period during which Radisson could incur CEEs which were eligible for renunciation to the limited partnership. [33] Even if for purposes of this analysis the date appearing in the Eldorado- Radisson lease, i.e. February 27, 1988, is accepted, that date falls only two days before the end of the relevant period. How can a lease be set up on February 27, 1988 retroactive to May 19, 1987? [34]

Under a true lease a lessor gives a lessee enjoyment of property for a certain period in return for rental. The lease can therefore only begin when the lessor gives the lessee enjoyment of the leased property. One lessor cannot be retroactively substituted for another; nor is it possible by means of an agreement to retroactively alter the nature of payments made to a person as the purchase price under a contract of sale so that those payments become rental paid under a lease. The remarks made by Maclean J. in Malkin v. Minister of National Revenue, (1942), 2 D.T.C. 587 (Can. Ex. Ct.), at 591, are wholly appropriate here: [35]

... he appellant could not by any ex post facto act alter the destination of these moneys, or the purpose for which they were paid to and received by him. I know of no principle of law or equity which the appellant can summon to his aid to support his contention. I am therefore of the opinion that all the rental receipts in question constituted income in the hands of the appellant and were therefore taxable as such.

We may now consider whether a lease could have existed between Eldorado and Radisson in the period from May 19, 1987 to February 29, 1988. Not only is there no evidence that on May 18, 1987 (or before) Eldorado had agreed with Radisson to give it enjoyment of the “surface plant”, there is not even any evidence that Eldorado knew before February 27, 1988 that it was to give Radisson enjoyment of this “plant” for the period from May 19, 1987 to February 29, 1988.

Even if Eldorado knew this and was a party to an alleged verbal agreement on May 19, 1987, it no longer possessed the “surface plant” and therefore could not transfer enjoyment of it. Under the Rupert agreement of April 7, 1987 Eldorado disposed of ownership of the “surface plant” to Rupert. This agreement, governed by the laws of Quebec, expressly stipulates: “We hereby sell to you and you hereby purchase from us the plant...”. The Rupert agreement adequately described the property concerned in the sale. It also indicated a purchase price of $750,000. On May 12, 1987 the parties amended it, substituting a 4' x 3' hoist for one of 5’ x 4'. The price was increased from $750,000 to $894,665. In my opinion, all the components necessary for the formation of a contract of sale were present and the intent of the parties as to the date on which ownership would be transferred was clear: the date was April 7, 1987. One hoist was later exchanged for another on May 12, 1987. The Radisson-Rupert group in any case also believed that it had acquired the “surface plant”, since it stated in the alleged Rupert- Radisson lease of May 18, 1987 that Rupert [TRANSLATION] “acquired” the “surface plant” from Eldorado pursuant to an agreement dated April 7, 1987 and amended on May 12, 1987. [36] Eldorado accordingly ceased to be owner of the “surface plant” on April 7, 1987 and of the hoist on May 12, 1987.

Mr. Phénix submitted no evidence showing that Eldorado, on May 18, 1987 or earlier, had re-acquired ownership or possession of the “surface plant”. None of the Eldorado management testified. Eldorado was thus not in a position to provide the enjoyment of the “surface plant” to Radisson on May 19, 1987 and thereafter since it had neither ownership nor possession of that plant. The Eldorado-Radisson lease therefore had no true object and thus was not valid. Even if the Eldorado-Radisson lease was not a sham transaction in the strict sense, as recognized by the case law, it was not a legally valid transaction which could have the legal effects desired by Radisson.

There are also other indications that the Eldorado-Radisson lease was a sham. First, there is the fact that no accounting entry appears in Radisson’s [TRANSLATION] “Duquesne rental account” except a block entry of August 31, 1987 concerning the amount of $420,000 and another of May 30, 1988, later corrected, concerning the amount of $750,000. The entry of August 31, 1987 for the $420,000 cannot relate to the Eldorado-Radisson lease since the decision to “fabricate” this lease was made after December 21, 1987, and so well after August 31, 1987. I have already commented on the second entry. [37]

In her testimony Ms. Bernier, the Radisson comptroller, who was on duty at the time of the hearing but not during the relevant period, sought to corroborate the actual nature of the rental paid under the Eldorado-Radisson lease by an analysis of Radisson’s accounting records. To assist in understanding this analysis she gave the Court a summary containing eight appendices. In Appendix A, she sought to reconcile with the wording of the Eldorado-Radisson lease, and in particular the rental, the amounts relating to rental of the “surface plant” from May 19, 1987 to February 29, 1988. The rental expenses for the period from May 20 to August 31, 1987 were the subject of a renunciation to the CMP group, the total amount of these expenses being $420,000. She allocated the sum of $125,000 to each of the months of June, July and August and to the period from May 20 to May 31, 1987 the sum of $45,000 which, according to her calculations, was “Ai of $125,000. This $45,000 figure allowed her to arrive at a total of $420,000. In actual fact, if Ai of $125,000 is calculated one gets the figure of $44,354, which does not give a total amount of $420,000 either. [38]

Similarly, the reconciliation made by Ms. Bernier for the sum of $750,000 which was renounced to the limited partnership is also incorrect. She allocated rental of $125,000 to each month from September 1987 to February 1988, or six months’ rental ($125,000 x 6 = $750,000). Her figure of $125,000 for February must be adjusted, since the monthly rental of $125,000 ended on February 18, 1988. The rental subsequently became an annual rental of $1,000. Instead of $125,000, the sum of $77,618 [($125,000 x /29) + ($1,000/12 x '/2s»)] should be allocated to February 1988, giving a total rental for this period of $702,618. Rather than confirming the true nature of the rental allegedly paid to Eldorado by Radisson, the comptroller’s testimony actually confirmed that Radisson’s accounting records were not consistent with the terms of the Eldorado-Radisson lease.

There are also other signs that the Eldorado-Radisson lease did not reflect the true nature of the transaction. On June 17, 1988 Radisson paid the sum of $275,335 in addition to the amount specified in the amended Rupert agreement. Why would a buyer (the Radisson-Rupert group) of a “surface plant” purchased for $894,665 have agreed to pay an additional $275,335 without consideration to a seller (Eldorado) with whom it was not related? What is even more strange is that the money was paid not for the purchase of equipment but instead for its rental. What owner of exploration equipment would have agreed with the seller to transform its purchase contract into a lease (the effect of which amounted to renouncing its right of ownership) for an additional $275,335? Such an arrangement makes no sense, unless it was a sham.

What is much more logical and reasonable is that Radisson agreed with Eldorado that this amount of $275,335, received by the latter on July 8, 1988, would be returned to it. This indeed is what counsel for the Minister suggested in her argument. At almost the same time, Eldorado subscribed to Radisson flow-through shares for $275,000. Therefore, in my opinion, this inference is entirely reasonable in the circumstances of this appeal.

I must accordingly conclude that the alleged Eldorado-Radisson lease was a sham, that the agreement cannot be a genuine lease and that the $750,000 rental which Radisson allegedly paid Eldorado and which it claimed it had renounced to the limited partnership as CEEs does not represent rental paid for use of the “surface plant”. Only the sum of $894,665 paid to Eldorado as the purchase price of the “surface plant” represents CEEs. Mr. Phénix did not submit adequate evidence of the true purpose of payment of the sum of $275,335 and did not persuade the Court that this amount was CEEs.

As I have rejected the Eldorado-Radisson lease, I must determine whether the money paid by Radisson to Rupert could be genuine rental only part of which might be eligible as a CEE. I have no doubt that Radisson and Rupert were not dealing at arm’s length when the Rupert agreement and the alleged Rupert-Radisson lease were negotiated. Counsel for Mr. Phénix readily admitted this. As the amount of the alleged rental not only exceeded 20 per cent of the cost of acquiring the “surface plant” but also the total cost of acquisition, most of the rental expenses would be ineligible for renunciation under the subscription agreement, pursuant to s. 66(12.6)(b) of the Act and s. 1206 of the Regulations, which exclude CEDOEs from the CEEs which Radisson might renounce.

However, it is not even necessary to apply these provisions here since I have not been persuaded by the evidence submitted by Mr. Phénix that the facts on which the Minister relied in making his assessment were incorrect. More precisely, Mr. Phénix has not been able to refute the fact that Radisson acquired the “surface plant” under the Rupert agreement and the amended Rupert agreement and that Rupert acted as a nominee in that transaction. I am even persuaded on the weight of the evidence that Radisson became owner of the “surface plant” under those agreements.

It should be borne in mind that, according to what Mr. Dupont told Ms. Branchaud, Rupert was a company that [TRANSLATION] “had never been in operation nor had any assets”. It never prepared any financial statements (except its opening balance sheet) or filed a tax return (except for the period ending at the time of its incorporation). Rupert’s only accounting record was a [TRANSLATION] “cash-disbursements” sheet at February 29, 1988 prepared by Mr. Rocheleau at Mr. Bourrassa’s request. The latter even used the expression [TRANSLATION] “shell” to describe this legal entity. He did not even know he was a shareholder in this company, and indeed the only shareholder, at the time the Rupert agreement and the alleged Rupert- Radisson lease were signed.

Moreover, that company had no capitalization. Judging from the opening balance sheet, the only subscribed capital was the sum of $10. The company did not have the financial resources required to purchase the “surface plant”. Furthermore, Radisson had to intervene as surety to guarantee payment of the “surface plant” purchase price. All the money used to pay amounts owed under the amended Rupert agreement were advanced to Rupert by Radisson. [39]

Not only did Radisson advance all the money necessary to pay for the “surface plant”, it also advanced the money necessary to pay for the 166,667 Duquesne shares allegedly sold to Rupert and assumed all the bank charges of Rupert, which it also entered in its bank expense account. Another indication that Rupert acted as a nominee is the fact that it could not exercise the voting rights associated with the 166,667 Duquesne shares. Those rights had to be exercised by Mr. Smerchansky “subject to any agreement with Radisson”. Finally, on May 15, 1988 Rupert transferred the 166,667 Duquesne shares to Radisson for the amount which the latter paid the Duquesne shareholders, namely $500,000.

There are other indications that Rupert acted as a nominee in acquiring the “surface plant”. As mentioned earlier, not only was the sole Rupert shareholder the legal counsel, secretary and director of Radisson, he was acting on Radisson’s instructions. How are we to explain the fact that Rupert agreed to cancel the Rupert-Radisson lease without further consideration? If Rupert had obtained the $1,500,000 rental for a ten-month period, it would have made a profit of $605,335 ($1,500,000 - $894,665), not taking into account the $10,000 rental for each additional month! Rupert received no compensation from Radisson when the lease was rescinded. In my view, Rupert’s conduct was entirely consistent with the conduct of a company acting as an agent or simple nominee.

It should also be pointed out that in its accounting records Radisson did not show in the [TRANSLATION] “Duquesne rental account” the monthly rental of $150,000 specified in the alleged Rupert-Radisson lease. The amounts received by Rupert from Radisson never corresponded to the monthly rental of $15O,OOO. [40] The only payments to Rupert by Radisson appearing in the accounting records corresponded to the payments for the acquisition of the “surface plant” and Duquesne shares, which were repaid by Rupert to Eldorado on the same day. For the “surface plant”, there are five monthly payments of $78,933, followed by three monthly payments of $100,000 and one of $200,000.

Finally, the nature of the Rupert-Radisson lease was entirely unreasonable, since Radisson was to pay $1,500,000 for ten months’ use and $10,000 a month thereafter, amounts which exceeded the cost of purchase by Rupert while it was Radisson who guaranteed the “surface plant” purchase price. Moreover, it was Radisson who was responsible for maintaining the “surface plant” and was liable for any damage or loss caused to the “surface plant”.

It appeared from the evidence as a whole that Rupert acted as a nominee for Radisson’s benefit when Rupert acquired the “surface plant” under the Rupert agreement and the amended Rupert agreement. The “surface plant” belonged to Radisson from April 7, 1987 onwards. The Rupert-Radisson lease, like the Eldorado-Radisson lease, had no object and so was not valid in law.

Even if I were mistaken in this conclusion, I would still find that Radisson became owner of the “surface plant” on May 18, 1987 under the Rupert-Radisson lease. I would conclude, as Décary J. did in R. v. Lagueux & Frères Inc., (1974), 74 D.T.C. 6569 (Fed. T.D.), that in essence and in its legal effects this lease was instead a contract for the purchase of the “surface plant” by Radisson. It should be noted that under the Rupert-Radisson lease absolute ownership of the “surface plant” devolved on Radisson without any compensation if Rupert did not remove the “surface plant” within the deadlines mentioned in the lease. As its conduct indicates when it agreed to rescind the Rupert-Radisson lease without compensation, Rupert was under Radisson’s control. In the circumstances of this appeal, it can readily be assumed that Rupert would not have removed the “surface plant” and that Radisson would have become its sole owner without any compensation other than the alleged rental.

Though I have concluded that the cost of purchasing equipment acquired to engage in exploration work in Canada was CEEs, I must still decide the question of whether part of the cost of the “surface plant” could be the subject of a renunciation to the limited partnership. Under the flow-through share subscription agreement between Radisson and the limited partnership, and in accordance with s. 66(12.6) and (12.66) of the Act, only expenses incurred by Radisson during the relevant period could be the subject of such a renunciation. Radisson acquired the “surface plant” under the Rupert agreement and the amended Rupert agreement, dated April 7 and May 12, 1987 respectively. As it was incurred before September 1, 1987, the cost of purchasing the “surface plant” therefore could not have been the subject of a renunciation to the limited partnership.

In conclusion, the sum of $750,000 for the “surface plant” must be excluded from CEEs which were the subject of a renunciation to the limited partnership. The same conclusion also applies to the cost of purchasing two compressors acquired on June 1, 1987 for a total of $65,400.

For these reasons, the appeal is allowed and the assessment for the 1987 taxation year referred back to the Minister for reconsideration and reassessment on the basis that, of the amount of $1,529,488 disallowed by the Minister, Radisson could renounce to the limited partnership the sum of $702,065, that it could not renounce the balance, namely $827,423 ($750,000 + $65,400 + $12,023), and that Mr. Phénix’s share in the sum of $702,065 should be taken into account in calculating his CEEs and his MEDD.

The whole without costs.

Appeal allowed.