Wardean Drilling Co, LTD v. Minister of National Revenue, [1974] CTC 190, [1974] DTC 6164

Cattanach, J:—These appeals from the appellant’s assessment to income tax by the Minister of National Revenue for its taxation years ending March 31, 1968 and March 31, 1969 involve the applicability of subsection (8a) of section 83A of the Income Tax Act the pertinent portion of which, during the taxation years in question reads,

83A. (8a) Notwithstanding subsection (8), where a corporation (hereinafter in this subsection referred to as the “successor corporation”) whose principal business is

(a) production, refining or marketing of petroleum products or natural or exploring or drilling for petroleum or natural gas, or

(b) mining or exploring for minerals,

has, at any time after 1954, acquired from a corporation (hereinafter In this subsection referred to as the “predecessor corporation”) whose principal business was production, refining or marketing of petroleum, petroleum products or natural gas, exploring or drilling for petroleum or natural gas, or mining or exploring for minerals, all or substantially all of the property of the predecessor corporation used by it in carrying on that business in Canada,

there may be deducted by the successor corporation, in computing its income under this Part for a taxation year the lesser of

(There then follows, in paragraph (e), the formula for determining the amount of expenses incurred for drilling and exploring for petroleum and natural gas in Canada and prospecting, exploration and development expenses incurred in searching for minerals in Canada which may be deducted.)

Subsection 83A(8a) then concludes,

and, In respect of any such expenses included in the aggregate determined under paragraph (e), no deduction may be made under this section by the predecessor corporation in computing its Income for a taxation year subsequent to its taxation year in which the property so acquired was acquired by the successor corporation.

The appellant was incorporated as a joint stock company pursuant to the laws of the Province of Ontario by letters patent dated November 2, 1951 under the name of Old Smokey Oils and Gas Limited which corporate name was subsequently changed to Largo Oils & Mines Limited and still later to Wardean Drilling Co, Limited, the name in the style of cause.

Throughout the period from the incorporation of the appellant to March 31, 1969 the principal business of the appellant has been,

(a) production of petroleum, petroleum products or natural gas, and

(b) mining or exploring for minerals.

it has been agreed between the parties that the appellant is a “principal business corporation” within the meaning of paragraphs

(a) and (b) of subsection 83A(8a) but counsel for the appellant has emphasized that this agreement as to facts in this respect is not to be construed as an admission on his part that the business of the appellant is exclusively either the business described in paragraph (a) relating to petroleum or natural gas or the business described in paragraph (b) relating to minerals but rather that the business of the appellant was a conglomerate of the business described in both paragraphs (a) and (b).

Further it was the contention on behalf of the appellant that, in addition to carrying on the business of mining and exploring for minerals in its own name it also carried on that business through a subsidiary company incorporated in 1955 under the name of Uranium Leasehold Ltd during the periods 1956 to 1958 inclusive and 1963 to 1966 inclusive. The appellant owned approximately 80% of the issued and outstanding shares in the capital stock of that company.

During the period from its incorporation to March 31, 1967 the appellant incurred drilling and exploration expenses with respect to petroleum or natural gas and prospecting, exploration and development expenses in searching for minerals to the total amount of $572,374.96 which expenditures qualified as deductions in computing the appellant’s income within the meaning of subsection 83A(3) none of which had been claimed by the appellant as a deduction until its taxation years ending March 31, 1968 and March 31, 1969.

These facts are admitted by the Minister.

However in filing its income tax return for its taxation year ending March 31, 1968 the appellant reported income in the amount of $5,896 from which it deducted the identical amount as development and exploration expenses incurred in prior years so that the income tax return showed no taxable income and accordingly no tax payable and that there was a balance of $566,478.96 unused expenses available for deduction against future income.

Similarly in filing its income tax return for its taxation year ending March 31, 1969 the appellant reported income in the amount of $169,260 from which it deducted the like amount as development and exploration expenditures incurred in prior years so that there was shown to be no taxable income and therefore no tax payable and that there remained after such deduction a balance of $397,218.96 unused expenses available for application against future income of the appellant.

In assessing the appellant as he did the Minister disallowed the appellant’s claim for a deduction from its 1968 income of the sum of $5,896 and its claim for a deduction from its 1969 income of the sum of $169,260 and computed income tax and interest payable by the appellant accordingly.

The Minister disallowed the sums so claimed by the appellant as deductions in its respective 1968 and 1969 taxation years on the ground that on April 21, 1964 the appellant sold to Scurry Rainbow Oil Limited, a corporation whose business was one described in paragraph (a) of subsection 83A(8a), of which fact there is no dispute, all or substantially all of the property used by the appellant in carrying on its business in Canada so that the deductions claimed by the appellant in its returns of income for 1968 and 1969 were prohibited by subsection 83A(8a).

Assuming the facts to be as so alleged by the Minister, the result would be that the appellant is a “predecessor corporation” within the meaning of subsection 83A(8a) and Scurry Rainbow Oil Limited is a “successor corporation” within the meaning of that section.

The appellant as a predecessor corporation is then precluded by subsection 83A(8a) from claiming those expenses and that right passes to the succesor corporation, in this instance, Scurry Rainbow Oil Limited, subject to very stringent limitations which would result in a nil or negligible tax advantage to Scurry Rainbow Oil Limited.

Mr Peter Abt was the officer of Scurry Rainbow Oil Limited who negotiated the purchase of property from the appellant. He testified that he was interested in acquiring only this specific property from the appellant and it was not his intention to acquire the undertaking of the appellant and this despite that he knew of the drilling and exploration credits vested in the appellant. He was not interested in succeeding to those credits which would be negligible in the hands of Scurry Rainbow Oil Limited in any event. He had no interest in acquiring other property of the appellant. He was aware of one other property owned by the appellant but he was not aware of any others.

In short the Minister’s position is that the sale of property on April 21, 1964 by the appellant to Scurry Rainbow Oil Limited was a sale by the appellant of “all or substantially all of the property” used by it in carrying on its oil and gas and mining business in Canada.

On the other hand the position taken by the appellant is that subsection 83A(8a) is not applicable because the sale of the single property by the appellant to Scurry Rainbow Oil Limited on April 21, 1964 did not constitute a sale of “all or substantially all of the property” owned by the appellant and used by it in. carrying on its business in Canada at the time of the sale, which is the condition which must exist in order for subsection 83A(8a) to be applicable.

Counsel for the appellant carefully traced the history of section 83A from its first enactment in 1955 in support of his further contention that what is contemplated in subsection (8a) is the sale of the business undertaking of one corporation to another in the same business.

At the conclusion of its financial year ending October 31, 1962 the appellant had an interest in four properties as follows,

(1) a 1214% interest in six petroleum and gas leases from the Province of Alberta;

(2) a 5.49% interest in a gas lease described as the Sturgeon Hewitt Big Lake lease;

(3) a 33 1/3% interest in two Crown petroleum and gas leases, and

(4) a 5% carried interest in oil and gas leases in legal subdivisions 5 and 6 in a designated section.

In addition the appellant owned 52,000 shares of the capital stock of Uranium Leaseholds Ltd, which company owned mining claims known as the Gold King claims.

On November 1, 1963, that is prior to the conclusion of its 1963 financial year, the appellant sold its 5.49% interest in the Sturgeon Hewitt Big Lake lease to Medallion Petroleums Limited for a consideration of $7,936 and its 33 1/3% interest in two Crown petroleum and gas leases to Murphy Oil Company, Limited and Ashland Oil and Refining Company Limited for a consideration of $1,000.

As a result of these two dispositions the appellant, at the end of its October 31, 1963 financial year, remained in possession of the 12 /2% interest in Crown leases and its 5% carried or working interest in leases in legal subdivisions 5 and 6.

On April 21, 1964 the appellant sold its 5% interest in the leases in legal subdivisions 5 and 6 to Scurry Rainbow Oil Limited for a consideration of $5,000.

It is this sale by the appellant to Scurry Rainbow Oil Limited which gives rise to the controversy between the parties which dispute may be succinctly expressed as whether this sale constitutes a sale of substantially all of the property of the appellant used by it in carrying on its business in Canada.

There is no question that this sale did not constitute a sale of all of the property of the appellant used in its business because it still retained its 12 /2% interest in six Crown leases.

The first position taken by counsel for the appellant was that subsection (8a) of section 83A must be read in the context of section 83A as a whole as constituting a separate code of the subject matter therein dealt with and that what is meant by the acquisition by a successor corporation of “all or substantially all of the property” used by a predecessor corporation used by it in carrying on its business in Canada is the acquisition of the business undertaking of the predecessor corporation.

In support of this contention counsel for the appellant, as I have said before, carefully traced the history of section 83A from its first enactment in 1955 replacing prior legislation which was of more limited extent.

Basically the legislation was designed as an incentive to corporations, the business of which is exploiting minerals or oil and natural gas, to encourage the search for oil, gas and minerals in Canada by permitting those corporations in computing their income to deduct what would otherwise be capital expenditures incurred in exploration, drilling, prospecting and development and by permitting those expenditures to be carried forward on a cumulative basis to be applied against income in future years.

He also pointed out that under the laws of the Province of Ontario and Manitoba, the amalgamation of corporations was possible but this was not so in the remaining jurisdictions of Canada. In those jurisdictions non-technical mergers were effected by the purchase of assets of one corporation by another in exchange for shares or by a take-over bid offer for shares. In 1958 section 85! of the Income Tax Act was enacted to govern the succession to drilling and exploration expenses in the event of amalgamation of two corporations.

Until the passage of subsection (8a) of section 83A in 1956 a corporate merger proceeding by way of the transfer of a business undertaking by one corporation to another did not include the right to deduct drilling and exploration expenses incurred by the transferring corporation.

By the enactment of subsection (Ba) that right was given, but subject to the limitation in paragraph (c) that the transfer had to be by way of a non-technical merger, that is, by the purchase of assets in exchange for shares of the purchasing corporation. Paragraph (c) was repealed in 1962 thereby removing that limitation.

As I understood the submission by counsel for the appellant he was outlining the general object and purpose of the legislation to justify a departure from the literal meaning of the words used in subsection (8a) of section 83A.

In construing a subsection of an Act of Parliament, the verbal construction of the particular subsection in question, if it is plain and simple, must govern. If there is any degree of doubt or difficulty consequent upon the wording of the subsection in question, then, and only then, the Court may look to the circumstances attending its passing and to the whole purport and scope of the section of which the subsection forms a part, to be collected from the various subsections thereof other than the particular subsection the meaning of which is in dispute.

I am satisfied, from the numerous decisions on the cardinal rules for the interpretation of statutes that I ought not to have resort to the general object of the enactment of subsection 83A(8) if the words used therein are clear and unambiguous.

In my view there is no ambiguity or lack of clarity in the words used in subsection (8a) and therefore I ought not to enter upon a refined consideration of the question whether those words carry out the object of the statute.

Counsel for the appellant clearly pointed out that he made no admission that the principal business of the appellant was one or other of (1) exploring or drilling for petroleum or natural gas or (2) mining or exploring for minerals but rather he maintained that it was a combination of both.

Accordingly he contended that the predominant business of the appellant, after the sale of its 5% interest in Crown oil and natural gas leases on April 21, 1964, was that of mining and that business was carried on by the appellant in the exploitation of the Gold King mining claims through its subsidiary, Uranium Leaseholds Limited.

The appellant did not own any mining claims in its own name. All claims that it had owned had been written off by 1961 and 1962.

In the appellant’s balance sheet for October 31, 1964 there is shown as an asset an investment in a subsidiary at cost being $13,000 and that subsidiary was Uranium Leaseholds Limited.

On December 15, 1962 the appellant acquired 20,000 shares in Uranium Leaseholds Limited at 25 cents per share for a total cost of $5,000. It is my recollection of the evidence that this cost of $5,000 was covered by the $5,000 received by the appellant on the sale of its 5% interest to Scurry Rainbow Oil Limited.

On December 15, 1963 a further 32,000 shares in Uranium Leaseholds Limited were acquired by the appellant at a cost of $8,000 or 25 cents per share. The appellant did not have $8,000 to pay for the shares so it issued 1,000,000 of its own treasury shares for $10,000 and applied $8,000 of the money so received in payment of the shares of Uranium Leaseholds Limited.

This was the means used to put money into Uranium Leaseholds Limited which became a subsidiary of the appellant in 1962.

Jesse Crockart who was a director of both the appellant and Uranium Leaseholds Limited and who was also a prospector and free miner had staked the Gold King Fraction claims in British Columbia.

At first it was contemplated that these claims might be acquired by the appellant in exchange for 500,000 of its treasury shares. This transaction was found to be impractical. Therefore the Gold King claims were acquired by Uranium Leaseholds Limited in exchange for the issue of its treasury shares to Mr Crockart.

Considerable exploratory work was done on the Gold King claims but the bulk of those expenses was charged to Uranium Leaseholds Limited with the exception of an amount of $350 which was a grub staking advance to Crockart by the appellant and an amount of $843.87 shown in the appellant’s financial statement for the period ending October 31, 1964.

In 1964 the appellant sold the shares it owned in Uranium Leaseholds Limited to Kodiak Minerals Limited for $5,200. The $13,000 which had been paid into the treasury of Uranium Leaseholds Limited on the acquisition of its 52,000 shares by the appellant had been expended on exploration expenses.

In my view the mining business carried on with respect to the Gold King claims was that of Uranium Leaseholds Limited and the facts that the controlling shares in Uranium Leaseholds Limited were owned by the appellant and that the same persons were on the boards of directors of both companies do not make that business the business of the appellant.

It is well settled that the mere fact that a person, natural or artificial, holds all the shares in a company does not make the business carried on by that company the shareholder’s business nor does complete and detailed domination by the shareholder over the company make the company the shareholder’s agent.

It is conceivable that there may be an arrangement between the shareholder and the company which will constitute the company the shareholder’s agent for the purpose of carrying on the business and so make the business that of the shareholder.

In the present appeals there was no evidence whatsoever that such an arrangement existed.

It was the contention of counsel for the appellant that the appellant had put money into Uranium Leaseholds Limited and had devoted management time to the affairs of that company. He relied upon the decisions of the Supreme Court of Canada in MNR v Consolidated Mogul Mines Limited, [1968] CTC 429; 68 DTC 5284, as authority for the proposition that the financing and management by one company on behalf of another constitutes the business of mining.

Spence, J, speaking for the Court, said (p 432 [5286]):

. . . The respondent company could be engaged in the business of mining or exploring for minerals just as well as the owner of the property if, under its contract with the owner, it did the mining or exploring for minerals.

Later he had described the business of the company as follows (p 431 [5285]):

. . . Although It continued after the year 1957 to carry out considerable exploration work on properties In which it held some kind of Interest, Its chief task in the years which are now under appeal seems to have been the development and management of properties owned by other companies. In such companies the respondent had some share-interest usually acquired by the contract made between the respondent and such company. These contracts provided for the investment in the shares of the various companies and then the control of the expenditure of the proceeds of such sales of shares by the various companies in the exploration and development of the various mining prospects.

In the present appeals there was no evidence that any contract existed between the appellant and Uranium Leaseholds Limited that the appellant would do the mining and exploring for minerals as was the circumstance in the Consolidated Mogul Mines case nor was there evidence of any arrangement whereby the appellant undertook the management of the business of Uranium Leaseholds Limited. All that was present in these respects was that the directors of the appellant and Uranium Leaseholds Limited were common to both companies and that the appellant put funds in the treasury of Uranium Leaseholds Limited by the purchase of its shares but did not contract to do anything further such as to control the expenditure of those funds in the exploration and development of the Gold King claims. That was the function of Uranium Leaseholds Limited.

Without deciding the question whether the business of the appellant was a conglomerate of mining, oil and natural gas, it is for these reasons that I have concluded that the mining business carried on with respect to the Gold King claims, which was the only mining business at the relevant time, was that of Uranium Leaseholds Limited and not that of the appellant.

Because of the conclusion I have reached on the two foregoing contentions put forward on behalf of the appellant, it follows that the narrow issue upon which the appeals herein fall to be determined is whether the sale by the appellant of its 5% interest in the oil and gas leases to Scurry Rainbow Oil Limited was the sale of “substantially all of the property” of the appellant used by it in carrying on the business of exploring or drilling for petroleum or natural gas in Canada.

Ai the end of its 1963 taxation year the appellant was possessed of two properties, (1) a 12 /2% interest in six Crown petroleum and natural gas leases and (2) a 5% carried or working interest in the oil and gas leases sold by it to Scurry Rainbow Oil Limited on April 21, 1964 that is in the appellant’s next succeeding taxation year. No other properties were acquired by the appellant subsequently in those years excluding the acquisition of further shares in Uranium Leaseholds Limited from the proceeds of the sale to Scurry Rainbow Oil Limited.

Consequently the question whether the sale of that 5% interest by the appellant was a sale by it of “substantially all of the property” used by it in carrying on its business must be determined primarily by comparing that property with the 12 /2% interest retained by the appellant in the six Crown leases.

The words used in subsection (8a) of section 83A are “all or substantially all”. Used in this context the words “substantially all’ must mean the substantial portion of the whole business.

Accordingly I embark upon a comparison of the facts relating to both properties.

Counsel for the appellant pointed out that the 12 /2% interest that the appellant had in the six Crown leases was a 12 /2% interest in 960 acres and that the 5% interest was a 5% interest in 80 acres. He therefore computed the appellant’s interests to be an interest in 120 acres retained as against an interest in 4 acres which was sold.

I do not think that mere quantity of acreage standing alone is the proper criterion for determining substantiality. Regard must also be had to quality.

Scurry Rainbow Oil Limited was the operator of legal subdivisions 5 and 6 of section 1, township 39, range 21 west of the 4th meridian. It owned a 52.5% interest in those leases. There were five other fractional interest owners, three of whom, including the appellant, owned a 5% interest, one owned a 12.5% interest and another owned a 20% interest.

The appellant’s interest, and I presume the interest of the others, was at one time described as a carried interest. By that is meant that the operator bore all the expenses of working the leases. However when the leases became productive and generated income the operator would deduct the expenses incurred in working the lease proportionately among the fractional interest owners so that the interest then became a working interest.

At one time the appellant held a 10% interest in these particular leaseholds but it surrendered half of that interest as its share of the cost of drilling a well thereby reducing its interest to 5%. I would assume that at that time the appellant’s interest must have been a working interest because it bore its proportionate share of the drilling expense.

This leasehold proved productive. It was the appellant’s sole source of operating income. I reach this information from an examination of the appellant’s financial statements for the years ending October 31, 1962, 1963 and 1964 which were the financial statements available to me. In 1962 the appellant’s revenue from this source after deducting royalties and the operator’s working expenses was $2,014.48, in 1963, $1,889.83 and in 1964, $1,004.96. Bearing in mind that the appellant’s interest was 5% the annual net production of this leasehold would be approximately $40,000.

Scurry Rainbow Oil Limited was anxious to consolidate its interest in this property and for this reason attempted to purchase the fractional interests of the lesser owners. Accordingly it offered to purchase the appellant’s 5% interest for $5,000 which offer was accepted by the appellant.

On the other hand Scurry Rainbow Oil Limited was also the operator and owner of the largest interest in the six Crown leases in which the appellant held a 12 /2% interest. Scurry Rainbow Oil Limited acquired its interest in these leases on May 9, 1957. From that date until the spring of 1966, at which time the leases were cancelled by the Crown, no exploration or drilling work whatsoever had been done on these leases.

On June 14, 1965 the appellant offered to sell its 12 /2% interest in these Crown leases to Scurry Rainbow Oil Limited but the appellant’s offer was not accepted because Scurry Rainbow Oil Limited did not wish to do so. Mr Abt testified that these were isolated leases and that it would not be economically feasible to drill a well thereon.

On April 20, 1965 the Department of Mines and Minerals for the Province of Alberta advised Scurry Rainbow Oil Limited that it was required to commence drilling operations on these leases within one year. The time to commence drilling could be extended upon application therefor and payment of a penalty. If drilling operations were not begun within the year the leases would be cancelled.

Scurry Rainbow Oil Limited advised all of its joint owners, including the appellant, of the receipt of this notice. Under the operating agreement any one of the joint owners could undertake the drilling operations and thereby become the sole owner.

No drilling operations were undertaken, no application was made to extend the time to begin drilling operations and accordingly the leases were cancelled in April 1966.

Mr Abt testified that Scurry Rainbow Oil Limited paid the nominal rent on the leases for 1965 and billed the joint owners for their proportionate share. /

There is no record of the payment of its share of that rent by the appellant in its financial statements but I would assume that it did so.

The appellant did not exercise its right to do the required drilling itself and become the sole owner. This is understandable because of its precarious financial position at that time but neither did it attempt to seek financing to do so.

The value of the appellant’s 12 /2% interest has been carried in its financial statements at $640 which was the cost of the acquisition thereof. In the financial statement for the year ending October 31, 1964 that value was reduced to nil. This was explained as an accounting error. In the next year, October 31, 1964 that value was restored to $640 and in the next ensuing year it was reduced to $120.

The salient facts which emerge from this comparison of the two properties are that the 5% interest in leaseholds which was sold to Scurry Rainbow Oil Limited was the sole source of the appellant’s revenue. It was an oil producing property on which extensive exploration and drilling had been done. It was considered by Scurry Rainbow Oil Limited to be a desirable property which it sought to acquire and did acquire. There was no exploration or drilling work done on the six Crown leases at any time between their acquisition by the operator in 1957 and the cancellation of those leases in 1966. AIT that was done by the joint owners, including the appellant, was to pay their proportionate shares of the nominal rent to keep the leases in good standing. The property lay dormant with no effort being made to explore and drill for potential oil or natural gas deposits. When threatened with the revocation of the leases in the event of failure to drill, the leases were allowed to lapse by the joint owners, including the appellant. The appellant offered to sell its interest to Scurry Rainbow Oil Limited but that company declined the appellant’s offer.

Without purporting to decide the question whether mere ownership of a minor percentage in these Crown leases is use of that property in carrying on the business of exploring or drilling for oil or natural gas by the appellant the evidence is abundantly clear that this business was not actively engaged in and that the prospect of exploration and drilling thereon was remote.

As a consequence of the foregoing comparison of the facts relating to the two properties owned by the appellant I am led to the conclusion that the 5% interest in the leaseholds which was sold by the appellant on April 21, 1964 to Scurry Rainbow Oil Limited was a sale of substantially all of the property used by the appellant in carrying on its business in Canada.

It follows from that conclusion that the appellant is precluded by subsection 83A(8a) from deducting expenses previously incurred by it in exploring or drilling for oil or natural gas or in searching for minerals as the appellant sought to do in its 1968 and 1969 taxation years.

Accordingly the appeals are dismissed with costs.