M P Drilling LTD (Formerly Mountain Pacific Pipeline Ltd) v. Minister of National Revenue, [1974] CTC 426, 74 DTC 6343

Bastin, DJ:—The appellant is a corporation incorporated on September 30, 1963, under The Companies Act of Alberta for the primary purpose of carrying on the business of marketing liquified petroleum gases in the Pacific Northwest, Hawaii, Japan and the Far East.

The result of the operations of the appellant were as follows: in 1964 a loss of $48,506; in 1965 a loss of $293,819; and in 1966 a loss of $64,502. It claims that with the exception of the sum of $17,520 paid for legal fees in 1965, all of these losses are deductible from subsequent profits. In 1966 it decided that the plan to market gas was not feasible and it commenced the operation of contract drilling which was within its corporate powers, and it has since then carried on this enterprise profitably.

The Minister has disallowed these deductions and has assessed income taxes and interest with respect to them on the ground that the expenditures which resulted in the losses in the three years in question were expended on capital account.

What is a payment on account of capital and what can properly be charged to revenue must depend on the facts of the particular case. As stated by Lord Pearce in the Privy Council decision B P Australia Ltd v Commissioner of Taxation of the Commonwealth of Australia, [1966] AC 224 at 264:

The solution to the problem Is not to be found by any rigid test or description. It has to be derived from many aspects of the whole set of circumstances some of which may point in one direction, some in the other. One consideration may point so clearly that it dominates other and vaguer indications in the contrary direction. It is a commonsense appreciation of all the guiding features which must provide the ultimate answer.

The plan to market liquid petroleum gases originated with Mr G A Van Wielingen, a chemical engineer employed in Calgary by J C Sproule and Associates Ltd, oil and gas engineering and geological consultants. He came to the conclusion that a large quantity of these gases, such as propane and butane, could be produced from Alberta oil if a market could be developed for it in Japan, Korea, Taiwan, Hawaii and the Pacific Northwest of the United States. He convinced a successful oil driller, Mr V W Bawden, of the feasibility of the plan, and the latter incorporated Mountain Pacific Pipeline Ltd for the purpose of carrying on this marketing plan. The corporate name was later changed on July 16, 1969 to M P Drilling Ltd. Mr G A Van Wielingen joined the company as vice-president and general manager in August 1964 and during the remainder of that year and during 1965 he and Mr V W Bawden devoted their efforts and expended money to bring their marketing plan to a successful conclusion. By the end of 1965 it became apparent that the plan would not succeed and Mr Van Wielingen left the company and Mr Bawden made use of the power of the company to drill for oil to operate in this business which has been very profitable.

The successful marketing of liquid petroleum gas involved many difficult problems: arranging the supply with the producing oil companies; creating extraction plants; gathering the gas and transporting it to seaboard by pipeline or other means; obtaining permits for its export from the National Energy Board and the two provinces, Alberta and British Columbia; constructing refrigerated storage and loading facilities at the west coast; acquiring or chartering refrigerated tankers to transport the gas overseas and, finally, negotiating firm contracts with overseas buyers.

A large part of the expense was for expert analysis and feasibility studies, primarily to convince the Alberta oil producers, the overseas buyers, the officials of the three governments concerned, and financial interests, that the plan was sound and potentially profitable. Many firms were hired to conduct research, but the two largest were J C Sproule and Associates, which was paid $71,912, and Bechtel Corporation of California, which was paid $93,368. Mr Bawden and Mr Van Wielingen spent several months in Japan trying to interest potential buyers, and conducted negotiations with buyers in other parts of the world and with the Alberta oil producers. As a first step in solving the problem of transporting the gas, they arranged to have a company incorporated by special Act of the Parliament of Canada, with the same name as the Alberta company, Mountain Pacific Pipeline Ltd.

At the opening of the trial, counsel for the appellant stated that there was no dispute as to the items of expense involved in the appeal, so he had made no plans to prove the individual items and, in fact, the only witness who could do so was out of the country. Counsel for the respondent denied any such understanding. The outcome of this misunderstanding was an agreement between counsel that if the Court was not satisfied that these amounts had been expended by or on behalf of the appellant, the parties were to have 30 days to resolve the matter by agreement, failing which they would return to Court to adduce further evidence. In his argument, counsel for the respondent contended that the appellant had failed to prove that these items had been spent by or on behalf of the appellant, so on that ground the appeal should be dismissed.

The only witness at the trial was Mr Van Wielingen. He testified that Mr Bawden had formed the appellant company to market liquid petroleum gas, and all his activities, and those of Mr Bawden, in relation to this marketing plan, were carried out through the agency of this company. Counsel for the respondent did not contend that the sums in question had not been paid, so if I believe the evidence of Mr Van Wielingen, I must hold that it was the appellant company which incurred these expenses. I believe that Mr Van Wielingen was a truthful witness and his evidence on this point is corroborated by the numerous exhibits filed, so I hold as a fact that the items of expense set out in paragraph 8 of the Notice of Appeal were incurred by or on behalf of the appellant. It is immaterial that Mr Bawden actually provided the money since he was the owner of the company and was providing all its finances.

The legal argument of counsel for the respondent was that these expenses were incurred in an effort to found a business and not in the course of carrying on a business. His contention was expressed in paragraph 3(c) of the reply: that any activity carried on by the appellant from the date of the incorporation until May 1, 1966 was not that of carrying on a business but was actually preparatory to carrying on a business. He argued that such expenses were therefore not made for the purpose of producing income from a business of the taxpayer. His reasoning was that only a business in operation would be entitled to make such deductions, and since the appellant never sold any gas it never became a business. The answer to that argument is found in the definition of “business” in the Income Tax Act, which is as follows:

139(1)(e) “business” includes a profession, calling, trade, manufacture or undertaking of any kind whatsoever and includes an adventure or concern in the nature of trade but does not include an office or employment.

This definition was considered in the case of MNR v Henry J Freud, [1968] SCR 75; [1968] CTC 438; 68 DTC 5279. The facts of the case are that Freud and several friends, as a leisure time activity, constructed a sports car in the hope of selling it to an automobile manufacturer, but were unsuccessful in making such a sale. Freud sought to deduct his expenditures on the car of $13,840.47 from the income of his normal occupation for income tax purposes. In holding that he could do so, Pigeon, J at pages 79 and 80 [440-441; 5281] discussed the principle as follows:

It must also be noted that the Income Tax Act defines business so as to include “an adventure or concern in the nature of trade” (s. 139(1)(e)). By virtue of this definition, a single operation is to be considered as a business although it is an isolated venture entirely unconnected with the taxpayer’s profession or occupation. This consequence of the definition has been recognized and given effect to in many cases but I will refer only to one of them, namely McIntosh v Minister of National Revenue in which it was held that a single venture of speculation in land gave rise to taxable income when profit was obtained as a result of an acquisition made with a view to a profit on the resale. . . .

Such being the principles to be applied in cases when a profit is obtained, the same rules must be followed when a loss is suffered. Fairness to the taxpayers requires us to be very careful to avoid allowing profits to be taxed as income but losses treated as on account of capital and therefore not deductible from income when the situation is essentially the same.

It is reasonable to assume that if the appellant had made a profit from its marketing plan, it would have been subject to income tax. It follows that since these expenditures were incurred for the purpose of producing income they were revenue expenses and deductible. All the items with which we are concerned, except consultation fees and legal fees, are the normal operating expenses of a business. Such items as salaries, employees’ welfare, travel, rent and utilities, stationery, advertising, casual help, telephone and telegraph and miscellaneous, are current expenses which obviously were not made on capital account. The appellant has admitted that $17,528 of the legal fees were on account of capital. With respect to consultation fees, the words of Jackett, then President of the Exchequer Court, now Chief Justice of the Federal Court of Canada, in Canada Starch Company Limited v MNR, [1968] CTC 466 at 474 [68 DTC 5320 at 5324], are applicable:

. . . Similarly, in my view, expenses or other measures taken by a businessman with a view to introducing particular products to the market—such as market surveys and industrial design studies—are also current expenses. They also are expenses laid out while the business is operating as part of the process of inducing the buying public to buy the goods being sold.

It might be argued that the investigations by Bechtel Corporation of California into the construction of a pipeline might be in a different category since they concerned the creation of a capital asset, but this Court has held in Bowater Power Co Ltd v MNR, [1971] CTC 818; 71 DTC 5469, that when the plans for a capital investment are abortive, the expense of such preliminary studies are revenue expenses. I quote from the judgment at page 835 [5479] and at page 837 [5481]:

No property resulted, however, to the appellant because of those expenditures. The sites were not developed. With regard to the Little Grand Lake project, it was not economically feasible to proceed at that time with the report. As for the Hinds Brook project, although it was economically feasible to proceed with the report and the appellant went so far as to arrange the financing for the job, it did not materialize. Just before it got off the ground, the Provincial Power Commission came onto the scene and wanted to develop a fairly large hydro site at Bay Despair. They offered to sell the appellant power from their Bay Despair plant at a cheaper rate than the appellant could produce at Hinds Brook at that time and the plan was abandoned.

I do not indeed feel that merely because the expenditure was made for the purpose of determining whether to bring into existence a capital asset, it should always be considered as a capital expenditure and, therefore, not deductible. In distinguishing between a capital payment and a payment on current account, regard must always be had to the business and commercial realities of the matter. While the hydroelectric development, once it becomes a business of commercial realty is a capital asset of the business giving rise to it, whatever reasonable means were taken to find out whether it should be created or not may still result from the current operations of the business as part of the every day concern of its officers in conducting the operations of the company in a business-like way. I can, indeed, see no difference in principle between all of these cases.

The appeal is allowed and the assessments for the years 1967 and 1968 are referred back to the respondent for reassessment on the basis that the loss of $48,506 in 1964, the loss of $276,291 in 1965, and the loss of $64,502 in 1966, are revenue expenses and are deductible from earnings in subsequent years. The respondent is to pay the costs of the appeal.