Gunnar Mining Ltd. v. Minister of National Revenue, [1965] CTC 387, 65 DTC 5241

Gibson, J.:—This is an appeal from the decision of the Tax Appeal Board dated September 24, 1963 in respect of assessments for income tax made against the appellant in the sum of $1,753,200.07 being respectively a tax in the sum of $171,271.01 levied in respect of income for the taxation year 1958, a tax in the sum of $222,252.93 levied in respect of income for the taxation year 1959 and a tax in the sum of $1,359,676.13 levied in respect of income for the taxation year 1960.

The appellant is a company incorporated under the laws of the Province of Ontario.

The appellant established a business in the Beaverlodge Area of Saskatchewan consisting of mining and milling uranium ores from mineral claims, producing uranium concentrates and selling the same to Eldorado Mining and Refining Limited. For the 36-month period ending February 28, 1959 the Appellant was not required to include in computing its income the income derived from the operation of (its) mine’’ by reason of the provisions of Section 83(5) of the Income Tax Act.

In order to bring into operation its uranium mining and milling activities, the appellant raised $19,500,000 by way of sale to the public of debentures bearing interest at 5%. The evidence discloses that the appellant expended all these monies prior to any relevant taxation year in respect of which this appeal is concerned.

Subsequently, namely after March 1, 1956 and during the relevant taxation years, the appellant in its mining and milling operations earned very substantial sums of money and accumulated large profits, but instead of using these accumulated profits to pay off and extinguish all of its liabilities in respect to its debenture debt, the appellant invested certain of the surplus funds derived from these profits in short-term investments such as Dominion of Canada bonds and provincial government bonds. On balance, these short-term investments did not earn 5%. The appellant, in its interest accounting, netted the debenture interest payable on its debentures outstanding and the interest received from these short-term investments. By co-relating the interest paid out and the interest received, because the interest paid out in all cases was 5% and the interest received was less than 5%, it was inevitable that the net interest account was less than it otherwise would have been.

The schedule attached to this judgment illustrates this.

The appellant founded its appeal substantially on the evidence of its expert witness Mr. R. M. Parkinson, a chartered accountant of some 36 years experience.

The evidence of Mr. Parkinson in brief was that it was proper from a commercial and business point of view for the appellant, or indeed for any business, to differentiate in its statement of income and expenditures between what he refers to as ‘operating items’’ and ‘‘non-operating items”.

The figure obtained by considering only operating items, this witness said, results in arriving at a figure of “operating income’’. This is done by first obtaining the figure of gross sales less returns, allowances etc., and subtracting from that sum the cost of sales to arrive at a figure for gross profit. From this figure is then deducted selling expenses and general and administrative expenses from which the figure of operating income is obtained.

Then this witness said it is proper to consider the non-operating items in the business.

These non-operating items the witness said are categorized as ‘‘other income’’, and include interest and dividends and miscellaneous items on the receipt side and also on the disbursement side; and from which there is computed the figure of income before federal and other taxes. Then the witness said that it is proper to make a computation of federal and other taxes and subtract the figure so found from the figure of income above referred to, in order to obtain the figure of ‘‘net income’’ of the business for the fiscal year.

It is the submission of the appellant that if the provisions of the Income Tax Act are considered in relation to this approach to the statement of income and expenditure, that the deductions from its income hereinafter referred are legally proper.

It is convenient to consider this appeal from the point of view of two periods of time, because different provisions of the Income Tax Act are relevant to each.

The first period may be referred to as the exempt period, that is the 36-month period ending February 28, 1959. This is the period during which the appellant’s income from the operation of its mine was exempt from taxation by reason of Section 83(5) of the Income Tax Act.

The second period may be referred to as the non-exempt period by which is meant the period after the 36-month interval referred to in Section 83(5) of the Income Tax Act had expired.

In respect to the first period, it is the submission of the Appellant that the income that the company received from its investments in short-term securities is correctly categorized as nonexempt income and that the remaining income of the company namely, ‘‘that derived from the operation of (its) mine’’ was the exempt income.

The submission of the appellant is that by reason of Section 11(1) (c) the appellant was entitled to deduct interest for the purpose of computing its income from all sources and that this subsection did not require or permit the appellant to relate separate portions of the permissible interest deduction to its various sources of income; and that the only interest deduction not permitted to the appellant during the exempt period by Section 11(1) (c) was to the extent that interest expense for that year “may reasonably be regarded as having been made or incurred for the purpose of gaining or producing exempt income’’ within the meaning of Section 12(1) (c) [sic].

The appellant therefore submits that a determination of fact must be made as to what part of the debenture interest may reasonably be considered a cost of earning this non-exempt income ; and such interest expense so found, the appellant submits, is a permissible deduction under Section 11(1) (c) and is not taken away by Section 12(1)(c). Any method of computing the quantum of this sum, the appellant says, is legally correct so long as it is reasonable; and it submits that netting the interest account as it did is a reasonable method. That is the submission in so far as the first period is concerned.

The second period is the non-exempt period.

The matter of trying to allocate any expense of debenture interest under Section 12(1) (c) is not in issue during this period because the deduction of debenture interest was allowed in full under Section 11(1) (c).

What is in issue during this second period is the quantum of the depletion allowance authorized by Section 1201(2) of the Income Tax Regulations. This regulation provides for a depletion allowance of 3314 % of ‘‘the aggregate of . . . profits for the taxation year reasonably attributable to the production of . .. industrial minerals . . . minus the aggregate amount of deduction provided by . . .’’ Section 1201(4) (d). This latter regulation is the deduction permitted. under Section 11(1) (c) ‘‘in respect of (i) borrowed money used in connection with, or used for the purpose of acquiring property used in connection with, or

(ii) an amount payable for property used in connection with . .. production of . . . industrial minerals . . .’’.

It is the submission of the appellant that in calculating the depletion allowance under Section 1201(2) there must be deducted from the operating profits ‘‘reasonably attributable to the production of . . . industrial minerals . . .’’ only such part of the appellant’s interest expense on its debentures incurred during the taxation year as is attributable to its mining operations and not the portion of such debenture interest as is attributable to earning income on its short-term investments. In other words, the appellant submits that the historical approach to the purpose for which the original debenture debt was incurred is not the proper approach but instead the approach should be on the basis of an annual inquiry of the use to which any borrowed monies are being put in any taxation year and that such is a question of fact. If such borrowed monies are used to earn income from more than one source, it is the submission of the appellant that any reasonable method of calculating the portion of interest charges applicable to each separate source of income is legally correct. The appellant submits that netting the interest costs and interest expenses is such a reasonable method. The appellant further says that the fact that it employed surplus monies in earning income on short-term investments rather than in paying off its debenture debt or rather than leaving the money in the bank without earning interest does not destroy pro tanto its right to make such a deduction from the interest on its debentures from its income.

I accept Mr. Parkinson’s evidence in so far as it describes a method currently recommended as good practice and employed by many accountants in determining the profit or loss of a company from its business operations including miscellaneous revenues of investments of surplus cash. His method no doubt is not only good accounting practice but is also acceptable as a method of determining the company’s income for the purpose of the Income Tax Act for a fiscal year (when the company is taxable on its income from all sources) in that it is not contrary to any particular statutory direction.

In the matter under appeal, however, what is being considered is not income for the year from all sources but income from a source other than the company’s mining business, namely, the income from its short-term investments. Therefore it becomes necessary as a matter of accounting fact to consider solely the question as to what sources particular expenses are related to, and for the purposes of the Income Tax Act to consider the same in relation to its relevant provisions.

It is therefore necessary firstly to resolve a question of fact.

The sole question of fact is whether or not part of the interest paid on the debenture debt of the appellant was a cost of earning the interest income on its short-term investments. In my opinion on the evidence it was not. There was nothing adduced in evidence through Mr. Parkinson or any other witness to prove this; indeed no connection between these transactions was established at all.

In view of this finding, it follows, in respect to both of the said two periods, that none of the provisions of the Income Tax Act, by reason of which the appellant submits that some deduction should be allowed in computing its income, are relevant.

The appeal therefore fails and is dismissed with costs.