Westar Mining Ltd. v. The Queen, 88 DTC 6505, [1988] 2 CTC 349 (FCTD)

Cullen, J.:—This is an appeal from reassessment of tax for the plaintiff's 1975 and 1976 taxation years. Since the filing of this appeal, a number of issues have been resolved and a judgment pro tanto has been ordered by the Senior Prothonotary Mr. Lefebvre. The only remaining issue to be dealt with by the Court concerns the proper tax treatment to be given to the $1,455,865 received by the plaintiff under business-interruption insurance policies.

The Facts:

The parties to this action filed a partial agreed statement of facts, which reads as follows:

1. The Plaintiff, formerly Kaiser Resources Ltd., is a corporation incorporated under the laws of British Columbia and at all relevant times carried on the business of operating a coal mine and related processing facilities in the Sparwood area of British Columbia.

2. Among the mines operated by the Plaintiff was the Balmer Mine at Elkview and it processed coal therefrom at its processing plant.

3. The Plaintiff commenced production of coal from its Elkview Mine in reasonable commercial quantities on May 1, 1971.

4. On December 4, 1971 a fire occurred at the Plaintiff's Elkview processing plant and as a result the plant did not operate from December 4, 1971 to December 20, 1971. The plant was in partial production from December 21 to December 29, 1971 after which time full production was resumed.

5. In its 1972 taxation year, the Plaintiff received the net amount of $1,455,865 under business interruption insurance policies in respect of its loss of profits resulting from the fire in its processing plant.

6. At the time of the fire and at the time it received the insurance proceeds, all of the Plaintiff's income derived from the operation of its Balmer mine at Elkview, including income derived from the processing of coal from the mine, was exempt from taxation pursuant to section 28 of the Income Tax Application Rules, 1971.

7. Of the sum of $1,455,865 received by the Plaintiff as business interruption insurance the sum of $127,865 related to the loss of profits in respect of coal from a mine or mines other than the Balmer mine. The income from the operation of the mine or mines in respect of which the sum of $127,865 was received was not exempt under section 28 of the Income Tax Application Rules, 1971. The balance of $1,328,000 related to its loss of profits in respect of coal from the Balmer mine.

8. The parties agree that the sole issues for determination in this matter are the following:

(a) Is the sum of $1,328,000 received as proceeds of business interruption insurance in respect of the loss of profits from the Balmer mine exempt from tax pursuant to section 28 of the Income Tax Application Rules, 1971 as “income derived from the operation of a mine"? and

(b) If the answer to question (a) is in the negative, is such amount income to the Plaintiff within the meaning of the Income Tax Act?

9. The parties agree that if this Honourable Court holds that the answer to question (a) is in the affirmative or that the answer to question (b) is in the negative the assessments for 1975 and 1976 should be referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the amount of $1,328,000. should be excluded from the Plaintiff’s income for its 1972 taxation year, and for the purpose of making such adjustments to the Plaintiff's income for 1975 and 1976 resulting from such exclusion and the consequential changes to the amounts of the Plaintiff's exploration and development expenses, non-capital loss carry forwards, earned depletion claim and resource allowances and capital cost allowances.

Also, when the plaintiff calculated its income for the 1972 taxation year, it did not include the money received as net proceeds under the business interruption insurance policies. By notice of assessment, dated July 14, 1977 the Minister of National Revenue (M.N.R.) included the amount of $1,455,865 in computing the plaintiff's income for its 1972 taxation year as an amount "from business interruption insurance considered taxable income". This resulted in an increase in the plaintiff's exploration and development expense deduction under section 83A of the Income Tax Act, R.S.C. 1952 c. 148 (the old Act) as carried forward under section 29 of the I.T.A.R., and the consequence of the M.N.R. reassessment the taxable income was nil.

By notice of objection dated October 7, 1977, the plaintiff objected to the inclusion in its income for the 1973 taxation year the amount of $1,455,865. By notice of confirmation dated November 27, 1980, the M.N.R. confirmed that no tax was payable for the plaintiff's 1972 taxation year, but otherwise did not alter the basis upon which the plaintiff's income for that year was computed, and specifically did not exclude the amount of $1,455,865 in the computation of the plaintiff's income.

Plaintiffs Position

The plaintiff argues that the amount received under its business interruption insurance policies was properly excluded in the computation of income for the 1972 taxation year as the amount received was "income derived from the operation of a mine” within the meaning of section 28 of the I.T.A.R. and was received by the plaintiff during the three year exemption period set out in the same section of the I.T.A.R.

In the alternative, the plaintiff submits that if such amount is not the income derived from the operation of a mine, it is not income within the meaning of the Income Tax Act.

Defendant's Position

For the defendant, it is argued that the net amount received by the plaintiff under its business interruption insurance policies was properly considered income and the amount received was not "income derived from the operation of a mine" within the meaning of section 28 of the I.T.A.R.

Applicable Provisions of the Income Tax Act

Subsection 83(5) of the pre-1972 Income Tax Act, R.S.C. 1952, c. 158, provided:

(5) Exemption for 3 years. Subject to prescribed conditions, there shall not be included in computing the income of a corporation income derived from the operation of a mine during the period of 36 months commencing with the day on which the mine came into production.

The prescribed conditions were contained in regulation 1900. Therefore, under subsection 83(5), if a corporation complied with the prescribed conditions outlined in regulation 1900, its income derived from the operation of a mine during the period of 36 months beginning on the day on which the mine came into production in reasonable commercial quantities, was excluded in the computation of its income for tax purposes. Section 28 of the I.T.A.R. continued this exemption until December 31,1973 for corporations which comply with regulation 1900. At the applicable time, section 28 of the I.T.A.R. provided:

28. (1) Subject to prescribed conditions, there shall not be included in computing the income of a corporation, income derived from the operation of a mine that came into production before 1974 to the extent that such income is gained or produced during the period commencing with the day on which the mine came into production and ending with the earlier of December 31, 1973 and the day 36 months after the day the mine came into production, except that this subsection does not apply in respect of any mine that came into production after November 7, 1969 unless the corporation so elects in respect thereof in prescribed manner and within prescribed time.

(Section 28 of the I.T.A.R. was repealed in 1985.)

The prescribed conditions were outlined in regulation 1900 (revoked by P.C. 1988-39D, s. 10, effective October 29, 1985) and basically contained rules regarding the manner in which an election under I.T.A.R. 28(1) was to be effected. Regulation 1900 is set out below:

1900. (1) For the purposes of subsection 28(1) of the Income Tax Application Rules, 1971, the following conditions are hereby prescribed:

(a) the corporation shall maintain separate accounting records in respect of the mine

(i) for the period beginning with the commencement of operation of the mine by the corporation and ending with the day before the day on which the mine came into production, and

(ii) for each taxation year of the corporation which includes a part of the 36 months beginning with the day on which the mine came into production;

(b) if the operation of the mine was the only business carried on by the corporation on the day before the day on which the mine came into production, the corporation shall end its taxation year and close its books of account as of that day;

(c) if paragraph (b) does not apply, the corporation shall close its accounting records in respect of the mine on the day that is 36 months after the day on which the mine came into production; and

(d) the corporation shall file a return in triplicate in prescribed form with the Minister.

(2) Any election by a corporation under subsection 28(1) of the Income Tax Application Rules, 1971 in respect of a mine that came into production after November 7, 1969 shall be made by filing with the Minister one of the following documents in duplicate:

(a) where the directors of the corporation are legally entitled to administer the affairs of the corporation, a certified copy of their resolution authorizing the election to be made; and

(b) where the directors of the corporation are not legally entitled to administer the affairs of the corporation, a certified copy of the authorization of the making of the election by the person or persons legally entitled to administer the affairs of the corporation.

(3) The document referred to in subsection (2) shall be filed on or before

(a) the day on or before which the corporation making the election referred to in subsection (2) in respect of a mine is required to file a return of income pursuant to section 150 of the Act for its taxation year in which the mine came into production in reasonable commercial quantities, or

(b) June 30, 1974,

whichever is the later.

As the plaintiff began commercial production of coal on May 1, 1971, the plaintiff made the required election.

Comment - Issue #1

A review of the case law clearly reveals that proceeds from business interruption insurance are generally treated as income for tax purposes. The following cases are: London and Thames Haven Oil Wharves Ltd. v. Attwooll, [1967] 2 All E.R. 124 (C.A.); The King v. B.C. Fir and Cedar Lumber Company Limited, [1932] A.C. 441 (P.C.); [1928-34] C.T.C. 36; Seaforth Plastics Ltd. v. The Queen, [1979] C.T.C. 241; 79 D.T.C. 5174 (F.C.T.D.); Cominco Ltd. v. The Queen, [1984] C.T.C. 548; 84 D.T.C. 6535.

Collier, J. in Seaforth provides an excellent analysis on how to characterize proceeds from business interruption insurance. According to Collier, J., one must first examine the character of the indemnity paid under the policy for business interruption. Once that is done, one must decide whether the moneys so paid were in respect of loss or destruction of property, as those words are used in the Income Tax Act. The Court found that the business interruption coverage was a separate and distinct coverage from the property damage coverage and concluded that it was an income receipt rather than a capital receipt. (Emphasis added.)

Counsel for the plaintiff all but conceded that the proceeds for the insurance was income, but felt that it would serve to show what he felt was the illogical position of the defendant — namely if it is not income from the production of a mine, what really was its source.

It is clear that money received as proceeds from a business interruption insurance policy is income within the meaning of the Income Tax Act.

Comment — Issue #2

Having determined that the proceeds from the business interruption insurance are income for tax purposes, the question becomes — can these proceeds be considered income derived from an operation of a mine and therefore exempt by virtue of the provisions of section 28 of the I.T.A.R.

The meaning of the words “income derived from the operation of a mine" has been considered in a number of cases in the context of subsection 28(5) of the old Act. As section 28 of the I.T.A.R. is a continuation of subsection 83(5) and contains exactly the same phraseology, I see no reason why the comments made in respect of 83(5) cannot be used to assist in the determination of whether the proceeds can be considered income derived from the operation of a mine.

The word “derived” in the context of subsection 83(5) is broader than "received" and is equivalent to “arising or accruing”. Further, the expression is not limited to income arising or accruing from the operation of a mine by a particular taxpayer.

M.N.R. v. Hollinger North Shore Exploration Co. Ltd., [1963] C.T.C. 51 at 54; 63 D.T.C. 1031 at 1033. In Hollinger, the Supreme Court of Canada found that royalties received from a lessee operating a mine were exempt from income within the meaning of subsection 83(5) of the old Act. Abbott, J. (for the Court) found that the mine in question was operated as a unit by the respondent company and Iron Ore Company of Canada as a joint venture for their joint benefit, and the ore in place represented a capital investment of both companies. A return on that capital investment could be realized only through the operation of the mine and in Abbott, J.'s opinion, such operation was the source of the respondent's income within the meaning of subsection 83(5), whether that income came from the extraction and sale of its own ore or from the royalty paid to it with respect to the remainder of the ore belonging to the Iron Ore Company of Canada. It should be noted that at the Exchequer Court level, the Court came to the same conclusion, ((1960] C.T.C. 136; 60 D.T.C. 1077) based on the fact that there was no wording in the statute which restricted the exemption only to income received by the operator of the mine. The M.N.R. tried to read words into the statute that were not there and the Court refused to accept that argument. (Emphasis added.)

In Falconbridge Nickel Mines Ltd. v. M.N.R., [1972] C.T.C. 374; 72 D.T.C. 6337, a Federal Court of Appeal decision, which affirmed [1971] C.T.C. 789; 71 D.T.C. 5461 (F.C.T.D.), the taxpayer claimed an exemption under subsec- tion 83(5) of the Act for profits subsequently realized on ore mined during the exempt period provided for under that section. The Court of Appeal found that the M.N.R. had properly included the income accruing from all sales made during the 36-month period (notwithstanding that some of the ore from which the metals had been refined had been extracted prior to the commencement of the period) and had properly excluded income accruing from sales made after the expiry of the 36-month period of metals extracted and processed during the period. With respect to "operation of a mine” Sweet, D.J. noted at page 378 (D.T.C. 6341):

The operation of the mine within the meaning of the relevant legislation can only mean the conducting of a viable, practical undertaking for that purpose. For this it is necessary, and I would think obviously, required that there be an organization, a business enterprise, so structured and set up that the multiplicity of requirements to that end will be available. The extracting of the ore, the conversion of it into metal and the sale are parts, and important parts, but only parts, of those requirements. For realistic achievement of the result to be accomplished, and accomplished in a practical and effective sense, they must be supported and accompanied by other activities. It is the totality of that organization, of that enterprise and the totality of the conduct of the business which is "the operation of a mine” within the meaning of the legislation.

The Chief Justice specifically dealt with the question which is meant by the words "operation of a mine” and indicated at page 379 (D.T.C. 6342) that the correct view was that:

. . . when subsection 83(5) talks of income derived from operation of a mine, it is referring to income derived from a business of operating the mine, for, in relation to profit producing activity (as opposed to property or employment) a business is the sort of income source contemplated by the Income Tax Act. See, for example, section 3 of the Act, which reads as follows:

3. The income of a taxpayer for a taxation year for the purposes of this Part is his income for the year from all sources inside or outside Canada and, without restricting the generality of the foregoing, includes income for the year from all

(a) businesses,

(b) property, and

(c) offices and employments

A mere physical act considered apart from the other steps necessary to bring income into existence is not a source of income as contemplated by the Act. It follows that the mere physical act of extracting ore from the mine, considered apart from the business of which it forms a part, is a barren act that is not, in itself, capable of being an income source. That physical act cannot, therefore, be what is contemplated by subsection 83(5) when it speaks of "operation of a mine" as something from which income is derived.

I realized at this juncture that if the plaintiff could convince me that the proceeds from the business interruption insurance policies related to the profit producing activity of a business and fell within an income source, per section 3 of the Act, and was part of that totality of the conduct of the business, then it might be possible to include it in income derived from the operation of a mine.

The trial judge in Falconbridge Nickel, supra dealt with the interpretation of 83(5). After reviewing the scheme of the Act, Cameron, D.J. noted that if it were not for the provisions of subsection 83(5), the income arising or accruing from the operation of a mine would form part of the computation of the taxpayer's taxable income in each year. By 54 (now 59) income for a taxation year from a property or business is the profit therefrom for the year subject to the provisions of Part 1. He continued at page 798 (D.T.C. 5467):

In section 83(5) the word "income" is used twice and I see no reason why its meaning should not be the same on each occasion. I think also that as income is not defined in the interpretation section 139, it should here have the same meaning as that contained in section 4 inasmuch as section 83(5) is dealing (1) with a computation of the income of a corporation (which would normally comprise all its profits for the year, subject to any permitted deductions) and (2) the income derived from the operation of a mine during a period of 36 months commencing with the day on which the mine came into production in reasonable commercial quantities.

Income is also not defined in section 248 of the current Act and section 28 of the I.T.A.R. is not particularly helpful, as it defines "income derived from the operation of a mine" as the income derived from the operation of the mine before any deduction is made under sections 65 or 66 of the amended Act (paragraph 28(2)(a) of the I.T.A.R.). Accordingly, if one follows Cameron, D.J.'s reasoning, income in section 28 of the I.T.A.R. should have the same meaning as that contained in section 4 (now section 9) of the Act, in that section 28 deals with (1) the computation of the income of a taxpayer (including a corporation) which would normally comprise all its profits for the year and (2) the income derived from the operation of a mine during a period of 36 months commencing with the day on which the mine came into production in reasonable commercial quantities. Continuing, section 28 of the I.T.A.R. should relate to the computation of profit in the relevant taxation year.

However, I have serious reservations that the plaintiff was able to relate the insurance proceeds to profits from a business, other than that is how it was labelled for accounting purposes. This is not necessarily indicative, given the principle that a taxpayer's accounting practice or even generally accepted accounting principles are not controlling in the face of the express wording of the Act.

On the other hand Falconbridge Nickel can be distinguished from the case before me on the basis that the issues to be decided are different. The issue that was to be determined in Falconbridge Nickel was whether in computing under subsection 83(5) the income of the taxpayer derived from the operation of its new mines during the 36-month period there is to be included income arising or accruing from sales made during the 36-month period of metals from ore which had been extracted prior to the 36-month period and whether there is to be excluded income arising or accruing from sales made subsequent to the 36-month period of metals from ore which had been extracted during the 36-month period (p. 377 (D.T.C. 6340)). The Court in Falconbridge was dealing with extraction and the sale of ore, not with proceeds of insurance which are considered compensation for the interruption of the processing operation of a mine.

The Supreme Court of Canada in the case of Gunnar Mining Ltd. v. M.N.R., [1968] C.T.C. 22; 68 D.T.C. 5035, was faced with an argument similar to the one made before me. In Gunnar the appellant company decided to invest its surplus revenue from its mining operation in short-term investments until the money was required to retire debentures under the debenture agreement, rather than retire the debenture prior to maturity at a premium. The company argued that, during the period the income from the mine was tax exempt, the interest paid could reasonably be regarded as a cost of earning the non-exempt income from its short-term investments, and that, following the exemption period, the debenture interest paid should not be deducted in computing its depletion base under subsection 120(2) of the Regulations. Spence, J. for the Court noted at page 26 (D.T.C. 5038) that what is exempt under subsection 83(5) is income derived from the operation of a mine and found that income from the short term investments was not income derived from the operation of a mine but was income derived from the investment of the profits of the mine. Further, that "this income from the short term investments cannot be regarded as incidental income in the operation of the mine any more than any other income gained from use of profits of the mine could be so construed”. Therefore, as this income could not be claimed as exempt under subsection 83(5), it could not be regarded as reasonably attributable to the production of industrial minerals for the purposes of a depletion allowance under subsection 1201(2) of the Regulations.

Madame Justice Reed has also dealt with a matter somewhat similar to the one before me, in the case of Cominco Ltd. v. The Queen, [1984] C.T.C. 548; 84 D.T.C. 6535. In that case, the plaintiff operated a zinc ore processing plant. As a result of a fire that put one of the roasters out of commission, the taxpayer received business interruption insurance. The taxpayer included the insurance proceeds in income but claimed an ore processing allowance with respect thereto. The M.N.R. disallowed the deduction on the basis that the insurance proceeds could not be characterized as "production profits" or resource profits as defined by subsection 65(1) of the Act and Part XII of the Regulations. Before coming to her decision, Reed, J. noted that had the plaintiff actually earned the income for which the insurance proceeds were replacements, they would have been considered production profits and the allowances pursuant to subsection 65(1) would have been deducted. However, in the end, Reed, J. found that the insurance proceeds could not be characterized as production profits because they did not arise out of the production of metal or industrial minerals or from the processing in Canada from ores from a mineral resource. . She made the following comments at pages 551-2 (D.T.C. 6538):

None of the jurisprudence cited by the plaintiff goes further than to say that insurance proceeds of the kind in question should be treated as general revenues for the purposes of income. Such revenues can properly be brought within the wording of the statute because of the breadth of the wording of section 3 of the Income Tax Act.

The insurance proceeds, however, cannot be brought within the much more specific wording of Regulation 1201(2) — production profits (pre-May 6, 1974) and Regulation 1201 — Resource profits, (post-May 6, 1974). The proceeds simply did not arise out of the "production of . . . metal or industrial minerals" or from "the processing in Canada of ores from a mineral resource”.

Conclusions:

The onus of proving the M.N.R. was incorrect in its assessment falls to the plaintiff. Also, for good and important reasons, legislation exempting a person or a corporation from the payment of income tax must be strictly construed.

Here, in my view, we have a situation where the plaintiff is suggesting something should be incorporated into the legislation which is not there. The plaintiff suggests we can equate "mining business” with the "operation of a amine”, the actual words used in the section permitting an exemption. In my view, and I accept the definition of the defendant that operation of a mine has three and three only components, if moneys received are to fall within the exemption, operation of a mine, they must be received as a result of:

(a) extraction

(b) processing

(c) sales

This is made all the clearer by an examination of the French text.

The funds received from the business interruption insurance policies did not come from processing, extraction or sales. They arose as a result of an interruption of earnings or profits due to a fire. The policies made provision for two types of payment, namely one for loss of property and the other for loss of earnings/profits.

To permit these proceeds to be defined as accruing or arising from the operation of a mine is clearly going beyond that which Parliament intended. To do so would really give the plaintiff a double benefit — the right to charge off premiums paid for this insurance and then an exemption when proceeds are paid — clearly not the intended result.

The tax exemption clause in the policies of insurance clearly articulated that proceeds from the insurance policies would not be exempt, and provision would have to be made for taxes accruing as a result of any payments. This is not determinative, but is an indication by the parties to the contract that proceeds would not be income earned from the operation of a mine, and these parties had the advice of counsel and chartered accountants before signing the documents. They may have acted from a mistaken impression of the law, and that's why it is not determinative. However, here, in my view, this assumption or conclusion was correct.

For the reasons cited, the plaintiff's action is dismissed with costs to the defendant.

Action dismissed.