Spur Oil Ltd. v. The Queen, 81 DTC 5168, [1981] CTC 336 (FCA)

Heald, J:—This is an appeal from a judgment of the Trial Division, allowing in part, but otherwise dismissing, the appeal of the appellant from its income tax assessment for the taxation year 1970. The appellant was a Canadian corporation with head office at Calgary. At all material times it carried on business under the name of Murphy Oil Quebec Ltd, in the Province of Quebec as a refiner and marketer of petroleum products and in the Province of Alberta as an explorer of crude oil and natural gas. Its corporate name was changed in 1976 to Spur Oil Ltd. The appellant was a wholly- owned subsidiary of Murphy Oil Company Ltd of Calgary (the Canadian parent) which also engaged in the business of exploring for and producing oil and gas in Western Canada and the business of marketing crude oil in Western Canada and of refining petroleum products in Ontario. At all material times the Canadian parent was, in turn, a partially-owned subsidiary of Murphy Oil Corporation (the US parent) of El Dorado Arkansas USA which, through subsidiary corporations carried on the business of a fully integrated oil company in the United States and Canada, as well as the business of refining crude oil and marketing refined products in the United Kingdom and Sweden and the business of exploring for and producing and selling petroleum substances in Venezuela, offshore Iran, Libya, Nigeria, Indonesia and elsewhere. Tepwin Company Limited (Tepwin) was an offshore Bermuda company wholly owned by the Canadian parent.

In the 1970 assessment, the Minister had disallowed as a deduction the amount of $1,622,738.55 on account of expenses claimed by the appellant in computing its income for 1970 and had failed to eliminate from the appellant’s 1970 income the profit element of a crude oil shipment which was properly attributable to the 1971 rather than to the 1970 taxation year.

The elimination of the said profit element reduced the appellant’s taxable income in 1970 to $1,063,368. Accordingly, the learned Trial Judge, to give effect to that elimination, allowed the appeal of the appellant and referred the assessment back to the Minister for reassessment on the basis that the appellant’s taxable income for its 1970 taxation year was $1,063.368. The said disallowed deduction of $1,622,728.55 was found by the learned Trial Judge to be approximately the equivalent of US 27 cents per barrel of crude oil purchased by the appellant in its 1970 taxation year from Tepwin (hereafter referred to as “the Tepwin charge”). The Tepwin Charge represents the difference between US $1.9876 per barrel, the price at which the appellant had purchased crude oil from Murphy oil Trading Company (a Delaware corporation wholly owned by the US parent) under its arrangement with that company dated August 2, 1968 (the Murphy Oil trading arrange- ment), and US $2.25 per barrel, the price at which the appellant agreed to purchase crude oil in its 1970 taxation year after February 1970 under its contract with Tepwin dated February 1, 1970 (the Tepwin contract).

The learned Trial Judge made the following findings on the evidence adduced:

(a) that the Murphy Oil trading arrangement was considered by the parties to be a valid contract and all parties acted upon it pursuant to its terms, at all relevant times, including the taxation year 1970, notwithstanding the Tepwin contract;

(b) that Murphy Oil Trading Company, prior to and up to February 1, 1970, did in fact sell crude oil to the appellant at $1.9876 US per barrel under the Murphy Oil Trading arrangement and that this arrangement was never formally or informally abrogated, the learned Trial Judge accordingly concluding that the Murphy Oil Trading arrangement was a valid and subsisting contract;

(c) that it was never intended that the officers and directors of Tepwin in Bermuda would exercise management and control of Tepwin’s business in any aspect. Instead they were to carry out the instructions given by the officers and directors of the US parent, and, to a lesser degree in certain matters, the instructions given by the officers and directors of the Canadian parent and the appellant;

(d) that the officers and directors of Tepwin in Bermuda had nothing to do with the purchase of crude oil from the Persian Gulf area or from the spot market or with the delivery of it to Portland, Maine, for on-going pipeline delivery to Montreal or with the sale of the crude oil to the appellant; and specifically that Tepwin did not do so in Bermuda by way of those officers or directors qua Tepwin who had the management and control of Tepwin (those directors being personally resident in El Dorado, Arkansas and in Canada;

(e) that the purpose of acquiring and operating Tepwin was to use it as a vehicle to repatriate tax-free dividends to its Canadian parent by causing Tepwin to declare such dividends; and

(f) that what the officers, directors and solicitors in Bermuda did was to act merely as “scribes” under the direction of Mr J W Watkins, Secretary and General Counsel of the US parent of El Dorado, Arkansas, for the purpose of having directors’ meetings, declaring dividends, which dividends are passed tax-free to the Canadian parent; that said dividends were based on the quantum of the Tepwin Charge times the number of gallons of crude oil in each shipload which left the Persian Gulf for delivery to Portland, Maine, en route by pipeline to Montreal; that, besides declaring those dividends, the Bermuda officers, directors and solicitors did practically nothing because Tepwin did not carry on the business of buying, selling and delivering crude oil in 1970.

The learned Trial Judge then found the Tepwin contract artificial within the meaning of subsection 137(1) of the Income Tax Act, RSC 1952, c 148 which reads as follows:

137.(1 ) In computing income for the purposes of this Act no deduction may be made in respect of a disbursement or expense made or incurred in respect of a transaction or operation that, if allowed, would unduly or artificially reduce the income.

In the result, he found that the Tepwin Charge was not an allowable expense in computing appellant’s net income for the 1970 taxation year.

The appellant alleges two fundamental errors in the Reasons for Judgment of the learned Trial Judge. Initially, the appellant submits error in a failure to determine the fair market value at Portland, Maine of the Iranian and Venezuelan crude oil purchased by the appellant during its 1970 fiscal year from Tepwin and, in particular, error in failing to find as an inference of fact that such fair market value was equal to or in excess of the price of $2.25 US per barrel paid by the appellant to Tepwin for such crude oil. The learned Trial Judge made no specific finding as to fair market value. However, there was considerable evidence adduced that the fair market value at Portland, of the oil purchased by the appellant from Tepwin, was in excess of appellant’s purchase price of $2.25 per barrel (probably in the order of $2.2635 per barrel). Furthermore, the respondent, in its factum (see paragraph 9 thereof) and in its oral submissions before us, conceded that the Tepwin contract was below fair market value but submitted that this fact was not determinative of the applicability of subsection 137(1) supra.

The second allegation of fundamental error is the finding by the learned Trial Judge that the “Quotation Letter”* [1] w^s at all material times a valid and subsisting contract (AB, Vol III, p 1236).

The appellant conceded that if this finding by the learned Trial Judge is correct, then the failure to enforce such contractual right against Murphy Oil Trading and the actual purchase by it from Tepwin at an increase of 27 cents per barrel would result in an artificial reduction of its income within the meaning of subsection 137(1) even though that purchase price of $2.25 US was below the then current fair market value in arm’s length transactions.

The “Quotation Letter” referred to supra reads as follows (see AB, Vol Il, pp 211-214 incl):

Gentlemen:

This letter when executed by you in the space hereinafter provided shall constitute our agreement whereby Murphy Oil Trading Company (Seller) agrees to sell and deliver and Murphy Oil Quebec Ltd (Buyer) agrees to purchase and receive crude oil in accordance with the following terms, provisions and conditions:

1. TERM: The term of this Agreement shall be for a period of time commencing August 1, 1968 and ending April 30, 1973.

2. QUALITY: Iranian Light Export Grade crude oil of 33.0° - 34.9° API gravity as available to Seller from time to time. Upon acceptance by Buyer, Seller may substitute other crudes of similar qualify.

3. QUANTITY: The maximum quantity of crude oil to be sold and delivered under this agreement shall be as follows:

August 1, 1968 through April 30, 1969 — 12,750 barrels per day.

May 1, 1969 through April 30, 1970 — 14,550 barrels per day.

May 1, 1970 through April 30, 1973 — 15,225 barrels per day.

4. DELIVERY AND TITLE: Delivery shall take place and title and risk of loss shall pass from Seller to Buyer when the crude oil passes the vessel’s outlet flange and enters Portland Pipe Line Corporation’s receiving hose, Portland, Maine, which is the port of delivery therefor.

5. DETERMINATION OF QUANTITY & QUALITY: The quantity and quality of crude oil sold and delivered hereunder shall be determined by Portland Pipe Line Corporation’s personnel, as inspector, unless either Buyer or Seller desires an independent inspector. In the latter case such inspector shall be appointed jointly and the cost of his services shall be shared equally by the parties hereto. The inspector’s determination as to quantity and quality shall be conclusive and binding.

The quantity of each cargo shall be determined by taking the temperature of and measuring and gauging the crude oil either in the tanks to which delivery is made, both immediately before and immediately after delivery, or by using meters where meters are available. All measurements hereunder shall represent one hundred per cent (100%) volume, consisting of barrels of forty-two (42) United States gallons, the quantity and gravity of which will be adjusted to sixty degrees (60°) Fahrenheit temperature. Procedures for measuring and testing, except for delivery through positive displacement type meters shall be computed in accordance with the latest ASTM published methods then in effect. Procedures for such meter type deliveries shall be in accordance with latest ASME-API (Petroleum PD Meter Code) published methods then in effect. In the event of meter failure, all measurements and tests shall be computed in accordance with the second and third sentence of this paragraph. The crude oil delivered hereunder shall be merchantable and acceptable to the pipeline carriers involved but shall not exceed one percent (1%) BS&W and full deductions shall be made for all BS&W content according to the ASTM Standard Method then in effect.

6. PRICE: Subject to the other provisions as in this “Article 6” and “Article 8”) hereinafter set forth, the price payable for Iranian Light Export Grade Crude Oil delivered hereunder shall be $1.9876 (US funds) per barrel.

If, as a result of delivering crude oil other than Iranian Light Export Grade, a “processing fee penalty” is assessed to the existing processing fee now in existence between Buyer and BP Canada Limited under contract dated October 20, 1966, as amended, the price payable for the crude oil delivered hereunder shall be reduced by the amount of such “processing fee penalty”.

7. PAYMENT : Unless otherwise agreed to by Seller’s prior written consent, payment shall be made in US Dollars within 15 days of receipt of invoice and supporting documents covering each cargo unloaded.

8. DUTIES AND TAXES: The amount of any new or increased taxes, duties, fees or other similar charges (hereinafter called “taxes”), which may hereafter be imposed or levied by any governmental authority having jurisdiction in the premises upon the crude oil sold and delivered hereunder, or upon the export from the country of origin or by the United States, or upon the importation into the United States or Canada, or upon the delivery, sale or use of such crude oil, or upon the production, manufacture, storage or transportation thereof, or upon any vessel or pipeline used in such transportation, shall, subject to the second paragraph of this Article 8, be for the account of Buyer.

No new or increased taxes at any time imposed or levied upon such crude oil, before the crude oil in question passes the tankship’s permanent hose connection at the loading port in the country of origin, shall be for the account of Buyer, unless and until Seller notifies Buyer of such new or increased taxes. From the date such notice is received by Buyer, such new or increased taxes shall, as aforesaid, be for the account of and paid by Buyer unless Buyer forthwith notifies Seller that Buyer elects not to pay such new tax or taxes or, in the case of any increased tax, the amount by which such tax is increased. If Buyer does so notify Seller, then, unless Seller elects forthwith to pay such new tax or taxes, or the amount of increase of any such increased tax, for Seller’s own account, this Agreement shall terminate effective as of the date on which such notice is received from Buyer.

Any sums payable by Buyer as aforesaid and paid by Seller for the account of Buyer shall be added to the price of the crude oil sold and delivered hereunder and shall be reimbursed by Buyer to Seller, when payment therefor is otherwise made as provided herein.

9. WARRANTY: Seller warrants title to all crude oil sold and delivered hereunder and that such crude oil shall be free from all royalties, liens, encumbrances and that all taxes applicable thereto prior to delivery shall have or will be paid.

10. RULES AND REGULATIONS: All of the terms and provisions of this Agreement shall be subject to the applicable orders, rules and regulations of all governmental authorities of all countries having jurisdiction in the premises.

11. FORCE MAJEURE: Either party hereto shall be relieved from liability for failure to deliver or receive crude oil hereunder for the time and to the extent such failure is occasioned by war, fire, explosions, riots, strikes or other industrial disturbances, acts of God, governmental regulations, restraints, embargoes, disruption or breakdown of production or transportation facilities, perils of sea, delays of pipeline carrier in receiving and delivering crude oil tendered, or by any other cause whether similar or not, reasonably beyond the control of such party, provided that nothing herein contained shall serve to excuse Seller from making payment hereunder in the manner herein required.

12. SPECIAL PROVISIONS: (a) The size of the vessels, arrival dates at port of delivery, laytime and demurrage rates shall be mutually agreed upon between Buyer and Seller.

(b) Buyer warrants that it has filed all documents with the proper US Customs offices and agents required in order for the crude oil to be sold and delivered hereunder to be received “in bond” upon entry into the United States at the port of delivery and transported from such receiving facility into Canada.

In the event this letter correctly sets forth your understanding of our agreement, then you are requested to evidence that fact by signing and returning the two duplicate originals hereof in the space as so provided.

Yours very truly

MURPHY OIL TRADING COMPANY

“E H Haire”

E H Haire

Vice President

EHH:mas

Enclosures

APPROVED AND ACCEPTED this

30th day of August, 1968

MURPHY OIL QUEBEC LTD

By “AW Grant”.

The appellant’s submission is that the question as to whether or not the “Quotation Letter” supra is a contract creating enforceable rights for the respective parties thereto is a matter of law. I agree with that submission.* [2] I have also reached the conclusion that the learned Trial Judge was in error in finding that the “Quotation Letter”, supra, was a valid, subsisting and enforceable contract. I agree with counsel for the appellant that there is a total failure of consideration, flowing from the appellant to Murphy Oil Trading under the “Quotation Letter”. The appellant does not agree to do anything under the letter. Paragraph 3 dealing with the Quantity of Crude Oil speaks of a maximum but provides no minimum quantity of oil to be sold and delivered under the agreement. In my opinion, appellant’s counsel is correct when he says that there is no obligation, present or future, on the part of the appellant to purchase a single barrel of crude oil from Murphy Oil Trading. Furthermore, there is no certain or ascertainable volume of crude oil which can be said to be the subject matter of a contract for purchase. Likewise, in paragraph 2 of the letter, the quality of the oil to be sold is not defined with any precision. Thus, even if it could be said that there was consideration moving from the promisee, the “Quotation Letter’’ is not a contract because two essential and critical terms of the contract are not settled, that is, quantity and quality of the goods. As stated by Lord Buckmaster in May and Butcher Ltd v The King, [1929] All ER 679 at 682:

It has been a well recognized principle of contract law for many years that an agreement between two parties to enter into an agreement by which some critical part of the contract matter is left to be determined is no contract at all . . .

and by Viscount Dunedin in the same case at 683:

The law of contract is that to be a good contract you must have a concluded contract, and a concluded contract is one which settles everything that is necessary to be settled, and leaves nothing still to be settled by agreement between the parties.

The respondent, in reply, submits initially that there was ample evidence to justify the finding of the learned Trial Judge that both the appellant and Murphy Oil Trading intended the “Quotation Letter” of August 2, 1968, to be a binding contract. The difficulty with this submission in my view is that the question as to whether the letter of August 2, 1968 is a contract is a question of law and not of fact. The contents of that letter must be examined on the basis of whether, as a matter of law, they form a legally binding contract, and not whether, by extrinsic evidence, it appears that the parties intended to enter into a legally binding contract. On the basis of the August 2, 1968 document, it is my opinion that, regardless of what they may have intended, they did not execute a legally binding contract.

Alternatively, the respondent submits that if the August 2, 1968 document was not a valid and subsisting contract, that nevertheless a contract for the purchase and sale of specific quantities of crude oil at a specific price came into existence by the conduct of the parties by early August, 1968 which contract was at all material times a valid and subsisting contract. In support of this submission, counsel relied on, inter alia, Chitty on Contracts, 24th Edition, paragraph 479 (page 343) where the view is expressed that while extrinsic evidence is not admissible to vary the terms of a written instrument, evidence may be admitted to show that the instrument was not intended to express the whole agreement between the parties. However, the learned author also expresses the following caution:

“But a heavy burden of proof rests upon the party who alleges that a seemingly complete instrument is incomplete and it would seem that the extrinsic evidence must not be inconsistent with the terms of the instrument.

In order to evaluate this submission, it is instructive to look at the uncontradicted extrinsic evidence. For many years prior to 1970, the crude oil trading function in the Murphy conglomerate was performed by Murphy Oil Trading which serviced the major needs of the enterprise around the world from company headquarters in El Dorado, Arkansas. Late in 1969, the management of the US parent decided to divide the functions of Murphy Oil Trading into three segments based on the geographical area being served by each segment. So far as the Canadian operations were concerned, it was necessary to transfer to a new corporation that portion of the business of Murphy Oil Trading which related to the crude oil supply from offshore Canada to meet appellant’s needs under its processing contract with BP Canada, together with those arrangements by Murphy Oil Trading, then in place for transportation of the crude oil from point of its origin to Montreal. It was decided that the new corporation would be a Bermuda corporation (Tepwin) since it would not be transacting business in either Canada or the United States. The Tepwin contract was entered into effective February 1, 1970. The principal officers of the appellant knew in December, 1969 that the purpose for the creation of Tepwin was to take over the supply of proprietary crude to the appellant. The appellant knew that beginning in February of 1970 Murphy Trading would no longer be selling crude oil to the appellant under the Quotation Letter. Accordingly, it is my view that, on the uncontradicted evidence in this case, there was not any contract by conduct during the relevant period. The respondent submitted, in the further alternative, that the August 2, 1968 document was an offer to supply oil to the appellant by Murphy Oil Trading which remained unrevoked at all material times and on this basis, Murphy Oil Trading was contractually bound to supply such quantities of crude oil as the appellant may have ordered. The answer to this Submission is that since the appellant knew that effective in February of 1970 the Tepwin contract would supplant the Quotation Letter, it was a necessary inference that the Quotation Letter was no longer operative either as an offer of crude oil to the appellant or an invitation to the appellant to tender offers for crude. No formal termination in writing of the Quotation Letter was given by either party but there is no such requirement so long as the appellant, at the relevant time, was aware that it was in fact no longer operative* [3] as was the case here.

The final submission of the respondent was that even if there was not in existence at all material times a valid and subsisting contract, that, nevertheless, the finding of the learned Trial Judge that the purported transactions of February 1, 1970 and the subsequent conduct of the appellant, Tepwin, and others giving rise to the Tepwin charge, were artificial, stands independently of his finding that there was a valid and subsisting contract and that in substance, the finding by the learned Trial Judge of artificiality amounts to a finding of sham.

My first comment with respect to this submission would be that the finding of artificiality in the transaction being examined, does not, per se, attract the prohibition set out in subsection 137(1) of the Income Tax Act (supra). To be caught by that subsection, the expense or disbursement being impeached must result in an artificial or undue reduction of income. “Undue” when used in this context should be given its dictionary meaning of “excessive”. In light of the Crown’s concession referred to supra, that under the Tepwin contract the appellant would be paying slightly less than fair market value, it cannot be said that the Tepwin contract and the Tepwin charge result in an excessive reduction of income. Turning now to “artificial”, the dictionary meaning when used in this context is, in my view, “simulated” or “fictitious”. On the facts in this case, the reduction in the income of the appellant resulting from the Tepwin contract can, in no way, be said to be fictitious or simulated. The Tepwin contract dated February 1, 1970, provided for the purchase by the appellant and the sale by Tepwin of crude oil of 33° - 34.9° gravity at $225 US per barrel at the equivalent rate of 15,500 barrels per day ( 10%) during the primary twelve month term commencing February 1, 1970. The actual payment by the appellant to Tepwin during 1970 was effected by set-offs made by the cashier of the US parent through operation in El Dorado of a “cash account” with the objective of minimizing the amount of foreign exchange currency purchases. As a result, a net balance of Canadian funds was transmitted from El Dorado to the Canadian parent each month and all accounts, including indebtedness from Tepwin’s dividend to the Canadian parent, Tepwin’s purchase of crude from Murphy Trading, appellant’s purchases of crude from Tepwin, etc., were satisfied by set-off or assignment of other indebtedness in the cash account. These transactions are all documented in the evidence and are demonstrated in the cash flow chart (Exhibit 1, AB Vol VI at p 942 and Notes) thereto. The operation of the cash account making settlement of indebtedness on a fixed day each month (the 25th) required complete details of all inter-corporate transactions between the various entities of the Murphy enterprise to be immediately communicated to El Dorado as they occurred without awaiting the formalities of invoicing which followed later in the normal course of events. The documentary evidence clearly demonstrates, in my view, that the reduction in the appellant’s income can, in no way, be said to be fictitious or simulated.

Turning now to the respondent’s submission that the finding of the learned Trial Judge of artificiality amounts to a finding of sham. First of all, it is clear from his reasons that the learned Trial Judge did not make a finding of sham. Furthermore, it is my opinion that the facts of this case do not fit the generally accepted definition of sham provided by Lord Diplock in the Snook case.* [4] Lord Diplock defined “sham” as:

. . . acts done or documents executed by the parties to the “sham” which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intended to create.

And again on page 528, Lord Diplock said:

.. . for acts or documents to be a “sham”, with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating.

On the uncontradicted evidence in this case, particularly the evidence detailed supra with respect to the purchase by the appellant and the sale by Tepwin and with respect to the evidence of the complex accounting procedures carried out with respect to the actual payment for subject crude oil, it is not possible, in my view, to make a finding of sham.

I have, I believe, dealt with all of the respondent’s submissions and, in not accepting any of them, have concluded that this appeal should succeed.

However, even if one were to assume that on this record, a proper finding would be that the February 1, 1970 Tepwin contract was a “sham” thereby vitiating it, then Murphy Trading itself as the vendor of the crude to the appellant could have increased its price to the appellant to $2.25 US per barrel effective February 1, 1970 on terms corresponding to those of the Tepwin contract. I say this because that price was slightly below fair market value and therefore could not be construed as a transaction prohibited by subsection 137(1) supra. Thus, it is my opinion that, in the circumstances of this case, the question as to whether or not the Tepwin contract is valid is irrelevant to a final determination of the issue in this appeal. Subsection 137(1) supra, does not, in my view, prevent someone in the position of either Murphy Trading or Tepwin from generating the same profit from a transaction with an affiliate like the appellant as it would from a similar transaction with a third party with whom it was dealing at arm’s length. Such a transaction would, I think, only attract the prohibition of subsection 137(1), supra, when appellant’s cost of crude oil supply, by reason of an act of the appellant, or those controlling it, increased above the cost prevailing in the industry at the same time and under similar circumstances. Such an event did not occur in this case.

I have, therefore, for all of the above reasons, concluded that this appeal should be allowed with costs both here and in the Trial Division and that the matter should be referred back to the Minister for reassessment on the basis that the appellant’s cost of goods sold should be determined by reference to the amounts actually paid or payable to Murphy Trading and Tepwin for crude oil purchased by the appellant in the 1970 taxation year.

Pratte, J:—I agree.

Verchere, DJ:—I agree.