Citation: 2007TCC243
Date: 20070504
Docket: 2004-1170(IT)G
BETWEEN:
ATCO ELECTRIC LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Sheridan, J.
[1] The Appellant,
ATCO Electric Ltd., is appealing the reassessments by the Minister of National
Revenue of its 1997, 1998 and 2000 taxation years. In those years, the
Appellant was in the business of generating, transmitting and distributing
retail electricity in Alberta and owned, wholly or jointly, the generating
stations and adjacent coal mines at Battle
River
and Sheerness.
[2] The
reassessments concern two unrelated aspects of the Appellant's business operations:
1. in respect of its 1997 and
1998 taxation years, for the purposes of determining its income from resource
profits and its entitlement to certain capital cost allowances, at what point
the coal used as a fuel to provide electric energy reached the "prime
metal stage or its equivalent"; and
2. in respect of its 2000
taxation year, whether certain expenses incurred in the replacement of
transformers used in the transmission and distribution of electricity were
capital or current in nature.
[3] The parties
filed a partial Agreed Statement of Facts[1]
and a Joint Book of Documents[2] pertaining to these issues. Each issue is dealt with
separately in these Reasons for Judgment.
The
Prime Metal Stage or its Equivalent Issue
Legislation
[4] The relevant
legislative provision is clause 1204(1)(b)(ii)(A) of the Income Tax
Act Regulations[3]:
1204: (1) For
the purposes of this Part, "gross resource profits" of a taxpayer for
a taxation year means the amount, if any, by which the aggregate of
(a) the amount, if any, by which the aggregate of
(i) the aggregate of amounts, if any, that would be included in
computing the taxpayer's income for the year by virtue of subsection 59(2) and
paragraphs 59(3.2)(b) and 59.1(b) of the Act if subsection 59(2)
were read without reference to subsection 64(1) therein, and
(i.1) the amount, if any, by which the amount included in computing
his income for the year by virtue of paragraph 59(3.2)(c) of the Act
exceeds the proceeds of disposition of property described in clause 66(15)(c)(ii)(A)
of the Act that became receivable in the year or a preceding taxation year and
after December 31, 1982 to the extent that such proceeds have not been deducted
in determining the amount under this subparagraph for a preceding taxation year
exceeds
(ii) the aggregate of amounts, in any, deducted in computing his
income for the year by virtue of paragraph 59.1(a) of subsections 64(1.1) and
(1.2) of the Act,
(b)the amount, if any, of the aggregate of his
incomes for the year from
…
(ii) the production and processing in Canada of
(A) ore, other than iron ore or tar sands ore, from mineral
resources in Canada operated by him to any stage that is not beyond the prime
metal stage or its equivalent,
…
[5] Pursuant to
subsection 248(1) of the Income Tax Act, a "mineral resource"
means "a coal deposit".
[6] Paragraph 20(1)(a)
of the Act permits a taxpayer to deduct such part of the capital cost of
a property as is allowed by the Regulations. Pursuant to subparagraphs
1100(1)(a)(i) and (xxvii) of the Regulations, Class 1 assets may
be deducted at a rate of 4% of their undepreciated capital cost and Class 41
assets, at 25%. Class 41(b)(i) of Schedule II of the Regulations
includes property that was, among other things, acquired "for the purpose
of gaining or producing income from a mine". Subparagraph 1104(5)(a)(i)
defines "mining" for the purposes of Class 41 assets as:
"Mining –
for the purposes of ... [Class] ... 41 in Schedule II, a taxpayer's
"income from a mine", or any expression referring to a taxpayer's
income from a mine, includes income reasonably attributable to
(a) the
processing by the taxpayer of
(i) ore (other than iron ore or tar sands ore) all or
substantially all of which is from a mineral resource owned by the taxpayer to
any stage that is not beyond the prime metal stage or its equivalent,
Pursuant
to subsection 1104(2) of the Regulations, "ore" includes ore
from a mineral resource that has been processed to any stage that is not beyond
the prime metal stage or its equivalent.
[7] Paragraphs 12 to
16 of the Agreed Statement of Facts set out the respective positions of the
Appellant and the Respondent in respect of the calculation of the Appellant's
tax liability for 1997 and 1998:
12. In
computing its income tax liability under Part I of the Act for the
taxation years ending December 31, 1997 and December 31, 1998, the Appellant:
(a) computed its resource profits for resource allowance purposes
based on an imputed rate of return on coal handling equipment; and
(b) classified the coal handling equipment utilized up to the
point that the coal has been pulverized in the pulverisor ("Assets")
as Class 41 assets pursuant to Class 41(b)(i) of Schedule II to the Regulations,
on the basis
that the equivalent of the prime metal stage for coal is reached at the point
immediately after the coal has been pulverized. Copies of Appellant's T-2
Returns for the 1997 and 1998 taxation years are located in the Joint Book of
Documents, Tabs 3 and 4, respectively.
13. Based
on its position that the equivalent of the prime metal stage for coal is
reached immediately after the coal has been pulverized, for its taxation years
ended December 31, 1997 and December 31, 1998, the Appellant:
(a) determined its resource loss to be $3,992,848 and its
resource profits to be $2,351,924, respectively, pursuant to the formula
prescribed in section 1210.1 of the Income Tax Regulations ("Regulations")
and included 25% of such amounts, being an inclusion of $998,212 and a
deduction of $587,981, respectively, in its calculation of income tax for the
taxation years ending December 31, 1997 and December 31, 1998 pursuant to
paragraph 12(1)(2.5) of the Act; and
(b) deducted 25% of the undepreciated capital cost of the
Assets pursuant to paragraph 20(1)(a) of the Act and paragraph 1100(1)(a)(xxvii)
of the Regulations.
14. The
Assets were acquired after 1987.
15. The
Assets used to handle coal up to the point of deposit at the reclaim or
reclamation piles constitute property, machinery, equipment, a building or
other structure that were acquired for the purpose of earning or gaining income
from a mine.
16. The
Minister of National Revenue ("Minister") issued reassessments to the
Appellant on May 9, 2002 for its taxation years ending December 31, 1997 and
December 31, 1998 ("Prime Metal Stage Reassessments"), on the basis
that the equivalent of the prime metal stage for coal is reached at the
reclamation piles. As a result, the Minister:
(a) decreased the Appellant's resource loss and increased the
Appellant's resource profits under paragraph 12(1)(z.5) of the Act by
$29,858 and $29,871 for the taxation years ending December 31, 1997 and
December 31, 1998 respectively, on the basis that profits imputed to that
part of the process occurring after the point the thermal coal was deposited at
the reclaim or reclamation piles at the Generating Stations are not eligible to
be included as part of the Appellant's resource profits; and
(b) decreased the Appellant's capital cost allowance claim
under paragraph 20(1)(a) of the Act by $446,252 and $669,156 for
the taxation years ending December 31, 1997 and December 31, 1998 respectively,
on the basis that the assets used during that part of the process after the
point the thermal coal is deposited at the reclaim or reclamation piles do not
constitute Class 41 assets, but rather are Class 1(m) assets.
Issue
[8] Expressed in the
language of the legislative provision, the issue is to what stage in the
production and processing of the sub-bituminous coal from the coal deposit
operated by Appellant was the sub-bituminous coal not beyond its equivalent of
the prime metal stage.
[9] The Respondent
says the point at which the sub-bituminous coal was not beyond its equivalent
of the prime metal stage was when it was placed on the reclaim pile, just after
having gone through the primary crusher.
[10] The Appellant's
position is that the sub-bituminous coal reached that point later in the
crushing process when it had been pulverized, just before being introduced as
fuel into the generating stations’ combustion chamber to manufacture
electricity.
[11] It is necessary to determine when the coal reached its
equivalent to prime metal stage in order to calculate the Appellant's resource
profits and resource allowance, as well as to determine whether its assets are
Class 1 or Class 41 assets for the purposes of calculating the applicable capital
cost allowance.
Preliminary Issue: The Admissibility of the Respondent's
Expert Witness Report
[12] Each party proposed an expert witness, each of whom had prepared
reports. While taking no objection to his qualifications, counsel for the
Appellant objected to the admission of the report of the Respondent's expert witness,
Mr. John Mossop, on the basis that the opinions expressed therein
amounted to a determination of the ultimate issue before the Court: the interpretation
of the term "prime metal stage or its equivalent" and when, on the
facts of this case, the coal reached its equivalent of the prime metal stage.
[13] According to
counsel for the Appellant, Mr. Mossop's report is riddled with the very conclusions
that are the Court's to make. To see the extent to which the report exceeded
the bounds of expert evidence, counsel argued, one need look no further than
Mr. Mossop's statement of his mandate: "I was asked to examine at what
point thermal coal reaches 'prime metal stage or its equivalent' (the 'PMSE')
in the Battle River and Sheerness mine mouth electricity generation operations"[4]. After acknowledging that "prime metal stage"
is a term without "technical or trade meaning from use within the industry"[5], Mr. Mossop sets about interpreting its meaning.
Looking first to the ordinary dictionary meaning of the word "prime",
he concludes in the first section of his report "that 'prime metal stage'
for a metal, and 'the equivalent' for a non‑metal, is reached at the
point when the product of the mine first becomes a recognized commodity with a
market value". In Section II under "Background", Mr. Mossop
writes that "… it was required to establish the PMSE for the Battle River
and Sheerness Operations". In Section III, applying "[his]
definition" of prime metal stage, he explains how copper ore is processed
to the prime metal stage of the metal known as copper. In Section IV he states
that for "commercial coal", the equivalent state is reached when it "has
become a commercial product, widely traded on both local and world markets".
He then applies that test to the operations at Battle River and Sheerness to
conclude in Section VI that when coal at the generating stations is "placed
in the stockpile to be reclaimed for use in the power plant …, it has reached
the customer's specification for power plant operation" and can then "…
be considered as the equivalent stage as prime metal because it is a recognized
commodity with market value to a customer". In Section VII, he sets out
his conclusion that "… the PMSE for coal at Battle River and Sheerness is at the coal stockpile [the reclaim
pile] after it has been mined and prepared to be delivered to the power plant".
[14] Counsel for the
Respondent did his best to minimize the effect of the above by attributing it
to Mr. Mossop's particular writing style. I share the view of counsel for the
Appellant, however, that the report's flaws go beyond semantics. As stated by
Dussault, J. in Oligny v. The Queen[6], "… it is the responsibility of the judge, not
of an expert, to interpret the Act and to give the words that are used
therein their rightful meaning"[7].
In my view, the Mossop report violates this principle and is therefore, not
admissible.
[15] Even if the
report had been admitted, however, I would have preferred the evidence of the
Appellant's expert witness, Mr. Donald Downing. No objection was taken to Mr.
Downing's qualifications or to his report[8].
He was duly recognized as an expert qualified to give opinion evidence in
connection with providing a general background on the coal industry and
coal-fired generating facilities. Mr. Downing has had direct experience in the
operation of coal-fired generating stations. In preparing his report, he
visited the Battle River and Sheerness operations; Mr. Mossop, on the other
hand, relied on photos of the sites and generalized information on coal mining
from various publications including, at Tab 7 of the report, a print-out on "Coal-Fired
Thermal Generating Plants" from Appellant's[9] own website. Finally and most importantly, in his
report, Mr. Downing restricted his conclusions to his area of expertise
providing technical information regarding the coal mining industry, leaving to
the Court the task of determining, on the evidence of the present case, the
stage at which the equivalent of the prime metal stage for thermal coal was
reached.
The Witnesses
[16] The Respondent called no witnesses other than Mr. Mossop. In addition
to its expert witness, the Appellant called Mr. Thomas Walker. From 2001 to
2005, Mr. Walker was the commercial manager at the Sheerness Generating
Station. In 2005, he became responsible for both generating stations as the
commercial manager of operations at ATCO Power[10], overseeing the commercial activities at both
Sheerness and Battle River. Using diagrams[11] of the generating stations as an aid, Mr. Walker
explained the Appellant's operations at Battle
River and Sheerness. His testimony was entirely
credible and, except for the matter of the "specifications" of the
coal as delivered to the reclaim pile, went largely unchallenged by the
Respondent on cross-examination.
[17] As for Mr.
Downing, in addition to the qualifications set out above, he has a Bachelor of
Science in Geology and a Bachelor of Arts in Economics from the University of New
Brunswick. He holds a Master of Science
from the Department of Mining and Metallurgical Engineering at McGill University
and a Master of Science from Pepperdine University School of Business. He has
extensive experience in the coal industry, including mine operations, domestic
marketing and export abroad, and transportation. He has dealt with a wide
variety of coal customers including electricity producers, utilities, steel
mills and other industrial clients. He acted as a consultant on Genesee 3, an Alberta coal‑fired
electricity generating station supplied by an adjacent coal mine. He served as
president of the Coal Association of Canada from 1993-1998.
[18] He presented his
testimony in a knowledgeable and straight-forward fashion. His report addressed
six specific questions put to him by the Appellant, as well as certain of the
ministerial assumptions with which the Appellant took issue[12].
Facts
[19] In 1997 and 1998, the Appellant owned, wholly or jointly, the coal
mines and the generating stations at Battle River and Sheerness. The coal mined there is sub-bituminous
coal; while ideal for fueling generating stations, its low energy content can
make the transport of sub-bituminous coal and therefore, its use, uneconomical.
One solution is to minimize its transportation costs (thereby making its
production and processing more economical) by building the generating station
beside the mine; such facilities, like those at Battle River and Sheerness, are
known as "integrated" coal-fired generating stations.
[20] The mines at the
Appellant's integrated generating stations were exploited specifically to
provide an economic source of fuel for the manufacture of electricity in its
adjacent generating station. Except for a negligible quantity which under the Mines
and Minerals Act of Alberta the Appellant was required to sell for domestic use[13], the coal was not directly marketed or sold to third
parties[14]. Indeed, according to the Minister's own assumption, the Appellant was the
only consumer for the coal extracted from the mines. Thus, in 1997 and 1998,
there was effectively no general market for the sub‑bituminous coal mined
at Battle River and Sheerness.
[21] Before considering
the Appellant's coal-related activities at Battle
River
and Sheerness, it is useful to note certain unique aspects of the Appellant's
operations. First, the Appellant owned both the mines and the electricity
generation stations; this differs from the more typical situation where "miner"
and "consumer" are separate entities. As aptly summarized by counsel
for the Respondent, the question in this case is to define "… the edge of
the Appellant's mining activities as opposed to [its] manufacturing of
electricity activities"[16]. A related factor is the Appellant's
contractual relationship with a third party to extract and transport sub‑bituminous
coal. At no time relevant to this appeal, however, was that third party "selling"
coal to the Appellant since it was the Appelllant who owned the Battle River
and Sheerness mines.
[22] Turning, then, to
the Appellant's activities at Battle River and Sheerness, the coal mines adjacent to the generating
stations were "strip mines". The first step in the extraction of coal
was the removal of the layer of top soil. A drag line then removed the next
layer of earth (the “over-burden”) to expose the coal deposit below. Machines
called "dozers" pushed out large pieces of coal and broke them into
chunks capable of being handled by the "front-end loaders" that loaded
them into over-sized trucks known as "haulers". Such large pieces of
coal are referred to in the industry as "run-of-mine" or "ROM"
coal.
[23] The haulers then
transported the run-of-mine-coal to the receiving hopper, a metal-lined
cone-shaped pit approximately 20-feet deep. Above the receiving hopper was a
kind of grate, known as a "grizzly", consisting of bars spaced
closely enough to permit the haulers to drive safely over them while at the
same time, allowing pieces of run-of-mine-coal measuring "not in excess of"
3 feet (1.2 meters) to pass through it. As Mr. Downing explained, in the
coal mining industry, the optimum size of the coal pieces at each stage in the
crushing process is typically expressed in terms of a size "not to exceed"[17] a certain specified dimension.
[24] From the
receiving hopper, sub-bituminous coal of varying quality was drawn from identifiable
access points at its base and "blended" in the conveyor system; the
percentage of low-quality coal in the mix ranged from 10 to 30 percent[18].
[25] The blended sub-bituminous
coal then proceeded to the "primary crusher" where it was crushed to
a size not in excess of 6 inches[19]
and stockpiled on the "reclaim pile". (It is at this point that the
Respondent says the sub-bituminous coal reached its equivalent of prime metal
stage.)
[26] The
sub-bituminous coal was then drawn from underneath the reclaim pile through another
series of feeders and conveyed to the secondary crusher[20] where it was crushed to a size not in excess of 1
inch. Also at this stage, electro-magnets were employed to remove metals from
the sub-bituminous coal to improve its efficient combustion.
[27] Next, the
sub-bituminous coal was conveyed into the generating stations and dropped into
the "bunker", a large cylindrical storage container. From the bunker's
conical bottom, the coal was drawn into a "mill" where it was further
crushed to a baby-powder fineness[21].
Pulverizering the coal in this fashion also served to remove pyrites[22] and other waste products which could not be burned.
At this stage, the pulverized sub-bituminous coal was ready to be blown by air
from the pulverizer to the nozzle tip which introduced the fuel into the
combustion chamber. (It is at this point that the Appellant says the
sub-bituminous coal reached its equivalent of prime metal stage).
[28] Finally, if there
was a lack of suitable-quality coal or there were emissions problems resulting
from an excess of sulfur or ash in the coal, the combustion chambers were
equipped to use natural gas and could have been modified to use oil. In such
circumstances, the alternate fuel would also have been introduced into the
combustion chamber at the nozzle tip.
[29] Coal is a rock
that is a combination of minerals, including a significant percentage of
organic carbonaceous material that is combustible and can be used as a source
of heat energy in electricity generation. As a non-metallic ore, coal is ranked
from its lowest grade, lignite, to sub-bituminous coal to bituminous coal and
finally, to anthracite. Its rank depends on how much ash and moisture it
contains as well as its carbon and energy content. Its energy content, as well
as determining its use, is a factor in determining the whether its transport is
economical.
[30] Metallic
mineral-bearing rock is known in the industry as "mineral ore", an
economic (rather than geological) term indicating a sufficient concentration of
metal in that rock to give rise to an expectation that its mining and
processing will be economic. An example would be the processing of copper
mineral-bearing rock to produce nearly pure copper metal. Briefly summarized, that
process involves freeing the metal from the rock in three specific steps:
extracting and crushing the ore for handling, separating metallic mineral
concentrate from the ore and finally, smelting the concentrate to produce
(nearly) pure metal. Metals are not ready for use prior to the smelting process,
although metallic mineral-bearing ores and concentrates are tradeable
commodities in themselves. The term "ore" is not typically applied to
coal within the coal industry, making difficult direct comparisons between the
production and processing of coal rock and metallic mineral-bearing rock.
Analysis
[31] Because
sub-bituminous coal is a non‑metallic ore, it cannot be said to have a "prime
metal stage"; accordingly, what must be determined in the present
case is when the sub‑bituminous coal at Battle River and Sheerness
reached "its equivalent" of prime metal stage. To answer that
question, it is necessary to know what is meant by the term "prime metal
stage" in clause 1204(1)(b)(ii)(A) of the Income Tax Regulations.
The term "prime metal stage" is not defined in the Act nor
does it have a technical meaning in the industry. It has, however, been the
subject of judicial consideration in two Federal Court of Appeal decisions, Canadian Pacific
Ltd. v. Canada[23] and Gulf Canada Resources Ltd. v. Canada[24].
[32] In Canadian
Pacific Ltd., the Court considered its meaning in the context of the Excise
Tax Act[25]. Stating that there was not "… a 'popular sense'
in which the term 'prime metal stage', much less its equivalent as applied to
coal, is understood by those conversant with the subject matter"[26], Mahoney, J.A. concluded:
In my opinion,
when metallurgical and thermal coal has been processed to the condition in
which it meets the specifications of its consumers and they buy and take
delivery of it as coal in that condition, it has certainly reached the
equivalent of the prime metal stage within the contemplation of the definition
of "mining" in subsection 49.01(1) of the Excise Tax Act.[27]
[33] This
interpretation was adopted by Linden, J.A. (a member of the panel in Canadian Pacific
Ltd.) in his dissenting judgment[28]
in Gulf Canada Resources Ltd.[29],
who expressed the test for "prime metal stage" as follows:
In my view,
the equivalent of the prime metal stage for mineral production is that point
where the production processes have produced a marketable, saleable
commodity which meets the specifications of its consumers.[30]
[Emphasis added.]
[34] It is upon the use
of the word "commodity" in the above passage that the Respondent hinges
its argument that the sub-bituminous coal at Battle River and Sheerness reached its equivalent to the prime
metal stage when it arrived at the reclaim pile. Under the rubric "thermal
coal is thermal coal as a commodity", counsel for the Respondent argued
that:
… the case law
establishes that the application of the test to determine the point of ‘prime
metal stage or its equivalent' is not related to the particular contractual
arrangements under which coal is brought to the point where it is
transportable, deliverable and marketable for users or the particular business
structure under which coal moves from a mine to a user's operation. It is
related to the determination of the point where the coal, as a commodity,
is transportable, deliverable and marketable for use by consumers.[31]
[35] As I understand
the Respondent's thesis, there is a universally applicable point at which coal
reaches its equivalent to prime metal stage which, regardless of the facts of
any particular production and processing operation, attaches upon its arrival
at the reclaim pile of a generating station. I am not persuaded by this
argument. In my view, the Respondent's position is inconsistent with the
legislation, the jurisprudence and the evidence in the present case.
The
Legislation
[36] Reduced to its
essential elements, clause 1204(1)(b)(ii)(A) states that the calculation
of the gross resource profits of "a taxpayer" for a
taxation year will depend on[32]
his incomes for that year from "… the production and processing …
of ore … from mineral resources … operated by him [the taxpayer] to any
stage that is not beyond the prime metal stage or its equivalent".
[Emphasis added.] Nowhere in the provision is there any reference to
"commodity".
[37] In my view, the
wording of clause 1204(1)(b)(ii)(A) contemplates a subjective approach
to the determination of when, for any particular ore in the circumstances of
any particular taxpayer, the prime metal stage or its equivalent may be
reached. The language used in clause 1204(1)(b)(ii)(A) requires an
examination of the facts of the actual production and processing operation of a
specific taxpayer in a specific year. By defining the moment at which the prime
metal stage or its equivalent may occur as "any" stage that is not
beyond that point, the legislation provides for an infinite range of
possibilities, suggesting to me Parliament's intention to leave that determination
to the particular circumstances of each case.
[38] I agree with Counsel for the Appellant that had Parliament intended to impose on producers and
processors of ore the standardized "commodity" regime argued by the
Respondent, it would have been a simple matter to add "for that ore"
to the words "prime metal stage or its equivalent". Alternatively, it
could have devised a regulatory schedule (similar to that established for
capital cost allowances) arbitrarily assigning a prime metal stage for each ore
mined in Canada. Instead, Parliament chose to express itself in a
manner which permits a flexibility consistent with its objective of providing incentives
to Canadian resource development and production in a diverse and ever-changing
industry.
The
Jurisprudence
[39] As for the case
law, in the two cases which have addressed the issue of "prime metal stage",
the Federal Court of Appeal was careful to couch its conclusions in terms of
the particular facts of each case.
[40] Looking first at Canadian
Pacific, the facts in that case were significantly different from the present
matter. There, the Appellants were the railways that had transported the coal
from the mine to the consumer[33]. Hoping to bring their transportation of the coal
within the definition of "mining" under the Excise Tax Act[34] so as to qualify for a fuel tax rebate, the railways argued
that during its transport, the coal was not yet beyond its equivalent to prime
metal stage. In rejecting the railways' argument, the Court carefully examined
the findings of the lower tribunals including the types of coal in question (metallurgic
or thermal) and the respective roles of the mine, the railways and the consumers
of the coal in its journey from extraction to consumption. Noting that, for the
purposes of determining the prime metal stage or its equivalent, "nothing
in the definition of mining requires that the processing included in the
definition be conducted at the mining site"[35]. Mahoney, J.A. went on to say:
… There is
necessarily a point in the processing of a metal-bearing ore to the ultimate
state required by a user of the metal where what is being processed is no
longer ore or concentrate or something else and is recognized by knowledgeable
persons as metal. It has, at that point, reached the prime metal stage.[36]
[41] The above citations
illustrate firstly, that in determining when the prime metal stage is reached,
there is no magic in any particular location. Further, the Court recognized that
although there would "necessarily" be a point at which it could be
determined that a metal had reached it prime metal stage, it left to the facts
of each case what "the ultimate state required by a user" might be. Consistent with the open-ended
nature of the legislative provisions, the Court
went on to consider the different uses (steel production vs. electricity
manufacturing) to which each consumer intended to put the coal, the different
modes of "processing" the coal ore (crushing, pulverizing and
blending vs. crushing, pulverizing and drying) as well as the different nature
of the "ores" (metallurgical coal ore and thermal coal ore) involved:
… I would not
exclude the possibility that [the coal] had reached that stage sooner but that
is not the issue here. The crushing, pulverizing and blending, in the case of
metallurgical coal, and the crushing, pulverizing and drying, in the case of
the thermal coal, done by the steel and electricity producers were not integral
to the processing of coal to the equivalent of the prime metal stage.[37]
[42] The same
fact-specific analysis was conducted by Linden, J.A. in Gulf Canada Resources. Before
considering the findings in that case, he turned his attention to section 1204
which he described as:
... a
provision which regulates the computation of "resource profits" for
the resource income sources it describes. As a provision triggering resource
income treatment, section 1204 plays an important part in the larger scheme
applicable to resource operations generally. It is better understood against
this larger backdrop, and it is advisable, if possible for its interpretation
to be consistent with the scheme as a whole. Hence, a contextual approach to
statutory interpretation is vital when any one provision of a complicated
scheme becomes the focal point of an analysis.[38]
[43] With this approach in mind, the
learned appellate judge stated that:
[T]he question
that follows, then, is to determine in the context of Syncrude's operations,
what is meant by the "equivalent of the prime metal stage"[39].
[Emphasis added.]
[44] Being careful to
link his conclusions to the facts in that case, he then concluded:
… In the
present context, the equivalent of the prime metal stage is that point where
bituminous sands are turned into marketable crude oil. I am, therefore,
satisfied that the production process contemplated by both clause
1204(1)(b)(ii)(A) and (B), for the purposes of this appeal, is the
production to the point of crude oil. [Emphasis added.]
[45] This qualifying passage immediately follows the portion
of Linden J.A.'s dissent that forms the corner stone to the Respondent's submission
that "thermal coal is thermal coal
as a commodity":
In my view,
the equivalent of the prime metal stage for mineral production is that point
where the production processes have produced a marketable, saleable commodity
which meets the specifications of its consumers.[41] [Emphasis added.].
[46] It seems to me then, that when taken in context, Linden J.A.'s use of the word
"commodity" does not have the significance urged by the Respondent. Rather
than setting a prime metal stage benchmark for bituminous sand that would apply
in all cases, the overall effect of Justice Linden's analysis is to underscore
the importance of the specific requirements of the consumer in assessing the
marketability and saleability of what is being produced and processed. The
evidence shows that this determination will necessarily be subject to an
infinite range of variables including such things as the kind of ore produced,
its quality, its location relative to the consumer, the economics of its
transport, technological developments and the market demand, at any given
moment, for the product which the ore is required to produce. Mr. Downing gave as an
example certain non-integrated generating stations located in Ontario and
Atlantic Canada. Without the necessary coal resources locally to produce the electricity
needed for community demand, these generating stations have been constructed
near coastal waters (rather than coal mines) to provide access to barge
delivery of coal from foreign markets. In the United States, where coal rail
rates are more favourable than in Canada, some non-integrated generating stations may be
located near rail lines. In these examples, the coal will have been crushed at
the mine to a “deliverable size”; upon delivery to a reclaim site, the coal
will typically be subjected to additional crushing at the generating station to
permit its intended use as a combustible fuel. This is not always the case,
however. In Japan, where storage space is a factor, coal may be crushed
to its ultimate useable state at the mine and then delivered to the generating
station ready for immediate combustion.
[47] Accordingly, I am not persuaded that the above passage
supports the Respondent’s position that
the determination of "the prime metal stage or its equivalent is not
related to the particular contractual arrangements or the particular business
structure under which coal moves from a mine to a user's operation". While
such factors may not be solely determinative of the question, the case law does
not preclude taking them into consideration along with any of the other
circumstances surrounding a taxpayer's "operations" to determine when
the production and processing results in the equivalent of the prime metal
stage having been reached.
The Evidence
[48] The Respondent's view of the evidence is that it establishes "that
the point where one has a recognized ‘marketable saleable commodity which meets
the specifications of its consumers', or where that commodity is 'processed to
the condition in which it meets the specifications of its consumers and they
buy and take delivery of it as coal in that condition', is the point where
thermal coal is crushed and available for transportation and delivery into the
conveyoring and combustion system at an electricity generating station, and
that that occurs at the reclamation stockpiles …"[43].
[49] A significant weakness in the Respondent's position is that it has for its foundation the
opinion evidence of its expert witness, Mr. Mossop. According to the
Respondent's submissions, Mr. Mossop's evidence "… focuses on the
status of the thermal coal as a physical commodity with economical value when
it is in the form it has reached in the stockpiles [reclaim pile] ..."[44]. Having excluded Mr. Mossop's report and in any
event, preferring the evidence of the Appellant's expert witness, I am unable
to conclude there is sufficient evidence to support the Respondent's position
that the coal reached its equivalent to prime metal stage at the reclaim pile.
[50] There is ample evidence, however, in favour of the
Appellant's arguments. As mentioned above, I found Mr. Walker to be very
credible in his evidence. As for Mr.
Downing's evidence, in addition to his general testimony, I accept his evidence
in response to certain of the assumptions challenged by the Appellant: first, that it is difficult to draw precise parallels between the
processes for metallic ore and non-metallic ore; that the specifications for
coal as fuel for electricity manufacturers will vary (i.e., in form or size)
according to the particular needs of each consumer; that while the coal at
Battle River and Sheerness is not "washed" in the sense that there
are no technical "washing" facilities located at the mines, the
removal of impurities from the coal through the use of screening or magnets was
an essential part of the handling and crushing the coal to put it in a form
suitable for combustion in the Appellant's generating stations. Further, that the
Minister's assumption that no "benefication (removal of waste to improve
quality)" occurred after the reclaim pile[46] is incorrect; in fact, hard pieces of rock and
foreign matter were separated from the coal throughout the crushing process and
pyrites in particular could only be removed at the pulverization stage. The
term "beneficiation" in its technical sense is different from its use
in paragraph 23(q) in that it means the removal of ash content; this step was simply
not required for the coal used at the Battle River and Sheerness generating stations.
[51] On the whole, the
evidence satisfies me that the Appellant was engaged in the production and
processing of sub-bituminous coal up to and including its pulverization. To
paraphrase Justice Linden's conclusion in Gulf Resources that
"[t]he complete Syncrude operation is geared toward the production of
marketable crude oil"[47], the Appellant's complete operation up to and
including the pulverization hopper was geared toward the crushing and purifying
of sub‑bituminous coal preparatory to its only marketable use as a fuel
in the Appellant's generating stations. From the extraction of the coal from
the seam to its final pulverization, the essence of the process was the
crushing of coal: large chunks of run-of-mine-coal had to be broken to fit into
the front-end loaders and haulers; broken again, to fall through the grizzly; further
crushed to 6‑inch and 1‑inch pieces in the primary and secondary
crushers; and finally, pulverized. Thus, while I take the Respondent’s point
that Mr. Downing agreed that the sub‑bituminous coal deposited on the
reclaim pile "met the Appellant's specifications", his response has
to be considered in light of the fact that such specifications were just one in
a series of varying size specifications required to permit the coal to move
through each stage of what was, in fact, a seamless crushing operation to
produce and process the coal ore into the state required by its only user, the
Appellant.
[52] There was no
market for the Appellant's sub-bituminous coal in its reclaim pile condition.
The only condition in which it became marketable and saleable was in its
pulverized form, crushed to a baby-powder fineness that would permit its injection
into and combustion in its generating stations. Indeed, the Appellant's
generating stations were equipped to use (or, with some modification of its
equipment, could have used) an alternative fuel in the event coal was not
available. No matter what the fuel – pulverized coal, natural gas, oil – the
point at which it met the Appellant's specifications for use in its electricity
manufacturing business was at the nozzle tip. Had the Appellant converted its
generating stations from coal fuel to natural gas or oil, all of the machinery
and conveyor systems as well, as the coal mine themselves, would have become
obsolete.
[53] Expressed in the
language of the case law, the "marketable saleable commodity" which
met the Appellant's specifications as a consumer, and the point at which that
commodity was processed to the condition in which it met the specifications of
the Appellant who bought and took delivery of it as coal, was in its pulverized
form. At that point, as a result of the Appellant's multi-step crushing
operations, the coal first acquired the measure of economic equivalence
contemplated by the term "prime metal stage or its equivalent". In
these circumstances, the heavy machinery, system of conveyors and crushers and
other assets employed in each step of the process up to that point were, "integral"[48] to the production and processing of sub-bituminous
coal to its equivalent of the prime metal stage.
[54] For the reasons set out above, I am satisfied that the sub-bituminous coal used by the Appellant
in its electricity manufacturing reached its equivalent to the prime metal
stage at the pulverization stage of the crushing operation. It is on this basis
that the computation of the Appellant's resource profits and its resource
allowance and the characterization of its assets is to be made.
Transformer
Issue
[55] The second issue
is whether the amount of $622,990[49]
incurred by the Appellant in its 2000 taxation year to replace certain transformers
in its business of the transmission and distribution of electricity is a
current expense that is deductible from business income under paragraph 18(1)(a)
of the Income Tax Act, or a capital expenditure that is precluded from
being deducted under paragraph 18(1)(b) of the Act.
The
Legislation
[56] The relevant
legislative provisions are subsection 9(1) and paragraphs 18(1)(a)
and (b):
SECTION 9:
Income.
(1) Subject
to this Part, a taxpayer's income for a taxation year from a business or
property is the taxpayer's profit from that business or property for the year.
...
SECTION 18:
General Limitations
(1) In
computing the income of a taxpayer from a business or property no deduction
shall be made in respect of
(a) General
limitation – an outlay or expense except to the extent that it was made or
incurred by the taxpayer for the purpose of gaining or producing income from
the business or property;
(b) Capital
outlay or loss – an outlay, loss or replacement of capital, a payment on
account of capital or an allowance in respect of depreciation, obsolescence or
depletion except as expressly permitted by this Part;
...
The
Evidence
[57] The parties filed
an Agreed Statement of Facts in respect of the Transformer issue:
...
19. During
its taxation year ending December 31, 2000, ATCO Electric incurred expenses in
the amount of $1,280,267.51 relating to the cost of materials and labour to
replace transformers throughout its distribution and transmission network which
were under 3MVA in capacity that had failed.
20. The
actual cost of materials and labour incurred by ATCO Electric in 2000 to
replace all transformers under 3 MVA was $1,707,023, as described in the
schedules contained in the Joint Book of Documents, Tab 12. This amount was
reduced by 25% to $1,280,267.51 based upon an internal study conducted by ATCO
Electric for 2002 which indicated that 75% of the transformers replaced were
replaced due to failure and were not reusable, whereas the balance were reused
as the replacement was due to other reasons, such as a change in voltage. The
same percentage applies to 2000. A summary of the study entitled "Equipment
Report Analysis for 2002" is located in the Joint Book of Documents, Tab
10.
21. A
copy of ATCO Electric's T2 Return for the 2000 taxation year is located in the
Joint Book of Documents, Tab 11.
22. In
reassessing the Appellant for its taxation year ending December 31, 2000 by
Notice of Reassessment dated April 4, 2002, the Minister made adjustments to
certain balances of the Appellant, none of which are in issue in this appeal.
23. ATCO
Electric served a Notice of Objection on the Minister on April 23, 2002
raising for the first time an issue regarding the proper characterization of
certain outlays as current instead of capital expenditures including, inter
alia, a claim for adjustment in the amount of $622,990 in respect of
outlays which related to the material and labour costs of replacing
transformers which had been damaged ("Rainbow Pipelines Objection").
A copy of ATCO Electric's Notice of Objection for the 2000 taxation year is located
in the Joint Book of Documents, Tab 13.
24. By
Notice of Reassessment dated February 11, 2004 ("Transformer Reassessment"),
the Minister allowed the Rainbow Pipelines Objection in part, but did not
accept that $622,990 in transformer replacement costs were not capital in
nature (“Transformer Expenses”). A copy of the Notice of Reassessment and the
T7WC are located in the Joint Book of Documents, Tab 14.
[58] In reassessing
the Appellant's 2000 taxation year in respect of the transformer replacements,
the Minister relied on the following assumptions:
a) the Appellant is a corporation with a fiscal year end of
December 31;
b) the Appellant is engaged in the generation, transmission,
distribution and retailing of electrical energy;
c) the Appellant expended the amount of $622,990 with respect
to the replacement of electrical transformers;
d) the replacement of the electrical transformers included the
installation of new transformers and the removal of existing transformers;
e) electrical transformers are sold as separate assets;
f) electrical transformers are expensive;
g) electrical transformers are large;
h) the Transformer Replacement Amounts were expended in order
to achieve an enduring benefit to the Appellant's operations and business; and
i) the Appellant capitalized the Transformer Replacement
Amounts for accounting purposes.[50]
[59] As in all tax
appeals, the Appellant has the onus of proving wrong the assumptions upon which
the reassessment was based. However, most of the assumptions set out above are
not in dispute and have been incorporated into the Agreed Statement of Facts.
Analysis
[60] The case law for determining whether an expense is current or capital
in nature are well established.
In Rainbow Pipe Line Co. v. Her Majesty the Queen[52], Mogan, J. set out the relevant considerations:
1. whether the expense was
recurring or non-recurring;
2. whether the expense was a
major repair;
3. whether the expense brought
into existence an asset for the enduring benefit of the appellant's business;
and
4. whether the expense was
substantial in relation to the book value of the property, other expenses and
annual profits.
[61] The only witness
to testify was Mr. Dennis DeChamplain, a Chartered Accountant who is currently
the vice-president controller of financial reporting and accounting for the
Appellant. He presented his evidence in a clear and concise manner. I found his
answers entirely convincing, including his explanation of the regulatory
environment in which the Appellant decided to change how it expensed the
transformers.
[62] How do
transformers fit into the Appellant's electricity manufacturing business?
Electricity is generated at the Appellant’s generating stations and makes its
way to Alberta consumers through a series of substations, wires,
poles and transformers. A transformer is a device that allows for the transfer
of electricity from one circuit to another: the voltage can be either increased
or decreased depending on what is required for the movement of electricity at any
particular point in the network. There are approximately 83,000 transformers in
the Appellant's system varying in capacity, size and price: from the “10kVA”
(10,000 volts), about the size of a garbage can[53] at a unit price of $300 to $350 to the "3MVA"
(3 million volts), the size of a mini-van and worth approximately $50,000 each.
[63] Because the
smaller transformers are sealed units, it is more economical to replace than to
repair them. I accept Mr. DeChamplain's evidence detailing his calculation that
in 2000, the Appellant replaced 709 transformers ranging from 10 to 75 kMV
at an average unit cost of $943.16[54].
Only about 2,000 of the Appellant's 83,000 transformers were 3MVA transformers.
Unlike smaller transformers, in the case of malfunction they can be opened up
and repaired; in 2000, however, five of the 3MVA's had to be replaced rather
than repaired. Because of their greater value and the infrequency of their replacement,
the Appellant classified such expenses as capital; thus, their cost was not
included in the $622,990 at issue in this appeal.
[64] Turning, then, to
the Rainbow Pipe Line factors, the Respondent contends that the
transformer replacement costs were "non-recurring" since the average
life span of a transformer is 33 years. This submission might be persuasive if all
of the transformers always lived up to such projections. The fact is, however,
that each year 500 to 1,000 of the 83,000 transformers in the Appellant's
distribution system become non-functional thanks to lightning strikes, "shorting-out"
and vandalism all of which are, by their nature, quite likely to
continue to occur. In these circumstances, it is probable that the Appellant
will always be and in 2000 was obliged to replace a certain percentage of its
transformers. Accordingly, the expense of regular transformer replacement is
recurring in nature.
[65] The next
consideration is whether the replacement expense was "major". This,
like the Minister's assumption that transformers are "large"[56] and "expensive"[57], is a relative question. It is common ground that the
Appellant's outlays were limited to the costs of replacing transformers which
had been damaged; newly acquired transformers or upgraded models of existing transformers
were not included in the Appellant's claim. The number of transformers and the
cost per unit was small relative to the Appellant’s overall distribution
system, representing less than 1% of all of the transformers in the system and
their replacement cost, less than 1% of the Appellant's revenues, expenses and
profit for 2000.
[66] In these
circumstances, the replacement of a few transformers here and there in a
multi-million dollar electrical system is akin to changing a few bulbs in an
otherwise functioning string of Christmas tree lights[58]. Perhaps a better example is that of the spark plug,
described in Interpretation Bulletin IT-128R:
...
(d) Relative
value - The amount of the expenditure in relation to the value of the whole
property or in relation to previous average maintenance and repair costs often
may have to be weighed. This is particularly so when the replacement itself
could be regarded as a separate, marketable asset. While a spark plug in an
engine may be such an asset, one would never regard the cost of replacing it as
anything but an expense; but where the engine itself is replaced, the
expenditure not only is for a separate marketable asset but also is apt to be
very substantial in relation to the total value of the property of which the
engine forms a part, and, if so, the expenditure likely would be regarded as
capital in nature.
[67] In the
circumstances of this appeal, the small transformers are the sparkplugs, rather
than the engine, in the automobile that is the Appellant's electricity
distribution system. Relative to the quantum of the expense in relation to the
book value of the assets, other expenses and annual profits, the transformer
replacement expense was not "major" in the sense contemplated by Rainbow
Pipe Line.
[68] It remains to
consider whether the transformers constituted an "enduring benefit"
to the Appellant's business. In support of the Respondent's position that their
replacement was an enduring benefit, counsel for the Respondent argued that the
transformers are an integral part of the electrical distribution system. As
each one was replaced, the overall asset was enhanced by 33 years of use; thus,
their replacement was a "betterment" that materially improved the
distribution system beyond its original condition.
[69] I am not
persuaded this is so. The issue of the transformers' life expectancy has
already been considered above. I accept that the transformers were "integral"
to the Appellant's system in the sense that electricity could not be
transmitted without them. Their replacement, however, did not enhance the system;
it merely restored it to the state required to keep it functioning as intended.
Turning once more to Interpretation Bulletin IT-128R, "(w)here an
expenditure made in respect of a property serves only to restore it to its
original condition, that fact is one indication that the expenditure is of a
current nature" as illustrated by the example of the replacement of a ship's
rudder in IT-128R:
...
(c) Integral
Part or Separate Asset - Another point that may have to be considered is
whether the expenditure is to repair a part of a property or whether it is to
acquire a property that is itself a separate asset. In the former case the
expenditure is likely to be a current expense and in the latter case it is
likely to be a capital outlay. For example, the cost of replacing the rudder or
propeller of a ship is regarded as a current expense because it is an integral
part of the ship and there is no betterment; but the cost of replacing a lathe
in a factory is regarded as a capital expenditure because the lathe is not an
integral part of the factory but is a separate marketable asset.
[70] Thus, while any
given transformer might remain useful for 33 years, at any given moment there
will always be another, somewhere in the system, that needs to be replaced. In these
circumstances, the benefit of replacing non-functional transformers is anything
but enduring; rather, the effect of the replacement was simply to preserve the status
quo of the original network.
[71] For all of these
reasons, I am persuaded by the Appellant's argument that the transformer
replacement expenditures are analogous to the costs associated with the sort of
on-going maintenance repairs which Mogan, J. concluded in Rainbow Pipe Line
should be treated as current expenses. On the evidence before me, I am
satisfied that the replacement of the transformers was a current expense.
[72] The appeals are
allowed with costs and the reassessments are referred back to the Minister of
National Revenue for reconsideration and reassessment on the basis that:
1. in respect of the 1997 and
1998 taxation years, the sub-bituminous coal used by the Appellant to produce
electric energy reached its equivalent to the prime metal stage at the
pulverization stage; and
2. in respect of the 2000
taxation year, the amount of $622,990 expended by the Appellant to replace
electrical transformers was a current expense.
Signed at Ottawa,
Canada, this 4th day of May, 2007.
"G. Sheridan"
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