Gibralter Mines Ltd. v. The Queen, 85 DTC 5085, [1985] 1 CTC 116 (FCTD)

Muldoon, J:—This litigation is concerned with the effects of retroactive tax legislation. The plaintiff corporation is appealing from an income tax assessment whereby the Minister of National Revenue disallowed $1,057,916 of the plaintiffs royalty expense claim of $1,326,925 in the calculation of the plaintiffs 1974 taxable income. There is in evidence a deep pile of financial documents so chock-full of financial facts and suppositions, in their myriad lines, that the mind cannot simultaneously contemplate them all, except in terms of a prodigious clump of numerical factors and sums. This is further complicated by having to regard these lines upon lines of numbers from differing points in time during the year 1974.

The material before the court discloses that in April, 1974, the government of British Columbia announced a new royalty program which, in effect, was to replace the previously enforced mining taxes in that province. A Bill to that effect was introduced that very month. After a time that Bill was enacted as the Mineral Royalties Act, SBC 1974, Chap 54, to which Royal Assent was accorded on June 20, 1974. In September a proclamation by the Lieutenant-Governor brought the Act into effect on October 1, 1974, but the Act already contained the following provision:

27. (1) This Act, excepting this section and the title, comes into force on a date to be fixed by the Lieutenant-Governor by his Proclamation, and he may fix different dates for the coming into force of the several provisions; and upon coming into force, the Act or its provisions are retroactive and shall be deemed to have come into force on the first day of January, 1974 to the extent necessary to give full force and effect to the Act or the provisions on and after that date.

(2) This section and the title come into force on Royal Assent.

Then, by a statute passed to amend the Income Tax Act, which was added by SC 1974-75-76, Chap 26, subsection 7(1), to which Royal Assent was accorded on March 13, 1975, Parliament enacted paragraph 18(l)(m) of the Income Tax Act. It provided that in computing a taxpayer’s income from a business no deduction could be made in respect of royalties paid or payable by statute to Her Majesty in right of . . . a province. Hopefully the foregoing summary does not erroneously over-simplify the statutory run-on sentence which is attempted to be encapsulated. In any event, by subsection 7(5) of SC 1974-75-76, Chap 26, Parliament further enacted that the above summarized provision . . is applicable to amounts paid or payable or the fair market value of any property paid or payable after May 6, 1974 in respect of a period after May 6, 1974 . . .”.

The counsel for each party have helpfully produced a document styled: PARTIAL AGREEMENT AS TO FACTS AND DOCUMENTS, by which they no doubt mean a complete agreement about some certain facts and documents, although not all. However it ought to be styled, that agreed document is Exhibit 1 in these proceedings. Several of its paragraphs refer sparsely to attached schedules and they are therefore necessary, although not edifying to recite, but the more fully charged paragraphs in Exhibit 1 do helpfully set a scene into which one must plunge at some point of entry. Here they are, preceded by a note of caution which ought also to be quoted:

The parties hereto admit the several facts and documents hereinafter stated and identified, provided that these admissions are made for the purpose of this cause only and may not be used against either party on any other occasion or by anyone other than the parties hereto.

1. The Plaintiff is a mining corporation that is owned 70 percent by its parent company, Placer Development Limited and at all material times to this action was engaged in the business of mining and selling copper, silver and molybdenum in the Province of British Columbia.

2. The Plaintiffs 1974 taxation year was from January 1, 1974, to December 31, 1974.

3. The Mineral Royalties Act, SBC 1974, c 54 came into force on October 1, 1974, with effect retroactive to January 1, 1974.

4. The Mineral Royalties Act provided for a royalty (hereinafter referred to as a basic royalty) on designated minerals produced in the Province of British Columbia equal, in 1974, to 2.5 percent of the weighted average net value to a producer of minerals sold, disposed of or used by him during a calendar year.

5. In addition to the basic royalty, the Mineral Royalties Act provided for an additional royalty, (hereinafter referred to as super royalty), of a percentage calculated in the manner prescribed by the Act and regulations, such super royalty being payable only if the gross value of mineral production for the year exceeded by a specific amount a base determined by regulation; the rate and amount of super royalty payable for the year therefore fluctuated as the market price of minerals fluctuated. Depending on the relationship of the base to the gross value of mineral production for the year, provision was also made to reduce the basic royalty by either one-half or one percent. A significant decline in mineral prices occurred during the period from May 7, 1974 to December 31, 1974.

6. Pursuant to sections 6 and 27(3)(b) of the Mineral Royalties Act, the Plaintiff was required and did file prior to the 15th of November, 1974, a return containing an estimate of the gross and net value of the designated minerals produced in the period January 1, 1974 to October 31, 1974, on which a royalty was payable. The said return was accompanied by a payment of the royalty payable.

In accordance with Schedule 1, (herein, page 1)*, the Plaintiff made the following estimates and calculated the royalties payable to October 31, 1974, as follows:

			Rate of		Net Unit	Royalty
Mineral	Units sold	X	Royalty	X	Value	=	Payable
Copper	61,622,382 lb		.03896		$0.74475	$1,788,001
Silver	108,376 oz		.02500		$3.66101	$	9,919
					TOTAL	$1,797,920

7. Pursuant to section 6 of the Mineral Royalties Act the Plaintiff was further required to file monthly returns with respect to minerals produced in the months of November and December, 1974, containing respectively an estimate of the gross and net value of the designated minerals produced in each month on which a royalty was payable.

8. By return dated November 30, 1974, for the eleven months ended on November 30, 1974, the Plaintiff, in accordance with Schedule 2, (herein, page 11), made the following estimates of the royalties payable:

			Rate of		Net Unit		Royalty
Mineral	Units sold	X	Royalty	X	Value	—	Payable
Copper	71,331,140 lb		.025		$0.71280	$1,271,120.91
Silver	123,192 oz		.025		$3.59193	$	11,062.43
					TOTAL	$1,282,183.34

* Bracketed page numbers refer to the document produced by agreement of counsel.

9. By return dated January 8, 1975, for the twelve months ended December 31, 1974, the Plaintiff in accordance with Schedule 3, (herein, page 19), made the following estimates of the royalties payable:

			Rate of		Net Unit	Royalty
Mineral	Units sold	X	Royalty	X	Value	Payable
Copper	79,011,653 Ib		.02500		$0.67129	$1,325,993.31
Silver	136,147 oz		.02500		$3.58042	$	12,186.59
					TOTAL	$1,338,179.90

10. Under section 7 of the Mineral Royalties Act, the Plaintiff was required to file, prior to February 15, 1975, a return containing the detailed calculation of the royalty payable for the 1974 taxation year: it received an extension of the February 15th deadline and the said return was filed May 15, 1975. Section 7(2) of the Act required payment of the amount by which the royalty payable under sub-section (1) exceeded the royalty estimated and paid for the year of calculation under section 6.

Attached as Schedule 4 (herein, page 28), is the Plaintiffs 1974 Annual Return dated May 15, 1975, wherein the Plaintiff calculated its 1974 royalty payable as follows:

		Rate of		Net Unit Royalty Royalty
Mineral	Units sold	X Royalty	x	Value		Payable
Copper	79,760,658 lb	.025		$0.65574	$1,307,556.35
Silver	141,057 oz	.025		$3.62306	$	12,776.45
Molybdenum	128,133	.025		$2.05806	$	6,592.64
				TOTAL	$1,326,925.44

11. The Plaintiff filed an Amended Return dated January 9, 1976, Schedule 5, (herein, page 40), to eliminate from the royalty calculated in its Annual Return the minerals contained in its inventory as of December 31, 1973, and calculated its liability for the 1974 years as follows:

			Rate of		Net Unit Royalty Royalty
Mineral	Units sold	X	Royalty	xX	Value		Payable
Copper	69,115,035 lb		.025		$0.59737	$1,032,181.21
Silver	141,057 oz		.025		$3.62306	$	12,776.45
					TOTAL	$1,044,957.66

12. The Plaintiff filed a second Amended Return on March 1, 1976, Schedule 6, (herein, page 43), to eliminate from the royalty calculated in its amended return of January 9, 1976, a revised amount for the mineral contained in its inventory as of December 31, 1973 and calculated its final liability for the 1974 years as follows:

		Rate of		Net Unit Royalty Royalty
Mineral	Units sold	X Royalty	X	Value	==	Payable
Copper	73,407,387 lb	.025		$0.62582	$1,148,495.57
Silver	130,047 oz	.025		$3.56711	$	11,597.30
Molybdenum	82,122	.025		$2,12889	$	4,370.72
				TOTAL	$1,164,463.29

13. In its 1974 Interim Reports to its shareholders, Schedule 7, (herein, page 48), the Plaintiff estimated its liability under the Mineral Royalties Act as follows:

Report Dated	Year to Date	Royalties Payable
April 19, 1974	March 31, 1974	$4,800,000.
July 16, 1974	June 30, 1974	$4,824,000.
October 22, 1974	September 30, 1974	$1,421,000.
January 21, 1975	December 31, 1974	$1,306.00.

14. Section 18(l)(m) of the Income Tax Act denies the deduction of royalties paid or payable in respect of a period after May 6, 1974.

15. Attached as Schedule 8, (herein, page 56), is the Plaintiff's 1974 tax return dated June 20, 1975. In adjusting its profits as determined in its statement of earnings to arrive to its income for tax purposes, the Plaintiff added back the royalty expense of $1,306,000 and deducted $1,326,925 as royalties payable in respect of the period prior to May 7, 1974.

16. The amount of $1,326,925 claimed as a deduction by the Plaintiff represented the Plaintiff's estimate of the royalties paid or payable in respect of the period from January 1, 1974 to May 6, 1974, and was calculated on the basis of the data contained in its 1974 Annual Return dated May 15, 1975, (Schedule 4, herein, page 28), and on the basis that production had ceased and no further sales took place after May 6, 1974.

17. By notice of assessment dated December 12, 1977, with respect to the Plaintiffs 1974 taxation year, Schedule 9, (herein, page 68) the Minister of National Revenue disallowed the deduction of $1,326,925 claimed by the Plaintiff and allowed an amount of $269,009 on account of royalties paid by the Plaintiff with respect to the period prior to May 7, 1974.

18. In so assessing the Plaintiff for its 1974 taxation year, the Minister assumed that the proper method to allocate the Plaintiffs royalty expense between the periods prior to and after May 6, 1974, was to use the number of units sold as of May 6, 1974, and multiply it by the rate of royalty determined for the year and the net unit value of the minerals for the year. The details of the Minister’s calculations are set forth in the attached Schedule 10 (herein, page 70), and are summarized as follows:

			Rate of		Net Unit		Royalty
Mineral	Units sold	X	Royalty	X	Value	=	Payable
Copper	16,792,737 lb		.025		$0.62582	$262,731.00
Silver	70,401 oz		.025		$3.56711	$	6,278.00
					TOTAL	$269,009.00

19. Attached as Schedule 11, (herein, page 71), is the Plaintiffs calculations of Concentrate Revenue for the calendar year 1974.

20. Attached as Schedule 12, (herein, page 72), are the Plaintiff's Journal Vouchers estimating its royalty payable from March 1974 to December, 1974.

21. Attached as Schedule 13, (herein, page 109), are the Plaintiffs Statements of Earnings for the months January to December, 1974, inclusive.

22. Attached as Schedule 14, (herein, page 121), is a copy of a letter dated March 24, 1975, to the Plaintiff from the British Columbia Department of Mines and Petroleum Resources.

23. Attached as Schedule 15, (herein, page 124), is a copy of the Plaintiffs letter dated April 2, 1975, to the Department of Mines and Petroleum Resources.

William Keith Service, a chartered accountant and manager of taxation for the plaintiff, as he was also for its parent company Placer Development Limited, testified for the plaintiff. He said that as a result of seeing the provincial Bill 31 being introduced:

As soon as we realized that we would be subject to this royalty we began to reflect the royalty charge in the earnings statements of the company, (transcript p 65)

Thus, in paragraph 13 of the agreed facts one notes that in the report to March 31, 1974 the royalties were calculated, as of that date, to have been $4.8 million. So it proceeds to the end of December 1974 when the royalties were calculated to have been $1.306 million. Those are the calculations for the interim reports to shareholders, produced quarterly.

Mr Service testified about how new mineral royalties represented quite a departure from the previous form of income tax levied on mining corporations:

A Yes, it was a significant change. The mining industry had previously paid to the

province as a payment for the resource a mine tax, under the Mining Tax Act, which was a tax — and is, a tax based on profits. The Mineral Royalties Act proposed to levy a tax on the gross revenues of the mining companies so that there would be a liability whether or not the company was profitable.

A . . . the Act imposed a basic royalty which was a fixed percentage of the value of the

minerals sold in the year. There was, in addition, an additional royalty which came to be called the super royalty, which proposed to take as a tax roughly fifty per cent of the amount by which the revenues exceeded a certain basic amount which would be set by regulation.

Q Had mineral prices been strong, weak, or what, in the early months of 1974?

A At that time prices were very strong, strong enough that clearly at the beginning of

1974 the mining industry would be subject to this so-called super royalty in addition to the basic royalty.

Q And I think we’re all agreed that after, perhaps about May of ’74, metal prices kind

of tumbled, is that right”?

A Yes, they plummeted. In fact the peak price for copper, which is the principal metal

at issue here, it peaked at around $1.50 a pound at the beginning of May and by the end of the year it was down in the range of fifty, sixty cents a pound.

Because the Mineral Royalties Act was both passed and proclaimed in force well into the year, the first monthly return was required to be filed on November 15, 1974, for the ten months to October 31. That return, summarized in paragraph 6 of the agreed statement and shown above, revealed an estimated royalty of $1,797,920, a sum to which counsel referred in rounded expression as $1.8 million. As time went by, and estimates were either confirmed or transformed into real facts, the plaintiff filed with the provincial taxation authorities a second amended return, mentioned above in paragraph 12 of the parties’ agreed statement, revealing a total sum of royalties payable of $1,164,463.29, a sum to which counsel referred in rounded expression as $1.1 million.

The figure of $1.8 million included some super royalty and the average price during the ten months of 1974 up to October 31, was high enough to have supported a portion of super royalty in the overall liability for royalty. However, prices continued to decline until the end of 1974, such that by the end of December, the year’s average price had declined below the level at which the super royalty was engaged. Thus, only the basic royalty applied for the whole year. Finally, taking into account 1973 inventory which ought to have been deducted, the plaintiffs finally computed liability for 1974 provincial mineral royalties came to approximately $1.164 million, referred to throughout this case as $1.1 million.

The issue in dispute in this appeal can be usefully illuminated from the testimony in chief of Mr Service, speaking of notional or hypothetical returns.

A In preparing our income tax return for 1974 we had to calculate the amount of the

royalty that would be deductible as being incurred for the period prior to May the 7th, 1974. We took the view, and we received advice from our auditor, Price Waterhouse, on this, that the appropriate method of doing so was to make a cutoff at May 6th, 1974; in other words, to prepare a financial statement as of May 6, 1974, as we would do for our shareholders, following the same procedures.

We did this, using the annual return which had been filed at that time and had a liability of $1.3 million. We analysed the revenues reported in that return and arrived at a figure of $2.8 million as being the royalty that would have been payable at May 6th, 1974.

That calculation was done on a royalty return form and we called it a hypothetical return. Sometime later, when the final royalty was settled at $1.1 million for the year, and by that time we had in fact begun this appeal, I believe, we realized that the calculation of the royalty applicable to the period prior to May 7th, 1974 would have to be revised in view of the second amended royalty return.

We then did a second calculation of the amount of royalty that was in respect of that period using the second amended royalty return and arrived at a number of $1.9 million.

Q And that’s how —

A That’s called a notional return.

Q Yes, and that’s how the old figure of $2.8 worked itself down to $1.9.

A That’s right.

Q While the royalty liability was working its way down from $1.3 to $1.1.

A That’s right.

Q And that’s the result of the same adjustment concerning inventory that you talked

about.

À Yes.

Notwithstanding that the price per unit plummeted from May until the end of 1974, production seems to have continued unabated. In terms of copper alone, whereas approximately 10 million pounds were produced before May 7, the total production during 1974 amounted to approximately 73 million pounds. So, approximately 13.7 per cent, rounded up to 14 per cent of the year’s production occurred up to May 6 and, accordingly, approximately 86 per cent of the year’s production took place on and after May 7, until the end of 1974. That is approximately 86 per cent of the year’s production during only approximately 65 per cent of the year.

The plaintiffs position in regard to that reality was aptly described by Mr Service on cross-examination.

Q Do I follow your position to say, then, that there was no royalty applicable to the

units after May 6th for the rest of the year?

A The position is that in the period following May 6th, to December 31st, 1974, that

there was effectively a recovery of overpayment of royalties in the period prior to May 7th.

Q So that it was on a prepayment before May 6th? The recovery of what?

A The actual payment was not made until November, of course.

Q That is correct, there was no Act involved on May 6th, it was not even proclaimed

yet.

A That’s right. But the Act was retroactive to January 1st, 1974. The Act applied to

this period.

Q So you go back —

A So at this period of time, at May 6th, 1974, this is the amount of royalty that would

have been payable had the Act in fact been proclaimed at that time, for the period prior to May 7th.

Q So you are effectively saying you do a notional closing of accounts as of that date,

May 6th?

A Yes.

Q And you just say, from that moment on, don’t look towards the future of the rest of

the calendar year period.

A For this purpose, yes.

Q Notwithstanding that the rest of the calendar year period goes in determining that

final amount of royalty expense for the year.

A Yes.

Q Notwithstanding that the amount that you claim at May 6th is bigger than the

royalty that is paid for the whole year.

A The amount that we’re claiming now, remember, is the $1.1 million.

(transcript pages 112 & 113)

Q And when you came to your notional return, when you said 1.9, that 1.9 was bigger

than the 1.3 that was in the first annual return filed with the income tax return, so at that time, event, the 1.9, you wanted to deduct more for the whole year than what you had in fact paid for the whole year.

A Yes, not on accounting principles, on legal advice for the correct application of

Section 18(l)(m).

Q And when you made those calculations you knew the whole year’s facts. You knew,

physically, the whole year’s facts. The annual return was prepared in May ’75, the income tax return is filed in June ’75 amended returns are off into 1976, and in the future you’re making those calculations going back to May 6th, you’re putting breakers on, you say that’s it, you stop, and you close at May 6th.

A Yes, we prepared this return on the basis that there would be a May 6th, 1974

cutoff.

Q And when you were doing those actual, factual returns you knew, right before you,

what the true liability for the year was.

A Yes, in fact these calculations are derived from that return.

Q Did I understand you to say a few moments ago that those calculations in the

hypothetical and the notional were based on legal advice?

A Yes.

Q They were not based on — were the auditors consulted at all?

A For tax advice.

Q For tax advice, you mean in the sense of accounting principles to be applied in a

taxation question?

A These returns are prepared for tax return purposes, not for accounting statements

that are presented to the shareholders.

(transcript pages 114 & 115)

The plaintiffs management did however ordain the preparation of interim, quarterly statements for shareholders, which statements were, in effect, in the public domain. Alerted by the introduction of Bill 31 in the legislature, Mr Service and his personnel made the best estimates which they could of liability for royalties exigible under what they rightly presumed would be enacted into law. Mr Service testified that there was no complex accounting principle to be followed and that future estimates would be revised in accordance with past realities.

The issue generated by paragraph 18(l)(m) of the Income Tax Act remains: what portion, if any, of the $1.1 million royalty paid for the year 1974 was paid or payable in respect of the period after May 6, 1974? The answer depends on how one approaches the problem and that, in turn, may depend on some method of accounting as Mr Justice Martland wrote in Canadian General Electric Co Ltd v MNR, [1962] SCR 3; [1961] CTC 512; 61 DTC 1300 or on “ordinary commercial principles” as he also mentioned at pages 12 and 13. Reinforcing that theme, President Jackett (as he then was) wrote in Associated Investors of Canada Ltd v MNR, [1967] 2 Ex CR 96; [1967] CTC 138; 67 DTC 5096:

Profit from a business, subject to any special directions in the statute, must be determined in accordance with ordinary commercial principles. The question is ultimately “one of law for the court”. It must be answered having regard to the facts of the particular case and the weight which must be given to a particular circumstance must depend upon practical considerations. As it is a question of law, the evidence of experts is not conclusive.

(pages 101 & 102 [143])

More recently the appeal division of this Court, speaking unanimously in the reasons rendered by Mr Justice Urie in Neonex International Ltd v The Queen, [1978] CTC 485; 78 DTC 6339, made this point:

There is no doubt that the proper treatment of revenue and expenses in the calculation of profits for income tax purposes with a view to obtaining an accurate reflection of the taxable income of a taxpayer, is not necessarily based on generally accepted accounting principles. Whether it is so based or not is a question of law for determination by the Court having regard to those principles (see: MNR v Anaconda Brass Ltd (1956) AC 85; see also Associated Investors of Canada Ltd v MNR (1967) 2 Ex CR 96 at pages 101 and 102).

(page 499 [6348] )

The same consideration was discussed by Mr Justice Walsh, and he came to the same conclusion in Mandel v The Queen, [1976] CTC 545; 76 DTC 6316 at 565 [6330], where he invoked the closely similar thoughts of the late President Thorson of the Exchequer Court in the earlier case of Publishers Guild of Canada Ltd v MNR, [1956-60] Ex CR 32; [1957] CTC 1; 57 DTC 1017 at pages 49 and 50 [16-17].

Therefore, on the firm footing and understanding that the Court must not abdicate to accountants, be they ever so eminent, the judicial function of determining the taxpayer’s income tax liability, the parties each called an eminent chartered accountant to support the contentions of the plaintiff and the defendant respectively. Those experts’ testimony was duly presaged by respective compliances with Rule 482(6)(b) pursuant to which a written statement signed by each expert and accompanied by a certificate of a barrister was filed before trial.

The plaintiff called Robert Beverley Harrison, B Comm (Queen’s, 1962), CA (1965) of Arthur Andersen & Co as its expert witness. The defendant’s counsel promptly accepted that Mr Harrison is an expert on the accounting principles and questions upon which he was asked to formulate his opinion. Mr Harrison’s signed, written statement is Exhibit 6 in these proceedings.

Mr Harrison annexed to his written statement several excerpts from the Handbook of the Canadian Institute of Chartered Accountants. Contained in the CICA Handbook are recommendations with respect to accounting principles issued from time to time by the Institute’s Accounting Standards Committee, of which this witness was a member from September 1974 to September 1977. In stating the issue (in a somewhat diffused, but generally acceptable manner) Mr Harrison noted:

. . . Since the Income Tax Act provides no method of allocating royalty expense to the period before and after May 6, 1974, we must use generally accepted accounting principles to allocate expense.

Then, Mr Harrison’s opinion is expressed thus:

Pursuant to generally accepted accounting principles, the amount of royalties under the Mineral Royalties Act determined for the period ended May 6, 1974, is the amount of royalty expense that would be reflected in a statement of Gibraltar as at that time. I understand that the amount was determined to be approximately $1.9 million. [Later herein noted to be approximately $1.1 million.] No part of that amount is a royalty paid or payable in respect of a period subsequent to May 6, 1974. Subsequent economic events should not be used to adjust the royalty expense determined for the period ended May 6, 1974.

The opinion above expressed is rather indirect and appears not to meet the issue head-on. In setting out the basis of his opinion, Mr Harrison placed much emphasis on section 1750 and its several paragraphs in the CICA Handbook. It begins at page 601, thus:

GENERAL ACCOUNTING — SECTION 1750

An interim financial report may be prepared as at any date and may cover any period within the fiscal year. The Recommendations in this Section apply to those interim financial reports which are sent by companies to their shareholders on a regular periodic basis. The recommendations deal with matters relating to the financial position and results of operations presented in such reports and are not intended to apply to interim reports prepared for internal purposes.

It is important for shareholders that more frequent and timely information be available than that provided by the annual financial statements. It is therefore desirable that interim financial reports be issued. For many companies, interim financial reports are required by regulatory authorities.

In most cases financial data included in interim financial reports will not be reported on by the auditors. For greater clarity it is desirable in these circumstances that the financial data be marked “unaudited”. Terms such as “subject to audit” may incorrectly imply that the interim financial data presented will be reported on by the auditors at a later date and therefore the use of such terms is inappropriate.

This is perplexing and seems to be moving further and further from the issue to be resolved.

Some passages from Mr Harrison’s viva voce testimony in chief will establish the perspective from which he viewed the issue.

But there was no suggestion, and in fact I could find no support in accounting literature for restating that early period to annualize that expense when preparing interim statements. And I therefore concluded that the proper royalty expense for Gibraltar to include in its interim statements was that calculated with the facts and information known at May 6th, and that no subsequent events should be taken into account in adjusting that amount.

(transcript, page 151)

Q And as I understand what you’re saying, you say you don’t modify that by reason

of subsequent economic events, namely the decline of metal prices.

A No, you don’t.

Q But you do for mechanical adjustments of the sort that had to do with the inventory

mistake.

A Yes.

Q Yes, thank you.

A If I might illustrate that one further, if Gibraltar had been preparing a prospectus in

’75 with comparative financial statements it would not have recast those 1974 four or five month statements for anything other than the error made. It would not have annualized its royalty expense.

In other words, the interim statements would have been just as presented to its shareholders in its quarterly reports and the securities legislation would not require, in fact it would frown on, any annualization in the ’74 prospectus.

Q Thank you, Mr Harrison; and to the extent you’ve not said so orally I take it you

would otherwise affirm your statement as filed?

A Yes.

(transcript page 152)

Q Mr Harrison, just before we conclude, I wanted to ask you, do you have any comment you’d like to offer on what you’ve read of what Mr Kelsey’s position 1s?

A I guess there is one section of the Handbook which we both quote to support our

positions, which is a little unusual, I suppose. That is the section 17-50, I believe it’s

25. Yes, 17-50-25, I believe we both used to support our position.

(transcript, page 153)

Applied to the Gibraltar situation I read that to say “Remember, now, you’ve got high royalties here and you need to look at all the facts that would attach — I’m sorry, the high metal price and you need to look at all the facts that will attach because of the high metal price.”

The super royalty was one thing to pull in there and that’s why I refer to that paragraph and interpret it in a different manner than Mr Kelsey did, or so it seemed to me.

(transcript, page 154)

As was confirmed in cross-examination, Mr Harrison was concentrating on interim financial statements prepared during the year, and that is why his opinion appears to be off the point.

What have interim financial statements got to do with determining what portion, if any, of the $1.1 million royalty paid for 1974 was paid or payable in respect of the period after May 6? They are attempts to plot the enterprise’s position from time to time during the course of its annual voyage. In this instance the annual voyage from January 1 to December 31 — in 1974 at least — was that of the taxpayer as well as of the Legislature of British Columbia and of Parliament in their respective retroactive enactments. All the interim financial statements do is to apprise the shareholders and management how matters are roceeding and what is their position during the course of the fiscal year, as the ICA Handbook indicates at section 1750. Being merely interim, each does not efine the whole year’s operations. The reality of the whole voyage becomes down only at the end of the taxpayer’s own year.

The plaintiff here wants to seek its refuge in what might have been, before ■ay 6, 1974, when it ephemerally and temporarily attracted gigantic royalties. nd in order to hang on to, and to preserve, that short-lived, passing situation nd make it appear to be a salient reality, the plaintiff is constrained to cut off ■s accounting of royalty payments for income tax purposes at midnight, May 6, 974. But that artifice, unrealistic in itself, cannot preserve the chimera of more an a year’s royalties — logically reduced to the actual amount of that year’s lyalties — being artificially compressed into the first four months of that year. .11 of that was simply temporarily notional, not unlike the notional returns. The ^ality is that the year lumbered on to its end-of-December end, and approximately 86 per cent of the production was effected in those almost eight months ginning on May 7. No pounds of copper and no ounces of silver produced by le taxpayer after May 6 escaped the royalty imposed by the Mineral Royalties ct of British Columbia. Consequently royalties paid or payable from and after lay 7 — whether or not they amounted to what the plaintiff apprehended be- )re May 7, for that is finally irrelevant — cannot be deducted in computing icome tax.

What says the other eminent expert, called by the defendant? This was Den- am John Kelsey, FCA who serves as a consultant to Thorne Riddell, Chartered accountants, of which firm he was the senior partner before retiring as a partner 1 1982. Mr Kelsey graduated as a chartered accountant in 1947 and was gold ledallist for British Columbia. He has been active in the practice of his profes- mon as well as in the affairs of the CICA and the provincial institute, especially 1 regard to research and education. He was chairman of the CICA committee which studied and responded to the Carter Report on tax reform. He is a member of the Advisory Board to the Auditor General of British Columbia. Mr Kelsey disclosed that since 1982, he has become a director of two major compares in the natural resources field, namely British Columbia Forest Products Amited and Cominco Ltd, the mining company. Mr Kelsey’s signed written tatement is Exhibit 7 in these proceedings.

In stating the issue directly in the terms it has been stated by both counsel and 1 these reasons, Mr Kelsey noted:

In considering this question, I believe attention has to be given to a subsidiary matter, namely the extent to which finally established factual data may and perhaps should be used in arriving at the amount of royalty for 1974 out of which an allocation is to be made for the period May 7 to December 31, 1974.

"hen, Mr Kelsey’s opinion is expressed, thus:

It is my opinion that the amount of the royalties in respect of the period May 7 to December 31, 1974 should be determined for each designated mineral by multiplying the annual rate of royalty as determined for the calendar year 1974 times the number of units of that mineral sold during the period May 7 to December 31, 1974 times the weighted average net value of those units to Gibraltar. It is also my opinion that the use of finally established factual data in determining the rates and amounts of the royalty should not be constrained. On the contrary, I believe that the allocation of the royalty amounts should be based on the amounts finally determined as payable for 1974 under the BC Mineral Royalties Act.

Although Mr Kelsey acknowledges that his opinion is at variance with the positons taken by both the plaintiff and the Minister of National Revenue, it accords with the court’s view of the matter. Counsel for the defendant acknowledged that the documentary evidence and testimony which he led differed somewhat from the Minister’s position and he bears the responsibility as counsel to conduct his client’s case in this manner. He moreover adopts Mr Kelsey’s opinion for and on behalf of the Minister and the defendant.

Some of the commentaries expressed in Mr Kelsey’s written statement so commend themselves to the court for their reason and good sense that they bear repeating in these reasons.

At this point I should confirm that the royalties under the Mineral Royalties Act appear to me clearly to be . . . costs only established on an annual basis. The rates are established for each designated mineral for each calendar year, on the basis of data for the full year. Accordingly, the rates of royalty cannot be determined until after the end of the calendar year. In the interim, estimates may be made and refined as the year proceeds, and these estimates may prove in the event to range from the reasonably accurate to the wildly inaccurate.

First, there is the principle that accounting measurements (eg of value, of income, of costs) should be made on the basis that the enterprise is a going concern. This principle in my opinion seriously weakens Gibraltar’s position that the royalties should be calculated to May 6, 1974 on the basis of what the royalty rates would have been had the enterprise ceased activity on that date. In fact, Gibraltar continued operations for the rest of the year, and beyond, and the experience of the full year 1974 established factual, not hypothetical, rates of royalty for that year. It is also important for accountants to ask whether or not figures which they arrive at “make sense”. In this connection it is important to note that the total amount of royalty thus calculated by Gibraltar for the period January 1 to May 6, 1974 is substantially in excess of the total amount of royalty which was payable for the whole year. It follows arithmetically if this were so that the royalty for the period from May 7 to December 31, 1974 would be a negative amount.

The concept of “negative royalties” does not make sense to me. In 1974 royalty had to be paid on designated minerals taken out of the ground and sold. In the period May 7 to December 31, 1974 Gibraltar did sell designated minerals it had taken out of the ground, and inescapably there were royalties to pay on those sales. So the idea that royalties for that period could be negative is in conflict with the facts. It does not make sense.

The second accounting principle which guides me in reaching my opinion is the matching principle. . . . In my view, this need to match costs with revenues weakens the position taken by Revenue Canada as their calculations utilize an annual net unit value in allocating the royalties to the periods in question. These calculations ignore the differing values of the minerals in each of the periods. The royalty rates determined for 1974 to apply to both quantities (units) and net values attributable to those quantities, and to ignore this is to ignore the existence of a cause and effect relationship between the revenues and the royalty costs.

Mr Kelsey based his opinion directly on the provisions of the Mineral Royalties Act, in particular the definition of “weighted average’’ and the words of subsection 3(3) by which the amount of royalty is determined. Those provisions are as follows:

1. In this Act, unless the context otherwise requires,

“weighted average” means the average, weighted by volume or weight, of the gross value or net value, as the case may be, of the units of a designated mineral sold, disposed of, or used by a producer during the part of a year preceding the date the weighted average is calculated.

3. (3) Subject to an order under subsection (2), the amount of royalty payable by a producer shall be determined by multiplying the number of units of a designated mineral sold, disposed of, or used by him during the year of the determination by the rate of royalty determined under subsection (4) or (5), or both, and by multiplying that product by the weighted average net value to the producer of the units.

After considering the foregoing provisions, Mr Kelsey stated “. . . I am strengthened in my belief that the allocation ought to be made by multiplying the royalty rate for the year times the units in each period times the net unit values realized in each period.”

Mr Kelsey, like Mr Harrison, made reference to section 1750 of the CICA Handbook. He stated:

The matter of annually-determined costs and revenues is discussed in section 1750.25 of the CICA Handbook, part of the section on “Interim Financing Reporting to Shareholders’’, as follows:

“Some costs or revenues based on levels of income or sales are only determined once each year. Examples are management bonuses, volume discounts (on both purchases and sales), and sales commissions or rent based on income or sales. However, effective rates could be calculated at which each cost or revenue would be accrued during the year and the rates could be used in determining the interim portion of these costs and revenues.’’

In my view, the principal relevance of this to the issue between Gibraltar and Revenue Canada is the recognition it gives to costs which are determined once each year, and to the importance of using annual rates to reflect these costs. The need for estimates of such costs for purposes of interim (usually quarterly) reporting to shareholders, and the necessity to make revisions to those estimates as actual figures are known, pose problems in reporting to shareholders because of the risk of confusing rather than enlightening those shareholders by presenting frequently changing figures covering the same periods. This concern to avoid confusing the shareholder is not a factor in the relationship between taxing authority and taxpayer.

The principles of calculation evinced in Mr Kelsey’s statement of opinion accord with a fair construction of the provincial Mineral Royalties Act and of paragraph 18(l)(m) of the Income Tax Act and are consistent with the apparent scheme and policy of both statutes. The latter Act unexceptionably aims at the determination of the plaintiffs taxable income for the fiscal period of January 1 to December 31, 1974, not to mention subsequent fiscal periods. The calculations based on the cited principles will produce a tax liability for that year which conforms to the apparent scheme of the legislation.

Counsel for both parties referred many authorities of a jurisprudential nature to the court, but the above findings and concurrence with Mr Kelsey’s opinion will serve amply to dispose of the appeal.

Counsel for both parties requested the court to make a particular disposition, upon their agreement, that to the extent required, the plaintiffs 1975 non-capital loss be applied against its 1974 income. So shall it be done.

Now, it surely appears that the effect of these reasons is to dismiss the plaintiffs appeal, and so it would be forthrightly stated but for a quirk of the Income Tax Act in section 177. In order to refer the assessment back to the Minister for reconsideration and reassessment, the appeal actually has to be allowed.

The effect of the judgment then is that the plaintiff's appeal is allowed, with costs in favour of the defendant, and the assessment be referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that

(a) the 1975 non-capital loss, to the extent required shall be applied to the plaintiffs 1974 income; and

(b) the calculations of the Minister of National Revenue with respect to the royalty expense in 1974 under the Mineral Royalties Act be modified in accordance with the opinion evidence of the defendant’s expert witness.

In accordance with section 51 of the Federal Court Act and with Rule 337(2)(b) it is directed hereby that counsel for the defendant may prepare a draft of an appropriate judgment to implement the court’s conclusions and move for judgment accordingly. Counsel for the defendant should strive to obtain approval as to form from the plaintiffs counsel.