McNair,
|.:—These
are
appeals
from
the
decision
of
the
Minister
of
National
Revenue
concerning
the
deductibility
of
certain
items
in
the
calculation
of
Gulf
Canada
Limited's
base
for
depletion
allowance,
petroleum
profits
abatement
and
corporate
surtax.
The
parties
are
agreed
upon
the
amounts
in
issue;
the
dispute
centres
around
the
interpretation
to
be
given
to
certain
sections
of
the
Income
Tax
Act,
R.S.C.
1952,
c.
148
(am.
S.C.
1970-71-72,
c.
63)
(the
"Act"),
governing
the
calculations
in
question,
primarily
subparagraph
66.1(6)(a)(i)
and
sections
124.1
and
124.2.
The
two
actions,
pertaining
to
reassessments
of
the
plaintiff's
income
for
the
1974
and
1975
taxation
years
respectively,
were
tried
together
on
common
evidence
inasmuch
as
they
are
concerned
with
virtually
identical
issues.
The
parties
filed
an
agreed
statement
of
facts
wherein
they
outlined
the
central
facts
out
of
which
three
basic
issues
arise,
and
as
well
posed
a
series
of
questions
for
consideration
by
the
Court.
For
convenience,
I
will
set
out
the
facts
under
each
of
the
three
issues
as
well
as
the
respective
positions
of
the
parties,
and
then
return
to
an
analysis
of
the
evidence
and
argument
under
each
respective
heading.
By
way
of
background,
there
were
two
budgets
in
1974,
one
on
May
6,
which
was
reintroduced
in
substantially
the
same
form
on
November
18,
1974.
This
resulted
in
the
application
of
differing
sets
of
statutory
provisions,
one
pre-May
7,
1974,
and
one
post-May
6,
1974,
to
which
reference
will
be
made
from
time
to
time
hereafter.
It
is
unnecessary
to
detail
the
assessments
and
notices
of
objection
which
underlie
the
present
appeals.
The
parties
themselves
have
clearly
identified
and
set
out
the
issues
involved.
Issue
No.
1:
Lease
Rental
Payments
to
the
Provincial
Crown
In
the
1974
and
1975
taxation
years,
Gulf
made
certain
rental
payments
to
the
Crown
in
right
of
Alberta,
Saskatchewan
and
British
Columbia
for
subsurface
gas
and
oil
rights.
Gulf
submits
that
these
payments
come
within
the
definition
of
a
"Canadian
exploration
expense"
contained
in
paragraph
66.1(6)(a)
of
the
Act,
and
are
thus
to
be
included
in
the
earned
depletion
base
under
subparagraph
1205(1)(a)(ii)
of
the
Income
Tax
Regulations
for
purposes
of
the
depletion
allowance
authorized
by
section
65
of
the
Act.
The
Minister
takes
the
position
that
the
lease
rental
payments
constitute
a
"Canadian
development
expense",
and
are
excluded
from
the
earned
depletion
base
by
the
operation
of
clause
1205(1)(a)(iii)(C)
of
the
Regulations,
which
specifically
excluded
those
"Canadian
development
expenses"
referred
to
in
subparagraph
66.2(5)(a)(iii)
of
the
Act
as
it
then
read.
For
the
1974
taxation
year
I
am
concerned
only
with
expenditures
subsequent
to
May
6
in
the
total
amount
of
$1,626,867,
which
includes
the
sum
of
$25,772
for
oil
sands
leases
as
a
mineral
resource.
It
will
be
recalled
that
this
was
the
effective
date
of
the
amendments
to
the
aforementioned
statutory
provisions.
In
1975
the
sum
of
$2,555,875
was
paid
out
to
the
provincial
Crowns
in
lease
rental
payments,
of
which
$122,170
was
paid
in
respect
of
oil
sands
leases.
Gulf
has
reduced
both
of
these
figures
by
the
agreed
amount
of
25
per
cent
in
order
to
account
for
payments
made
in
respect
of
producing
leases.
Thus,
the
amounts
in
issue
are
$1,220,150
for
1974,
and
$1,916,906
for
1975.
Issue
No.
2:
Scientific
Research
This
issue
relates
to
Gulf's
expenditures
for
scientific
research
in
the
following
sectors
from
which
no
oil
or
gas
was
produced
in
either
of
the
taxation
years
in
question:
geological
research,
heavy
oil
projects,
special
projects,
payments
to
oil
and
gas
research
organizations,
and
Syncrude.
The
actual
dispute
is
simply
whether
or
not
such
payments
should
be
included
in
the
calculation
of"
taxable
production
profits”
under
sections
124.1
and
124.2
of
the
Act
and
"resource
profits”
under
Part
XII
of
the
Regulations.
These
terms
are
crucial
components
in
the
computation
of
corporate
surtax
under
subsection
123.2(1)
of
the
Act,
the
petroleum
profits
abatement
under
subsection
124(2.1)
of
the
Act,
and
the
depletion
allowance
under
subsection
65(1)
of
the
Act
and
Part
XII
of
the
Regulations.
In
1974,
for
purposes
of
computing
its
income
for
the
year
from
upstream
operations,
Gulf
treated
its
scientific
research
expenditures
of
$4,095,397
as
being
deductible
pursuant
to
paragraphs
20(1)(t)
and
37(1)(a)
of
the
Act.
This
is
not
in
issue.
However,
Gulf
did
not
make
similar
deductions
in
calculating
its
"production
profits”
(pre-May
7,1974)
under
Part
XII
of
the
Regulations
and
"taxable
production
profits"
(post-May
6,
1974)
under
sections
124.1
and
124.2
of
the
Act.
Gulf's
position
is
that
expenditures
for
scientific
research
which
are
unrelated
to
actual
production
in
the
sense
of
extraction
of
oil
or
natural
gas
form
no
part
of
the
calculations
under
sections
124.1
and
124.2.
The
Department
of
Industry,
Trade
and
Commerce
subsequently
approved
$3,904,402
of
the
total
amount
which
Gulf
had
claimed,
as
constituting
scientific
research
expenditures
under
the
Industrial
Research
and
Development
Incentives
Act,
R.S.C.
1970,
c.
1-10,
CIRDIA")
which
provided
a
system
of
grants
for
such
expenditures.
The
Minister,
in
reassessing
Gulf
for
the
1974
taxation
year,
accepted
this
classification
on
the
basis
that
the
definitions
of
scientific
research
in
the
IRDIA
and
the
Income
Tax
Act
are
identical.
Of
the
total
amount
of
$3,904,402,
$1,298,624
was
attributable
to
the
pre-May
7,1974
period,
and
$2,605,778
was
attributable
to
the
post-May
6,1974
period.
The
Minister
dia
not
deduct
the
scientific
research
expenditures
in
the
amount
of
$1,298,624
in
computing
Gulf's
"production
profits"
for
the
January
1
to
May
6
period
pursuant
to
Part
XII
of
the
Regulations
(applicable
to
the
pre-May
7,
1974
period).
However,
he
did
deduct
this
amount
to
determine
the
base
for
corporate
surtax,
pursuant
to
S.C.
1974-75,
c.
26,
s.
78(2),
for
the
post-May
6,
1974
period.
The
Minister
also
deducted
the
amount
of
$2,605,778
in
computing
Gulf's
“taxable
production
profits’
and
"resource
profits”
pursuant
to
sections
124.1
and
124.2
of
the
Act
and
Part
XII
of
the
Regulations
for
the
May
7
to
December
31,1974
period.
For
the
1975
taxation
year
the
issues
remain
basically
the
same.
Gulf
deducted
the
amount
of
$5,615,814
in
scientific
research
expenditures
in
comput-
ing
its
income
pursuant
to
paragraphs
20(1)(t)
and
37(1)(a)
of
the
Act,
and
also
deducted
mineral
development
capital
expenditures
in
the
amount
of
$61,525
pursuant
to
paragraphs
20(1)(t)
and
37(1)(b).
The
Department
of
Industry,
Trade
and
Commerce
approved
$4,804,399
as
constituting
scientific
research
under
the
IRDIA
definition,
which
was
accepted
by
the
Minister.
The
Minister
deducted
this
amount
in
computing
Gulf’s
resource
profits
under
Part
XII
of
the
Regulations
for
the
purposes
of
earned
depletion
allowance
and
in
computing
the
base
for
the
petroleum
profits
abatement.
Gulf
maintains
that
this
amount
should
not
be
deducted,
according
to
the
wording
of
sections
124.1
and
124.2
of
the
Act
and
on
the
interpretation
of"
production"
as
meaning
actual
production.
Issue
No.
3:
Capital
Cost
Allowance
This
issue
concerns
capital
cost
allowance
claimed
by
Gulf
with
respect
to
assets
purchased
for
Syncrude,
a
large
project
for
the
extraction
of
bituminous
sands
in
Northern
Alberta,
of
which
Gulf
was
one
of
the
participants.
Syncrude
was
not
in
operation
during
the
years
1974
and
1975,
nor
had
construction
been
commenced.
There
is
no
issue
as
to
Gulfs
deduction
of
capital
cost
allowance
under
paragraph
20(1)(a)
of
the
Act
in
determining
its
world
income.
It
is
Gulf's
submission,
however,
that
such
allowance
ought
not
to
be
deducted
in
calculating
its
"taxable
production
profits"
for
purposes
of
determining
the
corporate
surtax,
petroleum
profits
abatement
and
depletion
allowance.
Generally,
this
raises
the
same
questions
as
to
the
interpretation
of
sections
124.1
and
124.2
of
the
Act
that
were
raised
under
the
previous
heading,
namely:
whether
deductions
from
income
as
calculated
under
these
sections
must
be
related
to
actual
production
or
extraction
from
a
mine
or
well,
or
whether
the
same
deductions
taken
in
the
calculation
of
world
income
ought
to
be
taken
with
respect
to
the
determination
of
taxable
production
profits.
For
the
1974
taxation
year,
the
Minister
included
capital
cost
allowance
in
the
amount
of
$3,126,542
for
the
post-May
6,1974
period
for
purposes
of
determining
the
corporate
surtax
under
subsection
78(2)
of
the
amending
transitional
provision
enacted
by
S.C.
1974-75,
c.
26.
Subsection
78(2)
refers
to
sections
124.1
and
124.2
of
the
Act.
The
issue
is
simply
whether
on
the
proper
interpretation
of
these
sections,
capital
cost
allowance
is
deductible
in
the
calculation
of
taxable
production
profits
from
mineral
resources.
This
will
affect
the
base
for
the
corporate
surtax,
the
petroleum
profits
abatement
and
the
depletion
allowance
in
a
manner
similar
to
the
deduction
of
scientific
research
expenditures.
For
the
1975
taxation
year,
Gulf
deducted
capital
cost
allowance
in
the
amount
of
$21,556,788
in
respect
of
Syncrude
under
paragraph
20(1)(a),
and
also
deducted
the
same
amount
under
sections
124.1
and
124.2
of
the
Act
in
computing
its
resource
profits
under
section
1204
of
the
Regulations
for
purposes
of
depletion
allowance,
as
well
as
in
the
computation
of
taxable
production
profits
for
purposes
of
petroleum
profits
abatement
and
corporate
surtax.
Subsequently,
Gulf
reversed
its
position,
contending
that
capital
cost
allowance
should
not
be
deducted
under
sections
124.1
and
124.2.
After
a
series
of
skirmishes
by
way
of
reassessments
and
objections,
the
Minister
eventually
permitted
the
deduction
of
capital
cost
allowance
in
the
amount
of
$18,000,163
in
respect
of
Syncrude
(excluding
scientific
research)
pursuant
to
paragraph
20(1)(a)
of
the
Act.
The
Minister
also
recognized
the
deduction
of
the
same
amount
in
the
computation
of
Gulf’s
resource
profits
and
taxable
production
profits,
which
Gulf
disputes.
To
recapitulate,
the
amount
of
$17,790,909
of
Gulf's
1975
capital
cost
allowance
deduction
of
$18,061,688
in
relation
to
Syncrude,
including
$61,525
for
scientific
research,
was
related
to
assets
described
in
Class
28
of
Schedule
B
to
the
Regulations.
Questions
Posed
for
the
Court
1.
Do
Provincial
Crown
lease
rental
expenses
incurred
by
Gulf
in
its
1974
and
1975
taxation
years
constitute
“
Canadian
exploration
expenses"
as
defined
in
subparagraphs
66.1(6)(a)(i)
or
(iii)
of
the
Income
Tax
Act,
for
the
purpose
of
inclusion
in
the
earned
depletion
base
as
defined
in
Regulation
1205
of
the
Act?
2.
Are
the
amounts
deducted
by
Gulf
in
its
1974
(post
May
6)
and
1975
taxation
years
for
upstream
scientific
research
deductible
in
the
computation
of
Gulf's
"taxable
production
profits
from
oil
or
gas
wells
in
Canada"/'taxable
production
profits
from
mineral
resources
in
Canada",
as
defined
in
subsections
124.2(1)
and
124.1(1)
of
the
Act,
for
the
purposes
of
determining
its:
(1)"resource
profits”
under
Part
XII
of
the
Income
Tax
Regulations
(applicable
after
May
6,
1974),
to
enable
the
computation
of
its
depletion
deduction
under
Regulation
1201
and
section
65
of
the
Act?
(2)
petroleum
profits
abatement
under
subsection
124(2.1)
of
the
Act;
and
(3)
exemption
from
the
base
for
corporation
surtax
under
subsection
123.2(1)
of
the
Act?
3.
Ils
the
amount
deducted
by
Gulf
in
the
1974
taxation
year
in
respect
of
upstream
scientific
research
expenditures
in
the
pre-May
7,
1974
period
deductible
under
subsection
78(2),
c.
26,
S.C.
1974-75
in
the
computation
of
the
exemption
from
the
base
for
corporate
surtax
under
subsection
123.2(1)
of
the
Act?
4.
Is
the
mineral
development
capital
cost
allowance
deducted
by
Gulf
in
the
1974
taxation
year
in
respect
of
the
post
May
6,
1974
period
deductible
under
subsection
78(2),
c.
26,
S.C.
1974-75
in
the
computation
of
the
exemption
from
the
base
for
corporate
surtax
under
subsection
123.2(1)
of
the
Act?
5.
Is
the
amount
of
Gulf's
capital
cost
allowance
deduction
for
the
1975
taxation
year
in
respect
of
assets
located
at
Syncrude
deductible
in
the
computation
of
Gulf's
"taxable
production
profits
from
mineral
resources
in
Canada"/'taxable
production
profits
from
oil
or
gas
wells
in
Canada",
as
defined
in
subsections
124.1(1)
and
124.2(1)
of
the
Act,
for
the
purposes
of
determining
its:
(1)
"resource
profits”
under
Part
XII
of
the
Income
Tax
Regulations
(applicable
after
May
6,
1974),
to
enable
the
computation
of
its
depletion
deduction
under
Regulation
1201
and
section
65
of
the
Act;
(2)
petroleum
profits
abatement
under
subsection
124(2.1)
of
the
Act;
and,
(3)
exemption
from
the
base
for
corporation
surtax
under
subsection
123.2(1)
of
the
Act?
Lease
Rental
Payments
Subsection
65(1)
of
the
Income
Tax
Act
authorizes
a
depletion
allowance
in
addition
to
the
normal
deductions
of
expenses
in
computing
income.
This
additional
allowance
is
permitted
in
respect
of
oil
and
gas
wells
and
mineral
resources,
and
is
defined
in
Part
XII
of
the
Regulations.
Under
section
1201
of
the
Regulations,
as
amended
by
SOR/75-342,
the
taxpayer
is
authorized
to
deduct
the
lesser
of:
(a)
25
per
cent
of
the
amount,
if
any,
by
which
his
resource
profits
for
the
year
exceed
four
times
the
aggregate
of
amounts,
if
any,
deductible
under
subsections
1202(2)
and
(3)
in
computing
his
income
for
the
year,
and
(b)
his
earned
depletion
base
as
of
the
end
of
the
year
(before
making
any
deduction
under
this
section
for
the
year).
The
present
case,
as
I
see
it,
is
governed
by
paragraph
1201(b)
of
the
Regulations
relating
to
earned
depletion
base,
which
in
turn
is
defined
in
section
1205
of
the
Regulations.
The
relevant
portions
of
section
1205
read
as
follows:
1205.
For
the
purposes
of
this
Part"
earned
depletion
base”
of
a
taxpayer
as
of
a
particular
time
means
the
amount
by
which
33
1/3%
of
the
aggregate
of
(a)
all
expenditures
.
.
.
each
of
which
was
incurred
by
him
after
November
7,
1969
and
before
the
particular
time
and
each
of
which
(ii)
was
a
Canadian
exploration
expense
.
.
.
(iii)
was
a
Canadian
development
expense
other
than
.
.
.
(C)
an
amount
referred
to
in
subparagraph
66.2(5)(a)(iii)
of
the
Act,
.
.
.
The
definition
of''Canadian
exploration
expense"
is
set
out
in
paragraph
66.1(6)(a)
of
the
Act
as
follows:
Canadian
exploration
expense”
of
a
taxpayer
means
any
outlay
or
expense
made
or
incurred,
or
deemed
to
have
been
made
or
incurred,
after
May
6,
1974
that
is
(i)
any
expense
including
a
geological,
geophysical
or
geochemical
expense
incurred
by
him
(other
than
an
expense
referred
to
in
subparagraph
(ii))
for
the
purpose
of
determining
the
existence,
location,
extent
or
quality
of
an
accumulation
of
petroleum
or
natural
gas
(other
than
a
mineral
resource)
in
Canada,
(iii)
any
expense
incurred
by
him
for
the
purpose
of
determining
the
existence,
location,
extent
or
quality
of
a
mineral
resource
in
Canada
including
any
expense
incurred
in
the
course
of
(A)
prospecting,
(B)
carrying
out
geological,
geophysical
or
geochemical
surveys,
(C)
drilling
by
rotary,
diamond,
percussion
or
other
methods,
or
(D)
trenching,
digging
test
pits
and
preliminary
sampling,
but
not
including
(E)
any
Canadian
development
expense,
or
(F)
any
expense
that
may
reasonably
be
considered
to
be
related
to
a
mine,
whether
or
not
owned
by
the
taxpayer,
that
has
come
into
production
in
reasonable
commercial
quantities
or
to
be
related
to
a
potential
or
actual
extension
thereof,
..
.
It
is
Gulf's
submission
that
what
it
refers
to
«^'exploration
lease
rental
payments”
come
within
the
broad
definition
of
a
"Canadian
exploration
expense"
in
subparagraphs
66.1(6)(a)(i)
and
(iii),
as
expenses
incurred
"for
the
purpose
of
determining
the
existence,
location,
extent
or
quality”
of
an
accumulation
of
petroleum
or
natural
gas
or
of
a
mineral
resource.
Gulf
is
an
integrated
oil
company,
carrying
on
work
associated
with
the
exploration,
development
and
production
of
oil
and
gas
and
related
hydrocarbons,
or
what
is
frequently
referred
to
as
the"
upstream
sector”,
together
with
the
commercial
activity
involved
in
the
refining
and
marketing
of
those
products,
or
what
is
described
as
the
"downstream
sector".
The
company
has
a
combined
exploration
and
production
department.
The
exploration
group,
in
seeking
out
possible
development
sites,
is
responsible
for
gathering
information,
performing
seismic
work,
undertaking
economic
studies
and
determining
whether
to
acquire
subsurface
rights
in
order
that
exploratory
wells
may
be
drilled.
The
evidence
indicates
that
very
few
of
these
wells
actually
go
into
commercial
production.
The
three
provinces
in
question
grant
subsurface
rights
by
way
of
reservation,
permit,
licence
or
lease.
The
first
three
of
these
means
of
conveyance,
namely,
reservation,
permit
and
licence,
authorize
exploration
work
only.
It
is
only
under
a
lease
agreement
that
actual
production,
in
the
narrow
sense
of
the
extraction
of
oil
and
gas
from
the
ground
for
marketing,
is
permissible.
The
payments
under
each
of
these
types
of
agreement
are
generally
referred
to
as
‘lease
rental
payments”.
Gulf
argues
that
the
payments
to
acquire
these
rights
are
an
integral
part
of
the
exploration
process
and
therefore
ought
to
be
included
in
their
earned
depletion
base
as
a
Canadian
exploration
expense.
The
point
is
pressed
that
if
these
payments
were
not
made
for
the
acquisition
of
subsurface
rights,
no
exploratory
work
could
be
performed.
Because
it
is
Gulf's
position
that
the
deduction
is
only
applicable
to
non-producing,
exploratory
leases,
it
has
seen
fit
to
reduce
its
claim
for
these
payments
by
25
per
cent,
as
reflected
in
the
agreed
statement
of
facts.
However,
Gulf
was
unable
to
break
down
its
lease
rental
payments
to
reflect
the
actual
year
of
the
respective
lease
agreements
because
its
acreage
inventory
was
constantly
changing.
The
defendant
takes
the
position
that
these
payments
are
not
eligible
for
deduction
because
they
fall
within
the
definition
of
a
"Canadian
development
expense"
contained
in
paragraph
66.2(5)(a)
of
the
Act,
as
it
read
at
the
relevant
time,
and
more
specifically
within
subparagraph
(iii)
thereof.
Thus,
they
are
excluded
from
the
definition
of
"earned
depletion
base”
by
virtue
of
clause
1205(1)(a)(iii)(C)
of
the
Regulations.
Paragraph
66.2(5)(a),
enacted
by
S.C.
1974-75,
c.
26,
subsection
36(1),
as
amended
by
S.C.
1977-78,
c.
1,
subsection
31(2),
reads
as
follows:
"Canadian
development
expense”
of
a
taxpayer
means
any
outlay
or
expense
made
or
incurred,
or
deemed
to
have
been
made
or
incurred,
after
May
6,
1974
that
is
(iii)
notwithstanding
paragraph
18(1)(m),
the
cost
to
him
of
a
Canadian
resource
property,
.
.
.
but
not
including
any
payment
made
to
any
of
the
persons
referred
to
in
any
of
subparagraphs
18(1)(m)(i)
to
(iii)
for
the
preservation
of
a
taxpayer's
rights
in
respect
of
a
Canadian
resource
property
or
a
property
that
would
have
been
a
Canadian
resource
property
if
it
had
been
acquired
by
the
taxpayer
after
1971,
and
not
including
a
payment
.
.
.
to
which
paragraph
18(1)(m)
applied
by
virtue
of
subparagraph
(v)
thereof,
.
.
.
Paragraph
18(1)(m)
of
the
Act
prohibits
deductions
being
made
for
certain
royalty
payments,
and
subparagraph
(i)
thereof
makes
specific
reference
to
Her
Majesty
in
right
of
Canada
or
a
province.
"Canadian
resource
property"
is
defined
in
paragraph
66(15)(c)
of
the
Act,
as
amended
by
S.C.
1974-75,
c.
26,
subsection
35(21),
as
follows:
"Canadian
resource
property"
of
a
taxpayer
means
any
property
acquired
by
him
after
1971
that
is,
(i)
any
right,
licence
or
privilege
to
explore
for,
drill
for,
or
take
petroleum,
natural
gas
or
other
related
hydrocarbons
in
Canada,
(ii)
any
right,
licence
or
privilege
to
prospect,
explore,
drill,
or
mine
for,
minerals
in
a
mineral
resource
in
Canada,
(iii)
any
oil
or
gas
well
situated
in
Canada,
(iv)
any
rental
or
royalty
computed
by
reference
to
the
amount
or
value
of
production
from
an
oil
or
gas
well,
or
a
mineral
resource,
situated
in
Canada,
(v)
any
real
property
situated
in
Canada
the
principal
value
of
which
depends
upon
its
mineral
resource
content
(but
not
including
any
depreciable
property
situated
on
the
surface
of
the
property
or
used
or
to
be
used
in
connection
with
the
extraction
or
removal
of
minerals
therefrom),
or
(vi)
any
right
to
or
interest
in
any
property
(other
than
property
of
a
trust)
described
in
any
of
subparagraphs
(i)
to
(v)
(including
a
right
to
receive
proceeds
of
disposition
in
respect
of
a
disposition
thereof);
If
l
comprehend
the
defendant's
argument
correctly,
the
point
is
that
the
lease
rental
payments
were
not
made
for
the
actual
carrying
out
of
exploration
within
the
meaning
of
a
Canadian
exploration
expense,
but
rather
were
payments
for
maintaining
or
preserving
the
right
to
carry
out
such
activities,
and
therefore
fall
squarely
within
the
terms
of
subparagraph
66.2(5)(a)(iii)
of
the
Act.
As
such,
they
are
Canadian
development
expenses,
which
by
virtue
of
clause
1205(1)(a)(iii)(C)
of
the
Regulations
do
not
constitute
a
part
of
the
"
earned
depletion
base".
A
similar
position
was
taken
by
the
Federal
Court-Trial
Division
in
New
Continental
Oil
Co.
of
Canada
Ltd.
v.
The
Queen,
[1976]
C.T.C.
44;
76
D.T.C.
6038
[upheld
by
a
majority
decision
of
the
Federal
Court
of
Appeal
on
divided
grounds,
[1977]
C.T.C.
293;
77
D.T.C.
5202],
with
respect
to
former
section
83A
of
the
Act.
In
that
case,
Mahoney,
J.,
at
trial,
found
that
payments
for
leases
to
drill
and
explore,
including
the
right
to
take
oil
and
gas,
did
not
constitute
drilling
and
exploration
expenses
under
section
83A
and
were
consequently
not
deductible
inasmuch
as
they
were
payments
for
the
right
to
drill
and
explore,
and
not
for
expenses
incurred
in
drilling
or
exploring.
The
defendant
submits,
in
what
I
perceive
as
an
alternative
argument,
that
the
specific
exclusion
contained
in
clause
1205(1)(a)(iii)(C)
of
the
Regulations
overrides
the
wording
of
a
Canadian
exploration
expense
contained
in
paragraph
66.1(6)(a)
of
the
Act.
Leases
are
entered
into
by
Gulf
for
purposes
both
of
the
exploration
and
development
stages,
and
the
provincial
statutes
of
the
three
western
provinces
authorizing
the
payments
as
well
as
the
"lease"
agreements
themselves
recognize
that
the
payments
are
for
the
subsurface
rights
as
opposed
to
payments
for
production.
In
short,
these
rights
are
acquired
for
purposes
of
the
entire
upstream
sector
of
the
business.
Defendant's
counsel
cites
Edmonton
Liquid
Gas
Ltd.
v.
The
Queen,
[1984]
C.T.C.
536;
84
D.T.C.
6526
(F.C.A.),
and
submits
that
payments
to
maintain
an
acreage
inventory,
upon
which
both
exploration
and
development
may
or
may
not
take
place,
do
not
constitute
the
type
of
primary
exploratory
expenses
which
are
contemplated
by
subparagraph
66.1(6)(a)(i).
In
Edmonton
Gas,
test
wells
were
drilled
not
for
purposes
of
exploration,
but
for
actual
production.
However,
the
wells
turned
out
to
be
"dry
wells”,
and
the
question
before
the
Court
was
whether
the
costs
of
drilling
these
wells
constituted
exploration
expenses
within
the
meaning
of
subparagraph
66.1
(6)(a)(i).
The
Court
held
that
they
did
not
on
the
ground
that
this
subparagraph
was
limited
to
expenses
of
a"
primary
exploratory
type"
[per
MacGuigan,
J.
at
page
540
(D.T.C.
6530)].
As
I
interpret
the
definition
of
"Canadian
resource
property"
in
paragraph
66(15)(c)
of
the
Act,
there
is
no
question
that
the
annual
lease
rental
payments
made
by
Gulf
to
the
Crown
were
to
acquire
or
maintain
rights
in
property
falling
within
this
definition.
Furthermore,
these
payments
were
made
to
the
provincial
Crown,
and
are
therefore
excluded
from
the
definition
of"
Canadian
development
expense"
in
subparagraph
66.2(5)(a)(iii).
Consequently,
I
am
of
the
view
that
they
cannot
be
included
in
the
earned
depletion
base
under
section
1205
of
the
Regulations.
Based
on
budget
speeches
made
at
the
time
of
the
1974
amendments,
counsel
for
the
plaintiff
advances
the
proposition
that
the
purpose
of
the
exclusions
in
paragraph
18(1)(m)
of
the
Act
was
to
avoid
erosion
of
the
federal
tax
base
by
no
longer
recognizing
royalties
and
like
payments
made
to
the
provincial
Crowns
as
a
deduction
in
computing
income.
Prior
to
these
amendments,
royalties
payable
to
the
Crown
were
deductible
in
determining
income.
However,
as
a
result
of
increasing
production,
the
provincial
governments
were
increasing
their
revenues
by
increased
royalty
payments.
The
consequent
erosion
of
the
federal
tax
base
was
halted
by
making
such
payments
nondeductible.
It
is
also
clear
from
both
the
provisions
themselves
as
well
as
the
budget
speeches
that
the
government
was
attempting
to
encourage
exploration
through
use
of
the
earned
depletion
base.
Formerly,
the
depletion
allowance
was
not
predicated
on
an
"earned"
base.
Budget
speeches
and
similar
sources
are
useful
in
indicating
the
"mischief"
or
condition
at
which
the
legislature
was
directing
its
attention:
Lor-Wes
Contracting
Ltd.
v.
The
Queen,
[1985]
2
C.T.C.
79;
85
D.T.C.
5310
at
84
(D.T.C.
5314)
(F.C.A.),
per
MacGuigan,
J.
Nevertheless,
in
view
of
the
clear
wording
of
the
statutory
provisions,
I
do
not
find
the
excerpts
helpful
in
interpreting
the
language
used.
This
is
particularly
so
in
view
of
the
fact
that
both
parties
were
able
to
cite
the
speeches
in
support
of
their
own
positions.
As
well,
budget
speeches
are
not
intended
as
comprehensive
and
technical
aids
to
interpretation.
Clause
1205(1)(a)(iii)(C)
of
the
Regulations
excludes
amounts"
referred
to”
in
subparagraph
66.2(5)(a)(iii)
of
the
Act.
Thus,
I
have
no
hesitation
in
concluding
that
the
lease
rental
payments
by
Gulf
to
the
provincial
Crowns
are
amounts
referred
to
in
that
regulatory
provision.
Although
the
intent
of
paragraph
18(1)(m)
of
the
Act
may
have
been
to
exclude
royalty
payments
rather
than
lease
rentals,
the
language
employed
in
subparagraph
66.2(5)(a)(iii)
does
not
differentiate
between
the
two.
Rather,
the
subparagraph
simply
refers
to
"payments
made
to
any
of
the
persons
referred
to
in
any
of
subparagraphs
18(1)(m)(i)
to
(iii)
for
the
preservation
of
a
taxpayer's
rights
in
respect
of
a
Canadian
resource
property".
[Emphasis
added.]
It
does
not
limit
itself
to
royalty
payments
as
does
section
18,
nor
am
I
willing
to
read
in
any
such
limitation
in
view
of
the
clear
wording
referring
to
payments
made
to
preserve
rights
in
Canadian
resource
property.
Plaintiff's
counsel
relied
particularly
on
the
case
of
Western
Leaseholds
Ltd.
v.
M.N.R.,
[1961]
C.T.C.
490;
61
D.T.C.
1309
(Ex.
Ct.),
to
support
his
client's
position
that
these
annual
payments
constituted
Canadian
exploration
expenses.
I
must
say
with
all
due
respect
that
I
do
not
find
that
case
to
be
illuminative
of
the
point
in
issue.
Thorson,
P.
was
dealing
there
with
the
deductibility
of"
building
and
exploration
costs”,
including
all
general
geological
and
geophysical
expenses
incurred
by
[the
taxpayer]
directly
or
indirectly,
on
or
in
respect
of
exploring
or
drilling
for
oil
and
natural
gas
in
Canada"
under
section
53(1)
of
the
Income
Tax
Amendment
Act,
1949,
S.C.
1949,
c.
25
(am
S.C.
1950,
c.
40,
section
46).
A
restriction
was
imposed
by
subsection
(2A)
thereof,
which
stated
that
in
computing
such
deduction
"no
amount
shall
be
included
in
respect
of
a
payment
for
or
in
respect
of
a
right,
license
or
privilege
to
explore
for,
drill
for
or
take
petroleum
or
natural
gas
other
than
an
annual
payment
not
exceeding
$1
per
acre".
The
learned
president
held
that
this
did
not
permit
the
plaintiffs
to
deduct
one-time
fees
and
bonus
costs,
stating
in
this
context
at
page
493
(D.T.C.
1311):
"It
is
also
clear
that
the
land
costs
for
which
the
appellant
made
the
payments
referred
to
are
within
the
ambit
of
the
term
"exploration
costs"
in
subsection
(1)."
It
is
not
clear
that
the
definition
of
such
payments
was
at
issue
in
the
Western
Leaseholds
case,
and
I
do
not
take
it
to
be
determinative
of
the
issue
at
hand.
The
definition
of
a
Canadian
development
expense
now
makes
specific
reference
to
such
payments;
they
are
no
longer
referred
to
under
the
definition
of
Canadian
exploration
expense.
I
agree
with
the
Minister's
contention
that
the
specific
exclusion
in
section
1205
of
the
Regulations
of
payments
referred
to
in
subparagraph
66.2(5)(a)(iii)
of
the
Act
overrides
the
general
wording
contained
in
the
definition
of
a
Canadian
exploration
expense
in
paragraph
66.1(6)(a).
Support
for
this
view
may
also
be
found
in
the
legislative
history
behind
"Canadian
exploration
and
development
expenses",
as
defined
in
paragraph
66(15)(b)
of
the
Act.
Former
section
83A,
R.S.C.
1952,
c.
148,
permitted
the
deduction
of
drilling
and
exploration
expenses.
Subsection
(8e)
was
added
in
1965
to
include
in
such
expenses
annual
payments
made
for
the
preservation
of
a
right
[S.C.
1965,
c.
18,
subsection
20(6)].
In
the
1972
Act,
these
annual
payments
became
part
of
“drilling
or
exploration
expenses"
as
defined
in
paragraph
66(15)(d)
and,
by
virtue
thereof,
were
incorporated
in
the
definition
of
"Canadian
exploration
and
development
expenses"
in
paragraph
66(15)(b).
The
definition
of
"Canadian
resource
property"
in
paragraph
66(15)(c)
was
added
at
the
same
time,
including
subparagraph
(i),
"any
right,
licence
or
privilege
to
explore
for,
drill
for,
or
take
petroleum,
natural
gas
or
other
related
hydrocarbons
in
Canada".
"Canadian
exploration
expense"
and
"Canadian
development
expense"
were
split
into
two
separate
categories
effective
May
6,
1974
by
virtue
of
paragraphs
66.1
(6)(a)
and
66.2(5)(a)
respectively.
Moreover,
subparagraph
66.2(5)(a)(iii)
established
that
"the
cost
.
.
.
of
a
Canadian
resource
property"
fell
under
the
definition
of
"Canadian
development
expense"
[S.C.
1976-77,
c.
4,
subsection
25(2)].
Scientific
Research
Plaintiff's
counsel
makes
two
basic
arguments
concerning
Gulf's
expenditures
for
scientific
research
in
the
1974
and
1975
taxation
years.
First,
he
submits
that
since
the
Minister
accepted
that
the
expenditures
in
question
constituted
“scientific
research",
as
approved
under
IRDIA,
they
cannot
reasonably
be
regarded
as
being
related
to
production,
as
required
under
sections
124.1
and
124.2
of
the
Act.
As
indicated,
the
IRDIA
definition
of
scientific
research
is
the
same
as
that
contained
in
section
2900
of
the
Regulations,
which
reads
as
follows:
2900.
For
the
purpose
of
paragraph
(b)
of
subsection
(4)
of
section
72
[subsection
37(7)]
of
the
Act,
“scientific
research"
means
systematic
investigation
or
search
carried
out
in
a
field
of
science
or
technology
by
means
of
experiment
or
analysis,
that
is
to
say,
(a)
basic
research,
namely,
work
undertaken
for
the
advancement
of
scientific
knowledge
without
a
specific
practical
application
in
view,
(b)
applied
research,
namely,
work
undertaken
for
the
advancement
of
scientific
knowledge
with
a
specific
practical
application
in
view,
and
(c)
development,
namely,
use
of
the
results
of
basic
or
applied
research
for
the
purpose
of
creating
new,
or
improving
existing,
materials,
devices,
products
or
processes,
and,
where
such
activities
are
undertaken
directly
in
support
of
activities
described
in
paragraph
(a),
(b),
or
(c),
includes
activities
with
respect
to
engineering
or
design,
operations
research,
mathematical
analysis
or
computer
programming
and
psychological
research,
but
does
not
include
activities
with
respect
to
(g)
prospecting,
exploring
or
drilling
for
or
producing
minerals,
petroleum
or
natural
gas,
.
.
.
From
the
plaintiff's
standpoint,
section
2900
of
the
Regulations
is
a
key
provision,
insofar
as
paragraph
(g)
excludes
from
the
meaning
of
“scientific
research"
activities
with
respect
to
producing
minerals,
petroleum
or
natural
gas.
Having
accepted
an
amount
as
"scientific
research”
under
this
definition,
counsel
strenuously
contends
that
the
Minister
cannot
suddenly
contradict
himself
by
assessing
the
taxpayer
on
the
basis
that
the
amount
is
related
to
the
production
of
petroleum
or
natural
gas.
The
second
main
argument
of
plaintiff's
counsel
is
simply
that
the
research
to
which
the
payments
related
was
long-term
in
the
sense
of
not
being
directly
related
to
production
as
required
by
sections
124.1
and
124.2
of
the
Act,
but
rather
as
being
aimed
at
improving
the
future
business
of
the
company.
Counsel
submits
that
the
"production"
referred
to
in
these
sections
requires
actual
extraction
from
producing
wells
for
sale
on
world
markets.
In
his
submission,
there
was
no
production
in
this
sense
from
any
of
the
sectors
to
which
the
scientific
research
payments
in
question
relate.
In
support
of
this
argument,
plaintiff's
counsel
relied
particularly
on
the
cases
of
The
Queen
v.
The
International
Nickel
Co.
of
Canada
Ltd.,
[1975]
C.T.C.
620;
75
D.T.C.
5460
(S.C.C.),
affg
[1974]
C.T.C.
443;
74
D.T.C.
6382
(F.C.A.);
Cominco
Ltd.
v.
The
Queen,
[1984]
C.T.C.
548;
84
D.T.C.
6535
(F.C.T.D.);
and
Texaco
Exploration
Co.
v.
The
Queen,
[1975]
C.T.C.
404;
75
D.T.C.
5288
(F.C.T.D.).
Counsel
for
the
defendant
takes
the
position
that
the
references
to
"production"
in
sections
124.1
and
124.2
comprehend
the
entire
upstream
sector
of
Gulf's
business,
including
exploration,
development
and
production
in
the
sense
of
extraction,
as
opposed
to
the
downstream
or
marketing
sector
of
the
business.
He
maintains
that
the
structures
of
the
industry
and
of
the
plaintiff's
operations
support
this
division.
In
his
submission,
the
scientific
research
in
issue
was
related
to
improving
production
in
this
broad
sense.
Defendant's
counsel
relied
extensively
on
expert
evidence
to
support
his
argument
that
the
scientific
research
payments
were
treated
by
Gulf
in
its
financial
statements
in
a
manner
consistent
with
industry
practice
and
with
generally
accepted
accounting
principles
in
that
they
were
deducted
from
income
produced
from
the
entire
upstream
sector,
with
no
differentiation
being
made
between
exploration
and
production.
The
relevant
provisions
of
sections
124.1
and
124.2
of
the
Act
(now
repealed)
read
as
follows:
124.1
(1)
For
the
purposes
of
this
Part/'taxable
production
profits
from
mineral
resources
in
Canada”
of
a
corporation
for
a
taxation
year
means
the
amount,
if
any,
by
which
the
aggregate
of
(a)
where
the
corporation
has
production
from
a
mineral
resource
in
Canada
operated
by
it,
the
amount,
if
any,
included
in
computing
its
income
for
the
year
by
virtue
of
subsection
59(2.1)
and
paragraphs
59(3.2)(b)
and
(c),
less
any
deduction
allowed
in
computing
its
income
by
virtue
of
subsection
64(1.1),
and
(b)
the
amount,
if
any,
of
the
aggregate
of
its
incomes
for
the
year
from
(i)
the
production
in
Canada
of
(A)
petroleum,
natural
gas
or
related
hydrocarbons,
or
(B)
metals
or
minerals
to
any
stage
that
is
not
beyond
the
prime
metal
stage
or
its
equivalent,
from
mineral
resources
in
Canada
operated
by
it,
(ii)
the
processing
in
Canada
of
ores
from
mineral
resources
in
Canada
not
operated
by
it
to
any
stage
that
is
not
beyond
the
prime
metal
stage
or
its
equivalent,
and
(iii)
a
rental
or
royalty,
the
amount
of
which
is
computed
by
reference
to
the
amount
or
value
of
production
from
a
mineral
resource
in
Canada,
exceeds
(c)
the
aggregate
of
its
losses
for
the
year
from
those
sources,
computed
in
accordance
with
this
Act,
on
the
assumption
that
it
had
during
the
taxation
year
no
incomes
or
losses
except
from
those
sources
and
was
allowed
no
deductions
in
computing
its
income
for
the
taxation
year
other
than
(v)
such
other
deductions
as
may
reasonably
be
regarded
as
applicable
to
the
sources
of
income
described
in
any
of
subparagraphs
(b)(i),
(ii)
and
(iii).
124.2
(1)
For
the
purposes
of
this
Part,
“
taxable
production
profits
from
oil
or
gas
wells
in
Canada"
of
a
corporation
for
a
taxation
year
means
the
amount,
if
any,
by
which
the
aggregate
of
(a)
where
no
amount
is
included
in
computing
the
taxable
production
profits
from
mineral
resources
in
Canada
of
the
corporation
by
virtue
of
paragraph
124.1(1)(a)
and
the
corporation
has
production
from
an
oil
or
gas
well
in
Canada
operated
by
it,
the
amount,
if
any,
included
in
computing
its
income
for
the
year
by
virtue
of
subsection
59(2.1)
and
paragraphs
59(3.2)(b)
and
(c),
less
any
deduction
allowed
in
computing
its
income
by
virtue
of
subsection
64(1.1),
and
(b)
the
amount,
if
any,
of
the
aggregate
of
its
incomes
for
the
year
from
(i)
the
production
of
petroleum,
natural
gas
or
related
hydrocarbons
from
oil
or
gas
wells
in
Canada
operated
by
it,
and
(ii)
rentals
or
royalties,
the
amounts
of
which
are
computed
by
reference
to
the
amount
or
value
of
production
from
oil
or
gas
wells
in
Canada,
exceeds
(c)
the
aggregate
of
its
losses
for
the
year
from
those
sources,
computed
in
accordance
with
this
Act,
on
the
assumption
that
it
had
during
the
taxation
year
no
incomes
or
losses
except
from
those
sources,
and
was
allowed
no
deductions
in
computing
its
income
for
the
taxation
year
other
than
(ii)
the
amount,
if
any,
by
which
the
aggregate
of
the
losses
referred
to
in
paragraph
124.1(1)(c)
exceeds
the
aggregate
of
the
incomes
referred
to
in
paragraph
124.1(1)(a)
and
(b)
(v)
such
other
deductions
as
may
reasonably
be
regarded
as
applicable
to
the
sources
of
income
described
in
subparagraphs
(b)(i)
and
(ii).
These
sections
provide
a
means
for
a
separate
calculation
of
an
amount
known
as
”
taxable
production
profits”,
used
as
an
essential
component
in
the
calculation
of
certain
special
abatements,
namely,
petroleum
profits
abatement,
depletion
allowance
and
the
base
for
corporate
surtax.
Counsel
for
the
defendant
relied
on
the
texts
of
the
1974
budget
speeches
with
a
view
to
explaining
the
purpose
behind
the
incentive
programs
for
which
sections
124.1
and
124.2
were
designed.
While
the
1974
budget
set
the
basic
rate
of
corporate
tax
at
50
per
cent,
certain
allowances
were
to
be
given
to
corporations
with
resource
income
in
order
to
reduce
the
effective
rate
of
tax.
Furthermore,
separate
treatment
was
to
be
given
to
income
from
oil
and
gas
wells
as
opposed
to
income
from
mineral
resources.
Defendant's
counsel
makes
the
point
that
if
Gulf’s
scientific
research
expenditures
are
not
deducted
under
sections
124.1
and
124.2
of
the
Act
in
the
calculation
of
"taxable
production
profits",
while
at
the
same
time
being
deducted
under
sections
20
and
37,
the
effect
will
be
far
larger
abatements
than
would
be
the
case
if
the
base
for
the
abatements
was
calculated
on
the
same
basis
as
the
basic
federal
tax.
According
to
defendant's
counsel,
this
would
mean
that
the
purpose
of
the
incentives
will
be
exceeded
to
the
extent
that
the
abatements
will
be
extended
to
far
more
than
just
resource
income.
Plaintiff's
counsel
counters
with
the
rejoinder
that
this
result
is
not
illogical,
given
the
fact
that
the
purpose
of
the
"taxable
production
profits”
calculation
is
to
serve
as
a
base
for
a
tax
incentive
program.
In
support
of
this
proposition,
counsel
points
to
the
reasoning
of
Jackett,
C.J.,
in
the
International
Nickel
case,
supra,
at
page
447
(D.T.C.
6386).
In
the
alternative,
plaintiff's
counsel
proffered
a
different
explanation
of
the
purpose
of
the
tax
incentive
amendments.
Without
elaborating,
his
explanation
was
that
Parliament
intended
to
allow
for
the
taxation
of
petroleum
and
natural
gas
production
by
provincial
governments,
while
at
the
same
time
making
the
payment
of
those
taxes
nondeductible
under
the
Income
Tax
Act,
in
order
to
prevent
the
erosion
of
the
federal
tax
base
by
rising
provincial
rates
of
taxation.
To
accomplish
its
legislative
objective,
Parliament
set
up
a
scheme
isolating
and
permitting
abatements
in
respect
of"
production",
which
corresponded
to
the
activity
taxed
by
provincial
governments
through
royalties
on
actual
production.
Defendant's
counsel
submitted
that
the
sourcing
requirement
under
section
4
of
the
Act
ought
to
be
read
into
sections
124.1
and
124.2
on
the
basis
that
the
language
of
these
sections
refers
to
the
"
aggregate
of
its
incomes",
thus
implying
that
the
"income
from
source”
rules
in
sections
3
and
4
of
the
Act
should
apply
to
the
calculations
thereunder.
Plaintiffs
counsel
submits,
contra,
that
the
wording
of
sections
124.1
and
124.2
of
the
Act
makes
is
abundantly
clear
that
the
"sources
of
income"
referred
to
therein
are
attributable
to
“production”,
rather
than
"business".
In
his
submission,
these
sections
establish
a
separate
scheme
for
the
calculation
of
this
special-purpose
tax
base.
I
am
satisfied
to
accept
the
submissions
of
plaintiff's
counsel
on
this
issue,
namely,
that
sections
124.1
and
124.2
are
much
more
specific
in
their
scope
and
intendment
than
the
calculation
of
income
provisions
under
section
3
of
the
Act,
in
requiring
that
the
income
and
deductions
be
related
to
production
in
the
sense
of
extraction
from
the
ground
as
the
source
of
income.
In
my
opinion,
the
scientific
research
expenditures
in
issue,
being
related
to
the
long-term
objectives
of
the
plaintiff
and
not
to
the
actual
present
production
from
mineral
resources,
ought
not
to
be
included
in
the
calculations.
I
am
buttressed
in
this
conclusion
by
the
three
cases
relied
on
by
the
plaintiff.
In
The
Queen
v.
International
Nickel,
supra,
the
Minister
sought
to
deduct
long-term
scientific
research
expenditures
in
the
computation
of
depletion
allowance
under
section
1201
of
the
Regulations
with
respect
to
“profits
..
.
.
reasonably
attributable
to
the
production
of
oil,
gas,
prime
metals
or
industrial
minerals
from
.
.
.
resources
operated
by
[the
taxpayer]".
The
taxpayer
argued
that
these
expenditures
were
not
properly
deductible
in
computing
its
depletion
base
under
the
regulations
since
they
were
of
a
capital
nature
and
ought
not
to
be
deducted
in
the
calculation
of
"profits".
The
taxpayer
further
argued
that
these
expenditures
were
not
related
to
the
production
of
prime
metals
as
required
by
section
1201
of
the
Regulations.
The
Federal
Court-Trial
Division
allowed
the
taxpayer's
appeal
based
on
the
argument
that
the
expenses
were
of
a
capital
nature.
The
Federal
Court
of
Appeal
dismissed
the
Minister's
appeal,
but
on
different
grounds.
Essentially,
the
appellate
Court
held
that
long-term
scientific
expenditures
were
not
related
to
production
as
required
under
the
Regulations.
The
Court
chose
to
view
them
instead
as
part
of
a
separate
operation
designed
for
ensuring
the
future
success
of
the
business,
and
not
as
expenses
incurred
in
the
production
of
prime
metal.
Jackett,
C.J.
considered
the
scheme
of
allocating
income
to
a
source
with
reference
to
the
computation
of
the
depletion
base,
and
concluded
at
pages
448-49
(D.T.C.
6386-87)
:
Regulation
1201
does
not,
however,
adopt
such
a
scheme.
It
provides
for
a
calculation
of
profit
reasonably
attributable
to
the
particular
activity
and,
by
Regulation
1201(4)
enumerates
what
is
to
be
deducted
from
the
profit
so
calculated.
Moreover,
while
that
enumeration
specifically
singles
out
such
amounts
as
capital
cost
allowance
(depreciation)
and
interest
on
borrowed
money
for
deduction
from
gross
profit
in
computing
the
depletion
base,
it
does
not
require
deduction
in
that
computation
of
the
research
expenses
that
are
deductible
in
computing
income
by
virtue
of
section
11(1)(j)
and
section
72.
In
the
face
of
such
a
very
precise
formula
adopted
under
statutory
authority
for
the
specific
purpose
of
computing
the
depletion
base,
I
am
of
the
view
that
it
is
not
open
to
the
courts
to
read
into
the
statutory
formula
any
unspecified
deduction
that
might
seem
to
be
dictated
by
policy
considerations.
In
my
view,
this
statement
is
equally
applicable
to
the
Crown's
submission
in
the
present
case.
Incidentally,
the
decision
of
the
Federal
Court
of
Appeal
in
International
Nickel
was
affirmed
by
the
Supreme
Court
of
Canada.
In
Cominco
Ltd.
v.
The
Queen,
supra,
the
question
before
the
Court
was
whether
business
interruption
insurance
payable
in
respect
of
a
fire
at
the
plaintiff's
zinc
ore
processing
plant
could
be
characterized
as
production
profits
from
its
mineral
processing
operation,
and
therefore
allowable
as
a
deduction
by
virtue
of
the
combined
effect
of
subsections
65(1)
and
124.1(1)
of
the
Act
and
section
1201
of
the
Regulations.
The
plaintiff
argued
that
the
insurance
proceeds
should
be
treated
for
tax
purposes
in
a
manner
identical
to
the
assumed
earnings
for
which
the
proceeds
were
a
replacement.
The
Minister
argued,
on
the
other
hand,
that
in
order
to
qualify
for
the
allowances
in
question,
the
taxpayer
had
to
fulfil
the
literal
requirements
of
the
regulations.
He
further
argued
"that
the
allowance
provided
for
by
the
regulations
comes
into
existence
only
when
there
has
been
production
(or
a
processing)
of
minerals
as
required
by
the
regulations".
The
Court
held
that
the
defendant's
position
was
the
correct
one
on
the
grounds
that
the
insurance
proceeds
should
be
treated
as
general
revenue
within
the
breadth
of
section
3
of
the
Act
and
should
not
be
brought
within
the
much
more
specific
wording
of
section
1201
of
the
Regulations,
where
there
is
production
profits
or
resource
profits.
Reed,
J.
made
the
following
significant
comment
at
page
552
(D.T.C.
6538):
The
fact
that
the
plaintiff
treated
the
proceeds
as“
mineral
income”,
in
accordance
with
generally
accepted
accounting
principles
is
not
a
weighty
consideration
in
this
case.
Reference
can
be
made
to
the
Supreme
Court
decision
in
Gunnar
Mining
Ltd.
v.
M.N.R.,
[1968]
C.T.C.
22;
68
D.T.C.
5035,
for
an
illustration
of
the
principle
that
a
taxpayer's
accounting
practices,
or
even
the
generally
accepted
accounting
principles,
are
not
controlling
in
the
face
of
the
express
wording
of
the
Act.
An
appeal
of
this
decision
was
dismissed
[A-1324-84,
December
2,
1985],
and
leave
to
appeal
to
the
Supreme
Court
of
Canada
was
refused,
[1986]
1
S.C.R.
vil.
In
Texaco
Exploration
v.
The
Queen,
supra,
the
first
issue
before
the
Court,
and
the
only
one
with
which
I
will
deal,
went
to
the
amount
of
depletion
allowance
the
taxpayer
was
entitled
to
deduct,
pursuant
to
subsection
11
(1)(b)
of
the
Act
and
sections
1200
and
1201
of
the
Regulations.
The
parties
adduced
expert
opinion
evidence
as
to
the
meaning
of
“
production”.
Notwithstanding
the
helpful
opinion
evidence,
the
trial
judge
wisely
perceived
his
problem
as
being
to
determine
what
the
legislators
meant
by
the
words
"profits
reasonably
attributable
to
the
production
.
.
.”,
as
they
appear
in
paragraph
1202(2)(a)
of
the
Regulations.
The
plaintiff's
action
was
dismissed.
On
the
first
issue,
the
Court
concluded
that
production
of
gas
by
Texaco
ceased
at
the
well-head,
i.e.,
at
the
upstream
side
of
any
separator,
be
it
a
field
separator
or
an
inlet
separator,
in
the
plaintiff's
gas
plants.
The
matter
was
referred
back
to
the
Minister
for
reassessment
accordingly.
Collier,
J.
gave
the
following
definition
of
"production"
in
terms
of
oil
or
gas
at
page
412
(D.T.C.
5293):
In
my
opinion,
the"
production
of
oil
[or]
gas”,
in
this
suit,
means
the
bringing
forth,
or
into
existence
and
human
realization,
from
underground,
a
basic
substance
containing
gas,
and
at
the
same
time,
other
matter.
Whether
it
is
basically
oil
or
basically
gas
that
is
discovered
and
brought
forth,
or
whether
it
is
an
oil
well
as
distinguished
from
a
gas
well,
is,
I
think,
perhaps
a
matter
of
measurement,
or
the
bestowing
of
a
sensible
appellation
on
the
particular
substance
(be
it
energy,
or
fuel,
or
something
else)
or
source,
which,
or
from
which,
the
substance
is
recovered
in
the
largest
relative
volume.
In
light
of
these
cases,
I
am
unable
to
agree
with
the
submission
of
defendant's
counsel
that
income
under
sections
124.1
and
124.2
of
the
Act
must
be
computed
in
accordance
with
the
concept
of
the
source
principle.
As
I
read
these
sections,
contrary
to
what
defendant's
counsel
suggests,
the
calculation
of
taxable
production
profits
is
independent
of
the
calculation
of
income
for
purposes
of
section
3
of
the
Act.
In
my
opinion,
sections
124.1
and
124.2
set
up
their
own
separate
scheme
of
inclusions
and
exclusions
from
income
for
purposes
of
the
special
incentive
programs.
Capital
Cost
Allowance
I
consider
that
the
same
arguments
applicable
to
scientific
research
expenditures
also
apply
to
the
deductibility
of
capital
cost
allowance
for
Syn-
crude
assets
under
sections
124.1
and
124.2
of
the
Act.
Plaintiff's
counsel
made
the
additional
argument
that
under
former
section
1201
of
the
Regulations,
capital
cost
allowance
was
specifically
mentioned
as
a
deduction
from
the
base
used
for
the
calculation
of
depletion
allowance
and
that,
consequent
upon
the
amendments
of
the
Act
and
Regulations,
this
deduction
was
removed.
Counsel
submitted
that
this
was
consistent
with
the
intent
of
the
statutory
amendments.
I
conclude
therefore,
consistent
with
my
conclusions
regarding
the
scientific
research
deduction
issue,
that
the
calculation
of
“taxable
production
profits"
in
sections
124.1
and
124.2
of
the
Act
is
referable
to
production
in
the
narrow
sense
of
the
term.
It
is
common
ground
between
the
parties
that
there
was
no
actual
production
in
the
taxation
years
in
question.
Hence,
there
can
be
no
deduction
of
capital
cost
allowance
under
these
sections,
as
I
see
it.
Conclusion
I
am
of
the
opinion,
therefore,
that
the
answers
to
the
questions
posed
must
be”
no"
in
each
case,
and
the
matter
is
referred
back
to
the
Minister
for
reassessment
on
that
basis
and
in
accordance
with
these
reasons
for
judgment.
In
the
result,
the
plaintiff's
appeal
with
respect
to
the
first
issue
is
dismissed,
but
is
allowed
on
the
two
remaining
issues.
The
plaintiff
was
substantially
successful
in
the
actions
and
is
entitled
to
its
taxable
costs
thereof
on
the
basis
of
one
set
of
costs
only,
but
reduced
by
one-third.
Judgment
will
go
accordingly.
Appeal
allowed
in
part.
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