Alberta and Southern Gas Co. Ltd. v. The Queen, 76 DTC 6362, [1976] CTC 639 (FCTD), aff'd 77 DTC 5244 [1977] CTC 388 (FCA), aff'd 78 DTC 6566, [1978] CTC 780, [1979] 1 SCR 36

Cattanach, J:—These are appeals by the plaintiff from assessments to income tax by the Minister of National Revenue for the plaintiff’s 1972 and 1973 taxation years whereby the Minister disallowed the plaintiff's claim for a deduction of Canadian exploration and development expenses in the amount of $4,000,000 in each year and, consequent upon which disallowance, the Minister also disallowed the plaintiff’s claim for a depletion allowance under regulations passed pursuant to the Income Tax Act, as well as a claim for interest on borrowed money in the plaintiff’s 1972 taxation year but not for a like claim by the plaintiff in its 1973 taxation year.

Counsel for the Minister indicated that the failure to disallow the plaintiff's similar claim for interest in its 1973 taxation year was an oversight by the Minister. However, assuming that I should conclude that the plaintiff’s claim for interest in that year was improperly made and should have been disallowed by the Minister, which issue is before me with respect to the 1972 taxation year, this particular matter is not in issue with respect to the plaintiff’s 1973 taxation year.

In Harris v MNR, [1965] 2 Ex CR 653; [1964] CTC 562; 64 DTC 5332, my brother Thurlow held that on a taxpayer’s appeal it is the Minister’s assessment that is under appeal. There is no appeal given to the Minister from the assessment and accordingly to allow the Minister to disallow the plaintiff’s claim for the deduction of interest for the 1973 taxation year and so increase the plaintiff's assessment is tantamount to an appeal by the Minister from his own assessment. This I have no authority to entertain. Counsel for the Minister, when the point arose, quite properly neither suggested nor requested anything to the contrary.

The amounts involved are not in dispute between the parties nor are the basic facts in dispute. What is in dispute between the parties are the proper inferences to be drawn from the undisputed facts.

The plaintiff was incorporated as a joint stock company pursuant to the laws of the Province of Alberta on March 25, 1957. The plaintiff is the wholly-owned subsidiary of Pacific Gas and Electric Co, no doubt incorporated under the laws of one of the States of the United States of America, and that company is a major distributor of natural gas and electricity in Northern and Central California.

Prior to the incorporation of the plaintiff it is my recollection of the evidence that Pacific Gas and Electric Company purchased natural gas in Alberta to supply its customers in California, but for sundry varied reasons it found it expedient to incorporate the plaintiff for this purpose.

Pacific Gas and Electric Company was also instrumental in securing the incorporation of Pacific Gas Transmission or acquired the majority interest in the shares of that company. Therefore Pacific Gas Transmission is also a subsidiary of Pacific Gas and Electric Company.

Pacific Gas Transmission operates a pipeline from Kingsgate on the United States and British Columbia border to the Oregon and California border. Alberta Natural Gas Co, in which Pacific Gas Transmission owns 45% of the shares, operates a pipeline from a point in. southwestern Alberta to connect with the pipeline of Pacific Gas Transmission at the United States and British Columbia border. The plaintiff contracts with Alberta Gas Trunk Lines to carry the natural gas which the plaintiff purchases from producers in the field to the point in south-western Alberta as well as to intermediate customers along the route and the plaintiff contracts with Alberta Natural Gas Company to transport the gas purchased by it and remaining from the point in south-western Alberta to connect with the pipeline operated by. Pacific Gas Transmission through which the gas is transported to California to the ultimate consumers in that State.

The raison d’être for the plaintiff is to buy natural gas from producers ‘in Alberta to satisfy the requirements of its parent company for a constant supply of natural gas to meet the needs of its parent’s customers in California. The plaintiff does not sell that gas directly to its parent but rather it sells the gas purchased by it in Alberta to its sister company, Pacific Gas Transmission.

To that end the plaintiff has entered into some 300 to 350 gas purchase contracts with some 83 to 100 gas producers. These numbers are approximate and vary from time to time dependent upon the vagaries of available gas and obviously, from the numbers, the plaintiff enters into more than one gas purchase contract with the same gas producer.

The plaintiff's two major purchasers of its gas for foreign export are Pacific Gas Transmission and Canadian Montana Pipeline Company. The plaintiff also sells the natural gas it purchases in Alberta to Columbia Natural Gas Limited for distribution in British Columbia. Because of the policy of the appropriate governments export licences are not forthcoming unless the needs of domestic consumers are first satisfied. Accordingly the plaintiff sells gas to two major distributors in Alberta, Northwestern Utilities Limited and Canadian Western Natural Gas Limited, and to other domestic customers along the transporting gas pipelines such as towns, gas co-operatives and farmers. The plaintiff also sells gas to an extracting plant in Alberta. However, Pacific Gas Transmission is by far the major purchaser of the gas purchased in Alberta by the plaintiff and is destined for ultimate consumption by customers of the plaintiff's parent, Pacific Gas and Electric Company in California.

In 1972 approximately 86% of the plaintiff’s total gas sales was to Pacific Gas Transmission Company. In 1973 the plaintiff’s sales to Pacific Gas Transmission represented 83% of the plaintiff’s total gas Sales. In the same period approximately 6.27% of the plaintiff’s total gas sales was to Canadian Montana Pipeline Company, its other major purchaser. The balance of the plaintiff's sales, which would range between 8% and 11%, were to domestic consumers as mentioned above.

It is patently obvious that the plaintiff’s obligation is to maintain a constant source of supply of natural gas, ultimately destined for its parent company, and to maintain that supply it must also satisfy the needs of domestic consumers, which by reason of government policy constitutes a first charge on the plaintiff’s supply. In all likelihood the demands of the domestic market will increase and even if the demand of the plaintiff’s parent merely remained constant, it follows that the plaintiff must exercise vigilance to ensure that it is in a position to meet both of these mandatory demands. Accordingly that means that the plaintiff must make certain that the current gas purchase contracts are adequate and to be on the constant alert for additional sources when the current sources become inadequate, depleted or exhausted.

To do this the plaintiff makes risk exploration advances to producers in the hope of the discovery of further gas and participates as a working interest partner. Expenditures of this type made by the plaintiff have been allowed by the Minister as a deduction. To encourage exploration by producers the plaintiff thus made prepayments for gas thereby making funds available to the producers for exploration and to acquire the goodwill of those producers in order to remain competitive as a purchaser of gas.

The plaintiff has also made loans to producers on the understanding that the loan would be repaid by the dedication of gas which might be discovered to the plaintiff.

These are the three normal methods adopted by the plaintiff in furthering exploration for gas, (1) prepayments for known gas in the ground, (2) loans to producers to assist in the development of future resources to be dedicated to the plaintiff and (3) risk exploration activities. Thus this is a legitimate objective of the plaintiff incidental to its principal purpose of buying and selling gas.

The funds for these purposes are generated by the inclusion of 3¢ in the price of the gas sold by the plaintiff to its parent company through the intermediary, Pacific Gas Transmission. The price to the parent was 31¢ per thousand cubic feet for specification gas or the cost of service whichever was the higher. Arrangements were made with Canadian Montana Pipeline Company to provide the plaintiff with a fund to be used in exploring for and developing gas resources in Canada. However it was the 30 margin built into the plaintiff’s sale price to its parent that was the greatest source of funds available to the plaintiff for exploration and development expenses. That was specifically agreed in arranging the sale price of the gas and it was also agreed that the funds so derived would be dedicated exclusively to that end.

The funds that the plaintiff derived from its sale of gas to its parent company, or more correctly put to its sister subsidiary, in the plaintiff’s 1972 and 1973 taxation years was $4,000,000 in each year. In neither year did the plaintiff expend those amounts for exploration and development by any one of the three normal methods the plaintiff had adopted and as are described above. Accordingly these two amounts, if not disbursed as exploration and development expenses before the end of the respective taxation years, would be clearly income in each year and taxable as such. The officers of the plaintiff are well aware of this fact. The plaintiff sought the means, in each year, to circumvent this inexorable result.

The device adopted, as was aptly put by the witnesses, to “remove these amounts from the grasping reach of the tax collector and so preserve the funds for the purpose to which they were dedicated” {that is exploration and development expenses), was to enter into “carve-out’’ agreements with Amoco Petroleum Company Ltd (hereinafter for convenience referred to as “Amoco’’), a gas-producing company with which the plaintiff had also entered into gas purchase agreements. This fact apparently had no material influence on Amoco’s willingness to enter into these agreements with the plaintiff. These “carve-out” agreements were well known to the oil industry and Amoco had entered into several such agreements with parties other than the plaintiff.

The first such agreement between the plaintiff and Amoco was entered into on December 27, 1972, and was introduced in evidence as Exhibit 7-2, applicable to the plaintiff’s 1972 taxation year, and the second such agreement was entered into on December 27, 1973, applicable to the plaintiff’s 1973 taxation year, and was introduced in evidence as Exhibit 12. Subject to minor variations the two agreements are otherwise identical in substance.

Basically what the agreements provide is that in consideration of the payment by the plaintiff to Amoco of $4,000,000 Amoco “grants, sells, conveys, transfers and sets over unto’’ the plaintiff a percentage (in 1972 the percentage was 59% and in 1973 the percentage was 43.6%) of Amoco’s “working interest’’ which is defined in the agreements as the “right, licence or privilege” of Amoco to “produce, take and dispose of petroleum substances” from the lands set forth in a schedule to each agreement. Those lands were in fact the lands from which the plaintiff received the specification gas which it purchased from Amoco under existing gas purchase contracts between them and accordingly the plaintiff was familiar with those resources and exercised care and influence in the lands selected to be included in the schedules.

By virtue of the agreements the plaintiff is entitled to have and hold those assigned rights forever but subject to the provision that the right to Amoco’s share shall end when the plaintiff shall have received petroleum. substances to the value of $4,000,000 or the amount of $4,000,000, both with interest at 3% per annum. In fact in each year the amount of $4,000,000 was repaid in cash and not in kind within the year following the execution of each agreement. Again by virtue of the agreements, the plaintiff was given ownership of the petroleum substances and given the right to take those substances at no cost to it and to dispose of those substances. The plaintiff did not elect to do this but, as contemplated in the agreements, permitted Amoco to continue to extract the petroleum substances from the lands, refine those substances and dispose of the resultant products and consequent upon payment in moneys the plaintiff received payment of the full amount for the petroleum substances which it was entitled to receive. That being done the share that Amoco conveyed to the plaintiff revested in Amoco.

The agreements specifically provide that all costs and expenses of the production of petroleum substances shall be borne by Amoco and not by the plaintiff.

In the event that Amoco should default in its obligations to extract the petroleum substances and apply the proceeds of the disposition thereof to the discharge of its indebtedness to the plaintiff, then by virtue of the agreements the plaintiff has the right to enter upon the lands, take over Amoco’s rights to operate the extraction process, and so operate the fields, dispose of the petroleum products and apply the proceeds thereof first to the costs incurred by it in taking such production and then to discharge the amounts payable by Amoco to the plaintiff under the agreements.

In the lands sets forth in the schedules to the agreements Amoco did not hold 100% of the working interest therein. The lands were subject to unitization agreements which is simply that a number of leaseholders pool their leases and one of the leaseholders becomes the operator and all leaseholders who enter the pooling arrangement share in the proceeds in proportion to their respective contributions.

A review of the lands included in the schedules indicates that in almost all instances Amoco was the largest contributor to the pool and that Amoco was the “operator” of the fields under operation agreements entered into by the contributors. Accordingly when Amoco assigned a percentage of its working interest in these lands to the plaintiff it succeeded to the partial interest assigned to it by Amoco and became party to the appropriate unitization agreements with the concurrence of the other parties thereto. This concurrence was obtained in a most informal way usually by telephone conversations. Mr Goudie, a vice-president of the plaintiff, so testified.

Against the background of these facts the plaintiff in preparing its income tax returns for its 1972 and 1973 income tax years claimed as a deduction in each year the respective amounts of $4,000,000 as being laid out by it for the acquisition of a ‘Canadian resource property” as defined by subparagraphs 66(15)(c)(i) and (vi) of the Income Tax Act, that by virtue of subparagraph 66(15)(b)(iii) the cost of the acquisition of any Canadian resource property is a Canadian exploration and development expense and as such, by virtue of paragraph 66(1 )(a) is deductible by a “principal-business corporation” in computing its income for a taxation year. In order to so qualify the plaintiff must first fall within the definition of a “principal-business corporation” as outlined in paragraph 66(15)(h).

At this point it is expedient to reproduce the sections of the Income Tax Act mentioned immediately above. Paragraph 66(1)(a) reads:

66. (1) A principal-business corporation may deduct, in computing its income for a taxation year, the lesser of

(a) the aggregate of such of its Canadian exploration and development expenses as were incurred by it before the end of the taxation year, to the extent that they were not deductible in computing income for a previous taxation year, and

Subparagraph 66(15)(b)(iii) reads:

(b) “Canadian exploration and development expenses” incurred by a taxpayer means

(iii) the cost to him of any Canadian resource property acquired by him,

Subparagraphs 66(15)(c)(i) and (vi) read:

(c) “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,

(vi) any right to or interest in any property described in any of subparagraphs (i) to (vi).

Subparagraph 66(15)(h)(i) reads:

(h) “principal-business corporation’’ means a corporation whose principal business is,

(i) production, refining or marketing of petroleum, petroleum products or

natural gas, or exploring or drilling for petroleum or natural gas,

The general intention of the Income Tax Act is to the effect that in computing income no deduction shall be made in respect of a payment on account of capital. Under normal circumstances the payment made by the plaintiff herein to acquire an interest in a gas-producing or potential gas-producing property is an outlay for the acquisition of a capital asset and hence a capital outlay not subject to deduction. The sections of the Income Tax Act reproduced express a particular intention incompatible with the general intention and as such must be considered in the nature of an exception.

In order to qualify for an exception a taxpayer must fall precisely within the words of the exempting provisions.

in her statement of defence, Her Majesty expressly first denies an allegation in the plaintiff’s statement of claim that the plaintiff was duly qualified as a “principal-business corporation” as those words are defined in the statute. Secondly, the defendant also specifically denies in its statement of defence that the plaintiff acquired under its agreements with Amoco a “Canadian resource property”.

The onus is on the plaintiff to establish both such conditions precedent in order to succeed in claiming the deductions it seeks for the cost expended by it for the rights it acquired from Amoco and the other consequential deductions claimed by it but disallowed as has been mentioned at the outset. If the plaintiff fails, that is the end of the matter and both appeals must be dismissed in their entirety.

Accordingly consideration must first be given to whether the plaintiff falls within the definition of a “principal-business corporation” as set forth in subparagraph 66(15)(h)(i) as quoted above.

Mr Goudie has described the business of the plaintiff as the buying and selling of natural gas. The question then arises whether that activity constitutes “marketing” as that word is used in subparagraph 66(15)(h)(i). The word “marketing” as used in subparagraph 66(15)(h)(i) does not relate nor does it profess to relate to the subject of a particular art or science. In my view the word is not used in a technical sense and has no technical meaning. Therefore the word used in the Act must be understood as it is understood in the common language.

I am quite aware that dictionaries are not to be taken as authoritative exponents of the meaning of words used in statutes but it is a well known rule of courts of law that when a word is used in its ordinary sense, as I have concluded that the word “marketing” is so used, then I am sent and may resort to dictionaries for instruction.

The word “market” is defined in the Shorter Oxford English Dictionary, 3rd edition, as “the action or business of buying and selling’ and “marketing”, which is the verbal substantive of the verb “market”, is defined therein as “the action of market”.

Mr Goudie described the business of the plaintiff as buying and selling of natural gas and he also described how these activities were conducted. The plaintiff had to buy natural gas in sufficient quantity to meet the demands of its customers. Current in each financial year there were some 350 gas purchase contracts entered into by the plaintiff with some 100 producers of natural gas. That, to my mind, represents substantial buying. The plaintiff sells the gas it purchases to a major purchaser, its parent company. The parent company buys about 83% of the gas that the plaintiff buys. Another major purchaser buys some 6%, leaving about 11%, which is sold to a variety of purchasers. There is no doubt that the number of purchasers is large and the parent company is not the plaintiff’s exclusive purchaser. It cannot be because of the governmental policy that the requirements of domestic consumers must be met before an export licence is granted to the plaintiff. Therefore, the plaintiff must buy sufficient gas to meet the needs of its parent company but it must first buy sufficient gas to meet the domestic market which it must serve.

Counsel for the defendant contends that the plaintiff has failed to discharge the onus of establishing that its activities constitute “marketing” because it did not conduct an active campaign to search out purchasers. The plaintiff did not have to do so. It had three major purchasers paramount among which was. its parent company which purchased the greatest volume of the plaintiff’s purchases. It was obliged to purchase the gas to meet the needs of its parent and those other customers it was obliged to serve either by contract or to become eligible for an export licence. Certainly the plaintiff’s parent was its dominant purchaser but there were others, some of whom were imposed on the plaintiff but whom the plaintiff must supply. Therefore the plaintiff bought gas from numerous purchasers and sold it to numerous consumers, even though it sold the bulk of its purchases to one customer. That is buying and seiling and that, in my view, constitutes “marketing”.

It was also contended by counsel for the defendant that the purchaser was merely the purchasing agent for its parent company. The fallacies in that contention are that it overlooks the doctrine of separate corporate existence and the fact that the parent company was not plaintiff's sole purchaser. While a company may conduct the business of a purchasing agent for more than one principal, the plaintiff is not the purchasing agent of its other customers (assuming that it is the purchasing agent of its parent which assumption ! do not accept because of the separate entity concept), and accordingly its business is not that of a purchasing agent but that of purchasing and selling natural gas and in my view for the reasons previously expressed that still constitutes “marketing”.

I therefore conclude that the plaintiff has discharged the onus cast upon it in this respect.

It was also contended that what the plaintiff acquired under its agreements with Amoco was not a “Canadian resource property” in that the plaintiff under those agreements did not acquire “any right, licence or privilege to . . . take petroleum, natural gas or other hydrocarbons”, but what the plaintiff did acquire under the agreements was ownership of Amoco’s share in the petroleum substances under the lands specified in the schedules to the agreements and because what the transactions really embodied in the plaintiff’s agreements with Amoco were temporary loans with provision for the security thereof.

In my view the transactions are not temporary loans by the plaintiff to Amoco for the reason that an essential element of a loan is lacking. The essence of a loan is that the advance shall be repaid. The agreements provide that nothing there shall be construed as creating a personal liability on Amoco to repay the principal sum advanced and interest thereon but that the plaintiff for its reimbursement shall look exclusively to the petroleum substances to the extent of Amoco’s share therein which was assigned to the plaintiff. In the event that the petroleum substances should become exhausted, or otherwise unavailable, which is a distinct possibility which remains even though the plaintiff exercised extreme care in selecting fields for inclusion in the schedules to the agreements in which it was aware of the potential and estimated deposits underground, then in that event the plaintiff has no recourse against Amoco. I have not overlooked a provision that Amoco shall be liable for damages for breach of covenant but in view of the provision to the contrary that provision cannot include a covenant to repay.

It is for these reasons that I am of the opinion that the transactions cannot be construed as being a loan in substance.

The consideration which the plaintiff received under the agreements for its payments of the two amounts of $4,000,000 each was the conveyance from Amoco of its percentage of its interest in what is clearly a Canadian resource property in the hands of Amoco, the cost of which to the plaintiff is a Canadian exploration and development expense.

Clearly Amoco had the right to take its proportionate share of the petroleum, natural gas and other related hydrocarbons and what the plaintiff acquires was a percentage of Amoco’s right or interest in a Canadian resource property. The plaintiff acquired that property and was entitled to retain it until it was repaid by Amoco from the production of petroleum substances at which time the interest reverted to Amoco.

Amoco transferred to the plaintiff a share of its ownership of petroleum substances and it also conferred upon the plaintiff the right to take those petroleum substances in kind.

A paramount right to “take” is predicated upon ownership. While the plaintiff did not exercise its right to take the petroleum by entering upon the lands and itself extracting these substances it elected instead to permit Amoco to continue its extracting of petroleum substances from the ground which Amoco had been doing as operator under a unitization agreement among the owners of pooled resources as was the plaintiff’s right under the agreement with Amoco.

In my view the plaintiff in so doing has constituted Amoco its agent to take the petroleum substances on its behalf. On the ordinary principle of agency what one does by an agent one does for oneself. That being so, in addition to having the right to take petroleum substances, the plaintiff in fact took petroleum substances which it also permitted Amoco to retain and dispose of the plaintiff’s share on its behalf, the proceeds of which were applied in discharge of Amoco’s obligation to the plaintiff. To me there is no inconsistency in transferring ownership in the petroleum substances simultaneously with the transfer of a right to take these petroleum substances. It seems to me that ownership is a condition precedent to the right to take.

I therefore conclude that the plaintiff acquired from Amoco a Canadian resource property within the meaning of those words as defined in paragraph 65(15)(c) and not merely ownership of the petroleum substances as contended on behalf of the defendant.

The conclusions I have reached to this point do not resolve the matter. In addition to contending that the plaintiff was not a principalbusiness corporation and that the plaintiff did not acquire a Canadian resource property counsel for the Minister contended that in substance the agreements between the plaintiff and Amoco (which are colloquially and aptly called “carve-out” agreements) were a sham and subterfuge and that no matter what gloss is put upon the language the true purpose, which was to avoid tax, shines through that artificial covering and further that the agreements were entered into by the plaintiff for no business purpose but rather for the purpose of claiming a deduction for Canadian exploration and development expenses and depreciation allowance, thereby unduly or artificially reducing the plaintiff's income which is prohibited by subsection 245(1) of the Income Tax Act as amended by Statutes of Canada, 1970-71-72, chapter 63, formerly subsection 137(1) of the Income Tax Act, RSC 1952, chapter 148.

Subsection 245(1) of the Income Tax Act reads:

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

From the nature of these contentions there is considerable overlapping of the argument in support of each which cannot be segregated.

Both Mr Goudie and Mr Clark, who are officers of the plaintiff, were called as witnesses and candidly admitted that the motive of the plaintiff for entering into these “carve-out” agreements with Amoco was to remove the two amounts of $4,000,000 which would have been taxable as income in the 1972 and 1973 taxation years from the grasp of the tax collector to preserve these amounts which were dedicated for exploration and development expenses and to use these moneys at some future time in a much more direct, active and realistic way for that purpose than by resort to carve-out agreements.

It appears to me, in the circumstances of these particular appeals, so long as the transactions were not shams, that if the plaintiff by resort to express provisions in the Income Tax Act has succeeded in bringing itself precisely within the terms of those provisions regardless of the motivation which inspired the taxpayer to resort thereto, that motive admittedly being the reduction of tax, and in these appeals the reduction was to nil, or complete avoidance, that concludes the matter and the motivation is irrelevant.

The classical exposition as to what constitutes a sham was given by Diplock, LJ (as he then was) when he said in Snook v London & West Riding Investments, Ltd, [1967] 1 All ER 518 at page 528:

As regards the contention of the plaintiff that the transactions between himself, Auto-Finance, Ltd and the defendants were a “sham”, it is, I think, necessary to consider what, if any, legal concept is involved in the use of this popular and pejorative word. I apprehend that, if it has any meaning in law, it means acts done or documents executed by the parties to the “sham” which are intended by them to give to third parties or to the court the appearance of creating between the parties legal rights and obligations different from the actual legal rights and obligations (if any) which the parties intend to create. One thing I think, however, is clear in legal principle, morality and the authorities (see Yorkshire Railway Wagon Co v Maclure ((1882), 21 Ch D 309); Stoneleigh Finance, Ltd v Phillips ([1965] 1 All ER 513; [1965] 2 QB 537), that for acts or documents to be a “sham”, with whatever legal consequences follow from this, all the parties thereto must have a common intention that the acts or documents are not to create the legal rights and obligations which they give the appearance of creating.

The agreements between the plaintiff and Amoco created between the parties the exact legal rights consequent thereon that the parties intended to create and which both parties complied with in accordance with the terms of the agreements between them. That being so the parties had no intention whatsoever that the agreements did not create the legal rights and obligations other than those which the agreements did in fact create. Amoco got $4,000,000 in the years 1972 and 1973 which it could use as working capital at a rate of interest one-half the current bank rate. That is what Amoco wanted and was of benefit to it. At the same time the plaintiff got from Amoco the right to a share of Amoco’s share in petroleum substances.

The plaintiff had gas purchase contracts with Amoco during the currency of the “carve-out” agreements. While it is true that the gas purchase contracts were for specification gas derived from identical fields from which the plaintiff also derived petroleum substances under the carve-out agreements, nevertheless those derivatives are different. It may be that while the bulk of the petroleum substances that came from the underground deposit became specification gas, there remained petroleum products other than specification gas which had value and that is what the plaintiff received. It received the specification gas under the gas purchase agreements and it received the residue under the carve-out agreements, or the proceeds of the disposition thereof, assuming that the residue of the petroleum substances was sold to purchasers other than the plaintiff, which my recollection of the evidence indicates to have been the case.

In my opinion the “carve-out” agreements were not intended to give to strangers thereto, including the Minister of National Revenue, the appearance of creating rights and obligations other than those created by the agreements as were intended by the parties. To do otherwise would defeat the very motive which influenced the plaintiff to seek out these agreements. There was no dissemblance. Put another way and in more succinct and colloquial language if the parties to a contract do precisely what they contract to do there is no sham.

As a corollary of that if the parties do as they contract to do then that is the substance of the contract. The agreements were realities and not fictitious and they were within the competence of the plaintiff as incidental to its business of marketing natural gas.

Lord Tomlin in Commissioners of Inland Revenue v His Grace the Duke of Westminster, [1936] AC 1, said at page 20:

This so-called doctrine of ‘‘the substance” seems to me to be nothing: more than an attempt to make a man pay notwithstanding that he has so ordered his affairs that the amount of tax sought from him is not legally claimable.

For these reasons I conclude that the arrangements between the plaintiff and Amoco were not shams or subterfuges.

With respect to the applicability of section 245 to the results of these agreements between the plaintiff and Amoco I do not think that section 245 is properly applicable in the circumstances of these appeals.

As I have previously stated, it has been laid down as a rule for the construction of statutes that where there is a special section and a general section in the statute a case falling within the special section must be governed thereby and not by the general section.

Section 66 and the sections immediately following dealing with exploration and development expenses of principal-business corporations quoted above are special sections and clearly express a particular intention of Parliament. On the other hand, section 245 is a general section and expresses a general intention.

In the present appeals the plaintiff has brought itself precisely within the particular legislative intent expressed in the particular section 66. The general intention expressed in section 245 is incompatible with the particular intention expressed in section 66 from which it follows that section 66 must govern and not section 245.

The Minister also disallowed the plaintiff’s claim for the deduction of interest paid on borrowed money.

Paragraph 20(1 )(c) reads:

20. (1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(c) an amount paid in the year or payable in respect of the year (depending upon the method regularly followed by the taxpayer in computing his income), pursuant to a legal obligation to pay interest on

(i) borrowed money used for the purpose of earning income from a business or property (other than borrowed money used to: acquire property the income from which would be exempt or to acquire a life insurance policy),

While the plaintiff had liabilities payable to it in its 1972 taxation year in the amount of some $4,000,000 from Pacific Gas Transmission, those moneys were not in the plaintiff’s hands and therefore it borrowed funds from its banker to pay the $4,000,000 consideration to Amoco under its 1972 agreement.

The plaintiff did receive income from the transactions and accordingly the interest was paid on borrowed money used for the purpose of earning income from property. Income arose from the 3% interest rate negotiated by the plaintiff and Amoco on the consideration paid by the plaintiff to Amoco. It is true that the interest rate on the money borrowed from its bank by the plaintiff exceeded the rate that the plaintiff received from Amoco but that does not detract from the fact that the interest the plaintiff received from Amoco was income. As I recall the bank loan was paid by the plaintiff with expedition and the indebtedness of Amoco ran for a year which may have resulted in a profit to the plaintiff. Profit is different from income. Profit is the income less the cost laid out to earn the income. Therefore the interest paid to the plaintiff remains income even if no profit resulted.

in the plaintiff's 1972 income tax return there was disclosed royalty income received from Amoco in the amount of $12,842.43 and in the 1973 return royalty income from Amoco in the amount of $4,074,050.93 on which respective amounts and in the respective years depletion allowances were claimed in the respective amounts of $3,210.61 and $1,018,512.73, being 25% of the royalty income in accordance with Regulation 1202(1). As previously stated there is no dispute as to the accuracy of these figures. It follows that the interest so claimed by the plaintiff in its 1972 taxation year is a proper deduction.

The plaintiff, as indicated, also claimed depletion allowances as a deduction in its 1972 and 1973 taxation years in the respective amounts of $3,210.61 in 1972 and $1,018,512.73 in 1973, being 25% of royalty income pursuant to Regulation 1202(1), both of which claims for deductions were disallowed by the Minister. The amounts are not in dispute only the deductibility thereof. The depletion allowances claimed by the plaintiff in its 1972 and 1973 taxation years in respect of production income from a Canadian resource property are predicated upon Income Tax Regulation 1202(1) which reads:

1202. (1) Where a person other than an operator . .

(a) has an interest in a resource and in the proceeds from the sale of the products therefrom, or

(b) receives a rental or royalty computed by reference to the amount or value of production from a resource,

the deduction allowed is 25% of the amount included in computing his income for the year in respect of the interest in the proceeds or in respect of the rental or royalty, as the case may be.

In my opinion the plaintiff is not an operator and falls under Regulation 1202 rather than an operator to which Regulation 1201 would apply and different methods of computing the deduction and percentage rate thereon apply under each of the two regulations mentioned. Under Regulation 1201 a person who operates a resource is defined as a person who has an interest in the proceeds of a resource “under an agreement providing that he shall share in the profits remaining after deducting the costs of operating the resource”. Under the plaintiff’s agreements with Amoco it is specifically provided that all costs relating to the operation of the resource shall be borne by Amoco.. It is for this reason that I have concluded that the plaintiff is not an operator and accordingly falls under Regulation 1202 which is applicable to persons other than an operator.

I have also concluded for the reasons expressed above ‘that’ the plaintiff “has an interest in a resource and in the proceeds from the sale of the products therefrom” and is therefore entitled to claim the deduction to the extent provided in Regulation 1202(1).

I mention the submission by counsel for the Minister that the plaintiff did not record the results of these transactions in clear and unequivocal terms in its financial statements as giving credence to his submission that the agreements between the plaintiff and Amoco do not mean what they say only to indicate that I have not overlooked that contention. An explanation was proffered and a note to the balance sheet was made to the effect that the exploration expenses were written off even where creating an asset. The financial statements are designed by the plaintiff’s auditors to reflect for the benefit of the shareholder the financial position of the plaintiff at its financial year end. I do not think that I am obliged to delve further into the vagaries or the intricacies of accounting practices because I do not think that such entries, though not specific, or the lack of specific entries, can be accepted as contradictory to the provisions of a written agreement and the acts taken to implement those agreements when there is adequate other evidence of that implementation.

During the course of his submission, counsel for the Minister characterized these transactions into which the plaintiff had entered as a “gimmick” with the avowed object of avoiding tax. That description is both apt and accurate. These “carve-out” agreements are an importation and are well known in the industry. While they may well serve as the means for persons with funds anxious to participate in the production of petroleum and natural gas with a producer in a potential or proven field who has the right to exploit that field and is willing. to sell a share of that right, the planning and execution of these transactions was designed by the plaintiff as a tax avoidance device. With funds available which, if not expended for exploration and development, would be taxable as income, with a willing vendor of a percentage of its shares in a Canadian resource property and with a detailed knowledge and familiarity of section 66 of the Income Tax Act particularly and Regulations 1201 and 1202, it required no great ingenuity on the part of the plaintiff to envision this scheme and its possible results. In exculpation of the plaintiff it can be said that the funds it possessed were generated by an addition to the price it sold natural gas to its parent company and were to be devoted to exploration and development. The funds were not so expended by the plaintiff by the means it normally employed and accordingly the plaintiff was anxious to keep those funds from the tax collector and use them directly for the purpose for which they were dedicated at a future time.

It is not my function to make any moral judgment. My function is limited to determining if the plaintiff by those transactions has brought itself within the four corners of section 66. For the reasons given I think that the plaintiff has been successful in doing so.

In my view the three decisions of the House of Lords, Griffiths (Inspector of Taxes) v J P Harrison (Watford) Ltd, [1962] 1 Ail ER 909. Finsbury Securities Ltd v Bishop (Inspector of Taxes), [1965] 1 All ER 530, and FA & AB Ltd v Lupton (Inspector of Taxes), [1971] 3 At ER 948, are not helpful in resolving the problem before me. Each of these cases involved dividend stripping through the device of the purchase and sale of shares. In each instance the question was whether the purchase and sale of shares was trading in shares or not. In the first case it was held to be and in the other two cases it was held when the transactions were viewed in their totality that the purchase of shares was outside the scope of trading in shares but were in fact planned and carried out for the purpose of establishing a Claim on the Treasury.

In my appreciation, the question before me is not to determine if a transaction is one thing or another but to determine if the plaintiff has brought itself within the express provisions of section 66 and I have concluded that it has and I have also concluded that since the plaintiff has so brought itself within an express and specific provision of the Income Tax Act which permits of the plaintiff claiming deductions as it did, then section 245 is not applicable to the transactions.

Because of these conclusions which I have reached for the reasons I have heretofore expressed, it follows that the plaintiff’s appeals from its assessments for its 1972 and 1973 taxation years must be allowed with costs.