Irving Oil Limited v. The Queen, docket 98-1870-IT-G

Date: 20000609

Docket: 98-1870-IT-G

BETWEEN:

IRVING OIL LIMITED,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Rip, J.T.C.C.

[1] This is an appeal from a reassessment of tax of the appellant Irving Oil Limited's ("IOL") 1992 taxation year. The basic question before me is whether interest on a refund of tax may be income from an active business. If an amount of interest on a tax refund ("refund interest") is active business income, it is to be included in Irving Oil Limited's "adjusted business income" within the meaning of sections 5202 and 5203 of the regulations to the Income Tax Act ("Act") for the purpose of calculating the manufacturing and processing profits deduction for 1992 pursuant to section 125.1 of the Act.

[2] The appeal was heard by way of Statement of Admitted Facts[1] and the testimony of Mr. John C. Manning who was treasurer and chief financial officer of the appellant IOL. Mr. Manning was and is responsible for all financial functions at IOL, including reviewing of tax returns. An excerpt from the examination for discovery of a representative of the respondent was also produced.

[3] IOL, a corporation incorporated under the laws of New Brunswick, carries on an active business in Canada of refining crude oil and marketing refined petroleum products. Apart from the income tax refund interest, the characterization of which is in issue, substantially all of IOL's income is generated from these activities.

[4] In calculating its income for its 1992 taxation year, the appellant included interest paid to it by the taxing authority in 1992 in respect of amounts it had paid on account of income tax assessed (and accrued interest thereon), pursuant to certain assessments subsequently vacated on appeal, dividend income and investment income.[2]

[5] IOL had been reassessed tax in 1978 for its 1971 to 1975 taxation years and in 1980 and 1984 for taxation years 1976 through 1978 and 1979 and 1980 respectively. According to the Statement of Admitted Facts these reassessments (the "Irvcal assessments") related generally to the cost of crude oil purchased by IOL from Irving California Oil Company Limited ("Irvcal") for refining in IOL's refinery and for subsequent marketing by IOL of the refined products. Had the Irvcal assessments been upheld, IOL's resulting additional income would have formed part of its income from an active business carried on in Canada.

[6] IOL filed Notices of Objection in respect of the Irvcal assessments and pursuant to section 158 of the Act, IOL made payments pursuant to the Irvcal assessments on July 1, 1980, December 31, 1981 and April 24, 1982.

[7] Amounts assessed are payable forthwith by the taxpayer upon the receipt of the Notice of Assessment. The parties agree IOL was obliged to pay the amounts due within 30 days and, in the event of non-payment, the Minister could pursue collection action. At the time, IOL had the option under subsection 220(4) of the Act to request that the Minister accept security in lieu of payment. IOL originally arranged for security with respect to the reassessments but the directors of IOL reconsidered the matter when they realized the amount of interest accruing. Later IOL paid the secured assessments as well as subsequent assessments. IOL paid the assessments because, in its judgment, that alternative was less unfavourable than any available alternate course of action. Leaving the amounts assessed unpaid, whether or not security was posted, raised the prospect of non-deductible arrears interest accruing in the event that IOL's appeals proved unsuccessful. (The appellant produced calculations of estimated interest costs to it had it not paid the Irvcal reassessments to 1992. The amount of interest would have aggregated substantially more than the tax assessed.)

[8] On December 30, 1986 IOL paid interest accrued to that date in respect of the time it provided security for Irvcal assessments since, effective January 1, 1987, interest was compounded daily.[3]

[9] IOL paid the amounts assessed in the Irvcal assessments with funds generated from its refining and marketing business. Mr. Manning said that it was IOL policy to reinvest its profits in its refining business; IOL had no portfolio of passive investments. Mr. Leaman, the respondent's representative at the examination for discovery by the appellant's counsel, acknowledged the respondent did not have any evidence to refute the appellant's claim that had it not paid the tax, the money would have been used in its business.

[10] According to Mr. Manning IOL has paid dividends on only three occasions, in 1983, 1986 and 1988, when IOL's shares were held by the Irving interests ("Irving") and Standard Oil of California ("Socal"). Socal wanted a return on its investment and Irving did not, Irving wanted to reinvest all profits. In 1988 dividends were paid in the course of Irving acquiring all the shares of IOL.

[11] The Irvcal reassessments were confirmed and IOL appealed the assessments. The financial statements of Irvcal from 1978 to 1992 inform the reader that IOL paid the Irvcal assessments and that IOL contests the assessments. The IOL balance sheet as of December 31, 1980 included among its assets, "Income Taxes Recoverable", that is, payments of the Irvcal assessments.

[12] The appeals were heard by Muldoon J. of the Federal Court, Trial Division who allowed IOL's appeals.[4] The Crown appealed this decision to the Federal Court of Appeal, which dismissed the appeals.[5] Leave to appeal the decision of the Federal Court of Appeal to the Supreme Court of Canada was denied on September 5, 1991.

[13] The Minister then reassessed IOL in accordance with the decision of the Federal Court. On May 29, 1982, as required by subsections 164(4.1) and 164(3) of the Act, the Minister refunded the amounts of tax paid by IOL in respect of the Irvcal assessments and interest in respect of the tax.

[14] IOL used the money refunded by Revenue Canada, including the refund interest, to reduce its bank loan and for business opportunities, stated Mr. Manning.

[15] In its 1992 T2 Corporation Income Tax Return, IOL calculated its manufacturing and processing profits deduction pursuant to section 125.1 of the Act and its regulations. IOL included the refund interest in its taxable income and in its adjustable business income, as defined by sections 5202 and 5203 of the regulations. The Minister reassessed to exclude the refund interest from IOL's adjusted business income, thereby reducing IOL's manufacturing and processing profits deduction for 1992.

[16] The parties agree that in making the reassessment in issue on this appeal, the Minister did not rely on any facts peculiar or particular to IOL, the nature of its business, the manner in which it conducts business, the Irvcal assessments or the successful appeal from the Irvcal assessments in concluding that the refund interest was not "income . . . from an active business". The Minister relied, and the respondent continues to rely, on the facts admitted in the Statement of Admitted Facts and, in particular, the fact that the amount in issue was refund of interest on overpayments of tax.

[17] The calculation of the manufacturing and processing profits deduction available in 1992 to a Canadian-controlled private corporation by virtue of section 125.1 of the Act required, among other things, a determination of the corporation's "Canadian manufacturing and processing profits for the year". "Canadian manufacturing and processing profits of a corporation for a taxation year" means

. . . such portion of the aggregate of all amounts each of which is the income of the corporation for the year from an active business carried on in Canada as is determined under the rules prescribed for that purpose by regulation made on the recommendation of the Minister of Finance to be applicable to the manufacturing or processing in Canada of goods for sale or lease; [6]

[18] The regulations with respect to manufacturing and processing profits are contained in Part LII of the regulations to the Act. Regulation section 5200 states that Canadian manufacturing and processing profits of a corporation for a taxation year are prescribed to be a portion of the corporation's adjusted business income. Regulation 5202 defines "adjusted business income of a corporation" to include

. . . the amount, if any, by which

(a) the aggregate of all amounts each of which is income of the corporation for the year from an active business carried on in Canada exceeds . . .

[19] However, where a corporation had resource activities in 1992, the adjusted business income of the corporation was:

. . . the amount, if any, by which

(a) the amount otherwise determined under section 5202 to be the adjusted business income of the corporation for the year

exceeds

(b) the net resource income of the corporation for the year. [7]

[20] The manufacturing and processing profits deduction may be claimed only on Canadian active business income. The greater the active business income, the greater is the deduction. It is for this reason the appellant wants the refund interest to qualify first as income from a business and ultimately as active business income. The respondent's position is that given the nature of income tax and the scheme and operation of the Act, refund interest can never be income from a business.[8] However, the respondent concedes that if the refund interest was income from a business, then it was from active business. I agree with the respondent's concession.

[21] A taxpayer's income for 1992 from a business or property, section 9 of the Act stated, "is his profit therefrom for the year" and income tax is levied on that profit. Respondent's counsel explained that when a taxpayer overpays tax as a result of a reduction in the amount of tax originally assessed or otherwise, and the amount of the overpayment is refunded, as in the case at bar, interest is earned with respect to the overpayment amount and not with respect to the profit making activities of the taxpayer. Liability for income tax arises as a result of and after the making of profits, he insisted. Payment of tax is not part of the respondent's manufacturing and processing operations, even if the source of the payments was from profits previously generated from the appellant's business. The payments were made by IOL to meet tax liabilities flowing from the Irvcal assessments and to avoid non-deductible interest from accruing, declared respondent's counsel. Payment of tax is a statutory requirement and not a choice given to the business owner.

[22] An assessment of tax fixes the taxpayer's liability to pay the tax.[9] The amount paid by the taxpayer remains a tax until the amount is refunded in whole or in part but, submitted respondent's counsel, there is no change in the character of the original payment. The refund is an overpayment of tax, nothing else. Counsel referred to the definition of "overpayment" in paragraph 164(7)(b) of the Act:

In this section, "overpayment" of a taxpayer for a taxation year means . . .

(b) where the taxpayer is a corporation, the total of all amounts paid on account of the corporation's liability under this Part [I] or Parts . . . for the year minus all amounts payable in respect thereof.

Under the statutory scheme of the Act, according to the respondent, there was no risk to IOL in paying the assessed tax because if the Irvcal assessments were found to be wrong, IOL would receive a refund of what it paid in tax plus interest. And since the tax itself is not connected to the business, neither is the refund interest on its overpayment.

[23] If a taxpayer pays the assessed amount of tax, then during the time an appeal is outstanding, respondent's counsel explained, no interest runs on any overpayment because the amount of the overpayment has not been determined. The taxpayer, however, has avoided the payment of interest on the assessed tax. It is only when the courts issue a final judgment allowing the taxpayer's appeal and an assessment is issued to give effect to the judgment varying or vacating the assessment can the amount of overpayment of tax be fixed and the refund interest be calculated.

[24] In Terra Nova Properties[10] Jackett P., as he then was, explained how refund interest originates. He wrote that one ought not fail

. . . to distinguish between the actual amount of the taxpayer's income tax liability for a particular year as imposed by the substantive provisions of the Act, on the one hand, and, on the other hand, the determination of that amount by the Minister's assessment thereof, while it remains in force, by the judgment of the Tax Appeal Board, while it remains in force, or by the judgment of this Court, while it remains in force, or ultimately, by the Supreme Court of Canada. The actual liability is a constant amount that does not change as long as the facts and the substantive law remain unchanged. The assessed amount as varied by judicial decision, which is the amount which the Minister and all others concerned are bound to assume to be the actual amount of the liability, can change from time to time by virtue of new assessments or judicial decisions.*

Once that distinction between the actual amount of the taxpayer's liability** and the current assessment of that liability is appreciated, in my view, the problem vanishes.

If the Minister wrongly assesses a taxpayer for an excessive amount of income tax for a year, and if the taxpayer pays that amount, the taxpayer has made, as will ultimately be determined, an overpayment of tax in respect of which interest will ultimately be payable.

The overpayment occurs when the excess payment is made. The ultimate decision does not create the overpayment; it merely establishes that there was an overpayment. If this were not so, subsection (3) of section 57 [analogous to ss. 164(3)(d) of the present Act] would be of little practical value because, under it, the period in respect of which interest is payable commences not earlier than "the day when the overpayment arose". Moreover, this is the view upon which subsection (3a) of section 57 [analogous to ss. 164(4.1)‡ was framed as appears from the fact that it deals with a situation where the ministerial or judicial decision "makes it appear that there has been an overpayment". (Parenthesis added)

_________________________________

*This effect has been achieved by the drafting device of providing in the Income Tax Act (section 139(1)(ba)) [analogous to ss. 248(2) of the present Act] that "the tax payable by a taxpayer under Part I ... means the tax payable by him as fixed by assessment or re-assessment subject to variation on objection or appeal ..." and by such provisions as section 51(1) [analogous to s. 158 of the present Act; former s. 51(1) required the taxpayer to pay the assessed tax within 30 days of the date of the notice of assessment], which requires the taxpayer, after the mailing of the notice of assessment, to pay any part of the "assessed tax" then remaining unpaid. [S. 158 now refers to "amount assessed"] See Davidson v. The King, (1945) Ex. C.R. 160 [2 DTC 718], and Subsidiaries Holding Company, Limited v. The Queen, (1956) Ex. C.R. 443 [56 DTC 1141] (Parentheses added)

** Which is, as a practical matter, the amount at which it is ultimately determined.

‡ However, s.s. 164(4.1) does not refer to a decision that is "finally determined" by a Court nor do the words "make it appear that there has been an overpayment" appear in 1992 legislation. (Writer's footnote)

[25] Traditionally the courts have presumed that income earned by a corporation in the exercise of its duly authorized objects is income from a business.[11] The presumption is rebuttable, of course. In Canadian Marconi the Supreme Court of Canada was called upon to determine whether or not the income earned by the appellant from short-term securities was active business income for the purpose of computing its Canadian manufacturing and processing profits. As in the case at bar, the Crown conceded that if the income was from a business, then it was from an active business.

[26] In Wilson J.'s view ". . . an inference that income is from a business seems to be an eminently logical one to draw when a company derives income from business activity . . ." [12] However, respondent's counsel insisted that such inference cannot be drawn where the income is refund interest on tax overpayments since an overpayment of tax is property and interest from the overpayment is income from property and not business.

[27] The appellant found solace in the amendment in 1996 to the definition of "adjusted business income" in subsection 5203(1) of the regulations to the Act. Counsel submitted that the Governor-in-Council, in making the amendment, intended to change the definition of "adjusted business income". Adjusted business income of a corporation with resource activities was redefined as

. . . the amount, if any, by which

(a) the amount otherwise determined under section 5202 to be the adjusted business income of the corporation for the year

exceeds

(b) the net resource income of the corporation for the year, and

(c) all amounts each of which is an amount in respect of refund interest included in computing the taxpayer's income for the year, to the extent that the amount is included in the amount determined to be the adjusted business income, within the meaning of section 5202, of the corporation for the year;

[28] Appellant's counsel argued that if one reads the amendment to subsection 5023(1) of the regulations in 1996 together with section 5202, one may reasonably conclude that refund interest "could be" included in active business income in 1992. The amendment makes it clear that refund interest can, as a matter of law, be included in adjusted business income "within the meaning of" and can therefore be "income . . . from active business . . ." in 1992. The calculation of adjusted business income of a corporation, including a corporation having resource activities, starts with section 5202. Where the adjusted business income of a corporation having resource activities is concerned, subsection 5203(1) applies as well. The addition of paragraph (c) to subsection 5203(1) states that refund interest is to be deducted in computing adjusted business income for a corporation having resource activities. If refund interest cannot be "income . . . from active business", then appellant's counsel declared, no refund interest could be deducted according to the amended definition of "adjusted business income".

[29] That the Governor-in-Council intended a change in the definition of "adjusted business income", counsel asserted, is reinforced by the fact that the amendment introduced a distinction, as far as refund interest is concerned, between corporations without resource activities and those with resource activities. To ignore this amendment, counsel insisted, would mean that the definition of "adjusted business income" only to corporations having resource activities was superfluous, unnecessary and not done for the purpose of distinguishing between corporations having and not having resource activities and that would be absurd.[13] Thus, in 1992, adjusted business income could have included refund interest.

[30] According to the respondent the 1996 amendment was not intended to change the law but to clarify it. Clarification of the meaning is a valid purpose for an amendment and the court should not assume from the amendment that there is a change in meaning in the definition of "adjusted business income". Subsections 45(2) and (3) of the Interpretation Act specifically state that an amendment to an enactment does not mean the amended law is different from the law before the amendment nor does the amendment involve any declaration as to the previous state of the law.[14]

[31] Respondent also referred to the "Technical Note" released by the Department of Finance in March 1996 that the "amendments affecting resource corporations do not alter the treatment of refund interest".[15]

[32] The appellant is asking me to consider the 1996 amendment but not the "Technical Note" and the respondent is asking me to consider the "Technical Note" but not the amendment. I do not believe that my decision turns on either the amendment or the Technical Note.

[33] The statutory scheme of the Act does not support the respondent's position that under no circumstances can refund interest be active business income. Subsection 152(8) states that an assessment, subject to being varied or vacated, is deemed to be valid and binding notwithstanding any error. An assessment that is objected to or appealed, therefore, has the same force and effect as an assessment that is not challenged by the taxpayer. The main difference between the two is that with an uncontested assessment the taxpayer agrees that the actual amount of its tax liability is the amount determined by the Minister and with a contested assessment, the taxpayer alleges the Minister erred and the Minister's determination of tax is not the actual amount of the taxpayer's liability.

[34] An assessment is good until the courts decide otherwise. Once the courts finally decide an assessment is not good the assessment is no longer valid and binding and the Minister is to reassess, varying or vacating the assessment, and return the amount of the overpayment and refund interest from "the day the repayment arose". During the appeal process the overpayment is not employed or risked by the taxpayer in its business. Indeed, until the court finally decides the appeal, there is no overpayment. The final court decision gives the taxpayer the right to the overpayment back to the time the overpayment was made and then the test is to determine whether the overpayment was used to fulfill a requirement which had to be met in order to do business.[16] The reassessment has the effect, to the extent it possibly can, of placing the parties, that is, the Minister and the taxpayer, in the position they would have been had the Minister made a correct assessment in the first place.

[35] Once the court refers an assessment back to the Minister for reassessment or orders the assessment vacated, an overpayment is recognized to have occurred when the tax assessment was paid. Now the overpayment of tax can be fixed and refund interest can be calculated to the time the overpayment was made. The Act recognizes the taxpayer had a right to the overpayment from the moment the taxpayer overpaid the tax liability. This is the scheme of the assessment, appeal and payment provisions of the Act.

[36] There is an underlying assumption by the tax authority that refund interest "is generally regarded as investment income".[17] The assumption is rebuttable and depends on the circumstances resulting in the payment of the interest. Paragraph 12(1)(c) of the Act states that interest may be on account of income from a business or property. It is facile for the Minister to say tax is not connected to a taxpayer's business but that is not so: Absent the business, absent the tax. There is always a connection between a business and the tax the taxpayer is required by law to pay to the fisc.[18] When a taxpayer objects or appeals an assessment, the decision whether to give security for the assessed tax or pay the assessed tax immediately is influenced in no small part by what is best for the business.

[37] An error by the Minister in assessing should not prejudice a taxpayer's normal and intended course of action with respect to the monies used to pay assessments issued as a result of the error. An overpayment is the Minister's error. To determine whether refund interest on an overpayment of tax is income from property or business one must consider the origin of the funds used by the taxpayer to make the overpayment in the first instance. Was the money used to make the overpayment business income? One must also ask what was the taxpayer's probable intended use of that money. Was the money to be used in its business or for some other purpose? If the money used for the overpayment was business income that was intended for use in the business, then, once the courts have decided there was an overpayment of tax, the overpayment is no longer a tax but reverts to the time of overpayment to property owned by the taxpayer for use in its business and interest on that property is business income. (Therefore, the 1996 amendment to subsection 5203(1) of the regulations to the Act did change the definition of "adjusted business income" of resource corporations.)

[38] I am satisfied that IOL made the overpayment out of profits earned in its business and that the amounts of overpayments of the Irvcal assessments would have been used by IOL in carrying on its business at the time of the overpayment. That a taxpayer opts to pay an assessment rather than giving security does not affect its use of the money. When IOL received a tax refund with respect to the Irvcal assessments, the refund, the overpayment, represented a return of money that was intended for use in IOL's business at the time of the overpayment and was made impossible by actions of the government.

[39] The refund interest was active business income in the appellant's 1992 taxation year and is to be included in the appellant's adjusted business income within the meaning of section 5203 of the regulations to the Income Tax Act for the purpose of calculating the appellant's manufacturing and processing profit deduction for 1992 pursuant to section 125.1 of the Income Tax Act.

[40] The appeal is allowed with costs.

Signed at Ottawa, Canada, this 9th day of June 2000.

"Gerald J. Rip"

J.T.C.C.

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