Stelco Inc. v. R., [1997] 2 CTC 93, 97 DTC 5076

Jerome A.CJ.:

This is an appeal from the defendant’s reassessments of the plaintiff’s 1970, 1971 and 1972 taxation years. This appeal deals with the last of a series of issues raised by the plaintiff with respect to those reassessments and represents the only issue from those reassessments upon which the parties, over the years, have not been able to come to agreement.

FACTS

As a fully integrated steel producer, Stelco’s operations encompassed not only its main steel plant, the Hilton Works in Hamilton, Ontario, but also mines and other facilities for the production of the raw materials used in the steel making process and plants to produce a variety of steel products. The Agreed Statement of Facts submitted by the parties provides the following general description of the steps involved in the making of steel at the plaintiff’s Hamilton plant:

6. Three basic materials - iron ore, coal and limestone - are needed to make steel. Most of the iron ore used by Stelco was in the form of high-grade beneficiated pellets which were transported by ship to Stelco’s docks in Hamilton. The coal also arrived by ship. Giant cranes located on five moveable bridges unloaded the coal and iron ore onto the docks. The coal and iron ore are stored on dock until needed.

7. Stelco’s limestone requirements were met from its quarries at Beachville, Ontario. The limestone was baked in lime kilns to make it useable by Stelco and then brought by rail and truck to the Hilton works in Hamilton.

8. In order to smelt the iron out of the ore, high temperatures were necessary. Coal cannot produce the high temperatures required until it has first been turned into coke. This operation was carried out in Stelco’s coke ovens which baked coal at 1800 degrees F and operated 24 hours a day, 365 days a year. During 1970-72, there were four batteries in operation: #3 (61 ovens), #4 (83 ovens), #5 (47 ovens) and #6 (73 ovens). Battery #7 began operation in December 1972 (after the expiration of the exempt period of the Griffith mine).

9. The coke from the coke ovens was used to feed the four blast furnaces which were in operation during the years in issue. These were, blast furnaces “B”, “C”, “D” and “E”.

10. Alternate layers of ore, coke and limestone were charged into the top of the blast furnaces, which were cylindrical steel structures lined with heat resistant brick. Super heated air was blown upwards through a full furnace of descending material. The heat together with the limestone and carbon monoxide gas generated by the combustion of coke in the lower section of the furnace was utilized to smelt the iron out of the ore. The limestone acted as a purifying agent in the smelting process. Liquid iron accumulated at the base of the furnace while a layer of slag formed above the iron. The slag and iron were drained off periodically and iron in a liquid state (liquid pig iron) was transported directly to another area of Hilton Works for conversion to steel.

11. The parties are agreed that the prime metal stage of the ore was reached when the iron left the blast furnace in this liquid state (being equivalent to the pig iron stage).

During the taxation years in question, the iron ore required by Stelco was obtained from the following sources:

(a) the Griffith mine in Red Lake, Ontario, wholly owned by Stelco;

(b) the Scully mine in Wabush, Labrador in which Stelco had a 25.6 per cent interest;

(c) the Hilton mine in Shawville, Quebec in which Stelco had a 50 per cent interest;

(d) U.S. mines in which Stelco had an ownership interest; and

(e) purchases from third parties.

The Griffith mine was an open pit mine from which ore was extracted, sent through a crusher, a washer, a magnetic separator, indurating plant, an autogenous mill and a furnace. The resulting pellets were then carried by rail to the Lakehead and shipped through the Great Lakes to Hamilton where they were off loaded onto the docks at the Hilton works. For income tax purposes, the Griffith mine began producing ore in reasonable commercial quantities on December 1, 1969. The three year exempt period under subsection 83(5) of the Act with respect to income derived from the operation of the Griffith mine ran from December 1, 1969, to November 30, 1972.

The iron ore used by the plaintiff in the production of steel was a mix made up from any number of Stelco’s sources, depending on the metallurgical properties required for the type of steel being made at the time. Ore from the Griffith mine was, therefore, intermingled with ore from Stelco’s other sources in all four blast furnaces. Because of this intermingling, it was not possible to identify any particular pig iron as having been produced from Griffith mine pellets. The amount of pig iron attributable to the ore from each of the three Canadian mines supplying pellets during the relevant taxation years was calculated for the purpose of the Income Tax Act and regulations on the basis of the value of the pellets used from each source of supply as a proportion of the total value of the pellets used. On that basis, the pig iron production calculated as attributable to each mine was as follows:

Pig iron production attributable to each of the three mines, as a percentage of the whole of the pig iron production, was calculated by the plaintiff to be as follows:

Just as it was not possible to identify any particular pig iron as having been produced from the ore of any particular source, it was also not possible to identify any particular assets up to the pig iron state (“prime metal assets”) as assets relating to the production of pig iron from ore of any particular source. Where attribution of capital cost allowance on prime metal assets among one or more of the Griffith mine, Scully mine and Hilton mine is necessary, the parties are agreed that the percentages set out above provide the appropriate basis for such attribution.

During 1970, 1971 and 1972, the plaintiff had six assets under construction. It is these assets which are at the centre of this dispute:

1. the number 7 coke oven;

2. a gas precipitation and distribution system which fit into the coke ovens and is used to capture gases from the coke ovens, so that the gases could be used for useful purposes elsewhere in the process;

3. improvements on blast Furnace “E”;

None of those three assets were in use during the exempt period. In addition, there were in 1970 and 1971, the following three capital assets which were under construction and not operational:

4. a sanitary sewer used to remove waste from the blast furnace area at Hilton Works;

5. a lime kiln at Beachville, Ontario;

6. expansion of the docks at Hamilton.

In filing its income tax return for 1970, 1971 and 1972, the plaintiff claimed full capital cost allowance in respect of the assets under construction and not in use in calculating its taxable income under Part I of the Income Tax Act. On reassessment, the Minister applied the Griffith percentage of 25.881% to the capital cost allowance claimed by Stelco in respect of the assets, thereby reducing the plaintiff’s capital cost allowance claim for each year.

ISSUE

What is at issue in this appeal is whether Stelco can claim the full capital cost allowance on the assets which were under construction against its taxable income or whether its entitlement to claim full capital cost allowance is limited by subsection 83(5) of the Income Tax Act, R.S.C. 1952, c. 148, which at the time, read as follows:

83. (5) Subject to prescribed conditions, there shall not be included in computing the income of a corporation income derived from the operation of a mine during the period of 36 months commencing with the day on which the mine came into production.

By 1972, subsection 83(5) had been repealed, but its effect on the Griffith mine continued under the Income Tax Act, R.S.C. 1970-71-72, c. 63 by virtue of Regulation 28 which provided:

28.(1) Subject to prescribed conditions, there shall not be included in computing the income of a corporation, income derived from the operation of a mine that came into production before 1974 to the extent that such income is gained or produced during the period commencing with the day on which the mine came into production and ending with the earlier of December 31, 1972 and the day 36 months after the day the mine came into production, except that this subsection does not apply in respect of any mine that came into production after November 7, 1969 unless the corporation so elects in respect thereof in prescribed manner and within prescribed time.

Stelco’s position is that it is entitled to the full capital cost allowance in respect of all prime metal assets under construction and not in use in computing its income, and that it need not attribute any of the capital cost allowance to the Griffith mine during its exempt period because the assets did not relate to the “operation of the mine”.

The defendant maintains that, in computing its income from all sources, the plaintiff must exclude the Griffith mine. Since some of the prime metal assets under construction are attributable to the Griffith mine, capital cost allowance in respect of them must be deferred.

ANALYSIS

Subsection 83(5) and the manner in which income is to be calculated when a taxpayer has income from the operation of a mine which is exempt from taxation, was considered by the Federal Court of Appeal in Canadian Rock Salt Co. v. R., (sub nom. Canadian Rock Salt Co. v. The Queen) [1974] C.T.C. 725, 74 D.T.C. 6547, at page 727 (D.T.C. 6549):

Subsection 83(5) lays down one, among many rules to be found in the statute, for computing “annual” income of a corporation, which, to have any meaning, must be the global amount of world income for a year computed for the purpose of subsection 2(3) in accordance with the rules in sections 3 and 4. The first step in such a computation (leaving aside offices and employments because we are dealing with a corporation) is to set up a profit and loss account in which we put the revenues from all the corporations, businesses and properties on one side and the costs of earning those revenues on the other side. The second step in such a computation is to review that profit and loss account in accordance with such provisions as section 6 to 20 and applicable provisions of Division H of Part 1 of the Act. One of those provisions is subsection 83(5).

In attempting to apply subsection 83(5) read literally, in the process of calculating income for a year for subsection 2(3), it is found that it has no application because what it says is that “in computing the income of [the] corporation” there shall not be included “income derived from the operation of [the] mine” and one does not find that “income from the operation of the mine would, as such, be otherwise included in the computation of the corporation income for a year for the purposes of subsection 2(3) of the Income Tax Act. What would be included in such computation are the revenues of the mine on the one side of the profit and loss account and the expenses and other deductions related to the earning of those revenues on the other side. The income (profit) derived from the operation of the mine is the result obtained by adding up such deductions and deducting them from the aggregate of such revenues. It follows, in my view, that what subsection 83(5) in effect requires, when it provides that the income from operating the mine is not to be included, is the elimination of the revenues and the deductions that are used to calculate “income” from the mine for the year from the profit and loss account that would otherwise be used to produce the corporation’s world income for the taxation year for the purpose of subsection 2(3) of the Income Tax Act.

[Emphasis added.]

The statutory provision was also considered in Johnson's Asbestos Corporation v. Minister of National Revenue [1965] C.T.C. 165, 65 D.T.C. 5089 at page 177 (D.T.C. 5096):

I am of the opinion that the effect of subsection (5) of section 83 is to exclude the income derived from the mine from the totality of income that is contemplated by section 3 of the Act and that, therefore, income must be computed from all sources other than the mine as if the income from the mine did not exist. This brings into play the rule in paragraph (a) of the subsection (la) of section 139 of the Income Tax Act, which reads as follows:

(a) a taxpayer’s income for a taxation year from a business, employment, property or other source of income or from sources in a particular place means the taxpayer’s income computed in accordance with this Act on the assumption that he had during the taxation year no income except from that source or those sources, and was allowed no deductions in computing his income for the taxation year except such deductions as may reasonably be regarded as wholly applicable to that source or those sources and except such part of any other deductions as may reasonably be regarded as applicable to that source or those sources;

While paragraph (a) of subsection (la) of section 139 is drafted in relation to a single source of income, by virtue of paragraph (j) of subsection (1) of section 31 of the Interpretation Act, R.S.C. 1952, chapter 158, it is equally applicable to determining a taxpayer’s income for a year from several sources. The effect in my view is to exclude from the calculation of income for an exempt year all revenues from the operation of the new mine and all deductions reasonably regarded as applicable to the operation of the mine.

[Emphasis added.]

Thus, the effect of subsection 83(5) is to exclude from a taxpayer’s taxable income in a year, certain revenue and certain deductions; the revenue which is to be excluded is the revenue from the operation of the mine and the deductions which are to be excluded are those which may reasonably be regarded as applicable to the operation of the mine.

If the phrase “operation of a mine” in subsection 83(5) of the Income Tax Act meant only the physical act of extracting and processing of iron ore, I would agree with the plaintiff that the assets under construction should not be considered to be directly related to the operation of the mine. However, the jurisprudence has clearly established that the phrase “operation of the mine” connotes more than the physical act of extracting and processing of iron ore. In Falconbridge Nickel Mines Ltd. v. Minister of National Revenue [1972] C.T.C. 374, 72 D.T.C. 6337, the Federal Court of Appeal made the following comments in this regard at pages 379-80 (D.T.C. 6341-42):

It is also my opinion that the meaning which the appellant would ascribe to “the operation of a mine” is, having regard to reality, far too limited.

The operation of the mine within the meaning of the relevant legislation can only mean the conducting of a viable, practical undertaking for that purpose. For this it is necessarily, and I would think obviously, required that there be an organization, a a business enterprise, so structured and set up that the multiplicity of requirements to that end will be available. The extracting of the ore, the conversion of it into metal and the sale are parts, and important parts, but only parts, of those requirements. For realistic achievement of the result to be accomplished, and accomplished in a practical and effective sense, they must be supported and accompanied by other activities. It is the totality of that organization, of that enterprise and the totality of the conduct of the business which is “the operation of a mine” within the meaning of the legislation.

If, in section 83(5), “operation of a mine” means the mere physical extraction of the ore, in my view, the appellant should succeed, provided always, that it can ever be said that income is derived from a mere physical operation of that kind considered apart from a business of which it is a part.

The other view, and, in my view, the correct view, is that when section 83(5) talks of income derived from operation of a mine, it is referring to income derived from a business of operating the mine, for, in relation to profit producing activity (as opposed to property or employment) a business is the sort of income source contemplated by the Income Tax Act...

A mere physical act considered apart from the other steps necessary to bring income into existence is not a source of income as contemplated by the Act. It follows that the mere physical act of extracting ore from the mine, considered apart from the business of which it forms a part, is a barren act that is not, in itself, capable of being an income source. That physical act cannot, therefore, be what is contemplated by section 83(5) when it speaks of “operation of a mine” as something from which income is derived. [Emphasis added.]

It is clear therefore that the words “income derived from the operation of a mine” refer to an economic concept and mean income arising from the operation of the mine as a business. This principle was confirmed by the Federal Court of Appeal in Westar Mining Ltd. v. R., (Westar Mining Ltd. v. Canada) [1992] 2 C.T.C. 11, 92 D.T.C. 6358 at page 17 (D.T.C. 6363); “It is the operation of a mine as an economic activity, not the physical acts involved in extracting and process, that generates income.” Here, although the assets in question were under construction and not used to extract and process, they nevertheless formed part of the commercial enterprise which was the Griffith mine.

It remains to be determined how the income from the business of operating the mine should be calculated. Because of the intermingling of ore at the plaintiff’s Hilton works from a variety of sources of supply, the calculation of Stelco’s income derived from the operation of the Griffith mine required the use of a formula to allocate the pig iron production among these various sources. The plaintiff calculated the pig iron production attributable to each of the three mines, as a percentage of the whole of the pig iron production. The percentages attributable to the Griffith mine was 25.881% in 1970; 32.960% in 1971; and, 36.65% in the exempt period of 1972.

During the relevant taxation years, the plaintiff calculated the portion of its capital cost allowance claim in respect of prime metal assets in use during the year applicable to the Griffith mine by applying the appropriate percentages, and deferring that amount to a later date. As a result, the capital cost allowance deduction claimed by the plaintiff in computing its income included an amount in respect of the assets under construction which would be attributable, under the formula, to the Griffith mine. The effect of this was to reduce the plaintiff’s income from other sources by an amount of capital cost allowance which was applicable to the Griffith mine.

However, the source for purposes of computing the plaintiff’s exempt income during the years in question was the business of operating the Griffith mine. A portion of the prime metal assets which were under construction related to this business. If the capital cost allowance in respect of a portion of the assets in question did not relate to the business of operating the Griffith mine, what business did it relate to? There does not appear to be any other reasonable conclusion.

I am satisfied therefore that the plaintiff’s methodology is not consistent with the requirements of subsection 83(5) in that, in computing its income from its business of operating the Griffith mine, it has not deducted all those amounts reasonably regarded as applicable to that source. In other words, Stelco has included, in computing its income from all other sources, a deduction in respect of the Griffith mine which ought to have been excluded. This position is neither consistent with the wording used in subsection 83(5) of the Income Tax Act nor the jurisprudence interpreting that legislative provision.

For these reasons, the appeals are dismissed. No order as to costs.

Appeal dismissed.