The Queen (Appellant) (Defendant)
v.
Alberta and Southern Gas Co. Ltd. (Respondent)
(Plaintiff)
Court of Appeal, Jackett C.J., Pratte and Urie
JJ.—Ottawa, June 24, 1977.
Income tax — Calculation of income — Deductions —
Section 245(1) deductions unduly and artificially reducing
income, disallowed — Whether or not applicable to s. 66
deduction made following "carve-out" agreement concerning
Canadian resource property — Income Tax Act, R.S.C. 1952,
e. 148, ss. I2(1 )(g), 59, 66 and 245(1) as amended.
This appeal considers the income tax payable by the respond
ent for 1972. Respondent had invested $4,000,000, that other
wise would have been taxable, in "a working interest" in
petroleum producing lands, pursuant to a "carve-out" agree
ment. The agreement was to terminate on payment to respond
ent of $4,000,000 plus interest, or on respondent's receiving
that value of petroleum substances. The respondent deducted
this sum from its income pursuant to section 66 of the Income
Tax Act, and the Trial Division overturned the Minister's
assessment disallowing the claim. The appellant's sole ground
for appeal is that this deduction, even if otherwise permitted,
was prohibited by section 245(1) because of its unduly and
artificially reducing income.
Held, the appeal is dismissed. Section 245(1), considered in
context in the scheme of the Act, is applicable to every class of
deductible expenses. Section 245(1) does not operate, however,
to prohibit the deduction at issue in this case. Section 66 must
be read with section 59. Section 66 permits a deduction of the
cost of a "Canadian resource property" and sections 59 and
12(1)(g) provide that the proceeds of disposition of such prop
erty must be brought into income. These provisions have the
obvious purpose of encouraging taxpayers to put money into
such resource properties and keep it there. Since that is what
the provisions are intended to encourage, a transaction that
clearly falls within the object and spirit of section 66 cannot be
said to unduly or artificially reduce income merely because the
taxpayer was influenced in deciding to enter into it by tax
considerations.
Harris v. M.N.R. [1966] S.C.R. 489, applied.
INCOME tax appeal.
COUNSEL:
J. A. Scollin, Q.C., and Neil W. Nichols for
appellant.
F. R. Matthews, Q.C., and M. A. Putnam for
respondent.
SOLICITORS:
Deputy Attorney General of Canada for
appellant.
MacKimmie, Matthews, Calgary, for
respondent.
The following are the reasons for judgment
delivered orally in English by
JACKETT C.J.: This is an appeal from a decision
of the Trial Division [[1977] 1 F.C. 395] in a
proceeding in that Court concerning the tax pay
able by the respondent under Part I of the Income
Tax Act for the 1972 taxation year.
The facts are clearly set forth in the reasons for
judgment of the learned Trial Judge and, as no
attack has been made on his findings of fact, I will
not re-state them but will merely summarize the
facts, as I understand them, in so far as is neces
sary for considering the basic question upon which
this appeal turns.'
Such facts are:
1. The respondent acquires natural gas in
Alberta and re-sells it, in large part, to an
associated company for consumption in Cali-
fornia.
2. Out of funds generated by an addition made
for the purpose to the price charged to the
associated company, the respondent endeavours
to ensure future supplies of natural gas by vari
ous methods adapted to further exploration for
gas, viz:
(a) prepayments for known gas in the ground,
(b) loans to producers to assist in the de
velopment of future resources to be dedicated
to the respondent, and
(c) risk exploration activities;
and expenditures so made are, apparently,
accepted by the appellant as deductible in com
puting the respondent's income for purposes of
income tax for the year in which they are made.
I There is also an appeal for the 1973 taxation year but what
has to be decided in the two appeals would seem to be substan
tially the same.
3. in 1972, the respondent derived from its sale
of gas to its associated company $4,000,000 that
was available for such purposes but did not
expend them for such purposes in that year.
4. As that sum of $4,000,000 would, otherwise,
be included in its income for 1972 for income
tax purposes, the respondent, in 1972, adopted a
"device" to "remove these amounts from the
grasping reach of the tax collector and so pre
serve the funds for the purpose to which they
were dedicated", which "device" consisted in
entering into a "carve-out" agreement with
Amoco Petroleum Company Ltd. (hereinafter
referr.el to as "Amoco"), a gas-producing com
pany with which the respondent had gas pur
chase agreements extending into the future.
5. The "carve-out" agreement was an agree
ment whereby, in consideration of a payment by
the respondent to Amoco of $4,000,000,
(a) Amoco assigned to the respondent a per
centage of Amoco's "working interest" (i.e., a
right, licence or privilege "to produce, take
and dispose of petroleum substances") in cer
tain lands, which lands were lands from which
the respondent was to receive natural gas
which it was to purchase under pre-existing
contracts with Amoco;
(b) the respondent was entitled to hold the
ass tl ed rights forever but subject to a provi
sion that the rights would end when the
respondent received
(i) petroleum substances to the value of
$4,000,000 plus interest, or
(ii) the amount of $4,000,000 plus interest;
(c) the respondent could remove the pe
troleum substances from the land and process
and market the products itself, or it could
permit Amoco to continue to extract them,
refine them and dispose of the resultant prod
ucts, in which event the proceeds of disposi
tion of Hire respondent's share would go to the
respondent (all costs of such operation being,
in either event, assumed by Amoco).
6. The respondent permitted Amoco to continue
the latter operation and, as was expected by the
respondent when it entered into the agreement,
in approximately a year, was paid by Amoco the
amount of $4,000,000 plus interest out of the
proceeds of production as contemplated by the
"carve-out" agreement so that its rights under
the agreement came to an end.
The appellant, based on these facts, claimed to
deduct, in computing its income for the purposes
of the Income Tax Act for 1972, the sum of
$4,000,000 paid for the "working interest" under
section 66 of the Income Tax Act, which reads, in
so far as relevant for the year in question, as
follows:
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
(b) of that aggregate, an amount equal to its income for the
taxation year if no deductions were allowed under this sec
tion or section 65, minus the deductions allowed for the year
by subsections (2), (4), (6) and (7) and by sections 112 and
113.
(3) A taxpayer who is an individual or a corporation other
than a principal-business corporation may deduct, in computing
his income for a taxation year, the lesser of
(a) the aggregate of such of his Canadian exploration and
development expenses as were incurred by him before the
end of the taxation year to the extent they were not deduct
ible in computing his income for a previous taxation year,
and
(b) of that aggregate, the amount, if any, by which the
greater of
(i) such amount as the taxpayer may claim, not exceeding
20% of the aggregate determined under paragraph (a),
and
(ii) the aggregate of
(A) such part of his income for the taxation year as
may reasonably be regarded as attributable to the pro
duction of petroleum or natural gas from wells in
Canada or to the production of minerals from mines in
Canada,
(B) his income for the taxation year from royalties in
respect of an oil or gas well in Canada or a mine in
Canada, and
(C) the aggregate of amounts each of which is an
amount, in respect of a Canadian resource property or a
property referred to in paragraph 59(1)(c) or 59(3)(a)
that has been disposed of by him, equal to the amount, if
any, by which
(I) the amount included in computing his income for
the year by virtue of section 59 in respect of the
disposition of the property,
exceeds
(II) the amount deducted under section 64 in respect
of the property in computing his income for the year,
if no deductions were allowed under section 65,
exceeds
(iii) the amount of any deduction allowed by the Income
Tax Application Rules, 1971 in respect of this subpara-
graph in computing his income for the year.
(15) In this section,
(b) "Canadian exploration and development expenses"
incurred by a taxpayer means
(i) any drilling or exploration expense, including any gen
eral geological or geophysical expense, incurred by him
after 1971 on or in respect of exploring or drilling for
petroleum or natural gas in Canada,
(iii) the cost to him of any Canadian resource property
acquired by him,
(iv) his share of the Canadian exploration and develop
ment expenses incurred after 1971 by any association,
partnership or syndicate in a fiscal period thereof, if at the
end of that fiscal period he was a member or partner
thereof, and
(v) any expense incurred by the taxpayer after 1971 pur
suant to an agreement with a corporation under which the
taxpayer incurred the expense solely in consideration for
shares of the capital stock of the corporation issued to him
by the corporation or any interest in such shares or right
thereto, to the extent that the expense was incurred as or
on account of the cost of
(A) drilling or exploration activities, including any gen
eral geological or geophysical activities, in or in respect
of exploring or drilling for petroleum or natural gas in
Canada,
(B) prospecting, exploration or development activities in
searching for minerals in Canada, or
(C) acquiring a Canadian resource property,
(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 hydrocar
bons in Canada,
The claim was disallowed by assessment and the
proceeding in the Trial Division was, in effect, an
appeal from that disallowance as well as from
certain consequential adjustments in the respond-
ent's income as reported, to which reference will
be made hereafter.
While there was an issue in the Trial Division as
to whether the respondent was a "principal-busi
ness corporation" as those words are defined in
section 66, the Trial Division held that it was such
a corporation and there is no appeal from that
holding. The learned Trial Judge also held that the
respondent had acquired a "Canadian resource
property" within the meaning of those words in
section 66 and allowed the appeal in so far as the
deduction of $4,000,000 under section 66 was
disallowed.
On the argument of the appeal in this Court,
that conclusion was attacked on only one ground.
The question raised by the appellant is the
question whether, assuming the expenditure of
$4,000,000 was, otherwise, deductible, its deduc
tion was prohibited by section 245(1) of the
Income Tax Act, which 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 opera
tion that, if allowed, would unduly or artificially reduce the
income.
With regard to that question, the learned Trial
Judge said [at page 412]:
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 circum
stances 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 busi
ness 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 precise
ly 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.
With great respect, I cannot agree that the rule
of interpretation referred to by the learned Trial
Judge excludes the application of section 245(1) to
an amount that would otherwise be deductible
under section 66. If it does, it is difficult to think
of any case where section 245(1) would apply
inasmuch as, in relation to any provision providing
for a deduction in computing income, section
245(1) is always, by its nature, a general provision.
Parliament must have intended the provision to
have some effect and a non-statutory rule of inter
pretation is merely a crystallization of the judicial
reasoning employed in ascertaining Parliament's
intention in enacting a particular provision.
To appreciate the respondent's submission that
section 245(1) does not apply to an amount that is
otherwise deductible under section 66, it is neces
sary to consider the various classes of deductions
to which it might apply.
The first question to ask in determining the
deductibility of an outlay in computing "profit"
for a year for the purposes of the Income Tax Act
is whether the money was laid out to earn the
profit for the year—i.e., in the case of profit from
a business, was it a current business expenditure? 2
If the outlay passes this test, prima facie it is
deductible; if it does not, prima facie, it is not
deductible.
Other amounts are, however, specially made
deductible by statute, for example,
(a) amounts on account of capital that would
not otherwise be deductible because they are not
current expenses of the year in question
although they are related to the earning of profit
from the business, such as interest on capital
borrowed for the business, capital cost allowance
and depletion,
(b) amounts that are deductible under statutory
rules made for unusual situations in an attempt
to obtain a result as equitable as possible having
regard to the abnormal results obtained by
applying the ordinary rules re computation of
profits to such situations, and
2 Compare British Columbia Electric Railway Co. Ltd. v.
M.N.R. [1958] S.C.R. 133, per Abbott J. (delivering the
judgment of the majority) at pages 136-137.
(c) amounts that were not laid out for the earn
ing of profit (either as current or capital expen
ditures) but the deduction of which is allowed
by Parliament to achieve some end that Parlia
ment wishes to encourage (incentive allow
ances).
The provision considered in the Harris case, to
which I will refer, falls under the second of these
classes and expenses allowed by section 66, as I
understand it, fall under the second and third.
Depending on the circumstances, section 66 would
seem to provide for
(a) a carry forward of current expenditures
made in respect of a previous year,
(b) a special scheme for the deduction of capital
expenditures (i.e., pre-production costs of creat
ing a production operation), and
(c) incentives for exploration and development.
The view expressed by the learned Trial Judge, as
I understand it, depends upon reading section
245(1) as not applying to any deduction for which
there is a special statutory provision. In my view,
considering it in its context in the scheme of the
Act, section 245(1) is applicable to every class of
deductible expenses. Even if, reading the Act as a
whole, I came to a different conclusion, I should
feel constrained to hold that section 245(1) does
apply to deductions such as those otherwise per
mitted by section 66 by my reading of Harris y.
M.N.R. 3 per Cartwright J., as he then was, deliver
ing the judgment of the Supreme Court of
Canada, at page 505 4 .
3 [1966] S.C.R. 489.
° I refer to the passage in his judgment that reads:
While, in view of the conclusions at which I have arrived
on the points dealt with above, it is not necessary to express
an opinion upon the other grounds on which counsel for the
respondent opposed the appeal, I propose to state briefly my
opinion on the position taken in ground (e) set out above
which was fully argued.
Section 137 (1) of the Income Tax Act reads as follows:
137. (1) In computing income for the purposes of this
Act, no deduction may be made in respect of a disburse
ment or expense made or incurred in respect of a transac
tion or operation that, if allowed, would unduly or artifi
cially reduce the income.
(Continued on next page)
In my view, however, section 245(1) does not
operate to prohibit the deduction at issue in this
case. Section 66 must be read with section 59,
which reads, in part:
59. (1) Where in a taxation year a taxpayer disposes of
(a) a Canadian resource property,
the amount receivable by the taxpayer as consideration for the
disposition thereof shall be included in computing his income
for the year, notwithstanding that the amount or any part
thereof may not be received until a subsequent taxation year.
and section 12(1)(g), which reads:
12. (1) There shall be included in computing the income of
a taxpayer for a taxation year as income from a business or
property such of the following amounts as are applicable:
(g) any amount received by the taxpayer in the year that
was dependent upon the use of or production from property
whether or not that amount was an instalment of the sale
price of the property (except that an instalment of the sale
price of agricultural land is not included by virtue of this
paragraph);
When one reads section 66, one finds that one of
the things that is permitted is a deduction of the
cost of a "Canadian resource property" and, when
one reads section 59 and section 12(1)(g), one
finds that the proceeds of disposition of such a
property must be brought into income. These
provisions for deduction and taxation of capital
amounts seem to me to have the obvious purpose
of encouraging taxpayers to put money into such
resource properties and keep it there. That being
what the provisions seem to have been intended to
encourage, as it seems to me, a transaction that
clearly falls within the object and spirit of section
(Continued from previous page)
If, contrary to the views I have expressed, we had accepted
the appellant's submission that the transaction embodied in
the lease was one to which s. 18 applied and that on the true
construction of the lease and the terms of that section the
appellant was prima facie entitled to make the deduction of
the capital cost allowance of $30,425.80 claimed by him, I
would have had no hesitation in holding that it was a
deduction in respect of an expense incurred in respect of a
transaction that if allowed would artificially reduce the
income of the appellant and that consequently its allowance
was forbidden by the terms of s. 137(1). The words in the
sub-section "a disbursement or expense made or incurred"
are, in my opinion, apt to include a claim for depreciation or
for capital cost allowance, and if the lease were construed as
above suggested the arrangement embodied in it would fur
nish an example of the very sort of "transaction or opera
tion" at which s. 137(1) is aimed.
66 cannot be said to unduly or artificially reduce
income merely because the taxpayer was
influenced in deciding to enter into it by tax
considerations.
The Trial Division judgment also dealt with
consequential items. Counsel for the appellant did
not contend that these should be dealt with sepa
rately from the deduction of the $4,000,000 item.
For the above reasons, I am of the view that the
appeal should be dismissed with costs. By request
of the parties, the judgment will provide for a
reference back of the assessment for reassessment
in accordance with the prayer for relief in the
statement of claim.
PRATTE J. concurred.
URIE J. concurred.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.