T-646-74; T-4747-73
Sunshine Mining Company (Plaintiff)
v.
The Queen (Defendant)
Trial Division, Heald J.—Vancouver, March 21,
Ottawa, April 10, 1975.
Income tax—Deductions—Plaintiff paying damages in
Supreme Court action—Whether disbursements in respect of
action permissible deductions—Whether expenses incurred for
purpose of gaining or producing income—Whether paid on
account of capital—Whether expenses incurred in searching
for minerals in Canada—Income Tax Act, R.S.C. 1952, c. 148,
ss. 12(1)(a) and (b), 83A(3b)(b),
By a judgment of the Supreme Court of Canada, plaintiff
and its Canadian subsidiary were ordered to pay damages for
breach of contract to Dolly Varden Mines Ltd. Plaintiff dis
bursed $537,837.67 in respect of the action, of which $393,-
582.42, the amount of the judgment, would have been allowed
by the Minister as exploration and development expenses had
plaintiff performed the work under the agreement. Plaintiff
claimed deductions of the total amount, and as a result report
ed a business loss of $127,495.82 for 1969 and deducted the
same from its 1970 income. The Minister disallowed the
amounts claimed in the 1968, 1969 and 1970 taxation years.
Held, dismissing the appeal, the amounts are not deductible.
As to defendant's submission that the amounts were not
expenses incurred to gain or produce income from a business,
and not deductible under section 12(1)(a) because such pay
ment was ordered by the Supreme Court, it is necessary to look
behind the payment and inquire whether the liability from
which it arose was incurred as part of the income-earning
operation. As to defendant's second submission, the amounts
were payments on account of capital and not deductible under
section 12(1)(b). Had plaintiff done the work specified in the
agreements, it was to receive a one-half interest in Dolly
Varden Mining properties. The moneys paid pursuant to the
judgment were the amounts necessary to do the work agreed
upon; the true nature of the moneys was, in effect, the purchase
price of a one-half interest in the mining properties, an acquisi
tion of an addition to plaintiff's business organization and, as
such, a capital account. As to whether the facts in question
bring plaintiff within the exempting provisions of section
83A(3b), (J)(ii), the amounts were not incurred "in searching
for minerals in Canada".
Imperial Oil Limited v. M.N.R. [1947] Ex.C.R. 527,
followed; Associated Investors of Canada Ltd. v. M.N.R.
[1967] 2 Ex.C.R. 96 and Canada Starch Co. Ltd. v.
M.N.R. [1969] 1 Ex.C.R. 96, applied. Asamera Oil
(Indonesia) Ltd. v. The Queen [1973] 1 F.C. 534,
distinguished.
INCOME tax appeal.
COUNSEL:
P. Thorsteinsson and I. Pitfield for plaintiff.
M. Storrow and T. W. Ocrane for defendant.
SOLICITORS:
Thorsteinsson, Mitchell, Little, O'Keefe and
Davidson, Vancouver, for plaintiff.
Deputy Attorney General of Canada for
defendant.
The following are the reasons for judgment
rendered in English by
HEALD J.: These two actions were tried together
on common evidence, by the order of Cattanach J.,
and are appeals from assessments for income tax
for the plaintiff's 1968, 1969 and 1970 taxation
years.
At the commencement of the trial, an agreed
statement of facts was filed and reads as follows:
1. The Plaintiff, Sunshine Mining Company, (herein referred
to as "Sunshine") is incorporated under the laws of the State of
Idaho, one of the United States of America, and in the 1968,
1969 and 1970 taxation years, and in prior taxation years,
carried on business in Canada and elsewhere as a mining
exploration and oil and gas exploration and production
company.
2. Sunshine Exploration Limited (herein sometimes referred to
as "Sunshine Exploration") is incorporated under the laws of
the Province of Alberta and is a wholly-owned subsidiary of
Sunshine.
3. Sunshine is the owner and operator of a silver mine located
in the State of Idaho, in the United States of America and from
time to time before and after the events in question has entered
into agreements for the purpose of developing and operating
mining properties.
4. By agreement made as of March 5, 1964 and dated for
reference February 1, 1964, Sunshine Exploration entered into
an agreement with Dolly Varden Mines Ltd. (N.P.L.) a com
pany incorporated under the laws of the Province of British
Columbia (herein referred to as "Dolly Varden") which agree
ment is referred to as "the principal agreement". The principal
agreement is annexed as Exhibit 1 hereto.
5. By agreement made as of March 5, 1964, Dolly Varden,
Sunshine Exploration and Sunshine acknowledged and agreed
that in executing the principal agreement, Sunshine Explora-
tion was acting as agent for and on behalf of Sunshine. The
agency agreement is annexed as Exhibit 2 hereto.
6. Between March and October, 1964 work was done by
Sunshine on the property, and approximately $348,000 expend
ed for that purpose. On or about November 30, 1964, Sunshine
gave notice to Dolly Varden that it proposed to enter the second
development period. The notice is annexed as Exhibit 3 hereto.
On or about January 14, 1965 Dolly Varden gave notice of
default to Sunshine specifying in the said notice points in
respect of which defaults under the agreement were alleged.
The notice is annexed as Exhibit 4 hereto.
7. On or about January 22, 1965, Dolly Varden and Sunshine
concluded an amending agreement (herein referred to as "the
second amending agreement") a copy of which is annexed as
Exhibit 5 hereto.
8. Sunshine did not carry out all of the work stipulated in
Schedule "A" to the second amending agreement and on or
about August 31, 1965 the agreement was terminated as of
September 30, 1965. On October 1, 1965 Dolly Varden com
menced an action for damages for breach of contract against
Sunshine and Sunshine Exploration.
9. By judgment pronounced October 7, 1969, the Supreme
Court of Canada awarded damages for breach of contract to
Dolly Varden. The reasons for judgment are annexed as Exhib
it 6 hereto.
10. Sunshine retained Messrs. Bull, Housser & Tupper, Barris
ters and Solicitors of Vancouver in the Province of British
Columbia for the purpose of defending the action commenced
by Dolly Varden.
11. Sunshine disbursed amounts totalling approximately $537,-
837.67 in respect of the action commenced by Dolly Varden, of
which amount, the sum of $393,582.42 would have been
allowed by the Minister of National Revenue as exploration
and development expenses incurred in searching for minerals in
Canada had Sunshine performed the work under Schedule "A"
to the second amending agreement. Deductions of the total
amount were claimed by Sunshine on the basis that the
amounts represented exploration and development expenses in
searching for minerals or were otherwise deductible as follows:
(a) Incurred in prior years and claimed in
1968 year:
To professional services paid Bull, Housser
& Tupper $ 22,733.32
Deposit with Court for settlement of judg
ment and interest re Dolly Varden action 34,202.11
Paid Leslie Wright & Rolfe Ltd. re Court
bond, Dolly Varden action 3,260.00
To professional services paid 1966 Bull,
Housser & Tupper 14,938.02
Total $ 75,133.45
(b) Incurred and claimed in 1968 taxation
year:
To professional services paid Bull, Housser
& Tupper $ 3,436.00
Paid Leslie Wright & Rolfe Ltd. re Court
bond, Dolly Varden action 6,075.00
Total $ 9,511.00
(c) Incurred and claimed in 1969 year:
Final judgment paid Dolly Varden $393,582.42
Interest on judgment 41,978.60
Miscellaneous expenses re Dolly Varden
action 17,632.20
Total $453,193.22
12. As a result of deducting the amount referred to in para
graph 11, Sunshine reported a business loss of $127,495.82 in
its 1969 taxation year and in computing its 1970 taxable
income it deducted the same amount of $127,495.82.
13. By assessments dated December 29, 1971, the Minister of
National Revenue disallowed the deduction of the amounts
claimed by Sunshine in its 1968, 1969 and 1970 taxation years
as outlined in paragraphs 11 and 12 hereof.
The "principal agreement" referred to in para
graph 4 of the agreed statement is a lengthy and
detailed document, but its effect was to require the
plair tiff, as operator, to carry out successive stages
of work on Dolly Varden's mining properties in the
Kitsault Valley of British Columbia with a view to
developing said mining properties and bringing
them into production. There were to be four stages
of development. The first stage was to extend from
the commencement of the agreement to December
31, 1964 and was exploratory in nature. The
second stage was to commence with the conclusion
of the first stage and to extend until the property
was in production in reasonable commercial quan
tities. The third stage was the period in which each
of the parties was to recover its development costs.
The fourth stage was the remaining life of the
agreement (for a maximum of 50 years) during
which the parties would share equally any profits
realized from production. Dolly Varden agreed, on
the closing date, to assign and convey to the
plaintiff one-half of the mining properties
described in the agreement. The plaintiff agreed to
deposit with an escrow agent documents to evi
dence a complete reconveyance of the half interest
to Dolly Varden, which were to be delivered to
that company if the plaintiff terminated the agree
ment or failed to give notice of its intention to
proceed to the second development stage. Since the
plaintiff never did so proceed, the reconveyance
documents were so delivered to Dolly Varden.
The "second amending agreement" referred to
in paragraph 7 of the agreed statement provided
that:
(a) The plaintiff withdrew and cancelled its
notice of intention to enter the second develop
ment period.
(b) Dolly Varden withdrew its notice of default
and excused the plaintiff from any further work
on the programme described in Schedule "F" to
the principal agreement.
(c) The first development period was extended
to September 30, 1965 with the plaintiff havi
the right by giving notice before August 1,
1965 to extend it further to December 31, 1966.
(d) The plaintiff covenanted to carry out addi
tional work as set forth in Schedule "A" to the
second amending agreement prior to October 1,
1965. In the event the work outlined in said
Schedule "A" was not completed prior to Octo-
ber 1, 1965, Dolly Varden had the right to
terminate the principal agreement. The plaintiff
did not carry out said work and the agreement
was terminated by Dolly Varden as set out in
paragraph 8 of the agreed statement. The work
stipulated in said Schedule "A" included the
carrying out of a programme of diamond drill
ing and unwatering, testing the downward
plunge of one of the ore bodies, testing by
diamond drilling the width of mineralization in
parts of the ore body and completing stipulated
amounts of diamond drilling on other parts of
the property which had been included under the
umbrella of the principal agreement.
As stated in paragraph 11 of the agreed state
ment, the plaintiff's total outlay in respect of the
legal proceedings referred to in paragraphs 8, 9
and 10 thereof was the sum of $537,837.67. This
sum is further broken down as follows:
(a) Damages awarded to Dolly Varden by
final judgment of the Supreme Court of
Canada $393,582.42
(b) Interest thereon 76,180.71 -
(c) Legal fees and Court bond expense re
Dolly Varden action 68,074.54
Total $537,837.67
At the trial, counsel for the defendant agreed
that if the damage award in the sum of $393,-
582.42 was deductible, then the items of interest,
legal fees and costs set out in (b) and (c) above
would also be deductible because of the deductible
nature of the matter in respect of which they were
paid. Thus, the sole issue to be determined in these
proceedings is the deductibility or non-deductibili-
ty of the award of damages by the Supreme Court
of Canada.
The defendant made a threefold submission in
support of his position that said damage award
was not deductible. The defendant's first position
was that said amounts were not expenses incurred
by the plaintiff for the purpose of gaining or
producing income from a business (underlining
mine) and were thus not deductible pursuant to
section 12(1)(a) of the Income Tax Act'. The
defendant submits that the reason the plaintiff
made subject payments to Dolly Varden was for
the plain and simple reason that it was ordered so
to do by the Supreme Court of Canada. The
defendant argues that said payments were made
because the plaintiff wished to relieve itself of its
obligations under the Dolly Varden agreements
and that it was never the intention of the plaintiff
to make these expenditures with a view to gaining
R.S.C. 1952, c. 148.
12. (1) In computing income no deduction shall be made
in respect of
(a) An outlay or expense except to the extent that it was
made or incurred by the taxpayer for the purpose of
gaining or producing income from property or a business
of the taxpayer,
or producing income from a property or a business
and that, accordingly, the plaintiff has not brought
itself within the provisions of section 12(1)(a).
In view of the decision of President Thorson in
Imperial Oil Limited v. M.N.R. 2 , I am not able to
accept this first submission of the defendant. At
page 546 of said judgment, the learned President
said:
It is no answer to say that an item of expenditure is not
deductible on the ground that it was not made primarily to earn
the income but primarily to satisfy a legal liability. This was
the kind of argument that was expressly rejected by the High
Court of Australia in the Herald & Weekly Times, Ltd., case
[(1932) 48 C.L.R. 113] and it should be rejected here. In a
sense, all disbursements are made primarily to satisfy legal
liabilities. The fact that a legal liability was being satisfied has,
by itself, no bearing on the matter. It is necessary to look
behind the payment and enquire whether the liability which
made it necessary—and it makes no difference whether such
liability was contractual or delictual—was incurred as part of
the operation by which the taxpayer earned his income.
[Underlining mine.]
The defendant's second submission was to the
effect that the amounts in dispute were paid on
account of capital and are thus covered by the
provisions of section 12(1) (b) of the Income Tax
Act a .
In order to test the validity of this submission, it
is necessary to analyze the true nature of subject
payments in the light of the existing jurisprudence.
A perusal of the principal agreement and the
relevant amending agreements makes it clear that
the plaintiff was to perform the exploration work
specified for the first development stage and in
return therefor, it was to receive a one-half interest
in the Dolly Varden mining properties.
However, it did not complete said first develop
ment stage to the satisfaction of Dolly Varden and
2 [1947] Ex.C.R. 527.
3 12. (I) In computing income, no deduction shall be made
in respect of:
(b) an outlay, loss or replacement of capital, a payment on
account of capital or an allowance in respect of depreciation,
obsolescence or depletion except as expressly permitted by
this Part,
a dispute arose between the parties as a result of
which the second amending agreement was entered
into and under this agreement, the plaintiff was to
perform the exploratory work set out in Schedule
"A" thereto. Because of its failure to complete this
work, in effect, the first development stage was
never completed, thus the plaintiff never became
entitled to its one-half interest in the mining prop
erties, and because it had not earned said one-half
interest, the escrowed transfers covering said one-
half interest were returned to Dolly Varden.
The monies paid pursuant to the Supreme Court
judgment were the amounts which were necessary
to do the work agreed to be performed by the
plaintiff under said Schedule "A". Had the plain
tiff performed the work set out in Schedule "A"
within the time frame contemplated in the agree
ment, it would have earned and become entitled to
a one-half interest in the Dolly Varden mining
properties.
President Jackett (as he then was) said in the
Associated Investors of Canada Ltd. v. M.N.R.
case 4 :
The general concept is that a transaction whereby an enduring
asset or advantage is acquired for the business is a capital
transaction. (See British Insulated & Helsby Cables Ltd. v.
Atherton, [1926] A.C. 205).
In the case of Canada Starch Co. Ltd. v.
M.N.R. S , the learned President set out the distinc
tion between outlays on revenue account and on
capital account in this manner:
In other words, as 1 understand it, generally speaking,
(a) on the one hand, an expenditure for the acquisition or
creation of a business entity, structure or organization, for
the earning of profit, or for an addition to such an entity,
structure or organization, is an expenditure on account of
capital, and
(b) on the other hand, an expenditure in the process of
operation of a profit-making entity, structure or organization
is an expenditure on revenue account.
Applying the rationale of these cases to the facts
in the case at bar, I am satisfied that the true
nature of the monies paid by the plaintiff to Dolly
Varden was, in effect, the purchase price for a
one-half interest in the Dolly Varden mining prop
erties, clearly an expenditure for the "acquisition
6 [1967] 2 Ex.C.R. 96 at page 103.
[1969] 1 Ex.C.R. 96 at page 102.
of an addition to the plaintiff's business organiza
tion", and as such, in my view, an expenditure on
account of capital.
Plaintiff's counsel cited my decision in the case
of Asamera Oil (Indonesia) Ltd. v. The Queen 6 in
support of his submission that subject expenditures
in the case at bar were expenditures on revenue
account. However, in my view, the Asamera case
(supra) is clearly distinguishable on its facts. In
that case, I said at pages 542-3:
This is not the case of an oil company owning mineral rights or
mineral permits to explore which are exploited and developed
by said company. The plaintiff owned nothing in Indonesia; it
had no rights in the minerals; it had no property rights in the
wells or the equipment; it had been hired to perform services
and even its right to receive payment therefor was dependent on
the oil production on the subject lands.
The facts in the case at bar involving ownership
of mineral rights and permits and mineral proper
ties is a classic example of the kind of situation
contemplated in the above quotation and, in my
view, is a clear case of true capital assets.
I have thus concluded that the subject amounts
were payments on account of capital and thus non
deductible under the provisions of section 12(1)(b)
of the Act.
The only other question to be considered is
whether the facts and circumstances in this case
are such as to bring the plaintiff within the
exempting provisions of section 83A(3b)(b),(f)(ii),
the relevant portion of which reads as follows:
83A. (3b) A corporation whose principal business is
(b) mining or exploring for minerals,
may deduct, in computing its income under this Part for a
taxation year, the lesser of
(f) the aggregate of such of
(ii) the prospecting, exploration and development expenses
incurred by it in searching for minerals in Canada, ....
6 [1973] 1 F.C. 534.
On the facts in this case, it is clear that the
monies paid by the plaintiff to Dolly Varden were
"not incurred by the plaintiff in searching for
minerals in Canada" as that expression is used in
the above quoted section. This is apparent from
the plain meaning of the words as they appear in
the statute and is also supported by judicial
decisions'. It was my understanding that the plain
tiffs counsel agreed that section 83A had no
application to the facts of this case.
For the foregoing reasons, the plaintiffs appeal
is dismissed with costs.
See for example: Johnson's Asbestos Corporation v.
M.N.R. [1966] Ex.C.R. 212 and Farmers Mutual Petroleums
Ltd. v. M.N.R. [1968] S.C.R. 59.
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.