Date: 19991008
Docket: T-1260-90
BETWEEN:
MOBIL OIL CANADA, LTD.
Plaintiff
AND:
HER MAJESTY THE QUEEN
Defendant
Docket: T-1261-90
BETWEEN:
MOBIL OIL CANADA, LTD.
Plaintiff
AND:
HER MAJESTY THE QUEEN
Defendant
Docket: T-1262-90
BETWEEN:
MOBIL OIL CANADA, LTD.
Plaintiff
AND:
HER MAJESTY THE QUEEN
Defendant
Docket: T-1263-90
BETWEEN:
MOBIL OIL CANADA, LTD.
Plaintiff
AND:
HER MAJESTY THE QUEEN
Defendant
REASONS FOR JUDGMENT
NADON J.
[1] These are appeals by Mobil Oil Canada, Ltd. ("Mobil") under the Income Tax Act1 (the "Act") from Notices of Reassessment issued by the Minister of National Revenue (the "Minister") in respect of taxation years 1977, 1978, 1979 and 1980.
FACTS
[2] The following facts are derived from the Agreed Statements of Facts filed by the parties2.
[3] Mobil is a corporation whose business operations include the exploration for and production of petroleum and natural gas.
[4] In respect of its 1977, 1978, 1979 and 1980 taxation years, Mobil remitted $551,034.00, $646,254.00, $731,526.00 and, $822,178.00 respectively (the "Remitted Funds") to the Province of Saskatchewan in satisfaction of its obligations under The Road Allowances Crown Oil Act3 ("RACOA"). The Remitted Funds represent 1 per cent of the value, calculated on the average well-head price, of the oil produced by Mobil in Saskatchewan.
[5] All of the oil produced by Mobil in Saskatchewan was produced from properties subject to leases pursuant to which Mobil had acquired the right to take or remove the said oil. Substantially all of the oil produced by Mobil in Saskatchewan was from properties subject to Crown leases.
[6] In preparing its amended returns of income for its 1977 and 1978 taxation years, Mobil included the Remitted Funds in its income. By Notices of Reassessment, the Minister reassessed Mobil in respect of its 1977and 1978 taxation years.
[7] By Notices of Objection, Mobil objected to the Notices of Reassessment for the 1977 and 1978 taxation years, and claimed that it had made an error in including the Remitted Funds in its income for those years.
[8] By Notice of Confirmation, the Minister confirmed the Notices of Reassessment for the taxation years 1977 and 1978.
[9] In preparing its amended returns of income for its 1979 and 1980 taxation years, Mobil deducted the Remitted Funds from its income. By Notices of Reassessment, the Minister reassessed Mobil in respect of its 1979 and 1980 taxation years.
[10] By Notices of Objection, Mobil objected to the Notices of Reassessment for the 1979 and 1980 taxation years.
[11] By Notices of Confirmation, the Minister denied Mobil"s deductions in respect of the Remitted Funds for the 1979 and 1980 taxation years.
ISSUE
[12] The issue to be determined in these appeals is whether Mobil was required to include the Remitted Funds in its income under paragraph 12(1)(o) of the Act, and if so required, whether Mobil was entitled to a corresponding deduction under paragraph 18(1)(m) of the Act. Paragraphs 12(1)(o) and 18(1)(m) of the Act read as follows:
| 12(1)(o) Royalties, etc., to be included in income, " any amount (other than an amount, referred to in paragraph 18(1)(m ), paid or payable by the taxpayer, or a prescribed amount) that became receivable in the year by virtue of an obligation imposed by statute or a contractual obligation substituted for an obligation imposed by statute by (i) Her Majesty in right of Canada or a province, (ii) an agent of Her Majesty in right of Canada or a province, or (iii) a corporation, commission or association that is controlled, directly or indirectly in any manner whatever, by Her Majesty in right of Canada or a province or by an agent of Her Majesty in right of Canada or a province as a royalty, tax (other than a tax or portion thereof that may reasonably be considered to be a municipal or school tax), lease rental or bonus or as an amount, however described, that may reasonably be regarded as being in lieu of any such amount, and that may reasonably be regarded as being in relation to (iv) the acquisition, development or ownership of a Canadian resource property or a property that would have been a Canadian resource property if it had been acquired after 1971, or (v) the production in Canada of
from an oil or gas well or mineral resource situated on property in Canada from which the taxpayer had, at the time of such production, a right to take or remove petroleum, natural gas or related hydrocarbons or a right to take or remove metal or minerals; |
12(1)(o) Les redevances, etc. sont incluses dans le revenu, " toute somme (autre qu"une somme visée à l"alinéa 18(1)(m ), payée ou payable par le contribuable, ou une somme prescrite), devenue recevable au cours de l"année d"une ou plusieurs bandes selon la définion qu"en donne la Loi sur les Indiens ) au cours de l"année (i) par Sa Majesté du chef du Canada ou d"une province; (ii) par un mandataire de Sa Majesté du chef du Canada ou d"une province; ou (iii) par une corporation, commisison ou association contrôlée directement ou indirectement, de quelque façon que ce soit, par Sa Majesté du chef du Canada ou d"une province ou par un mandataire de Sa Majesté du chef du Canada ou d"une province à titre de redevance ou d"équivalent, de taxe (autre qu"une taxe ou fraction de taxe qui peut raisonnablement être considérée comme une taxe municipale ou scolaire), de loyer, de prime ou à titre de somme, quelle que soit la façon don"t elle est désignée, qui peut être raisonnablement considérée comme tenant lieu d"une telle somme, qui peut raisonnablement être considérée comme rattachée (iv) à l"acquisition, à l"aménagement ou à la propriété d"un avoir minier canadien ou d"un bien qui aurait été un avoir minier canadien s"il avait été acquis après 1971, ou (v) à la production, au Canada,
tirés d"un puits de pétrole ou de gaz ou de ressources minérales situées au Canada sur un bien sur lequel le contribuable avait, à la date de cette production, le droit d"extraire du pétrole, du gaz naturel ou d"autres hydrocarbures apparentés ou le droit d"extraire des métaux ou du minerai; |
| 18(1)(m) Royalties, etc. " any amount (other than a prescribed amount) paid or that became payable payable in the year by virtue of an obligation imposed by statute or a contractual obligation substituted for an obligation imposed by statute to (i) Her Majesty in right of Canada or a province, (ii) an agent of Her Majesty in right of Canada or a province, or (iii) a corporation, commission or association that is controlled, directly or indirectly in any manner whatever, by Her Majesty in right of Canada or a province or by an agent of Her Majesty in right of Canada or a province as a royalty, tax (other than a tax or portion thereof that may reasonably be considered to be a municipal or school tax), lease rental or bonus or as an amount, however described, that may reasonably be regarded as being in lieu of any such amount, and that may reasonably be regarded as being in lieu of any such amount, and that may reasonably be regarded as being in relation to (iv) the acquisition, development or ownership of a Canadian resource property, or a property that would have been a Canadian resource property if it had been acquired after 1971, or (v) the production in Canada of
from an oil or gas well or mineral resource situated on property in Canada from which the taxpayer had, at the time of such production, a right to take or remove petroleum, natural gas or related hydrocarbons or a right to take or remove metal or minerals. |
18(1)(m) Redevances, etc. " toute somme (autre qu"une somme prescrite) payée ou devenue payable au cours de l"année par une loi ou une obligation contractuelle qui remplace une obligation imposée par une loi (i) à Sa Majesté du chef du Canada ou d"une province; (ii) à un mandataire de Sa Majesté du chef du Canada ou d"une province; ou (iii) à une corporation, commission ou association contrôlée directement ou indirectement, de quelque façon que ce soit, par Sa Majesté du chef du Canada ou d"une province à titre de redevance, de taxe (autre qu"une taxe ou fraction de taxe qui peut raisonnablement être considérée comme une taxe municipale ou scolaire), de loyer, de prime, ou à titre de somme, quelle que soit la façon dont elle est désignée, qui peut être raisonnablement considérée comme tenant lieu d"une telle somme, qui peut être raisonnablement considérée comme rattachée (iv) à l"acquisition, à l"aménagement ou à la propriété d"un avoir minier canadien ou d"un bien qui l"aurait été s"il avait été acquis après 1971, ou (v) à la production, au Canada,
tirés d"un puits de pétrole ou de gaz ou de ressources minérales situées au Canada sur un bien sur lequel le contribuable avait, à la date de cette production, le droit d"extraire du pétrole, du gaz naturel ou d"autres hydrocarbures apparentés ou le droit d"extraire des minéraux ou du minerai; |
To qualify for inclusion in income under para. 12(1)(o) or to be disallowed as a deduction under para. 18(1)(m), the Remitted Funds must be amounts that: (i) became receivable by the province, or were paid or became payable in the year to a province by reason of an obligation imposed by statute; (ii) are royalties or taxes or amounts, howsoever described, that may reasonably be regarded as being in lieu of any such amounts4; (iii) may reasonably be regarded as being amounts in relation to (a) the acquisition, development or ownership of a Canadian resource property; or (b) the production in Canada of petroleum, natural gas or a related hydrocarbon; and (iv) the production in Canada is from an oil or gas well situated on property in Canada from which the taxpayer had, at the time of the production, a right to take or remove petroleum, natural gas or a related hydrocarbon.
[13] The real debate in these proceedings is whether the Remitted Funds are royalties or taxes or amounts that may be reasonably be regarded "as being in lieu" of royalties or taxes.
PARTIES" POSITIONS
General Positions
[14] Mobil"s position is that the Remitted Funds should not be included in its income under paragraph 12(1)(o) of the Act but, if the Remitted Funds are included in income, it is entitled to a corresponding deduction in respect of the Remitted Funds, which deduction is not precluded by paragraph 18(1)(m) of the Act.
[15] The Defendant"s position is that the Remitted Funds must be included in income pursuant to paragraph 12(1)(o) of the Act or, alternatively, they cannot be deducted from income pursuant to paragraph 18(1)(m) of the Act.
Royalty
[16] Mobil begins by submitting that the Remitted Funds are not royalties. Mobil submits that a royalty is a payment made for the right to explore for, bring into production, take or dispose of oil5. Mobil obtained the right to extract petroleum by entering into leases with the Saskatchewan Crown and pursuant to which it had to pay royalties to the Crown. Since the RACOA does not grant Mobil any right, Mobil argues that the Remitted Funds are not royalties.
[17] In support of its proposition that the Remitted Funds are not royalty payments, Mobil refers to the decision of the Alberta Court of Queen"s Bench in Suncor Inc . v. Norcen International Ltd.6. Mobil submits that the Court in Suncor made a clear distinction between payments made in respect of the Crown"s interest in lands from which minerals were extracted, which are royalty payments, and payments made to the Crown, pursuant to the RACOA , which are payments made in respect of the Crown"s ownership interest in oil.
[18] In Suncor, the facts were that two oil companies had leased land from the Crown and subsequently had subleased their interest to a third party, a predecessor company to Suncor Inc. The third party was required, under the terms of the sublease, to pay royalties to the sublessors as well as to the Crown, under the Crown lease. An action was brought by Suncor to recover what it alleged were overpayments in regard to royalties. The basis of the action was that the royalties payable to the sublessors had been calculated without deducting the royalties payable to the Crown. In other words, the royalties payable to the sublessors had been calculated on 100 per cent rather than 100 percent less the royalties payable to the Crown. In Suncor, the RACOA was not at issue.
[19] In arguing that the Remitted Funds are not royalties, Mobil also referred to the decisions of the Exchequer Court of Canada and the Judicial Committee of the Privy Council in B & B Royalties v. MNR7 and MNR v. Spooner8 for the proposition that royalties must be paid, for example in a lessor-lessee relationship, in order to obtain a right. In B & B Royalties, at page 370, "royalty" was defined as follows:
| The term "royalty", I think, more properly applies to the interest in production reserved by the original lessor by way of rent for the right or privilege of taking oil or gas out of a designated tract of land. |
[20] In MNR v. Spooner, a taxpayer sold her interest in twenty acres of land for money, shares and a royalty of 10 per cent of petroleum, natural gas and oil produced from land. Lord MacMillan, for the Judicial Committee of the Privy Council, in discussing the nature of a royalty, states at page 500:
| [T]he share which the respondent became entitled to receive of the oil from the land which she had sold to the company was not a royalty in the sense of s.27, or in the ordinary sense familiar in the case of mining leases where the lessor stipulates for payment by his lessee of a fixed rate per ton of the mineral won. Here there is no relation of lessor and lessee. The transaction was one of sale and purchase. |
[21] Mobil submits that although a relationship of lessor and lessee exists between the Saskatchewan Crown and Mobil, as a result of lease agreements entered into between them, the payments made under the RACOA were not made pursuant to or as a result of such a relationship and, therefore, the Remitted Funds are not royalties9.
[22] The Defendant submits that the word "royalty" is not a term of art. It can mean different things and its meaning must be determined from the particular circumstances of its use10. The Defendant further submits that the term "royalty" refers to compensation paid by one for the use of property owned by another11, and that a "royalty" is a percentage payment out of production.
[23] The Defendant further submits that royalty payments can occur even where there is no lessor-lessee relationship between the recipient and the payor of the royalty. However, because of the way the industry works, there will always be a lease. This is the reason why the notion of "royalty" has become tied up with the notion of a lease.
[24] The Defendant further submits that a liberal interpretation of the term "royalty" is appropriate given the broad wording in paragraphs 12(1)(o) and 18(1)(m) of the Act .
[25] Given the fact that the Plaintiff has not met its onus of proving that the Remitted Funds are not royalty payments, the Defendant argues that the Remitted Funds are indeed royalties.
Tax
[26] Mobil next submits that the Remitted Funds are not taxes. Mobil submits that the amounts remitted by Mobil under the RACOA relate to the delivery to the Saskatchewan Crown of amounts received by Mobil on the sale of property owned by the Saskatchewan Crown and, therefore, are not taxes since Mobil is simply remitting to the Saskatchewan Crown amounts which already belong to it.
[27] Mobil further submits that if the Remitted Funds are taxes, they are indirect taxes that the Saskatchewan legislature cannot impose. As such, if there is any doubt how the RACOA should be construed as to whether the Remitted Funds are or are not taxes, in keeping with the presumption of constitutionality, this ambiguity should be resolved by construing the relevant legislation so as to render it constitutional.
[28] The Defendant submits that the Remitted Funds satisfy the criteria of taxes because they are enforceable by law under ss. 9 and 10 of the RACOA, they are imposed under the authority of the Saskatchewan legislature, a public body, and they are made for a public purpose, the raising of revenue in and for the Province of Saskatchewan12.
[29] The Defendant relies on the Supreme Court of Canada"s decision in Canadian Industrial Gas and Oil Ltd. v. Government of Saskatchewan et al.13 ("CIGOL") where Dickson J., as he then was, in a dissenting opinion, described the difference between a royalty and a tax in the following terms:
| The first question to be determined in respect of a royalty surcharge, therefore, is whether the royalty surcharge is a royalty or a tax. The answer to that question turns on whether the Province, in imposing the royalty surcharge, was acting qua lessor or qua taxing authority. In other words, was the relationship of the Legislature vis à vis the oil producer that of lessor-lessee or was the true character of the relationship that of sovereign taxing authority-tax-payer.14 |
| ... In general terms, a royalty as applied to an oil and gas lease is a share, as provided in the lease, of the oil or gas produced, or the proceeds thereof, for the privilege of exploring for and recovering oil and gas. The conventional royalty is a flat percentage, frequently 12"%, of oil and gas produced. Section 58(1) of the Petroleum and Natural Gas Regulations, 1969 , illustrates a conventional royalty on a graduated basis. A tax, on the other hand, is a compulsory contribution, imposed by the sovereign authority for public purposes or objects. Duff, J., made that point in Lawson v. Interior Tree Fruit & Vegetable Committee, [1931] 2 D.L.R. 193 at pp. 197-98, [1932] S.C.R. 357 at p. 363. He identified certain levies as taxes and in so doing applied the following criteria: (i) enforceable by law; (ii) imposed under the authority of the Legislature; (iii) imposed by a public body; (iv) for a public purpose; see also Lower Mainland Dairy Products Sales Adjustment Committee v. Crystal Dairy Ltd., [1933] 1 D.L.R. 82, [1933] A.C. 168, [1932] 3 W.W.R. 639. In A.-G. B.C. v. Esquimalt & Nanaimo R. Co., supra, a forest protection fund levy was said to be a tax since it was imposed compulsorily by legislation and was recoverable at the suit of the Crown, even though it applied to a limited class of persons, was for a specific purpose, and its proceeds did not fall into general revenue. |
| Section 63(1) of the Regulations imposes the royalty surcharge on "oil produced or deemed to be produced from Crown lands". That imposition touches persons who are not in any contractual relationship with the Crown, such as those who assigned Crown leases but retained a gross override, or those persons who purchased royalty trust certificates under the terms of a royalty trust. It is hard to see that these people stand in a contractual relationship with the Crown. The obligation arises by legislative command, not by a process of negotiation between free wills, resulting in a meeting of minds.15 |
[30] Although Dickson J. dissented from the majority, Martland J., who wrote the majority decision, made it clear that he agreed with Dickson J. that the royalty surcharge was a tax. This is how he put it:
| I agree with the reasons of my brother Dickson for concluding that the royalty surcharge is a tax imposed upon Crown lessee of the same nature as the mineral income tax imposed upon lessee holding leases from freehold owners. It is significant that the royalty surcharge is computed in the same manner as the mineral income tax, and that the proceeds of both are to be paid into the same fund.16 |
[31] On the authority of CIGOL, the Defendant submits that the Remitted Funds are taxes. Specifically, the Defendant submits that the relationship of the Saskatchewan legislature to the oil producer is not that of lessor and lessee, but rather that of sovereign taxing authority and taxpayer, and that the obligation to pay the Remitted Funds arises by legislative command and not by contract.
[32] The Defendant submits, in response to Mobil"s assertion that the Remitted Funds cannot be taxes because taxes entail the Crown taking something that does not belong to it, that prior to the enactment of the RACOA , the concept of capture, which gave the driller absolute ownership in all oil, governed. The rule of capture provides that, for substances such as oil that migrate around when a well is drilled, the driller can take what comes out of the well despite the fact that some of the oil might have migrated from a neighbour"s land. The Defendant submits that the RACOA abrogated the rule of capture by providing that only 98.12 per cent of the oil belongs to the driller and the rest belongs to the Crown. As such, until the enactment of the RACOA, the 1.88 per cent of oil in the reservoir that now belongs to the Crown, belonged to the driller and so it cannot be said that the oil always belonged to the Crown.
Amounts In Lieu of Royalties or Taxes
[33] Mobil submits that the Remitted Funds are not amounts that may reasonably be regarded as being in lieu of either a royalty or tax, since there was no obligation in respect of a royalty or tax to which the Remitted Funds were substituted.
[34] The Defendant submits that if the term "in lieu of either a royalty or tax" required that there be an obligation in respect of a royalty or tax, the term would be meaningless and the words "in lieu of" would essentially be read out of the Act . The Defendant submits that the expansive language of paragraphs 12(1)(o) and 18(1)(m) of the Act suggests a flexible interpretive approach to the meaning of "a reasonable amount in lieu of". Rather, the Defendant submits, a payment in lieu of a royalty or tax will be one that partakes of the essential features of a royalty or tax.
Canadian resource property
[35] Mobil submits that the Remitted Funds do not fall within the ambit of the second criteria in paragraph 12(1)(o) of the Act, namely that the Remitted Funds "may reasonably be regarded in relation to the acquisition, development or ownership of a Canadian resource property". Mobil submits that the Remitted Funds may not so reasonably be regarded because the RACOA gives Mobil no rights.
[36] The Defendant submits that Mobil was given a right under the RACOA: a right to .88 per cent of oil that did not belong to Mobil but belonged to the Crown.
[37] The Defendant further submits that Mobil, by reasons of paragraphs 8 and 9 of the Agreed Statements of Facts17, has admitted that the Remitted Funds are amounts that may reasonably be regarded as being in relation to the ownership of a Canadian resource property or the production in Canada of petroleum, natural gas or related hydrocarbons, and that the said production is from an oil or gas well situated on property in Canada from which Mobil had, at the time of such production, a right to take or remove petroleum, natural gas or related hydrocarbons.
[38] The Defendant finally submits that the RACOA requires owners or those persons holding Canadian resource properties to pay 1 per cent of production. So, the 1 per cent is the amount that is in relation to the ownership of a Canadian resource property.
Deduction
[39] Mobil submits that if the Remitted Funds are included within income, they are entitled to a deduction under s. 18(1)(m) of the Act.
[40] Mobil submits that the language of paragraph 18(1)(m) tracks the language of paragraph 12(1)(o) of the Act. Paragraph 12(1)(o) requires certain items to be included in income. The purpose of paragraph 18(1)(m) is to prevent the taxpayer from taking a deduction for those same items once they are included in income. It follows that if the Remitted Funds do not fall within the ambit of paragraph 12(1)(o), then they will not fall within the ambit of paragraph 18(1)(m). Accordingly, Mobil submits that a deduction for the Remitted Funds is not prohibited by paragraph 18(1)(m).
[41] The Defendant"s position is quite straightforward. The Remitted Funds must be included in income, pursuant to paragraph 12(1)(o) and cannot be deducted from income, pursuant to paragraph 18(1)(m) of the Act.
[42] The Defendant submits that paragraph 18(1)(m) mirrors the wording of paragraph 12(1)(o), except that whereas paragraph 12(1)(o) relates to an amount receivable by the Crown, paragraph 18(1)(m) relates to an amount payable to the Crown. The Defendant submits that the effect of this inclusion/non-deduction scheme is to deny to taxpayers the ability to reduce their income by any of the payments to the Crown which are described in these provisions.
[43] The Defendant submits that the allowable deduction is the resource allowance provided for in paragraph 20(1)(v.1) of the Act:
| 20(1)(v.1) Resource allowance " such amount as is allowed to the taxpayer for the year by regulation in respect of oil or gas wells in Canada or mineral resources in Canada; |
20(1)(v.1) Déduction en matière de ressources. " les sommes que le contribuable est autorisé, par voie de réglement, à déduire pour l"année, au titre de puits de pétrole ou de gaz ou de ressources minérales situés au Canada; |
[44] In support of its overall position, the Defendant referred me to the Budget Speeches made by the Federal Minister of Finance, the Honourable John Turner, in May and November of 1974, wherein he introduced the income tax legislation at issue in these proceedings and whereby he indicated that the revenues derived by provincial governments in respect of petroleum and mineral resources should no longer be deductible in computing a taxpayer"s income:
| ... I am proposing that revenues derived by provincial governments in respect of production from petroleum or mineral resource should no longer be deductible in computing the income of the operator of the resource. 18 |
[45] Bearing in mind the practice of the provinces to charge the resource industry but to not consider those charges as taxes, the Minister of Finance proposed to consider the charges as income and disallow their deduction:
| ... I proposed that royalties, taxes and other like payments to governments should no longer be recognized as a deduction in computing income for tax purposes. My reasons for this action were described in the May 6 budget and I have elaborated upon them since. I am satisfied that this is a necessary step in order to avoid the erosion of the federal tax base. |
| I have considered carefully permitting deductibility of royalties and I have concluded that this approach does not offer a practical solution. |
| I acknowledge that royalties in respect of property rights have traditionally been deductable as a business expense. However, in tax reform we began the process of disallowing certain income royalties in the mineral field and substituting federal tax abatements. Today, it is evident that a royalty is no longer a royalty in the traditional meaning of the word. There have emerged various provincial charges which are thinly disguised income taxes. |
| Today provincial charges take many forms. They are no longer limited to flat charges against a unit of production. Now there are provincial charges that are determined by price, profit and volume. In addition, there are provincial claims exercised through joint ventures and marketing boards. In fact, there are so many kinds of provincial charges and claims that it would be virtually impossible to draft workable legislation which could distinguish between bona fide royalties, traditionally deductible, and other taxes and charges. |
| That being so, we have chosen to disallow the deduction of all these levies and to make room for the provinces by giving additional tax abatement. In this way, the provincial taxes and charges and the federal taxes will each be discrete and visible decisions, which each can take in the light of what they know the other is doing, giving full recognition to the needs of the industries.19 |
[46] Finally, the Defendant referred me to comments on the relevant provisions of the Act made by the learned authors of Taxation of Canadian Oil and Gas Income and of Canadian Taxation of Oil and Gas Income20. Firstly, the authors of Taxation of Canadian Oil and Gas Income offer the following comments at p. 5-12:
| Prior to May 6, 1974, taxpayers were allowed to deduct in computing taxable income the royalties, taxes and other payments made to provincial governments in respect of their resource activities. Following the sharp increases in the price of oil and natural gas in 1973 and 1974, the provinces increased the level of their royalties. The federal government felt that this action by the provinces resulted in an erosion of the federal tax base and, effective May 6, 1974, the federal government amended the provisions of the Act so as to disallow all provincial and other Crown levies on oil and natural gas production as a deduction from taxable income. |
As for the authors of Canadian Taxation of Oil and Gas Income, they state the following at pp. 161-162:
| BACKGROUND |
| Until May 6, 1974 the federal government allowed a deduction in computing taxable income for royalties and taxes levied by the various provincial governments on oil and gas production. In 1971 the federal government announced its plan to disallow mining taxes as a deduction in computing mining income as of January 1, 1977 and to allow a special reduction of federal tax on mining income instead. It intended to continue to allow royalties, such as are levied on oil and gas production, as a deduction beyond that date, and to tax oil and gas income at standard rates. In anticipation of the disallowance of the taxes but not of royalties, various provinces proceeded to increase the level of their royalties, and to appropriate to themselves an increased share of resource income through such guises as monopolistic marketing boards. As well, provinces such as Saskatchewan proceeded to levy special taxes on production from freehold land. The federal government felt the provinces were eroding its fiscal base and it reacted by disallowing all provincial and other Crown levies on oil and gas production as a deduction in computing taxable income. In lieu of the deduction for royalties, the government allowed a special reduction of federal tax on oil and gas income. At the start of 1976, the special tax rate reduction was replaced by the resource allowance. |
| ... |
| METHOD OF DISALLOWANCE |
| The federal government achieved disallowance of deductions for provincial oil and gas levies through four sets of provisions. The first provision requires a taxpayer to include in income the value of any production that vests in the Crown (paragraph 12(1)(o)). The second provision disallows most amounts paid to the Crown on account of oil, gas or mineral production or to maintain an oil, gas or mineral lease (paragraph 18(1(m). The third provision, ... |
| The provincial governments have shown remarkable imagination in structuring resource levies. The broad drafting approach of the Income Tax Act provisions denying a deduction for these levies reflects the federal government"s wish to protect its revenues from the provinces. The operating companies are left to fend for themselves. |
ANALYSIS
[1] It is not disputed that pursuant to section 3 of the RACOA, 1.88 per cent of the oil coming out of a well belongs to the Saskatchewan Crown. Sections 4 and 5 set out the options for providing oil or a payment for the value of the oil to the Crown. Section 6 provides that, of the 1.88 per cent, the producer can retain .88 per cent to cover his costs of producing the Crown"s 1.88 per cent of the oil.
[2] In Imperial Oil Ltd. v. Placid Oil Co.21, the Supreme Court of Canada was called upon to examine the Saskatchewan Crown"s property rights under s. 3 of the RACOA . At issue was a non-Crown oil lease which provided for the payment of royalties based on oil production from the particular property. The lease provided that if the lessor"s property interest in the leased substance was less than an undivided fee simple, the royalties should then be prorated. In other words, if the lessor did not own the entire property, the royalties would be prorated. Imperial, the lessee under the lease, and Placid Oil entered into a farm-out agreement with an overriding royalty provision to pay on production 5 per cent of the value of all crude oil and naphtha produced. Placid Oil, when paying the royalties to the lessor and to Imperial in respect of its production of oil from the lands, computed the total production of the oil less 1.88 per cent and claimed that it was entitled to the deduction by reason of the RACOA .
[3] The issue which the Court had to decide was whether Placid Oil was liable, upon paying the royalties to the lessor under the lease and to Imperial under the farm-out agreement, to pay in respect of all the oil produced by it from the lands or to pay a royalty on that quantity produced less 1.88 per cent or that quantity less 1 per cent thereof.
[4] The Supreme Court held that the obligation to pay royalties was upon the leased substances owned by the lessor and leased and granted by him to the lessee. Since pursuant to s.3 of the RACOA, 1.88 per cent of the oil belonged to the Crown, it followed that the lessee could not be compelled to pay a royalty upon oil which did not belong to him. The Court also found that Placid Oil could not be obligated to pay a royalty to Imperial under the farm-out agreement in regard to that portion of the oil which it produced not as a result of rights obtained pursuant to the lease, but pursuant to the provisions of the RACOA.
[5] It is my view that the Remitted funds are royalties and, if not, they are "amounts" that may reasonably be regarded as being in lieu of royalties. My reasons for so concluding are the following.
[6] In Imperial Oil, Martland J., for the Court, at pages 247 and 248, made the following comments regarding the Crown property rights under the RACOA::
| ... Section 3 refers to a "producing oil reservoir"; i.e. , a reservoir from which oil, as defined in para. 3 of s. 12, is being produced; namely, crude oil and those other hydrocarbons which, regardless of gravity, are produced at a well in liquid form by ordinary production methods. In such a reservoir 1.88% of the oil which is recoverable is declared to be the property of the Crown. In my opinion, the consequence of this provision is that, of the oil which is actually produced from a producing reservoir, 1.88% belongs to the Crown. |
| [,,,] |
| Section 3, however, declares a property interest in the Crown of 1.88% of all the recoverable oil within the whole of a producing reservoir. This is a property interest, not in relation to oil situated beneath the surface of specific lands, but in respect of a portion of all the oil in the whole of a reservoir. The result is that, no matter to where the oil in that reservoir migrates, the Crown"s interest remains in it and, on production, the property interest still remains. |
| This view of the effect of s. 3 is reinforced by the wording of s. 6. After the Act has provided for the payment to the Crown of 1% of the value of all oil produced, or for the delivery of that percentage in kind in lieu of payment, s. 6 then goes on to provide that the owner may retain and dispose of "oil declared by section 3 to be the property of the Crown" to the extent of .88% of the oil produced. This is a clear indication that the declaration contained in s. 3 was as to the ownership of oil produced from a reservoir and that of the 1.88% thereof belonging to the Crown the owner, after paying for or delivering 1% to the Crown, would be free to dispose of the remaining portion of the Crown interest for his own benefit. |
| Applying this view of the effect of s. 3 of the Act, it must, I think, follow that the respondent cannot be compelled to pay royalty, under the provisions of the lease or the farm-out agreement, upon all the oil produced from the lands, because, of that oil, 1.88% is the property of the Crown. |
| In so far as the lease is concerned, the obligation to pay royalty is upon the leased substances owned by the lessor and leased and granted by him to the lessee. The lessee cannot be compelled to pay royalty upon oil which does not belong to the lessor and this conclusion, which, I think, must follow, even apart from the provisions of cl. 4 of the lease, is reinforced by the terms of that clause. |
| Similarly, in my opinion, the respondent cannot be obligated to pay royalty to the appellant, under the farm-out agreement, on that portion of the oil which it produces, not by virtue of rights conferred upon it by the lease, but pursuant to the provisions of the Act. |
[7] As I have already indicated, the issue before the Supreme Court in Imperial Oil was whether Placid Oil was liable to pay royalties to the lessor under the lease and to Imperial under the farm-out agreement, in respect of all the oil produced by it from the lands. The Supreme Court answered that question lin the negative when it concluded that Placid Oil was not obligated to pay royalties to the lessor and to Imperial in respect of the 1.88 per cent of the recoverable oil owned by the Crown pursuant to the RACOA. That, in my view, is the only issue decided by the Supreme Court in Imperial Oil.
[8] It goes without saying that the Supreme Court did not decide, nor was it called upon to decide, whether the payment of 1 per cent of the value of the recoverable oil, which the owner of the oil-producing reservoir had to make pursuant to para. 4(1) of the RACOA, was a royalty or an amount in lieu of a royalty. The expression "royalty", as it was considered by the Supreme Court in Imperial Oil , was only considered in the context of the contractual relationships between the parties which arose by reason of a lease and a farm-out agreement.
[9] After careful consideration of the authorities to which both sides referred me, I am of the view that the position taken by the Defendant is correct. I accept the Defendant"s submission that the essential feature of a royalty is a payment to the owner of a resource from the production of that resource.
[10] In paragraphs 32 to 35 of its written submissions, the Defendant makes the following points, with which I am in complete agreement:
| 32. The application of the RACOA to freehold lands results in the freehold lessor"s property right beilng reduced to 98.12% of the produced oil. Without this legislation, the Crown would have no right to any part of the oil produced from freehold lands. The effect of the deeming provision in s. 3 of the RACOA, therefore, is to permit the Crown to impose a royalty obligation on both freehold and Crown lands. |
| 33. It is submitted that, applying the concept of the royalty as "the means by which the mineral owner shares in production of the substances from his land", the 1% levy under s.4(1) of the RACOA is a royalty. |
| 34. As a result, freehold land is subject to a two-tiered royalty regime: one regime imposed under the freehold lease in respec tof 98.12% of production and a second regime imposed under the RACOA in respect of 1.88% of production. |
| 35. This two-tiered regime is applicable to Crown lands as well: one regime imposed under the Mineral Resources Act and the Petroleum and Natural Gas Regulations thereunder in respect of 98.12% of production and a second regime imposed the RACOA in respect of 1.88% of production. |
[11] If one accepts, as I do, that the essential feature of a royalty is the concept of a payment to the owner of the resource from production, then it follows, in my view, that the sums remitted by Mobil to the Saskatchewan Crown, pursuant to the RACOA, are royalties or amounts paid in lieu of royalties22.
[12] The position taken by Mobil regarding the meaning of the words "in lieu of either a royalty or a tax" is, in my view, untenable. As the Defendant submits, requiring that the words "in lieu of either a royalty or a tax" be premised on the existence of an obligation in respect of a royalty or a tax, would render the words "in lieu of" meaningless. I agree entirely with the Defendant that an amount "in lieu of a royalty or a tax" is an amount that partakes of the essential features of a royalty or a tax. In my view, there is no doubt that the funds remitted by Mobil pursuant to the RACOA partake of the essential features of a royalty, in that the owner of 1.88 per cent of the recoverable oil from every producing reservoir requires from the oil producers payment of 1 per cent of production. I agree entirely with the submission made by the Defendant in paragraph 44 of its written submissions:
| The net effect of the RACOA is that the Crown in right of the Province takes a 1% share of all oil production in the Province. It is submitted that there is no substantive difference between a royalty and the provincial claim under the RACOA. |
[13] Since I am of the view that the Remitted funds are royalties or amounts in lieu of royalties, I need not decide whether the Remitted Funds are taxes or amounts in lieu of taxes.
[14] I am also satisfied that the Remitted Funds are amounts in relation to the acquisition, development or ownership of a Canadian resource property, or in relation to the production in Canada of petroleum, and that the said production is from an oil or gas well situated on property in Canada from which Mobil had, at the time of production, a right to take or remove petroleum. Thus, the Remitted Funds satisfy the criteria set out at subparagraphs 12(1)(o)(iv) and (v) of the Act.
[15] Paragraph 66(15)(c) of the Act defines Canadian resource property as follows:
| "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 related hydrocarbons in Canada, (ii) any right, licence or privilege to prospect, explore, drill or mine for minerals in a mineral resource in Canada, (iii) any oil or gas well situated in Canada, (iv) any rental or royalty computed by reference to the amount or value of production from an oil or gas well, or a mineral resource, situated in Canada, (v) any real property situated in Canada the principal value of which depends upon its mineral resource content (but not including any depreciable property situated on the surface of the property or used or to be used in connection with the extraction or removal of petroleum or natural gas therefrom), or (vi) any right to or interest in any property (other than property of a trust) described in any of the subparagraphs (i) to (v) (including a right to receive proceeds of disposition in respect of a disposition thereof); |
"Avoirs miniers canadiens" d"un contribuable signifie tout bien que celui-ci a acquis après 1971 et qui est (i) un droit, permis ou privilège afférent aux travaux d"exploration, de forage ou d"extraction, relatifs au pétrole, au gaz naturel ou à d"autres hydrocarbures apparentés au Canada, (ii) un droit, permis ou privilège afférant aux travaux de prospection, d"exploration, de forage ou d"extraction, faits en vue de la découverte de minéraux dans une ressource minérale au Canada, (iii) un puits de pétrole ou de gaz situé au Canada, (iv) tout loyer ou toute redevance calculée en fonction du volume ou de la valeur de la production d"un puits de pétrole ou de gaz, ou d"une ressource minérale située au Canada, (v) tout bien immobilier situé au Canada et don"t la principale valeur dépend de son contenu en matières minérales (mais à l"exclusion de tout bien amortissable se trouvant à la surface de ce bien ou utilisé ou devant être utilisé dans le cadre de l"extraction ou du prélèvement de minéraux provenant de ce bien), ou (vi) tout droit afférant à des biens (y compris le droit de recevoir le produit d"une disposition) visés à l"un ou l"autre des sous-alinéas (i) à (v); |
[16] More particularly, subparagraph 66(15)(c)(i) defines "Canadian resource property" as "any right, license or privilege to explore for, drill for or take petroleum, natural gas or related hydrocarbons in Canada". This is precisely what the leases entered into by Mobil with the Saskatchewan Crown conveyed to Mobil. Section 50 of the Saskatchewan Petroleum and Natural Gas Regulations , 1969 provides that:
| Subject to these regulations, each lease shall, unless otherwise specifically provided for in the lease, grant the lessee the exclusive right, licence, privilege and authority to search, dig, bore and drill for oil and gas within the lands described in the lease and to win, get, recover, procure, carry away, dispose of and sell the oil and gas found within such lands:23 |
[17] Pursuant to subsection 4(1) of the RACOA, Mobil, as the owner of an oil producing reservoir, was liable to pay to the Crown 1 per cent of the value of the oil produced. Section 2 of the RACOA defined "owner" as follows:
| ... a person who has a right to drill into an underground reservoir and produce therefrom oil or gas and to appropriate the oil or gas he produces either to himself or others, or to himself and others. |
[18] Consequently, under the RACOA, the owner of a Canadian resource property is required to pay 1 per cent of production to the Crown. It, therefore, cannot be disputed that the Remitted Funds are amounts in relation to the ownership of a Canadian resource property. It also cannot be disputed, in my view, that the production is from an oil or gas well situated on property in Canada from which Mobil had a right to take or remove petroleum, natural gas or related hydrocarbons.
[19] As paragraph 18(1)(m) of the Act mirrors the wording of paragraph 12(1)(o), and as the Remitted Funds meet the criteria set out at paragraph 12(1)(o) of the Act, it follows, in my view, that the Remitted Funds cannot be deducted from income under paragraph 18(1)(m) of the Act
[20] Before concluding, I wish to make it clear that in reaching the conclusion that the Remitted Funds are royalties or amounts in lieu of royalties, I have given no weight whatsoever to the budget speeches of the Minister of Finance when he introduced the legislation at issue.
[21] For these reasons, these appeals from the Minister"s Notices of Reassessment shall be dismissed. The Defendant shall be entitled to its costs.
"Marc Nadon"
JUDGE
CALGARY, Alberta
October 08, 1999
__________________1 Income Tax Act, S.C. 1970-71-72, c.63, as amended, and the regulations made thereunder, in force in 1977, 1978, 1979 and 1980.
2 The Agreed Statements of Facts were filed as Exh. P-1A, P-1B, P-1C and P-1D.
3 The Road Allowances Crown Oil Act, R.S.S. 1965, c.53, as amended. This Act came into force on April 1, 1959. For the purpose of these appeals, sections 3, 4, 5 and 6 of the RACOA are relevant and they provide as follows: 3. In every producing oil reservoir one and eighty-eight one-hundredths per cent of the recoverable oil shall be deemed to be within, upon or under road allowances and shall be the property of the Crown. 4. (1) Except as provided in section 5, every owner producing oil shall be liable to pay and shall on or before the last day of each month pay to the minister, one per cent of the value, calculated on the average prevailing well-head price, of the oil produced, free and clear of any deductions, during the preceding month. (2) For the purposes of subsection (1), "average prevailing well-head price" means the price of a barrel of the oil produced from a well, calculated by taking the total sale price of all barrels of oil from the well sold during the month in respect of which the average prevailing well-head price is to be calculated, and deducting therefrom the cost of transporting the oil from the well or battery to the point of sale, and dividing the difference so obtained by the number of barrels of oil sold at that point during the said month. 5. (1) Instead of payment as required by section 4, the minister may elect to receive payment in kind for all or any portion, as designated by him, of one per cent of the oil produced during the month in respect of which payment is to be made, by taking delivery of such oil or designated portion thereof; and where the minister so elects, the owner shall deliver such oil or such designated portion thereof at the time and place and in the manner specified by the minister. (2) Where under subsection (1) the minister requires oil to be delivered at a place other than the place of production of the oil and is satisfied that the proceeds of the sale by the owner of eight-eight one-hundredths of one percent of the oil produced during the month in respect of which payment is to be made are not sufficient to cover the cost of production during that month of the oil declared by section J to be the property of the Crown and the cost of delivery as required by the minister, the minister may authorize the owner to make such deduction from the quantity of oil to be delivered as the minister deems just and reasonable. (3) Where under subsection (1) the minister elects to take delivery of a portion only of one percent of the oil produced during the month in respect of which payment is to be made, section 4 shall apply mutatis mutandis with respesct to payment for the balance of the said one per cent of the oil of which the minister does not require delivery. 6. Subject to compliance with section 4 or 5, every owner producing oil may retain and dispose of oil declared by section 3 to be the property of the Crown to the extent of eighty-eight one-hundredths of one per cent of the oil produced, or the proceeds of the sale thereof, for his own use and benefit.
4 The Defendant has conceded that the Remitted Funds are not lease rentals or bonuses.
5 Ross v. MNR 50 DTC 775 (Ex. Ct.).
6 (1988), 89 A.R. 200 (Alta Q.B.).
7 [1940] 4 D.L.R. 369 (Ex. Ct.).
8 [1933] 3 D.L.R. 497 (P.C.); affirming [1931] S.C.R. 399.
9 Mobil also referred me to the decision of the Supreme Court of Canada in Imperial Oil Ltd. v. Placid Oil Co. (1963), 39 D.L.R. (2d) 244 (S.C.C.). I will be discussing this decision later on in these Reasons.
10 Bensette v. Reece, [1973] 2 W.W.R. 497, at p. 499 (Sask. C.A.); Vanguard Petroleums Ltd. v. Vermont Oil & Gas Ltd. [1977] 2 W.W.R. 66, at pp. 70 and 75.
11 Black"s Law Dictionary, 5th ed.
12 Lawson v. Interior Tree Fruit & Vegetable Committee, [1931] 2 D.L.R. 193 at pp.197-198; [1932] S.C.R. 357 at p 363..
13 Canadian Industrial Gas and Oil Ltd. v. Government of Saskatchewan et al. (1977), 80 D.L.R. (3d) 449.
17 These paragraphs read as follows:8. In its 1977 taxation year, Mobil remitted $551,034 (the "Road Allowance") to the Province of Saskatchewan in satisfaction of its obligation under the Road Allowance Act. This was 1% of the value, calculated on the average well head price, of the oil produced by Mobil in Saskatchewan. Mobil was not required by the Road Allowance Act to remit to the Province of Saskatchewan the remaining 0.88% deemed to be owned by the Province of Saskatchewan by the Road Allowance Act.9. All of the oil produced by Mobil lin Saskatchewan was produced from properties subject to leases pursuant to which Mobil had acquired the right to take or remove the said oil. Substantially all of the oil produced by Mobil lin Saskatchewan was from properties subject to crown leases. A copy of the standard form of such lease is attached.
18 Budget Speech, Minister of Finance, May 6, 1974.
19 Budget Speech, Minister of Finance, November 18, 1974.
20 J.B. Katchen & R.W. Bowhay, Taxation of Canadian Oil and Gas Income (De Boo Publishers, 1986), at 5-12 and J.V. Krukowski, Canadian Taxation of Oil and Gas Income, 2d ed. (Ontario: CCH Canadian Limited, 1987) at 161-162.
21 (1963), 39 D.L.R. (2d) 244 (S.C.C.).
22 The term "royalty" is defined and or explained as follows by the following authors:- Black"s Law Dictionary, 5th Edition, 1979 - In its broadest aspect, it is share of profit reserved by owner for permitting another to use a property;- John Bishop Ballem, The Oil and Gas Lease in Canada, 2nd Edition, University of Toronto Press - The royalty is the means by which the mineral owner shares in production of the substances from his land (chap. 7);- Joseph B. Katchen, Q.C. & Robert W. Bowhay, C.A., Taxation of Canadian Oil and Gas Income, Third Cumulative Supplement, 1991, De Boo Publishers - While it is difficult to define a royalty interest since these are creatures of contract and every contract could conceivably be different, ordinarily a royalty interest in a right to a portion of the oil or gas produced and marketed, payable either in kind or in money or both (p. 1-13).
23 The standard form of the leases entered into between the Saskatchewan Crown and Mobil provides NOW THIS LEASE WITNESSES that subject to the Mineral Resources Act and applicable regulations thereunder, as the Act or the regulations or any of them may be amended, revised or substituted from time to time and the covenants, conditions, restrictions and stipulations hereinafter contained, the Minister hereby leases unto the Lessee, the petroleum and natural gas within the meaning of The Petroleum and Natural Gas Regulations, 1969, as the same may be amended, revised or substituted from time to time, (hereinafter called "petroleum"), in so far as the Crown in the right of Saskatchewan has to right to grant the same, that are now or hereinafter may be found within, upon or under the following lands: