Date: 20020614
Docket: A-661-99
OTTAWA, ONTARIO, JUNE 14, 2002
CORAM: DÉCARY J.A.
BETWEEN:
RAINBOW PIPE LINE CO. LTD.
Appellant
and
HER MAJESTY THE QUEEN
Respondent
JUDGMENT
The appeal is dismissed with costs.
"Robert Décary"
J.A.
Date: 20020614
Docket: A-661-99
Neutral citation: 2002 FCA 259
CORAM: DÉCARY J.A.
ROTHSTEIN J.A.
MALONE J.A.
BETWEEN:
RAINBOW PIPE LINE CO. LTD.
Appellant
and
HER MAJESTY THE QUEEN
Respondent
Heard at Calgary, Alberta, on May 28, 2002.
Judgment delivered at Ottawa, Ontario, on June 14, 2002.
REASONS FOR JUDGMENT BY: ROTHSTEIN J.A.
CONCURRED IN BY: DÉCARY J.A.
MALONE J.A.
Date: 20020614
Docket: A-661-99
Neutral citation: 2002 FCA 259
CORAM: DÉCARY J.A.
BETWEEN:
RAINBOW PIPE LINE CO. LTD.
Appellant
and
HER MAJESTY THE QUEEN
Respondent
REASONS FOR JUDGMENT
[1] This is an appeal from a September 15, 1999 decision of the Tax Court. The sole issue on appeal is whether Mogan T.C.J. erred in concluding that capitalizing the cost of a 44 km replacement in the appellant's 781 km light crude oil pipeline from Zama to Edmonton provided a more accurate picture of the appellant's income for 1994 than expensing the cost of the replacement. The cost incurred for the replacement was $15,002,590.
[2] The appellant's position is that expensing yields a more accurate picture of its income for its 1994 taxation year than does capitalizing the expenditure. However, the appellant says that even if expensing or capitalizing were equally supported methods of computing income, the appellant should be entitled to elect the method it wishes to use.
[3] In finding against the appellant, Mogan T.C.J. wrote thorough reasons and, in my opinion, applied the correct legal principles to the issues before him. He did not err in his analysis or conclusion.
[4] No useful purpose would be served by a repetition of Mogan T.C.J.'s careful reasons here. It is sufficient to say:
1. He had regard to the decision of the Supreme Court of Canada in Canderel v. Canada, [1998] 1 S.C.R. 147, and in particular, to the principles for the computation of income set forth therein.
2. He had regard to well-accepted business principles to determine whether capitalizing or expensing the cost of the 44 km replacement provided a more accurate picture of the appellant's income for 1994 and concluded that capitalizing provided the more accurate picture.
3. He assessed the expert evidence of the appellant and respondent and, after a detailed consideration of that evidence, expressed his preference for the evidence of the respondent's expert which supported capitalizing the expenditure.
4. Having regard to the decision of the Supreme Court of Canada in Johns-Manville v. The Queen, [1985] 2 S.C.R. 46, and, in particular, to the considerations to be taken into account in deciding whether an expenditure should be capitalized or expensed, he concluded that the replacement should be treated as a capital expenditure and not as a current expense in 1994, on the basis that:
(1) it was non-recurring;
(2) it was a major repair;
(3) it brought into existence an asset for the enduring benefit of the appellant's business;
(4) the cost was substantial in relation to the book value of the whole pipeline, other expenses and annual profits;
I am of the opinion that his analysis and conclusion are unassailable.
[5] I will turn to the appellant's arguments, as I understand them, and explain why I do not find them persuasive.
1. The appellant says that the 44 km replacement was required for it to stay in business. Without it, the appellant could not operate its pipeline.
[6] I accept that the 44 km replacement was required for the appellant to remain in business. However, I am not aware of any overriding legal principle to the effect that every expenditure necessary to stay in business must be expensed rather than capitalized. Canderel, supra, is quite clear that well-accepted business principles are to be applied on a case-by-case basis, having regard to the facts of each case (at page 171). Johns-Mansville v. The Queen, supra, at pages 56-62, and especially page 61, is authority for the proposition that there are no fixed rules when determining whether to capitalize or expense an expenditure. On the evidence in Canderel, supra, the Supreme Court concluded that capitalizing tenant inducement payments over the term of the leases would not provide a more accurate picture of Canderel's income than would their immediate deduction in the year expended (page 180). On the evidence in this case, and based upon guidelines taken from the jurisprudence, Mogan T.C.J. found that capitalizing rather than expensing the expenditure would provide a more accurate picture of the appellant's 1994 income. It was open to him to so find.
2. The appellant says that the replacement was not a betterment and did not enhance the operation of the pipeline.
[7] Again, there is no rule that a replacement that is not a betterment must, according to well-accepted business principles, be expensed. Treating the matter on a case-by-case basis, it was open to Mogan T.C.J. to find on the facts here that the replacement should be capitalized.
3. The appellant says Mogan T.C.J. erred in comparing the cost of the 44 km replacement with the book value of the pipeline.
[8] I accept that for some purposes it may be misleading to compare current replacement costs with the original cost or depreciated book value of an asset. However, this comparison did not play an important part in Mogan T.C.J.'s analysis. His main focus was on comparing the replacement cost with other costs and income. Doing so, he concluded that expensing would distort the appellant's 1994 income. It was open to him to arrive at such a conclusion.
4. The appellant says Mogan T.C.J. erred in basing his decision on the fact that the appellant would have incurred a loss in 1994 if the expenditure were expensed.
[9] These considerations relate to the cost of the replacement in comparison with other costs and the income of the appellant. The expert evidence dealt with distorting the appellant's expenses and income as a consideration in the expensing-capitalizing determination. Therefore, it was not inappropriate for Mogan T.C.J. to have considered the distorting effect of expensing on the appellant's income.
5. The appellant says Mogan T.C.J. erred in comparing the pipeline to a railway.
[10] Mogan T.C.J. used the railway analogy to illustrate the difficulty in laying down a general rule or bright line to determine the expense or capitalization question on the basis of comparing a replacement as a percentage of the whole asset. His conclusion was that it was necessary to exercise judgment on a case-by-case basis. There is no error in this conclusion.
6. The appellant says that Mogan T.C.J. erred by preferring the evidence of the expert who relied on information and industry practice in the economically regulated pipeline industry, when the appellant's pipeline was not subject to economic regulation.
[11] I accept that there may be differences in accounting treatment as between regulated and non-regulated enterprises. However, the appellant does not explain why, in the case of a replacement of a continuous length of 44 km of pipeline, capitalizing that cost may be appropriate for a regulated entity but expensing the cost is appropriate for a non-regulated entity. Indeed here, for financial accounting purposes, the appellant chose to capitalize the expenditure. While that is not necessarily determinative of the most accurate picture of profit for income tax purposes, it does indicate that treating the expenditure as a capital outlay is not foreign to the non-regulated industry. Indeed, the respondent's expert compared the accounting policies for major renewals and maintenance between regulated and non-regulated entities and found that the practices were the same. The appellant has not demonstrated why Mogan T.C.J. erred in preferring the evidence of the respondent's expert.
[12] On the basis of the expert evidence, Mogan T.C.J. found that well-accepted business principles, including GAAP, ran against the appellant and, in particular, that there is much stronger support in GAAP in the circumstances of this case for capitalizing the replacement cost than expensing it. He further was influenced by the appellant's reason for capitalizing a replacement cost for financial accounting purposes - to spread the cost to shippers over the life of the pipeline or the reserves, as opposed to the shippers facing a sharply increased tariff in 1995. There is no error in his having regard to these considerations.
7. The appellant says Mogan T.C.J. erred in considering that the replacement was a non-recurring cost because there was no evidence to support that finding.
[13] This argument simply ignores what occurred. The 44 km pipeline was a replacement of the previously existing line. The appellant called it a replacement. The original line had been in place for close to thirty years. I think it is obvious that in replacing this type of asset that has been in place for a long period of time, the cost is intended to be a non-recurring cost. Any other interpretation would be unreasonable.
CONCLUSION
[14] Because I have found Mogan T.C.J.'s reasons thorough and cogent, and because the appellant has not persuaded me of any error in those reasons, I would dismiss the appeal with costs.
"Marshall Rothstein"
J.A.
"I agree
Robert Décary J.A."
"I agree
B. Malone J.A."
FEDERAL COURT OF APPEAL
NAMES OF COUNSEL AND SOLICITORS OF RECORD
DOCKET: A-661-99
STYLE OF CAUSE: Rainbow Pipe Line Company Ltd. and
Her Majesty the Queen
PLACE OF HEARING: Calgary, Alberta
DATE OF HEARING: May 28, 2002
REASONS FOR
JUDGMENT: ROTHSTEIN J.A.
CONCURRED IN BY: DÉCARY J.A.
MALONE J.A.
DATED: JUNE 14, 2002
APPEARANCES:
Mr. Barry R. Crump FOR THE APPELLANT
Ms. Kathleen T. Lyons FOR THE RESPONDENT
SOLICITORS OF RECORD:
Burnet, Duckworth & Palmer LLP FOR THE APPELLANT
Barristers & Solicitors
Mr. Morris Rosenberg FOR THE RESPONDENT
Deputy Attorney General of Canada