Tax Court of Canada Judgments

Date: 19990107

Dockets: 96-1239-IT-G; 96-1248-IT-G; 96-1231-IT-G; 96-1235-IT-G

BETWEEN:

KEVIN J. CAMPBELL, EDWARD DIELSCHNEIDER, ROCKY R. OISHI, DON PRICE,

Appellants,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Bell, J.T.C.C.

[1] The use of the term "Appellant" refers to each of the above Appellants, there being no difference in the facts attributable to each one.

ISSUE:

[2] The issue is whether the Appellant is entitled to a deduction in respect of "Canadian Exploration Expense" ("E") in excess of amounts claimed and allowed by the Minister of National Revenue ("Minister").

[3] All references in these Reasons to an Act are in respect of the Income Tax Act.

[4] E for the years in question was defined, inter alia, in subparagraph 66.1(6)(a)(iii) as

(6) In this section and sections 66, 66.2 and 66.4

(a) "Canadian exploration expense" of a taxpayer means any outlay or expense made or incurred after May 6, 1974 that is

(iii) any expense incurred by him for the purpose of determining the existence, location, extent or quality of a mineral resource in Canada including any expense incurred in the course of

(A) prospecting,

(B) carrying out geological, geophysical or geochemical surveys,

(C) drilling by rotary, diamond, percussion or other methods, or

(D) trenching, digging test pits and preliminary sampling, but not including

(E) any Canadian development expense, or

(F) any expense that may reasonably be considered to be related to a mine, whether or not owned by the taxpayer, that has come into production in reasonable commercial quantities or to be related to a potential or actual extension thereof, ...[1]

In subparagraph 66.1(a)(v) the definition of E also includes:

any expense referred to in any of subparagraphs (i) to (iii.1) incurred by the taxpayer pursuant to an agreement in writing with a corporation, entered into before 1987, under which the taxpayer incurred the expense solely as consideration for shares, other than prescribed shares, of the capital stock of the corporation issued to him or any interest in such shares or right thereto.[2]

[5] The taxation years appealed are 1985, 1986, 1987 and 1988.

[6] The computation of E will affect the amount of depletion and mining exploration depletion allowances.

FACTS:

[7] Mr. Ross Stanfield ("Stanfield") owned more than 99 percent of the issued and outstanding voting shares of Fort Steele Mineral Corporation ("Fort Steele") and Zeus Mining Corporation ("Zeus") and indirectly controlled Gallowai Metal Mining Corporation Ltd. ("Gallowai") and Bul River Mineral Corporation Ltd. ("Bul River"). These four companies are the only companies relevant in this appeal. These companies, in the taxation years in question, carried on mineral exploration programs on properties near Cranbrook in southeastern British Columbia. Bul River was the operator for the other companies in respect of exploration activities conducted under this flow-through share program. The mineral exploration program was financed by flow-through shares issued by Gallowai and Zeus.

[8] Approximately 200 investors, including the Appellant, purchased such shares in Gallowai and Zeus in the relevant years. A representative agreement, filed with the Court, between Gallowai and Don Price ("Price"), one of the Appellants, provided that Price would advance monies to Gallowai, that Gallowai would issue and allot Class B common shares to Price and that it would expend monies, as agent for and on behalf of Price, on its exploration program.

[9] The amounts of E claimed and the amounts of E allowed and disallowed by the Minister are as follows:

E claimed by Bul River:

1985	1986	1987	1988
$1,652,246	$1,769,415	$1,962,180	$1,527,485

E allowed:

1985	1986	1987	1988
$809,315	$744,389	$764,112	$655,161

E disallowed:

1985	1986	1987	1988
$842,931	$1,025,026	$1,198,068	$872,324[3]

These appeals are from the disallowance of those amounts.

[10] In the Reply to the Notice of Appeal the Minister is said to have relied on, inter alia, the following assumptions:

a) none of the expenses claimed by the Appellant and disallowed by the Minister of National Revenue were Canadian exploration expenses within the meaning of paragraph 66.1(6)(f) of the Income Tax Act;

b) the disallowed diamond drilling expenses relate to unreasonable rental charges by corporations related to Bul River Mineral Corporation Ltd.;

c) a reasonable diamond drilling charge did not exceed $20 per foot;

d) none of the disallowed percussion drilling expenses were incurred;

e) the disallowed CEE in respect of roadwork expenses did not relate to a specific drilling or exploration activity;

f) only a proportion of the camp expenses were allowed as CEE relating to that period when the exploration actually took place;

g) only 70% of the equipment rental, road expenses and B.C. payroll expenses in 1985 were CEE within the meaning of the Income Tax Act;

h) the CEE for 1985, 1986, 1987 and 1988 that were disallowed as either being:

i) expenses incurred but not CEE;

ii) expenses not incurred and not CEE; or

iii) unreasonable expenses and not CEE;

are attached as Schedules A, B, C and D respectively to this Reply.

[11] Mr. Benjamin Ainsworth ("Ainsworth") was accepted as an expert witness familiar with mineral exploration and prospecting in British Columbia. He submitted a report respecting the mineral exploration program of the aforesaid companies. He stated that his terms of reference were to collect and present evidence of the reasonableness of the mineral exploration program carried out through the period 1985 to 1988 particularly in light of normal industry procedures and the flow-through share regulations as he understood them. He said that it appeared that some expenditures had been disallowed by Revenue Canada because of

perhaps lack of understanding of exploration projects, practices and problems.

[12] He said that respecting drilling work the average cost determined by Revenue Canada was considerably lower than the maximum cost experienced by other exploration groups working in British Columbia. He stated that verification of some expenditures was complicated by poor records and missing vouchers, which was not uncommon among small mining companies attempting to keep their overhead as low as possible. He further said that some expenditures were disallowed because Revenue Canada

took upon itself to make a ruling that even when a project has had a demonstrated long life and even when provincial regulations require roads for exploration purposes to be maintained continuously, the exploration work using the road access must be carried out in a short timeframe to be connected as an adjunct exploration cost.

[13] He explained that he understood Revenue Canada to take the position that exploration and any road building had to be connected to exploration within two years of the time of the expenditure for road building or maintenance. He stated that he had never, in his experience, heard of such a two year period. His report included appendices respecting diamond, percussion and rotary drilling. He described diamond drilling as being typically more expensive saying that the cost per metre of diamond drilling would be approximately $35 a foot. He also said that the rate of $20 per foot used by Revenue Canada would appear to be a "very bare bones, basic, contract rate with none of the additional costs one normally associates with drilling".

[14] Ainsworth described the process of mineral exploration. The first step is the location of a mineral resource by prospecting, by satellite image analysis, by geochemical surveys involving the sampling of rock or soil materials and subsequent analysis of same. He added that geological mapping is important as is the sampling of rock material in natural outcrops or in hand or machine made trenches. He also spoke of the necessity of having access to the physical location of the mineral resource which would be by trail, road or helicopter.

[15] Ainsworth further testified that the owner of mineral claims in British Columbia must file an Assessment Report at least once a year showing the amount of work done in order to maintain claims in good standing. If the owner does not do that the owner is obliged to pay cash in lieu thereof. With respect to Assessment Reports he said that it is quite common for companies not to file all their information for two reasons. The first is the cost of filing which could be quite significant and the second is that there may be information that the company does not wish to reveal to its competitors, the information becoming public after a couple of years.

[16] He testified further that Bul River had carried out exploration over a long period of time. He said that

It's done it continuously for many years, including '85 and '88.

[17] He further testified, without challenge, explained that under British Columbia regulations the government required maintenance of access roads if future use of those roads was intended. If not maintained, it was required to close the roads and reclaim the land. He said that closing roads and reopening them would occasion much greater expense. He said that Bul River took advantage of being reasonably close to a large number of mineral showings and it extended that access with its own road system. He said that it was, in his view, the cost effective approach compared to using the alternative which is basically helicopter. The general tenor of his evidence was that the use of helicopters in high mountain country would be substantially more costly than the maintenance of roads to gain access to mineral claims

[18] He said with respect to percussion drilling that it looked as if Revenue Canada had based its decision on direct costs and did not include related costs such as mob-demob (mobilization and demobilization), fuel and other support costs, access, site preparation, geological supervision and campsites. He concluded with a statement that the costs were within the range of costs for British Columbia

[19] With respect to facilities he stated that he believed there was a cost of $3,000 a month for the total field office, core storage building and bunk houses. He stated that the machine shop was made as a separate charge. He then said that the costs were below industry norms. He stated that Gallowai, Zeus and Fort Steele owned various pieces of equipment which were leased to Bul River. These were exploration equipment including bulldozers, front-end loaders, backhoes and drills. There were also trucks and other equipment. He stated that the exploration work could not have been done without the equipment.

[20] When asked to summarize his conclusions, Mr. Ainsworth said:

The first conclusion was that all expenditures incurred relating to road work, including payroll, campsite, overhead, et cetera, are a proper adjunct of or to the exploration activity. I think Revenue Canada took a very rigid position disallowing some of the expenditures because of a lack of understanding of the exploration problems and norms and in particular the costs supporting the drill programs. Costs incurred because of standby are legitimate exploration expenses. In some cases the standby time, however, may appear to be high but there were probably extenuating circumstances that should be recognized. As an offset to that if costs for standby are not allowed there should be some allowance given for costs for mobilization and demobilization. Costs incurred for the campsite were not excessive and are within the costs typically incurred on other exploration projects. In that Appendix II where I looked at the Assessment Report filings and the documentation, the detail in which they described their expenditures, it's quite clear that its often that not a lot of detail for the costs for exploration related road work in British Columbia.

[21] On cross-examination, Ainsworth spoke of costs in addition to basic drilling costs. He stated that the expenses would include additives that are used to maintain the lubrication of the drill-string which could be drilling mud such as bentonite or barite to control water flows, much the same as barite is used in the oil patch. Such expenses would also include lost drill rods, wear and tear on the equipment, broken cables requiring replacement and core boxes normally being part of the direct drilling costs. He said that core boxes are used to store the solid cylinders of drilled core rock that the geologists would be inspecting. He also said there may be shut-downs because of bad ground and cementing so that time costs would be increased for the machine and for the crew. He said,

I don't have to know in detail anything about a given project. I know from experience that the cost will be more than the contract rate.

[22] He then referred to a current contract unrelated to the Appellant and stated that typically the overall drilling costs are often three times the contract rate.

[23] He explained that the companies in question were in business on a long-term basis and he implied that roads would not be easily abandoned. He also said that the fact that one actually has not found a locus of mineralization in one place on a claim does not mean that it is not useful to do exploration on that claim. He stated that the denial of mineralization underneath a certain piece of ground is

... almost harder than finding the mineral.

[24] Douglas Glenn Searle ("Searle"), branch manager for Bradley W. Manufacturing, a subsidiary of Bradley Brothers Drilling, a Canadian core contractor, testified that a skid mounted drill job in central British Columbia without helicopter support could cost as much as $58 to $62 with an "in-hole clause"[4]. This evidence was not compromised on cross-examination and was not contradicted by other evidence.

[25] Dennis de Souza ("de Souza"), a mining engineer, stated that he commenced providing consulting services to Bul River in the latter half of 1987. He said that he, from walking the property, knew of 27 mineral showings scattered throughout the property. He testified that the Dalton Mine Property, formerly owned by an unrelated person, produced 60,000 feet of diamond drill core. He stated that Bul River's exploration program produced approximately an additional 140,000 feet. He then said that all of that core had been stored. He stated that approximately 60,000 to 70,000 feet of diamond drilling took place during his currency with the company. De Souza's continuing evidence indicated that not all exploration was entered in the Assessment Report. He further testified that he had studied Government of Canada maps which were the result of "high level aerial geophysical survey" enabling him to outline certain areas of the property which had not been selected before. He also looked at other maps in older reports.

[26] He testified that Stanfield attended at the property every week. Specifically, he said

... I would imagine it's probably 80 to 85% every weekends would be down there. He would walk the hills, drive them, ride them. He would sit on the top of a mountain and formulate plans. I've been there with him. I've actively participated in this. This is something he has been doing since he first started acquiring claims in the area. ... Without a shadow of a doubt, it's prospecting. ... In this instance he knows it better than anybody else.

[27] With respect to Assessment Reports, de Souza said that exploration activities other than drilling were:

... very difficult to quantify. I can go up and down a mountainside and I can put together an exploration report. That exploration report is based on my observations and on a whole host of other things that go on. The formulation of that report is in itself an exploration document because of the thought processes. ... a prospecting document because of the thought processes that go into it. Largely, the sort of information that comes out of that kind of a study you don't want to give to anybody else because if you want to drop a claim, for instance, but you want to pick it up later if you've got more cash in hand. As soon as you drop a claim somebody else can come in and grab it if it's of interest. So you don't put that information out.

[28] He then gave evidence about additional extensive exploration programs carried out on the properties. He also commented that the road system was absolutely essential.

[29] In a report prepared in 1987 de Souza recommended a substantial exploration program for the company. He also stated that to date that program had not been carried out in full. De Souza testified that to his knowledge no roads were constructed in the period 1985 to 1988.

[30] De Souza said that equipment was used to pull big drill rigs from site to site and that another "Cat" would do general cleanup work and general road maintenance. He also said that the trucks were essential for the mineral exploration program and that the program could not have been carried out without the heavy equipment and the trucks. He also described the camp as being comfortable, not luxurious, and described the core shed where all core and chippings from percussion holes were stored. He also described a maintenance shop. He stated that the provision of a camp was essential together with an office, that there were mechanics on staff and that there were inter-company rentals of equipment. The Appellant filed with the Court a number of invoices covering rental equipment for the period from December 31, 1985 to December 31, 1988. They indicated that equipment used was rented to Bul River and paid for by it. Total camp facilities also were rented under the exploration program. The program also included trenching activity.

[31] Stanfield was the president of all four companies. He testified that he had a free miner's license entitling him to prospect on Crown lands and to stake any number of claims. He described the acquisition of claims. He described the camp facilities and the vehicles and equipment used in the exploration program. He described the exploration program which had been laid out by a Mr. Allen, de Souza's predecessor, amounting to $40 million in proposed exploration activity.

[32] He said that he initially built 110 miles of roads through the mountains and that they had to be maintained. He stated that the roads that were constructed under his supervision connected many, but not all, of the showings. He said that he has seen all the showings, including the 27 mineral showings described by de Souza. He stated that he saw everything including all the rocks that the men brought in on a continuous basis. He saw all the core that was brought in and checked all the chips that the rotary drillers brought in. He said:

It is my business.

[33] He said that he was involved in virtually everything that happened on the property. Addressing the necessity of roads he stated,

When you have 110 miles of roads, you have, by God, one of the most wonderful avenues to prospect.

He said, in this connection, that in effect smaller companies could not afford helicopter exploration activity.

[34] Stanfield, referring to assessment reports, said that they reported only the drilling needed for assessment work. Otherwise, it was not reported. He said that the last thing that would be reported to the government would be interesting discoveries because the records could be reviewed by the public within a year and sometimes within six months. He described in some detail the facilities at the camp including storage, repair facilities, office, recreation room, dining room, bunk houses, et cetera.

[35] He stated that the inter-company rental rates of equipment were determined by looking at the British Columbia forestry charges for various pieces of equipment on a rental basis and the Government of Alberta charges for various rental equipment. He said that he, after conferring with his internal office organization, made the decision as to rental charges. He described in some detail the uses to which the leased equipment were devoted. He also stated that geological surveys and geophysical surveys were conducted during the period. He described the reworking of roads and continuous trenching which involved cutting a piece off the wall of rock that presented new geology for study. He said that most of the mines discovered in British Columbia were discovered by road work and trenching.[5] He described the road work that was done and the core sampling being done on a continuous basis. He said that very little of the prospecting, geological surveys, drilling and trenching work was reported for assessment purposes. He then described an arm's-length company known as Cora Lynn which provided drilling services from 1984 to 1988. He described in detail also the manner of performing certain drilling functions including the preparation of pads et cetera. He also described a very successful mining operation which he had developed in British Columbia prior to the mineral exploration program under review.[6]

[36] Mr. Wallwork ("Wallwork"), an auditor with Revenue Canada instrumental in the audit for 1986 to 1988, stated that he never once visited the mining site. He also stated that the concept of allowing road work expense only if exploration activity related to the subject roads was performed within two years of the date of road work expense was in pursuit of a policy that came from the head office of Revenue Canada after consultation with the Department of Energy, Mines and Resources. He stated that he looked at the general ledgers for three years together with supporting invoices and the Assessment Reports. He also examined reclamation reports which were provided to him.

[37] Wallwork described the result of his review of the general ledger and invoices, with relation to camp and payroll costs, he said:

It would be looked at as a two step process. Step one was to analyze each invoice and determine whether it was camp expense or whether it was a general overhead expense or whether it was a non-deductible expense. The second step would be to take the amount determined as camp expense and prorate it between exploration and other activities.

[38] The approach taken by Maureen Chrusch ("Chrusch"), an auditor with Revenue Canada, was essentially the same as Wallwork's. She did the audit for 1985. She said her understanding of the business activities of the four companies was mineral exploration. She agreed that they carried on no other business activities.

[39] Appellant's counsel conceded that the following expenses incurred by Bul River in the years in questions were not E:

1. German office expenses of $106,145.46;

2. Total credit card expenses for 1986 of $64,028.61;

3. Total credit card expenses for 1987 of $50,988.08;

4. Certain credit card expenses for 1988 totalling $26,470.23; and

5. One-half of the total credit card expenses for 1985 in the sum of $45,945.

ANALYSIS AND CONCLUSION:

[40] I accept the evidence of all of the Appellant's witnesses. The Respondent has not taken issue with the fact that the sums claimed were indeed spent by the operator. Although the evidence was detailed and complex respecting different drilling activities and inter-corporate rentals, the distillation of the testimony of the Appellant's witnesses is that all monies expended on the mineral properties in question were laid out for the purpose of exploration for mineral resources.

[41] The definition of Canadian exploration expenses has no limitation with respect to the time for exploration after expenses incurred for roadwork as edicted by the Department of Energy, Mines and Resources. Accordingly, it has no effect in my appraisal of those expenditures.

[42] The activities described in the evidence, namely prospecting, carrying out geological, geophysical or geochemical surveys, rotary, diamond and percussion drilling and trenching, and preliminary sampling fall within the definition of E.

[43] Respondent's counsel attempted to persuade the Court that it should infer from an examination of invoices that certain inter-company equipment rental charges were not incurred. Specifically, he asked the Court to form a conclusion of that nature

as a reasonable or unreasonable inference, but there is no evidence on that point.

This followed an exchange between the Court and counsel as follows:

The Court: Well, you're advancing the proposition now to me that needs, I would have thought, some evidence to support it and the evidence could have been explored by cross-examination of at least two of the witnesses and it wasn't.

Counsel: No it wasn't, Your Honour, no, there is no evidence.

[44] I accept the evidence of Stanfield and Ainsworth that not all information was contained in the Assessment Reports for the simple reasons of costs and security of information. The Respondent inappropriately disallowed the expenses in question. The companies existed for the sole purpose of conducting mineral exploration on mineral properties. The evidence satisfies me that that is exactly what was done. Accordingly, apart from the concessions made by Appellant's counsel above described, the amounts shown as having been claimed as E in the four years in question are correctly so characterized.

[45] As the expenses incurred by the Appellant pursuant to the aforesaid agreement in writing fall within the description of expenses in subparagraph 66.1(6)(a)(iii) they constitute E pursuant to the provisions of subparagraph 66.1(6)(a)(v). Accordingly they are deductible by the Appellant under subsection 66.1(3) with the consequent depletion benefits.

[46] Costs are awarded to the Appellant. Having regard to the request of Appellant's counsel at the close of the hearing, counsel for both parties may communicate with the Court for the fixing of a time for dealing with this matter.

Signed at Ottawa, Canada this 7th day of January, 1999.

"R.D. Bell"

J.T.C.C.

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