Devon Canada Corp. v. R. – TCC: Successor Deductions Apply After Transfer of Res. Prop. by Pshp to Subsidiary Pshp

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Devon Canada Corporation v. The Queen[1] (December 18, 2013) is a case dealing with a fairly esoteric aspect of the rules dealing with resource properties.  The facts are not complex:

[2]             The facts are not in dispute. Anderson Exploration Ltd., the parent corporation of Home Oil Company of Canada (“Home Oil”), was acquired by Devon Acquisition Corporation on October 15, 2001 (the “Acquisition of Control”). Home Oil was continued by amalgamation as the Appellant, Devon Canada Corporation (“Devon Canada”).

[3]             Prior to the Acquisition of Control, Home Oil owned its resources properties (the “Anderson Properties”) through a partnership of which it was a direct member, the Anderson Exploration Partnership (the “Anderson Partnership”).

[4]             Following the Acquisition of Control, the Anderson Partnership transferred all of its resource properties (the “Transfer”) to a subsidiary partnership, the Devon Canada Partnership (“Devon Partnership”). The Transfer did not alter Home Oil’s proportionate interest in the Anderson Partnership.

[5]             The Minister of National Revenue (the “Minister”) reassessed Home Oil, denying its claim for successor deductions in respect of the Anderson Properties, which claim was made after the Transfer. The claim was denied on the basis that paragraph 66.7(10)(j) ceased to apply on the transfer of the property to the second level partnership. 

The appellant brought this application pursuant to paragraph 58(1)(a) of the Tax Court of Canada Rules (General Procedure) for the determination of a question of law:

whether, by operation of paragraphs 66.7(10)(j) and 66.7(10)(c) of the Income Tax Act, following the acquisition of control of Home Oil . . . and the transfer of the [Anderson Properties] by the [Anderson Partnership] to the [Devon Partnership], the proportionate share of income earned from the [Anderson Properties] owned through the Devon Partnership, allocated to the Anderson Partnership and further allocated to Home Oil, may reasonably be regarded as having been attributable to production from a particular resource property owned before the acquisition time by an original owner for purposes of subsections 66.7(1) to (5).

The court first concluded that the resource expenses did not expire upon being transferred to a second tier partnership:

[33]        In summary, the Respondent’s position in this case is based on the misconstruction that the deemed ownership concept applicable to property owned by a first-tier partnership as set out in paragraph 66(10)(j) ceases to operate if the property is transferred to a second-tier partnership. This is manifestly incorrect. For the change of control provisions to operate properly, the streaming restrictions must continue to operate from year to year. The impact is that if the corporation fails to earn income from those properties because the resource is depleted or the income is earned by another taxpayer that is subject to tax, then the corporation will be unable to deduct its resource expenses existing at the time of the change of control. As a result, while the corporate partner will remain a successor indefinitely, if it loses its connection with the resource property it will no longer have income “that may reasonably be regarded as attributable” to property, and its maximum deduction under subparagraph 66.7(10)(j)(ii) would be nil.

[34]        While Home Oil remained at all times a successor with respect to the Anderson Properties and was therefore entitled to deduct resource expenses in accordance with subsections 66.7(1) to (5), its deduction will be limited according to the extent to which its income “may reasonably be regarded as attributable to . . . production from” the Anderson Properties.

[35]        There is no specific requirement that the partnership continue to directly own the property at the time the “successored” resource expenses are deducted. I agree with the Appellant that the Respondent’s position requires me to read into subparagraph 66.7(10)(j)(ii) after the phrase “for a taxation year ending after that time” additional words such as these: “but only where the party continues to hold such properties throughout the taxation year.” The Supreme Court of Canada has admonished against reading words into the Act in this way.

[Footnotes omitted]

Next the court examined whether income derived from property held in a subsidiary partnership can be “reasonably regarded as attributable to the resource property”:

[58]        By treating the corporate partners as the owners of the resource properties, paragraph 66.7(10)(j) ensures that the corporation that incurred the expenses through a partnership structure can still use them following an acquisition of control. I find that the Respondent’s interpretation is directly at odds with this purpose, as it would deny the deduction of expenses by the very taxpayer that incurred them and that continues to pay tax on the income from the properties.

[59]        Parliament’s intention that resource expenses not become stranded when properties remain within a wholly owned corporate group is similarly reflected in paragraphs 66.7(10)(g), (h) and (i). These provisions permit a successor to designate in favour another member of the wholly owned corporate group, for the purpose of accessing the “successored” expenses, income from the “successored” properties following an acquisition of control.

[60]        Parliament has legislated to enable a form of tax consolidation within a wholly owned corporate group so that “successored” expenses do not become stranded. Under the Respondent’s interpretation, resource expenses cannot be used even though the property has not left the wholly owned corporate group. In fact, no taxpayer would ever be able to deduct the “successored” expenses. I find that this is inconsistent with Parliament’s intent.

[Footnote omitted]

In the result the taxpayer was successful on its motion and the matter was referred to a trial judge to determine the amount of income in question:

[61]        In conclusion, I find that following the transfer of the Anderson Properties to the Devon Partnership, the proportionate share of income earned from the Anderson Properties, determined in accordance with clauses 66.7(10)(j)(ii)(A) and (B) and allocated to the Anderson Partnership, and further allocated to Home Oil, may reasonably be regarded as having been attributable to production for the purposes of subsections 66.7(1) to (5). The amount of such income is a matter to be determined by the trial judge on the basis of his evidentiary findings.

[1] 2013 TCC 415.