Plains Midstream v. R. – TCC: Assumption of debt did not give rise to interest expense

Plains Midstream v. R. – TCC:  Assumption of debt did not give rise to interest expense

Plains Midstream Canada ULC v. The Queen (October 6, 2017 – 2017 TCC 207, Hogan J.).

Précis:   As part of a complex restructuring of Dome Petroleum Limited (Dome Petroleum) and Dome Canada Limited (Dome Canada) in the late 1980’s and early 1990’s, Amoco Canada Petroleum Company Ltd. (the predecessor of the appellant corporation) assumed liability for a $225 million loan payable by Dome Canada to Arctic Petroleum Corporation of Japan in 2030.  As consideration for the assumption of such liability Amoco received $17.5 million and additional consideration.  In this appeal the taxpayer argued that it was entitled to deduct the difference between $225 million and $17.5 million as a form of interest.  Although the original claim was based on a straight-line deduction at trial the appellant reduced its interest deduction claim to $1,043,700 per year. This amount was determined by applying a simple interest rate of 5.964% to the $17.5 million.  The original expense claimed had been roughly $4.8 million per year.  In characterizing the deduction claimed as simple interest the taxpayer relied upon subsection 16(1) and paragraph 20(1)(c) of the Income Tax Act.

The Court rejected the taxpayer’s “economic substance” argument holding that subsection 16(1) did not operate to convert the difference between $225 million and $17.5 million into an interest expense.  In obiter the Court observed that the payment might be an additional element of the cost of the shares of Dome Petroleum acquired by the taxpayer.  As a result the appeal was dismissed.  The parties were given 2 weeks to make submissions as to costs if they were unable to agree on the amount of costs.

Decision:   This case is unusual both in terms of the novelty of the various arguments advanced by the taxpayer as well as the “moving target” aspect in that the amount of the deduction claimed and the basis for the deduction (which appears to have changed several times during the course of the litigation):

[30]         At trial, the Appellant presented what can best be described colloquially as a Hail Mary argument. It alleged that the amounts in issue were deductible as income expenses under section 9 of the ITA. My questions to counsel during oral argument appear to have caused the Appellant to experience a change of heart. Approximately two weeks after the end of the trial, the Appellant’s counsel advised the Court that it had withdrawn this argument from my consideration. While this is the case, I believe a few observations are nonetheless warranted with respect to this theory.

[31]         The overwhelming evidence establishes that the Settlement Agreement, the Encor Indemnity and Subrogation Agreement and the Release Agreement were entered into on account of capital. The parties, in the PASOF, agree that the ultimate objective of Amoco in entering into these agreements was to complete the Plan of Arrangement. In other words, the purpose of those transactions was to allow Amoco to complete the acquisition of all of the issued and outstanding shares of Dome Petroleum, which are undisputedly capital assets in the hands of Amoco. Therefore, in this context, the expenses incurred by Amoco with respect to the implementation and execution of those agreements were not running expenses. This is particularly true with respect to the Appellant’s undertaking to Encor to repay $225 million owed to APCJ under the exploration loan instead of Encor.

[Footnotes omitted]

While this decision is replete with factual complexity and somewhat arcane argumentation Justice Hogan boiled the appellant’s arguments down to a broad brush “economic substance” approach which he held simply did not fly under settled income tax jurisprudence:

[107]     In summary, the Appellant’s approach places too much weight on its construction of the alleged economic substance of the Settlement Agreement. The broad interpretation of the scope of the application of subsection 16(1) of the ITA proposed by the Appellant is not consistent with a textual, contextual and purposive interpretation of subsection 16(1) of the ITA.

[108]     In closing, I observe that the Appellant’s position appears to be aligned with the way in which it claims the Key Transactions are to be characterized under generally accepted accounting principles. As noted earlier, the accounting evidence presented at trial was insufficient and unreliable. In any event, it is well recognized that GAAP serve different purposes than that intended by Parliament in enacting provisions of the ITA. Accounting principles are meant to ensure that companies report their earnings on a consistent and reliable basis so that investors may make well informed decisions when choosing to invest in companies in the same industry. In contrast, the ITA contains a detailed set of rules that serve to define how the federal tax burden is to be shared among taxpayers. These rules are constantly changing to take into account, inter alia, Parliament’s prevailing views of the concepts of fairness and progressivity and the need to stimulate certain economic activities and certain well regarded social activities.

[109]     The Appellant suggested that if I ruled against it, it would mean that the payment of the Difference is a so-called “tax nothing”. This argument is often made by taxpayers to gain the sympathy of the Court, but, as is the case here, it is rarely proven to be an accurate assessment of the situation.

As a result the appeal was dismissed.  The parties were given 2 weeks to make submissions as to costs if they were unable to agree on the amount of costs.

Comment:  This decision makes a good read and the appellant’s advisors are clearly in the running for novelty arguments of the year.