River Hills Ranch Ltd. et al. v. R. – TCC: Payments to Ranchers to Terminate Contracts Were Capital Receipts

Bill Innes on Current Tax Cases

http://decision.tcc-cci.gc.ca/en/2013/2013tcc248/2013tcc248.html New Window

River Hills Ranch Ltd. et al. v. The Queen[1] (August 2, 2013) involved payments made to ranchers to terminate contracts for the supply of pregnant mare urine (PMU) for use in pharmaceutical production:

[1]            River Hills Ranch Ltd. (“River Hills”), Avalon Ranch Ltd. (“Avalon”) and Bar M Stock Ranch Ltd. (“Bar M”) (collectively referred to as the “appellants”) were in the business of collecting pregnant mare urine (“PMU”) for Wyeth Organics (“Wyeth”), a multinational pharmaceutical corporation formerly known as Ayerst Organics Ltd. (“Ayerst”), a division of Wyeth Canada. The collection of the PMU was done pursuant to PMU Collection Agreements (the “Collection Agreements”). Between October and December 2003, Wyeth terminated its 2003-2004 Collection Agreements with each of the appellants and executed releases (the “Releases”). Wyeth paid the appellants amounts labelled as Feed and Herd Health Payments (the “FHH Payments”) under the terms and conditions of the Releases. The Minister of National Revenue (the “Minister”) treated those amounts as income. The appellants say they are capital.

The production of PMU for Wyeth required extensive investment by the taxpayers in very specialized buildings and equipment:

[3]            The appellants made significant capital investments in order to begin their PMU operations, including the following:

1.      the purchase of machinery and equipment, such as harnesses and feeding, watering, and urine-collection systems; and

2.      the construction of facilities, including independent barns for the sole purpose of PMU production that were equipped with tank rooms, stalls, pens and corrals, which conformed to the Code.

The evidence was that once the Collection Agreements were terminated by Wyeth the facilities and livestock were of little or no further use to the appellants:

[14]        By the end of the collection season (no later than April 2004) River Hills had sold all of its PMU horses.

[15]        River Hills refitted its PMU barn for use in a cow/calf operation and for storage. Mr. McIntyre also sold the 15 quarter sections of land he had acquired for the PMU herd.

[21]        The market price for horses fell sharply following the termination of the Collection Agreements. Mr. Meggison chose not to liquidate his PMU herd immediately. He believed he would receive a higher price for his mares if he waited for the market to recover. Eventually Avalon sold thirty-two horses in the 2004 taxation year and twenty-seven in the 2005 taxation year.

[22]        Following the termination of the 2003-2004 Collection Agreement, Avalon chose to refocus its business on the breeding and sale of appaloosa horses.

[23]        Mr. Meggison kept the exterior of the PMU barn intact. However, he modified the interior by removing some of the PMU box stalls and replacing them with box stalls for foaling. The PMU equipment was abandoned because it had no salvage value.

[27]        Mrs. Marsh and her husband were able to sell eighty-eight mares in 2004 and thirty-nine in 2005.

[28]        After the cancellation of the 2003-2004 Collection Agreement, Bar M tried getting back into the cattle business. This activity was abandoned after a short time because it was unprofitable. Bar M now grows hay on its pastureland. The PMU barns are used exclusively for storage and the PMU equipment was abandoned.

The case largely hinged on the language “Feed and Herd Health Payments” used in the Releases terminating the Collection Agreements.  On its face that language would suggest the payments were made to cover the ranchers’ operating expenses.  The court however concluded that inconsistencies in the Releases permitted it to look to the “factual matrix” of the Collection Agreements and the Releases:

[50]        The appellants argue that the following evidence confirms that the FHH Payments were contract termination payments intended to protect Wyeth’s image and to discharge it with respect to any future claims.

1.      Wyeth eliminated numerous PMU producer contracts.

2.      It was the parties’ understanding that the FHH Payments were payments for the termination of the Collection Agreements.

3.      The appellants received the FHH Payments regardless of the fact that they had no horses or that they had materially fewer horses than the number used in their PMU businesses at the time the contract was cancelled.

4.      The appellants understood that Wyeth was making the payments in response to concerns aired in the media with respect to sales of horses to slaughterhouses.

5.      Wyeth was informing the farms of the activities of People for the Ethical Treatment of Animals (PETA), whether or not those activities took place.

6.      There were confrontations between the pharmaceutical industry and various animal rights groups – a fact which is a matter of common knowledge.

[51]        It is clear from the earlier cited jurisprudence that evidence of the subjective intention of the parties has “no independent place” in the interpretative process. Therefore, evidence pertaining to the parties’ understanding as to the intended use of the FHH Payments is inadmissible.

[52]        With regard to the third point, I disagree with the respondent’s assertion that events following the signature of the Releases are beyond the scope of this analysis and should not be admitted for the purpose of interpreting the Releases. Nadon J.A.’s comments in GM indicate that subsequent conduct can be a useful guide to the interpretation of a written agreement “in some cases”. Indeed, in The Law of Contract in Canada, Fridman notes that “[i]n Canada it seems clear that the subsequent actions of the parties may be admissible to explain the true meaning and intent of their agreement. Indeed, “there is no better way of determining what the parties intended than to look to what they did under it”.

[Footnotes omitted]

Accordingly the court reached the common sense conclusion that the payments were made to compensate the appellants for the sterilization of a capital asset, e.g., their PMU business activities:

[63]        Wyeth was not required under the Collection Agreements to pay the appellants’ “feed” and “herd health” expenses. That obligation fell exclusively to the appellants. Wyeth’s obligation was to pay the agreed – upon rate for delivered PMU. Applying Associate Chief Judge Bowman’s reasoning in BP Canada, I conclude that the cancellation of the Collection Agreements led to the “sterilization of a capital asset”. The appellants were forced out of business.

[64]        While Wyeth might have hoped that the appellants would use the FHH Payments to cover “feed” and “herd health” expenses, the evidence shows that they were under no obligation to do so. The evidence also shows that the appellants were free to liquidate their PMU herds and that they did so over varying lengths of time. Describing the FHH Payments as “feed” and “herd health” expense does not change the fact that the payments were made to compensate the appellants for the loss of their PMU businesses occasioned by Wyeth’s cancellation of the Collection Agreements. Therefore, I conclude that the FHH Payments were capital receipts, no different than the collection season payments and rancher payments that were treated as capital receipts by the Minister. The FHH Payments therefore gave rise to a capital gain.

This case is a good example of the importance of common law principles of contractual interpretation in tax litigation.

[1] 2013 TCC 248.