Ruling has significant ramifications for broad range of legal issues
On May 22, 2008, the Supreme Court of Canada handed down an important decision providing definitive statements on the differences between absolute and contingent obligations and whether parties factually deal at arm’s length. The decision also affirms standards of appellate review for cases where findings of fact made by a trial judge are challenged on appeal.
Fraser Milner Casgrain LLP (FMC) successfully argued the Supreme Court of Canada appeal of the test case of Allan McLarty related to income tax assessments raised against a group of joint venture participants that invested in a very successful exploration joint venture that contributed to the growth and the taking public of Compton Petroleum Corporation, a S&P/TSX Composite Index corporation. The Minister of National Revenue had refused to allow the venture participants (including Mr. McLarty) full deduction for the seismic data used in the exploration joint venture.
The Supreme Court of Canada ruled in favour of Mr. McLarty and, as a result, the other joint venture participants and others affected by this test case, on both issues before the Court and reinstated the full deduction of Mr. McLarty’s expenses. The joint venture participants had been fighting the government for 12 years, including arguing the test case twice before the Tax Court of Canada and twice before the Federal Court of Appeal.
Mr. McLarty was represented by: Jehad Haymour, a partner and Tax Department Manager at Fraser Milner Casgrain’s Calgary office; Carman McNary, a partner at Fraser Milner Casgrain’s Edmonton office and National Tax Group Leader; and, Peter Banks, a litigation associate at Fraser Milner Casgrain’s Edmonton office.
"The Supreme Court’s guidance on the application of the law of contingency to the limited recourse debt represents an important statement for tax purposes and other purposes," said Mr. Haymour. "We live in a credit-based society. Taxpayers purchasing assets using debt can now confidently predict the tax treatment that will result. To understand the magnitude of this decision from a pure tax perspective, the government stated in its leave application that this case affects approximately 2,200 taxpayers and more than $350 million in deductions."
"This landmark case has very broad applications going forward," said Mr. McNary. "First and foremost, it impacts on the taxation of any limited recourse financing and clarifies law that had become confused by decisions of the lower Courts in this and other cases. With respect to the question of when two otherwise unrelated taxpayers deal with each other at ‘arm’s length’, the Supreme Court had not looked at the tests to be applied in many years, so it is very useful to have the nature of what it means to enter into agreement ‘at arm's length’ brought into the current economy. Finally, it is important that the Court has once again protected the role of a trial judge in finding facts after seeing and hearing all witnesses at a trial. In all these respects, the case will impact both tax and non-tax transactions and litigation."
Background
On December 31, 1992, Allan McLarty became a participant in an oil and gas exploration joint venture called the CRC 1992/1993 Oil and Gas Investment Fund and purchased an interest in proprietary seismic data from Compton Resource Corporation for $100,000. He paid for his interest in the seismic data partially in cash and partially by granting a promissory note to Compton, payable with interest on December 31, 1999. The promissory note was a limited recourse note that provided that it would be repaid through the sale of licensed copies of the data, cash flow from oil and gas property revenues, and through a third party sale of the proprietary rights to the seismic data at the end of the term of the note if any amount remained unpaid. On filing his income tax return for 1992, McLarty treated his purchase of seismic data as a Canadian exploration expense (CEE) and added $100,000 to his cumulative Canadian exploration expense pool. In calculating his income, he deducted $81,655 as CEE in 1992, and an additional $14,854 in 1994, reducing his pool accordingly. The Minister reassessed Mr. McLarty to allow a deduction of $32,182, not $100,000.
The issues at the Supreme Court trial appeal were twofold: whether Mr. McLarty’s liability under the promissory note represented an absolute liability, entitling him to full deduction, or a contingent liability and whether, in purchasing the seismic data, Mr. McLarty was dealing with Compton at arm’s length. The Court concluded that Mr. McLarty’s liability under the promissory note was absolute, and not contingent, and came into existence on December 31, 1992. The Court further solidified the law relating to whether parties factually deal at arm’s length and held there was no basis to interfere with the findings of the trial judge that Mr. McLarty’s dealings with Compton were at arm’s length. The Court dismissed the government’s appeal with costs throughout and allowed Mr. McLarty’s cross-appeal. Accordingly, the decision of the Federal Court of Appeal was set aside and the decision of the trial judge allowing Mr. McLarty the full deduction claimed was restored.
The complete Supreme Court of Canada decision can be found at http://scc.lexum.umontreal.ca/en/2008/2008scc26/2008scc26.html.
For more information, contact:
Alison Janzen
Fraser Milner Casgrain LLP
416-863-4455
alison.janzen@fmc-law.com
Suzanne Wintrob
Maverick Public Relations Inc.
416-640-5525, ext. 226
suzannew@maverickpr.com