Barrick Gold v. R. - TCC: Profits on gold hedges formed part of gross resource profits

Barrick Gold v. R. - TCC:  Profits on gold hedges formed part of gross resource profits

http://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/218484/index.do

Barrick Gold Corporation v. The Queen (February 1, 2017 – 2017 TCC 18, Paris J.).

Précis:   The only issue in this appeal was whether a profit of roughly $57,000,000 that Barrick earned in closing out gold forward contracts formed part of its gross resource profits.  The Minister denied that treatment and Barrick appealed to the Tax Court.  The Tax Court in a nutshell held that the profits on the forward contracts “were an integral part of the Appellant’s business of producing and processing gold ore and therefore that the profit that arose from closing out the Contracts were sufficiently connected to those activities to constitute income from that source and therefore are properly part of its gross resource profits in 1998. [para. [40]”  As a result the appeal was allowed with costs.

Decision:   The facts were not in dispute:

[5]             In 1998, the Appellant was in the business of producing and processing gold in Canada. It had interests in three mines. It owned the Holt-McDermott Mine and the Bousquet Mine, and held a 50% interest in the Doyon Mine. The other 50% interest in the Doyon Mine was held by Cambior Inc., an arm’s-length party.

[6]             To hedge the risk associated with fluctuations in the price of gold, the Appellant would enter into derivatives in respect of its anticipated gold production.

[7]             The Appellant recognized any profits or losses from its hedges of its gold production as income or loss from its business of producing and processing gold.

[8]             The Appellant included any profits or losses from its hedges of its gold production in computing its gross resource profits for purposes of computing its resource allowance, and except for the amounts in issue in this appeal, the Minister accepted this position. 

[9]             Prior to 1998, the Appellant entered into derivatives known as spot deferred forward contracts to hedge some of its anticipated gold production from each of its mines. These contracts included three spot deferred forward contracts (the “Forward Contracts”) to hedge anticipated production of 300,000 ounces of gold from the Doyon Mine.

[10]        On January 19, 1998, the Appellant entered into a letter of intent to sell its interest in the Doyon Mine to Cambior Inc. The letter of intent was subject to a number of conditions.

[11]        On January 20, 1998, the Appellant entered into contracts to purchase 300,000 ounces of gold at the then current spot price from a third party. On January 26, 1998, the Appellant took delivery of the gold and used it to close out the Forward Contracts.

[12]        All of the conditions relating to the sale of the Appellant’s interest in the Doyon Mine to Cambior Inc. were fulfilled and, on January 27, 1998, the Appellant entered into a purchase agreement with Cambior Inc. (the “Purchase Agreement”) and sold its interest in the Doyon Mine. The Purchase Agreement provided that the transfer of the Appellant’s interest was deemed to have occurred on January 1, 1998 (the “Deemed Transfer Time”) and that the Appellant was not entitled to any production or revenue derived after January 1, 1998 from the transferred interest, except to the extent of the Appellant’s “Participation Right” in the mine. The Participation Right was an amount payable annually to the Appellant if the average price of gold exceeded $375 U.S. per ounce. No amount was paid in respect of the Participation Right in 1998.

[13]        The Appellant realized a profit of $56,679,461 when it closed out the Forward Contracts.

[14]        On its 1998 financial statements, the Appellant reported the profit from the closing out of the Forward Contracts as part of the “Gain on Sale” of its interest in the Doyon Mine. Proceeds from the sale of gold produced from the Holt‑McDermott Mine and the Bousquet Mine, as well as profits from the closeout of derivatives in respect of gold sales from those two mines were reported as “Gold Sales Revenue”. “Gain on Sale” and “Gold Sales Revenue” were separate line items on the financial statements.

[15]        For tax filing purposes, the Appellant included the profit on the Forward Contracts as well as the amount reported on the financial statements as “Gold Sales Revenue” from the Holt-McDermott and Bousquet Mines in its gross resource profits for 1998 and computed its resource allowance on the combined amount.

[16]        The Minister allowed the inclusion of the Gold Sales Revenue in the calculation of gross resource profits but disallowed the inclusion of the profit from the Forward Contracts.

The Court concluded that the profit on the forward contracts was integral to Barrick’s business of earning income from extracting gold:

[35]        While the Respondent purports to accept the test laid down by the Federal Court of Appeal in 3850625 Canada Inc., counsel’s initial contention that income from production and processing as defined in subsection 1204(1) is “a narrow concept restricted to extraction from the ground” is one that was specifically rejected in that case.  At paragraphs 20 and 21 of the decision in 3850625 Canada Inc., the Court wrote:

[20] However, on appeal, the Crown contends that the construction that was given to the phrase “production and processing” in Gulf is more restrictive and that the Tax Court Judge erred in failing to follow that approach. In particular, the respondent refers to the following passage of the reasons of McNair J. at paragraph 44:

I am satisfied to accept the submissions of plaintiff's counsel on this issue, namely, that sections 124.1 and 124.2 are much more specific in their scope and intendment than the calculation of income provisions under section 3 of the Act, in requiring that the income and deductions be related to production in the sense of extraction from the ground as the source of income. In my opinion, the scientific research expenditures in issue, being related to the long-term objectives of the plaintiff and not to the actual present production from mineral resources, ought not to be included in the calculations. …

[Emphasis added]

[21] I do not read this passage as providing for an approach that is more restrictive than the one adopted by the Tax Court Judge. The reasoning is that in order to qualify for inclusion in the computation of “taxable production profits”, the income (or the deductions) must be related to production in the narrow sense of extraction from the ground as a source of income. This does not restrict the qualifying activity to extraction per se. As was made clear on appeal, extraction per se is not a source of income; only the “business of production” can give rise to income (see the decision of the Appeal Division at p. 6127). In my respectful view, the Gulf test is consistent with the one set out in Echo Bay Mines and which the Tax Court Judge applied in this case, i.e. whether the refund interest was sufficiently connected to the production and processing activities to constitute income from that source. I therefore reject the contention that the Tax Court Judge applied the wrong legal test.

[36]        According to 3850625 Canada Inc., then, the relevant nexus for determining gross resource profits is between the taxpayer’s business of production, as opposed to the more narrow nexus between the income and the physical act of extracting resources.

[37]        I find that the Respondent’s position that the income in question must be specifically referable to production and processing activities carried on by the Appellant in 1998 to be too restrictive. I do not accept that it is necessary to relate the Forward Contract profits to production and processing activities carried out in relation to the Doyon Mine in the 1998 taxation year alone in order for the profit to be “sufficiently connected to the production and processing activities to constitute income from that source.” In 3850625 Canada Inc., the Federal Court of Appeal upheld the decision of Woods J. of this Court that interest paid to the taxpayer in 1996 in respect of an overpayment of tax relating to its 1985 to 1990 taxation years was sufficiently connected to its production and processing activities to enter into the computation of its resource allowance for the 1996 taxation year. In determining that the refund interest was sufficiently connected, Woods J. took into account that the issues giving rise to the appeal were “primarily related to activities that are integral to production and processing.” Those issues arose in the earlier years and not in the year the interest was received. Despite the fact that the tax refund was received several years after the resource activities were completed in the 1985 to 1990 taxation years, Woods J. found that the refund interest was properly included in the computation of the taxpayer’s resource allowance.

[38]        In 3850625 Canada Inc., Woods J. also rejected the Crown’s contention that there was insufficient connection “because income tax is not paid in the course of the resource business but after the resource activities were completed.” In doing so, she relied on the decision of the Federal Court of Appeal in Munich Reinsurance Company (Canada Branch). v. The Queen, 2001 FCA 365 and Irving Oil Ltd. v. The Queen, 2001 FCA 364, in which the Court found that the right of the appellant to be paid its tax overpayments was a right acquired in the course of carrying on its business.

[39]        In this case, the Forward Contracts were entered into and closed out in the course of the Appellant’s business of production and processing from the Doyon Mine. There is no doubt on this point. The Respondent admits that the Appellant’s sole reason for entering into the Forward Contracts was to hedge the risk of price fluctuations in the price of gold that it expected to produce from the Doyon Mine. Furthermore, the evidence showed that the Appellant regularly entered into derivative financial instruments to reduce the risk associated with price volatility it was exposed to in the course of carrying on its gold producing and processing business and to stabilize the revenues it earned in the course of carrying on that business. Finally, the Appellant’s only source of income both at the time the Forward Contracts were entered into and closed out was that business.

As a result the appeal was allowed with costs.