Federal Court of Appeal Decisions

Date: 20060427

Docket: A-85-05

Citation: 2006 FCA 152

CORAM:        SEXTON J.A.

                        EVANS J.A.

                        MALONE J.A.

                                               

                       

BETWEEN:

HER MAJESTY THE QUEEN

                                                                                                                                            Appellant

and

ALLAN McLARTY

Respondent

Heard at Calgary, Alberta, on March 20, 2006.

Judgment delivered at Ottawa, Ontario, on April 27, 2006.

REASONS FOR JUDGMENT BY:                                                                               SEXTON J.A.

CONCURRED IN BY:                                                                                                    EVANS J.A.

                                                                                                                                    MALONE J.A.

                                                                                                                                                           

Date: 20060427

Docket: A-85-05

Citation: 2006 FCA 152

CORAM:        SEXTON J.A.

                        EVANS J.A.

                        MALONE J.A.

                                               

                       

BETWEEN:

HER MAJESTY THE QUEEN

                                                                                                                                            Appellant

and

ALLAN McLARTY

Respondent

REASONS FOR JUDGMENT

SEXTON J.A.

I.           INTRODUCTION

[1]                This is an appeal from McLarty v. Canada, 2005 TCC 55 ["McLarty"], a decision of the Tax Court of Canada (the "TCC"). The respondent, Allan McLarty, invested $100,000 in proprietary seismic data as part of a joint venture. The purchase price comprised $15,000 in cash and a limited recourse promissory note in the amount of $85,000. Pursuant to this transaction, the respondent added $100,000 to his Cumulative Canadian Exploration Expenses ("CCEE") pool. Subsequently, he claimed Canadian Exploration Expense ("CEE") of $81,655 for taxation year 1992 and $14,854 for taxation year 1994. The Minister of National Revenue (the "Minister") reassessed the respondent and found that the purchase price of the seismic data was in excess of fair market value ("FMV"). Consequently, the Minister disallowed additions to the respondent's CCEE account. The TCC allowed the respondent's appeals from the Minister's reassessments, permitting the respondent to claim the entire $100,000 as CCEE.

[2]                The appellant, Her Majesty the Queen, challenges the decision below on three main grounds. First, she claims that, contrary to the findings of the TCC, the seismic data was not "for the purpose of determining the existence, location, extent or quality of an accumulation of petroleum or natural gas (other than a mineral resource) in Canada," as required by the statutory definition of a CEE. Second, she alleges that the TCC erred in concluding that the respondent's promissory note was not an incurred expense, but a contingent liability. Third, she argues that the seismic data purchase was not an arm's length transaction. Because of this, the TCC should have determined that the respondent had failed to discharge his burden to establish that the FMV of the seismic data was in excess of the amount assumed by the Minister.

II.         FACTUAL BACKGROUND

[3]                The respondent's investment in the data in issue (the "Data") can be traced to Ernie Sapieha ("Sapieha"), the sole owner, officer and director of Compton Resource Corporation ("CRC"). Sapieha had hoped to build an oil and gas exploration and development corporation and envisioned that an interest in a proprietary seismic database would be its cornerstone. Accordingly, he attempted to gather investors to join CRC in the purchase of such a database.

[4]                Sapieha approached the respondent and others about participating in this joint venture (the "Joint Venture"). The respondent was presented with an offering memorandum (the "Memorandum"), which outlined the actions of the proposed Joint Venture. In part, the Memorandum stated:

(a) [t]he principle objectives of this offering are to provide subscribers with an opportunity to participate in the acquisition of, exploration for and development of Petroleum Rights while at the same time enabling investors to avail themselves of the income tax deductions and federal incentive programs which have been proposed to encourage petroleum and natural gas exploration developments; and

(b) [t]he primary purpose of the purchase of the Technical Data Base will be to analyze the data with a view to determining development and exploration prospects of the Joint Venture and to assist with the identification of producing PNG Properties for the Joint Venture to purchase. However, after a review and analysis of the Technical Data Base, some portion of the data may be licensed or sold to the industry in a manner and under circumstances consistent with industry practice.

[5]                The Memorandum also explained that "The purchase price of the Technical Data Base [the Data] will not be higher than the lowest appraised value received from three experienced, independent valuators." Indeed, before the Data was purchased, on behalf of the Joint Venture participants (the "Joint Venturers"), Sapieha obtained appraisals from Ray Jaskela in the amount of $39,787,800, Brian Curts in the amount of $41,930,760 and E.P. Webb in the amount of $34,405,000.

[6]                The Data that they appraised was owned by CRC. It was a subset of a larger data library (the "Data Library") that CRC had acquired from Seitel Inc. ("Seitel") when it purchased its "seismic business" on December 30, 1992. The total consideration paid by CRC for the "seismic business" was $21,000,000, $20,999,998 of which was allocated to the Data Library. This consideration was satisfied by $2,375,000 in cash and a debenture for $18,625,000. Seitel recorded the amount of the debenture as a contingent liability in its financial statements. The promissory note required that 60% of the revenues (net of commission) from the sale of licensed copies of the Data Library be applied towards it. Prior to this transaction, on June 26, 1992, Seitel had obtained the Data Library from Canadian Hunter Exploration Ltd. ("Hunter") for $2,388,000. That same day, Hunter had acquired the Data Library from Western Geophysical Ltd. ("Western") for $2,750,000.

[7]                Returning to the Joint Venture, Sapieha's control over the vendor of the Data, CRC, enabled him to dictate the price that the Joint Venturers were to pay for the Data. Sapieha set the purchase price of the Data by multiplying $21,000,000 by 30.35%, the total proportionate interest in the Data that the Joint Venturers were to acquire. The source of the figure of $21,000,000 is simply not clear. Obviously, $21,000,000 is not equal to any of the valuations that Sapieha obtained. Moreover, it has no logical connection to any of the prior sales of the Data. After all, CRC paid approximately $21,000,000 to Seitel for the entire Data Library, not just for the Data. Finally, there is no indication in the decision below that the respondent had any input into setting the price.

[8]                After reviewing the Memorandum, the respondent entered into a subscription agreement on December 31, 1992. As a result, the respondent acquired a 1.57% undivided interest in the Compton Resource Corporation 1992/1993 Oil and Gas Investment Fund (the "Joint Venture"). That same day, the respondent and the other Joint Venturers entered into a joint venture agreement (the "Joint Venture Agreement") with CRC. Under the Joint Venture Agreement, the Joint Venturers appointed CRC as their agent to, inter alia, purchase seismic data for the use of the Joint Venture. Pursuant to a Technical Data Base Purchase Agreement of December 31, 1992, CRC - as agent, and on behalf of the Joint Venturers - acquired from itself a 30.35% undivided interest in the Data. The total consideration given by the Joint Venturers for the Data was $6,373,335, satisfied by $956,002 in cash and $5,417,333 by way of promissory notes in favour of CRC.

[9]                The terms of the promissory notes were outlined in the admitted facts and included the following items:

(a) the Promissory Notes bear interest at a rate of 8% per annum on any unpaid portion of the principal sum;

(b) pursuant to the Joint Venture Agreement which is incorporated by reference into the terms of the Promissory Notes, the Individual Joint Venturers assigned to Compton sixty percent (60%) of the proceeds of the sales of licensed copies of the Venture Data and twenty percent (20%) of the cash flow from the drilling programs (the "Drilling Program") carried on by the Joint Venture as repayment of the Promissory Notes, first to interest then to principal;

(c) the Promissory Notes are secured by sixty percent (60%) of the sale proceeds from the disposition of the proprietary interest in the Venture Data and an undivided twenty percent (20%) of the rights acquired by the Individual Joint Venturers pursuant to the Drilling Program (collectively, the "Security"), with no further recourse against other assets of the Individual Joint Venturers; and

(d) in the event that any portion of the Promissory Notes remain unpaid on the due date, Compton will appoint an independent trustee to sell the Individual Joint Venturers' interests in the Security, with such proceeds being applied to the unpaid portion of the Promissory Notes and any shortfall would be forgiven.

[10]            These promissory notes included the respondent's note (the "Note"). It was in the amount of $85,000. The Note, along with $15,000 in cash, was the portion of the total consideration used to acquire the respondent's 1.57% undivided interest in the Data.

[11]            In accordance with the Joint Venture Agreement, Sapieha began the process of setting up an oil and gas business. He established an office for CRC that included mapping services, a facility for the storing of well logs, geophysical software and other technical services. Subsequently, Sapieha began to put together an exploration team for CRC to analyze and review the Data for the Joint Venture.

[12]            Carl Ringdahl ("Ringdahl"), an experienced geophysicist, was hired as part of the exploration team. According to Ringdahl, the team began reviewing the Data and "worked up the play" using all of the information available, including the existing wells. In the court below, Ringdahl also testified that he reviewed every seismic line systematically to ascertain whether there was an opportunity to develop a trend or play, and to decide whether to buy into a land sale.

[13]            Meanwhile, the respondent filed his 1992 return of income claiming, inter alia, an addition of $100,000 to his CCEE pool in respect of his acquisition of an interest in the Data. In his 1992 and 1994 returns of income, the respondent claimed deductions of $81,655 and $14,854, respectively, as a result of drawing down his CCEE pool.

[14]            By letter dated January 6, 1997, the Minister proposed to reassess the respondent on the basis that the Data had a value of $2,050,142. Consequently, the Minister disallowed the respondent's additions to his CCEE account.

[15]            The Appellant filed appeals to these Notices of Assessment. The court below allowed the appeals in their entirety. It is this decision that is on appeal to this court.

III.        STATUTORY REGIME

[16]            Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (the "Act")

IV.        THE FINDINGS OF THE TCC

1)       STATUTORY PURPOSETEST

[17]            The TCC began its discussion of whether the respondent's purchase of the Data was for the purpose of exploration for petroleum or natural gas as required in paragraph 66.1(6)(a) of the Act with a review of the jurisprudence. It noted that the courts in Global Communications Limited v. The Queen, 99 DTC 5377 (F.C.A.) ["Global Communications"] and Gulf Canada Ltd. v. Canada, 92 DTC 6123 (F.C.A.) asserted that "the purpose test in the definition of 'Canadian Exploration Expense' ('CEE') requires at least some connection between the purchase of seismic data and actual exploration work." Furthermore, the court below observed that in Petro-Canada v. The Queen, 2004 DTC 6329 (F.C.A) ["Petro-Canada"] at para. 35, Sharlow J.A. remarked:

Evidence of the actual use of the seismic data for exploration could provide that connection. However, in the absence of such evidence, there must be at least a credible plan for the use of the seismic data in an exploration program within a reasonable time after its acquisition. A hypothetical connection to exploration work that might be done in the future cannot suffice.

[18]            The TCC accepted the respondent's testimony that he had acquired his interest in the Joint Venture for the primary purpose of getting in on the ground floor of an oil and gas exploration company. In the view of the TCC judge, this subjective primary intention was corroborated by the objective evidence of the respondent's acceptance of the terms in the Memorandum.

[19]            In this context, the TCC distinguished prior subsection 66.1(6) jurisprudence in which the courts had examined what was actually done to the land or with the seismic data. The TCC emphasized that unlike these prior cases, McLarty concerned an individual taxpayer who had entered an agreement that stipulated that exploration for oil and gas would occur. Therefore, the TCC concluded that it was unnecessary to look beyond the respondent's purpose since the respondent had no control over what would be done and reasonably relied on the stated purpose in the Memorandum.

[20]            Finally, the TCC commented that CRC took a number of steps to use the Data for the purpose of determining the existence, location, extent or quality of petroleum or natural gas. For instance, the TCC observed that CRC set up an office, organized an exploration team and systematically reviewed all of the Data. In addition, the court below remarked that the Data was re-examined when land became available. For the TCC, such a systematic use of the Data met the requirements of the statutory purpose test.

2)       CONTINGENT LIABILITY

[21]            The court below conducted an extensive review of the authorities in determining whether the Note was an expense within the meaning of paragraph 66.1(6)(a) of the Act, or merely a contingent liability as claimed by the appellant. For example, it commented that in Canadian Pacific Limited v. The Minister of Revenue (Ontario), 99 DTC 5286 (Ont. C.A.), the Ontario Court of Appeal determined that uncertainties as to the amount ultimately paid do not necessarily result in a contingent liability. Further, the TCC added that in Wawang Forest Products Limited and Nerak Contractors Inc. v. The Queen, 2001 DTC 5212 (F.C.A.) ["Wawang"], this court reaffirmed that the generally accepted test for a contingent liability was set down by Lord Guest in Winter and Others (Executors of Sir Arthur Munro Sutherland deceased) v. Inland Revenue Commissioners, [1963] A.C. 235 (H.L.) ["Winter"] at 262:

I should define a contingency as an event which may or may not occur and a contingent liability as a liability which depends for its existence upon an event which may or may not happen.

In addition, the court below highlighted that in Wawang at para. 15, it was held that a legal obligation to pay an amount does not become contingent merely because payment may be postponed or no payment date is stipulated.

[22]            In applying this law to the facts, the court below focused on the provision in the Note concerning the noteholder appointing a trustee to sell the Data in the event of default. The TCC concluded that the sale of the Data could be contingent if there was some uncertainty as to whether it could be sold. Given the ongoing market for quality seismic data and the relative rarity of such quality, especially when the Data was purchased, the TCC determined that the Data could be sold. Therefore, the TCC decided that when the respondent purchased his interest in the Data, there was no contingent liability.

3)       ARM'S LENGTH TRANSACTIONAND FMV

[23]            Paragraph 69(1)(a) of the Act deems a taxpayer's acquisition to have been at FMV where, inter alia, the acquisition is from a vendor with whom the taxpayer was not dealing at arm's length. In considering the applicability of this provision to the case at bar, the TCC found that the appropriate relationship to assess was that between CRC and the respondent. Although Sapieha devised the plan and introduced the respondent to the Memorandum, the TCC determined that it was ultimately the respondent's decision to accept the terms of the Memorandum. The TCC did not see any evidence indicating that the respondent and CRC, through Sapieha, acted in concert without separate interests. Nor, in the mind of the TCC judge, was there any evidence that Sapieha unilaterally imposed the Data purchase on the respondent. The TCC also noted that there was no collusion to inflate the Data price because the respondent had accepted the terms of the Memorandum, including that limiting the purchase price to no higher than the lowest valuation. Therefore, in the opinion of the TCC, the purchase by the respondent of his interest in the Data was an arm's length transaction.

[24]            In addressing whether the respondent's outlays for the Data were reasonable expenses within the meaning of section 67 of the ITA, the TCC referred to Petro-Canada. In that case, this court confirmed the applicability of the test for reasonableness articulated in Gabco Limited v. M.N.R., 68 DTC 5210 (Exch. Ct.) at 5216:

It is not a question of the Minister or this Court substituting its judgment for what is a reasonable amount to pay, but rather a case of the Minister or the Court coming to the conclusion that no reasonable businessman would have contracted to pay such an amount having only the business consideration the appellant had in mind.

[25]            In applying this test, the TCC highlighted the steps that Sapieha took prior to the Data purchase to determine an appropriate purchase price. Moreover, it found that Sapieha was unaware of previous sales of the Data and believed it was valued at $30,300,000. The TCC then outlined several reasons why this was not an appropriate case to question the participants' business judgment: the highly speculative nature of the oil and gas exploration industry, the fact that seismic data is very difficult to value and Sapieha's industry experience. Accordingly, the TCC found that this was not a situation where paying more than FMV would be unreasonable. The TCC concluded that a reasonable businessperson in the respondent's position would have paid at least $100,000 for his interest in the Data.

V.         ISSUES

[26]            There are three broad issues in this appeal:

1.       Did the respondent purchase the Data for the purpose of exploration for petroleum or natural gas as required in paragraph 66.1(6)(a) of the Act?

2.       Did the Note constitute an expense as required by paragraph 66.1(6)(a) of the Act?

3.       Was the respondent's purchase of an interest in the Data a non-arm's length transaction? If so, was the FMV of the Data in excess of the amount assumed by the Minister?

VI.        ANALYSIS

1)       STATUTORY PURPOSE TEST

[27]            The court below suggested a novel approach to the question of whether a taxpayer has purchased seismic data for the purpose of exploration as required by paragraph 66.1(6)(a) of the Act. Because the respondent was an individual who had entered an agreement that stipulated that exploration for oil and gas would occur, the TCC indicated that it was unnecessary to look beyond the respondent's purpose in obtaining the Data, as evinced by his testimony and his reliance on the Memorandum. In other words, objective evidence of a connection between data purchase and actual exploration work was not legally relevant in cases such as that before it. This finding of law is subject to a correctness standard of review. See e.g. Housen v. Nikolaisen, 2002 SCC 33 ["Housen"] at para. 36.

[28]            The TCC admitted that its approach to considering whether the statutory purpose test was met departed from the prior jurisprudence. In Global Communications and Petro-Canada, the courts looked at what was actually done to the land or with the seismic data. In my respectful opinion, the TCC's departure from the prior case law was unjustified. The jurisprudence of this court does not suggest that the statutory purpose test varies with the taxpayer's identity. Instead, it indicates that the court must always examine either what was actually done or what was planned to be done with the seismic data. According to Petro-Canada at para. 35:

. . . As I read those cases, the purpose test in the definition of "Canadian exploration expense" requires at least some connection between the purchased seismic data and actual exploration work. Evidence of the actual use of the seismic data for exploration could provide that connection. However, in the absence of such evidence, there must be at least a credible plan for the use of the seismic data in an exploration program within a reasonable time after its acquisition. A hypothetical connection to exploration work that might be done in the future cannot suffice. [emphasis added]

[29]            In any event, the court below went on to examine the use to which CRC actually put the Data. After examining the evidence as a whole, the TCC concluded that what it characterized as CRC's "systematic use" of the Data sufficed to meet the purpose test in subsection 66.1(6) of the Act. This finding is an answer to a question of mixed fact and law. As such, it can only be overturned if it is characterized by a palpable and overriding error. Housen at para. 36.

[30]            In the result, the TCC's error in saying that it was sufficient to rely solely on the respondent's purpose in acquiring the Data to satisfy the statutory purpose test is immaterial. After all, the TCC went on to find that there was actual use of the Data that met the requirements of paragraph 66.1(6)(a) of the Act. I therefore find no palpable and overriding error in its conclusion on this point.

2)       CONTINGENT LIABILITY

[31]            A determination of whether an expense has been incurred or if the obligation is merely a contingent liability is a question of mixed fact and law. Consequently, the applicable standard of review is that of palpable and overriding error. General Motors of Canada Ltd. v. The Queen, 2004 FCA 370 at para. 14.

[32]            If the Note had only required repayment provided there were revenues from the licensing of the Data or from the drilling program, then the Note may well have been contingent. However, section 7 of the Note stated:

7. If the indebtedness created hereby either with respect to principal or interest remains in whole or in part unpaid as of December 31, 1999, the Noteholder will appoint an independent trustee to sell for cash only:

a. the Technical Assets; and

b. an undivided 20% of the undersigned's Participating Interest in Petroleum Rights acquired by the Joint Venture pursuant to the Drilling Program.

The proceeds of the sale will be allocated as follows:

a. Technical Assets:

i. 60% (net of commissions, if any) to the Noteholder as a reduction of amounts owing by the undersigned under this promissory note; and

ii. 40% (net commissions, if any) to the undersigned;

b. an undivided 20% of the undersigned's Participating Interest in Petroleum Rights acquired by the Joint Venture pursuant to the Drilling Program:

100% to the Noteholder as a reduction of amounts owing by the undersigned under this promissory note, allocated firstly as to interest and the remainder as to principal.

Any balance owing by the undersigned on this note after the allocation of the proceeds of the sale as described above will be forgiven by the Noteholder and the undersigned will have no further liability under this promissory note.

[33]            Indeed, the TCC's analysis of the contingent nature of the respondent's obligation turned on this final aspect of the Note. In the mind of the TCC judge, the Note was contingent if there was some uncertainty if the Data could be sold. According to McLarty at para. 49:

Ultimately, to determine whether the Appellant's Note is a contingent liability it is necessary to look at the surrounding facts. The ongoing market for quality seismic data, and relative rarity of such quality (especially at the time the Venture Data was purchased) leads me to the determination that the Venture Data could be sold. I find that at the time the Appellant purchased his interest in the Venture Data there was no contingent liability because the Venture Data was required to be and could be sold upon default.

[34]            It is not clear to me that it was necessary to consider whether the Data could be sold. It seems to me that one could determine whether the Note was contingent, simply by reading it.

[35]            In Wawang at paras. 13, 15 and 16, this court stated the following about the nature of a contingent obligation:

¶ 13          The Winter test has become confused by some obiter dicta in Samuel F. Investments Limited v. M.N.R., [1988] 1 C.T.C. 2181, 88 D.T.C. 1106 (T.C.C.) . . . In that case the Tax Court Judge relied on Winter in concluding that a certain obligation was contingent. In my view, he reached the correct conclusion on the facts. However, in his reasons for decision he said this:

My understanding is that a liability to make a payment is contingent if the terms of its creation include uncertainty in respect of any of these three things: (1) whether the payment will be made; (2) the amount payable; or (3) the time by which payment shall be made.

...

¶ 15          The "three uncertainties" listed in Samuel F. Investments cannot by themselves determine whether a liability is contingent. For example, with respect to the uncertainty as to payment, a taxpayer may incur an obligation at a time when it is in financial difficulty, with the result that there is a significant risk of non-payment. But that uncertainty cannot mean that the obligation was never incurred. Similarly, an obligation to pay a certain amount does not become a contingent obligation merely because events may occur that result in a reduction in the quantum of the liability (see, for example, Canadian Pacific, cited above). Nor does a legal obligation to pay an amount become contingent merely because payment may be postponed in certain events or no date is stipulated for payment. Parties are entitled to rely on the ordinary contract law principle that payment for services must be made within a reasonable time.

¶ 16          Returning to the Winter test, the correct question to ask, in determining whether a legal obligation is contingent at a particular point in time, is whether the legal obligation has come into existence at that time, or whether no obligation will come into existence until the occurrence of an event that may not occur. . . .

[36]            In this instance, a plain reading of the Note reveals that the respondent's liability was not contingent. Instead, his legal obligation came into existence when the Note was signed.

[37]            The terms of the Note themselves reveal that the respondent's liability did not depend on the occurrence of an uncertain event. The Note dictated that the respondent was obliged to pay the noteholder if there were revenues from the licensing of the Data or from the drilling program. Even if there were no such revenues, the respondent was not free from any legal obligations. According to the Note, if the debt remained unsatisfied by December 31, 1999, the noteholder could appoint an independent trustee to sell the Data and part of the respondent's interest in any petroleum rights acquired by the Joint Venture. In other words, regardless of whether the Data or drilling program generated revenues, the respondent was obliged to surrender property for the benefit of the noteholder.

[38]            My conclusion that section 7 of the Note results in its being an absolute obligation is sustained by Frederick W. Hill v. The Queen, 2002 DTC 1749 (T.C.C.). In that case, the TCC considered whether interest amounts in relation to a limited recourse mortgage were contingent liabilities. Even though the mortgagee could not seek any deficiency under the mortgage from the mortgagor, the TCC found no contingency. After all, the mortgagee could always take possession of or sell the land.

[39]            The appellant objects to these lines of reasoning by pointing to Global Communications. It is true that the structure of the note in that case seems similar to that of the Note in the present one. The Global Communications note obliged the taxpayer to pay the noteholder, if and when received, a percentage of net revenues from the sale or licensing of the taxpayer's seismic data and a percentage of net oil and gas revenues. Recourse under the Global Communications note was also limited to the liquidation of the seismic data and any oil and gas leases held when the note matured. Unfortunately, the court in Global Communications did not appear to consider this final aspect of the note before it in determining that the note represented a contingent liability. Therefore, this case is not of particular assistance in the present one.

[40]            In conclusion, then, the court below reached the right result when it equated the Note with an incurred expense.

3)       ARM'S LENGTH TRANSACTIONAND FMV

a)       Introduction

[41]            Several issues arise with respect to the TCC's analysis of whether there was an arm's length transaction in this case, as well as its consideration of the reasonableness of the respondent's expenditures on the Data.

[42]            It is helpful, in my view, to begin by reviewing the legal framework structuring the parties' arguments on this point. If there was an arm's length transaction, then the question becomes whether the respondent's expenditures on the Data were reasonable within the meaning of section 67 of the Act. No issue of FMV arises if the respondent's expenses were reasonable. In the alternative, if there was a non-arm's length transaction in this case, then the deeming provision in paragraph 69(1)(a) of the Act is triggered. That is, if the taxpayer acquired the asset for an amount in excess of the FMV, the taxpayer is deemed to have paid the FMV. In this scenario, the respondent bears the burden of establishing on a preponderance of the evidence that the FMV of his interest in the Data was higher than the FMV assumed by the Minister.

[43]            Three issues arise with respect to the TCC's analysis of whether there was a non-arm's length transaction in this case. The first question is whether the court below selected the correct transaction to scrutinize in its paragraph 69(1)(a) analysis. The second issue concerns the matter of which of the entities involved in that transaction needed to be at arm's length from each other to avoid the deeming provision in paragraph 69(1)(a) of the Act. The third inquiry centres on whether the correct entities in the pertinent transaction were in fact at arm's length. If I conclude that they were not, then I must go on to consider the FMV of the respondent's interest in the Data.

b)       The Relevant Transaction

[44]            The question of the appropriate transaction to analyze for the purposes of paragraph 69(1)(a) of the Act is one of law. The court below had to answer this question correctly. Housen at para. 8.

[45]            Unfortunately, it is not entirely clear from the decision below which transaction the TCC considered the relevant one in its paragraph 69(1)(a) analysis. At some points in the TCC's reasons, it seems as if the lower court viewed the significant transaction as that of the respondent subscribing to the Joint Venture and executing the subscription agreement. In McLarty at paras. 57-58, for instance, the TCC wrote:

¶ 57          In the case at bar, the Appellant chose to accept the terms within the Memorandum specifying that CRC would be the operator of the Joint Venture and purchase an undivided interest in the Venture Data for the investors. The Memorandum indicated that the exploration was to occur in Western Canada. Thus, although Mr. Sapieha devised the plan and introduced the Appellant to the Memorandum, it was ultimately the Appellant's decision to invest. No evidence was presented at trial that indicated that Mr. Sapieha influenced the decision of the Appellant or any of the Joint Venture participants. The appropriate relationship to assess is that between CRC and the Appellant.

¶ 58          The Appellant chose to subscribe to the Joint Venture and executed the subscription agreement, confirming his agreement to be bound by the Joint Venture Agreement and the Memorandum.

[46]            Then again, other passages in the decision below might be taken as indicating that the TCC considered the respondent's purchase of the Data to be the legally relevant transaction. For example, according to McLarty at para. 60:

There is no evidence to indicate the Appellant and CRC, through Mr. Sapieha, acted in concert without separate interests. Nor was there any evidence that Mr. Sapieha unilaterally imposed the purchase of the Venture Data on the Appellant or had the power to do so. There was no collusion to inflate the price of the Venture Data because the Appellant had accepted the terms of the Memorandum which limited the purchase price to not higher than the lowest valuation. Here, there is no party in a position to impose its will on others and the parties cannot be said to be acting in concert without separate interests. [Ibid., Beaumontv. The Queen, 86 DTC 6264; Special Risk Holdings Inc. v. The Queen, 86 DTC 6035.] I have therefore concluded that the purchase by the Appellant of the 1.57% interest in the Venture Data was an arm's length transaction.

[47]            It would appear, then, that the TCC failed to determine which transaction to analyze for the purposes of applying paragraph 69(1)(a).

[48]            Indeed, to pinpoint the transaction of interest, the court must bear in mind that it is considering whether the transaction was at arm's length to determine whether paragraph 69(1)(a) deems the taxpayer to have made the acquisition at FMV. In this case, the acquisition in issue is that of the Data. Therefore, the key transaction is that in which the Data was acquired. As I discussed above, the Data was purchased by the Joint Venturers, including the respondent, pursuant to the Technical Data Base Purchase Agreement.

c)       The Relevant Relationships

[49]            Having pinpointed the relevant transaction, I must now determine which of the relationships among the entities involved in that transaction is legally significant. According to the Technical Data Base Purchase Agreement, the transaction involved CRC, on behalf of the Joint Venturers, acquiring from itself a 30.35% undivided interest in the Data. Therefore, three entities were involved in the transaction: the respondent, as one of the Joint Venturers; CRC, as "agent" for the Joint Venturers; and CRC, as vendor. Throughout, CRC was represented by Sapieha, CRC's sole owner, officer and director.

[50]            This background suggests two ways of framing the central question on this point. One might ask if the fact that the respondent and CRC as vendor were at arm's length suffices to render the paragraph 69(1)(a) deeming provision inapplicable in this case. In the alternative, one might inquire as to whether the relationship between CRC as "agent" and CRC as vendor must also be at arm's length to avoid paragraph 69(1)(a). In my view, regardless of how the matter is framed, these questions are issues of law, subject to review on a correctness standard. Housen at para. 8.

[51]            The respondent argues that the fact that there was an arm's length relationship between the respondent and CRC as vendor is sufficient to avoid the strictures of paragraph 69(1)(a). After all, paragraph 69(1)(a) does not apply unless "a taxpayer has acquired anything from a person with whom the taxpayer was not dealing at arm's length [emphasis added]." CRC is not the taxpayer in issue. Instead, it was merely the respondent's "agent" in the transaction. Indeed, as "agent," CRC was not even a purchasing party in the transaction. See e.g. Adams v. Canada(appeal by Robinson), [1998] F.C.J. No. 397 (C.A.). Therefore, the respondent concludes that the relationship between CRC as "agent" and CRC as vendor is irrelevant in the arm's length analysis.

[52]            I do not agree with this approach. To be sure, the Technical Data Base Purchase Agreement stated that the agreement was between:

COMPTON RESOURCE CORPORATION, a body corporate having an office in the City of Calgary, Alberta (hereinafter referred to as the "Vendor")

OF THE FIRST PART

AND

COMPTON RESOURCE CORPORATION, a body corporate having an office in the City of Calgary, Alberta, purchasing as agent on behalf of the joint venture participants of the Compton Resource Corporation Oil and Gas Investment Fund joint venture formed pursuant to the Joint
Venture Agreement made as of December 31, 1992 (hereinafter referred to as the "Purchaser")

                                                                                                    OF THE SECOND PART

[53]            However, the court must look beyond this de jure relationship of principal and agent to what actually happened in the transaction. Paragraph 251(1)(b) of the Act provides:

[54]            In RMM Canadian Enterprises Inc. v. Canada, [1997] T.C.J. No. 302 at para. 33, Bowman T.C.J. (as he then was) said the following about this provision :

It is true that a determination whether persons are at arm's length requires that the court make findings of fact, but whether, on the facts, there is in law an arm's-length relationship is necessarily a question of law. Even Parliament which, subject to constitutional limitations, is supreme and has the power to deem cows to be chickens, cannot turn a question of law into a question of fact. All that paragraph 251(1)(b) means is that in determining whether, as a matter of law, unrelated persons are at arm's length, the factual underpinning of their relationship must be ascertained. The meaning of "arm's length" within the Income Tax Act is obviously a question of law. [emphasis added]

On the facts, the relationship between a purported "agent" and a vendor may indeed have a bearing on a determination of whether a transaction was conducted at arm's length.

d)       Arm's Length Analysis

[55]            It does not appear as if the court below considered whether the Technical Data Base Purchase Agreement resulted from an arm's length transaction in light of the relationships between both the respondent and CRC as vendor on the one hand and CRC as "agent" and CRC as vendor on the other. Therefore, I must consider the matter de novo. The parties' submissions indicate that it is

not in dispute that the respondent and CRC as vendor were at arm's length. Therefore, my analysis will focus on the relationship between CRC as "agent" and CRC as vendor.

[56]            In Peter Cundill & Associates Limited (Appellant) v. Her Majesty the Queen (Respondent), 91 DTC 5543 (F.C.A.) ["Peter Cundill"], this court identified three questions that may be used as a framework for analyzing whether entities are at arm's length:

a) the existence of a common mind which directs the bargaining for both parties to the transaction,

(b) parties to a transaction acting in concert without separate interests, and

(c) 'de facto' control.

[57]            In my view, the transaction in issue was not at arm's length because Sapieha was "a common mind . . . dictat[ing] the terms of the bargain on both sides of the transaction." The findings of the court below indicate that the respondent, and indeed, the Joint Venturers as a whole had minimal input into the terms of the Technical Data Base Purchase Agreement. To be sure, the Memorandum required the purchase price of the Data to be no higher than the lowest appraised value received from three experienced, independent valuators. However, that appears to be the extent of the respondent's control over the terms of the bargain. After all, Sapieha was responsible for obtaining the valuations. The findings of the court below do not indicate that the respondent was involved in choosing the appraisers or that he even reviewed their evaluations prior to purchase.

[58]            Instead, as Sapieha admitted in his testimony, he simply determined the purchase price by multiplying $21,000,000 by 30.35%. As I explained above, the origin of this $21,000,000 figure is simply unclear to me. Certainly, it was not reflective of the amounts that prior purchasers had paid for the Data, including CRC. After all, it bought the entire Data Library, not just the Data, from Seitel for $21,000,000. Furthermore, $21,000,000 bore no relation to any of the valuations that Sapieha had obtained. These appraisals were the only conceivable control that the Joint Venturers had over the purchase price.

[59]            I am affirmed in my view of the significance of the respondent's lack of involvement in setting the terms of the bargain by this court's decision in Deptuck v. Canada, 2003 FCA 177 ["Deptuck"]. In that case, the applicant argued that the transaction in question was conducted at arm's length because the partnership in issue had three limited partners. They were unrelated to the individual who controlled the vendor. Moreover, they held nine of the 12 limited partnership units issued by the partnership. Therefore, the partnership in issue was under the de jure control of these unrelated individuals on the date of the transaction. In addressing this argument, this court explained in Deptuck at para. 18:

The short answer to this argument is that there is no evidence that these additional partners had any say in the decision to acquire the assets at the stated price. . . .

[60]            Finally, I should remark on the final two considerations in the Peter Cundill analysis. Since CRC as "agent" and CRC as vendor were the same entity, it cannot be said that they were acting

with separate interests. Likewise, the final factor in the Peter Cundill analysis was clearly satisfied here, as Sapieha had de facto control over CRC as "agent" and CRC as vendor.

[61]            In conclusion, then, the court below erred by not considering the relationship between CRC as "agent" and CRC as vendor in its analysis of whether the Technical Data Base Purchase Agreement was the product of an arm's length transaction. Given that Sapieha was the directing mind of both parties on the crucial issue of the Data purchase price, this transaction was not conducted at arm's length. In light of this finding, the burden falls on the respondent to rebut the Minister's assumed FMV of the respondent's interest in the Data.

e)       FMV

[62]            Contrary to the submissions of the respondent, the TCC did not draw any conclusions as to the FMV of the Data or of the respondent's interest in it. Instead, the TCC found only that the respondent's payment of $100,000 for his interest in the Data was reasonable within the meaning of section 67 of the Act. According to McLarty at paras. 73 and 74:

¶ 73          Given the highly speculative nature of the oil and gas exploration industry, the fact that seismic data is very difficult to value as well as the experience of Mr. Sapieha in the oil and gas exploration industry, this is not an appropriate case to question the participants' business judgment. This is not a situation where paying more than the fair market value would be unreasonable. However, I find that a reasonable businessman in the Appellant's position would have paid at least $100,000.00 in return for the undivided interest in the Venture Data and the unlimited access that the Appellant obtained.

¶ 74          Since this was an arm's length transaction, and the expense was reasonable this is not an issue of fair market value. . . .

[emphasis added]

[63]            Nonetheless, the TCC briefly addressed the evidence of Siebert, an expert tendered by the appellant on the question of FMV. Clearly, the TCC was dissatisfied with Siebert's evidence. The TCC suggested that Siebert had not opined on the FMV of the respondent's interest in the Data. Moreover, the court below expressed concerns about Siebert's valuation of the Data as a whole. According to the TCC, Siebert failed to take into account the exploration value of the Data and the
fact that there might have been a special purchaser for it. He was also conservative in his cash flow projections and discount rates.

[64]            The appellant also reminds this court that, in light of a finding of a non-arm's length transaction, the onus is on the respondent to establish that the FMV of the Data was higher than that assumed by the Minister.

[65]            As the appellant points out, the respondent did not put forward any expert evidence on the question of FMV at trial. However, there was other evidence before the TCC on this point that might be relevant. It might include the values reached by Sapieha's three appraisers, as well as the evidence of the prior Data sales. However, the TCC judge reached no conclusion on the issue of FMV because he found that the transaction was at arm's length. As a result of my conclusions, it is necessary to determine the FMV of the Data acquired by the respondent. This is a factual question that is best answered by a trial court.

[66]            Therefore, the matter should be remitted to a different judge of the TCC to determine whether the respondent can discharge his burden to establish on a balance of probabilities that the FMV of his interest in the Data exceeded the Minister's appraisal of its value. In these subsequent proceedings, the parties should be at liberty to lead further and other evidence on the FMV issue.

[67]            The appeal should be allowed with costs to the appellant, the Order of the TCC is set aside and the matter is remitted to a different Judge of the TCC to determine whether the respondent can prove a higher FMV for the Data than that determined by the Minister.

"J. Edgar Sexton"

"I agree

     John M. Evans J.A.".

"I agree

     B. Malone J.A.".

FEDERAL COURT OF APPEAL

NAMES OF COUNSEL AND SOLICITORS OF RECORD

DOCKET:                                                                               A-85-05

STYLE OF CAUSE:                                                               HER MAJESTY THE QUEEN

                                                                                                AND

                                                                                                ALLAN MCLARTY

PLACE OF HEARING:                                                         Calgary, Alberta

DATE OF HEARING:                                                           March 20, 2006

REASONS FOR JUDGMENT BY:                                      SEXTON J.A.

CONCURRED IN BY:                                                          EVANS J.A.

                                                                                                MALONE J.A.            

                                                                                               

DATED:                                                                                  April 27, 2006

APPEARANCES:

Ms. Wendy Burnham Ms. Deborah Horowitz	FOR THE APPELLANT
Mr. Jehad Haymour Mr. Carman McNary Mr. Marek Jacina	FOR THE RESPONDENT

SOLICITORS OF RECORD:

Mr. John J. Sims, QC Deputy Attorney General of Canada	FOR THE APPELLANT
Fraser Milner Casgrain LLP Calgary, Alberta	FOR THE RESPONDENT