Powell River Energy Inc. v. British Columbia (Minister of Small Business and Revenue)

2015 BCCA 372 Powell River Energy Inc. v. British Columbia (Minister of Small Business and Revenue) COURT OF APPEAL FOR BRITISH COLUMBIA Citation: Powell River Energy Inc. v. British Columbia (Minister of Small Business and Revenue), 2015 BCCA 372 Date: 20150824 Dockets: CA41610, CA41611, CA41612, CA41613 Docket No.: CA41610 Between: Powell River Energy Inc. Respondent (Petitioner) And Her Majesty the Queen in Right of the Province of British Columbia Appellant (Respondent) - and - Docket Nos.: CA41611, CA41612, CA41613 Between: Catalyst Paper Corporation Respondent (Petitioner) And Her Majesty the Queen in Right of the Province of British Columbia Appellant (Respondent) Corrected Judgment: The case name of these reasons was corrected on September 17, 2015, and the text was corrected at paragraph 1 on September 21, 2015. Before: The Honourable Mr. Justice Chiasson The Honourable Mr. Justice Frankel The Honourable Madam Justice MacKenzie On appeal from: An order of the Supreme Court of British Columbia, dated January 28, 2014 (Catalyst Paper Corporation v. British Columbia, 2014 BCSC 123, Vancouver Dockets S081640, S081641, S087199, S092112). Counsel for the Appellant: D.J. Hatter Counsel for the Respondents: K.L.D. Cook Place and Date of Hearing: Vancouver, British Columbia February 4, 2015 Place and Date of Judgment: Vancouver, British Columbia February 4, 2015 Place and Date of Reasons: Vancouver, British Columbia August 24, 2015 Written Reasons by: The Honourable Mr. Justice Frankel Concurred in by: The Honourable Mr. Justice Chiasson The Honourable Madam Justice MacKenzie Summary: Appeal by the Crown with respect to assessments of provincial sales tax. Catalyst owned and operated hydroelectric facilities that generated electricity for its pulp mill. It sold those facilities to PREI, a subsidiary, to raise funds to upgrade the mill. Catalyst and PREI then entered into several agreements which gave Catalyst a possessory interest in the hydroelectric facilities. This was done to enable PREI to continue to pay the lowest provincial water rental rate. Catalyst paid "Rent" under those agreements. Under a separate power purchase agreement, Catalyst purchased electricity from PREI. The "Contract Price" in that agreement was the market rate of electricity less the rent. The Crown took the position the "purchase price" of the electricity was the total of the Contract Price and the Rent and assessed sales tax on that basis. In disallowing those assessments, a judge held sales tax was payable on the Contract Price only. Held: appeals allowed, assessments restored. The agreements were inter-related and had been entered into solely for the purchase and sale of electricity. Regardless of how the payments were labeled, they collectively constitute the "purchase price" of the electricity and are taxable on that basis. Reasons for Judgment of the Honourable Mr. Justice Frankel: Introduction [1] These appeals concern the liability of Catalyst Paper Corporation ("Catalyst") to pay British Columbia provincial sales tax ("PST") on electricity it purchased to operate a pulp mill. That electricity was generated by hydroelectric facilities formerly owned by Catalyst and now owned by Powell River Energy Inc. ("PREI"). Under contractual arrangements with PREI, Catalyst paid a "Contract Price" for electricity under a "Power Purchase Agreement" and a separate amount for "Rent" under "Possessory Interest Agreements". The Contract Price was determined by deducting the Rent from the market value of the electricity. [2] The Crown's position is that the "purchase price" of the electricity is the total of what Catalyst paid to PREI, and PST is payable on that amount. After PST was assessed on this basis, Catalyst and PREI appealed the assessments to the Supreme Court of British Columbia. Those appeals were allowed by Mr. Justice Skolrood, who held the Rent payments were not part of the purchase price and were, therefore, not subject to PST: Catalyst Paper Corporation v. British Columbia, 2014 BCSC 123, [2014] 3 C.T.C. 9. [3] The Crown appealed to this Court. At the conclusion of the hearing, we allowed the appeals with reasons to follow. These are my reasons for so doing. Relevant Statutory Provisions [4] This matter is concerned with the provisions of the Social Service Tax Act, R.S.B.C. 1996, c. 431, which has since been repealed and replaced with the Provincial Sales Tax Transitional Provisions and Amendment Act, 2013, S.B.C. 2013, c. 1. [5] By reason of ss. 5(1) and 6(1) of the Social Service Tax Act, a "purchaser" must pay PST on "tangible personal property" which, pursuant to the definition in s. 1, includes electricity. [6] Additional terms defined in s. 1 of the Act include: "purchase price" means the following: (a) in relation to tangible personal property, means a price in money, and also the value of services rendered, the actual value of the tangible personal property exchanged, acquired or repossessed, and other consideration accepted by the seller or person from whom the property passes as price or on account of the price of the tangible personal property covered by the sale, and includes "purchaser" means (a) a person who acquires tangible personal property at a sale in British Columbia (i) for the person's own consumption or use, (ii) for consumption or use by another person at the expense of the person acquiring the property, or (iii) on behalf of or as agent for a principal, if the property is for consumption or use by the principal or by another person at the expense of that principal, Factual Background [7] The facts leading up to Catalyst and PREI entering into the agreements that are at issue in this appeal are comprehensively set out in the reasons for judgment of the chambers judge and need not be repeated here to the same level of detail. [8] Catalyst owned and operated a pulp mill in Powell River, British Columbia. Prior to 2001, Catalyst also owned hydroelectric generating facilities that provided 42% of the electricity it needed to operate the mill. It purchased the remaining 58% from B.C. Hydro. Catalyst's hydroelectric facilities were located on six statutory rights of way granted in its favour. In addition, it held water licences issued by the Provincial comptroller of water rights under the Water Act, R.S.B.C. 1996, c. 483, for the purpose of storing and using water to generate electricity. Because Catalyst was generating electricity to manufacture products at its mill, it paid the lowest water rental rate--the "commercial" rate--under s. 15 of the Water Regulation, B.C. Reg. 204/88. If the "general" rate applied, then Catalyst would have paid approximately $2 million per year more. To qualify for the commercial rate, a licensee must use the electricity it generates in an industrial facility in which it holds an interest of more than 50%. [9] In 2000, Catalyst began to explore the possibility of raising funds to upgrade the mill by selling a partial interest in its hydroelectric facilities. Its plan was to transfer title to the facilities to its subsidiary, PREI, and then sell a 49.9% interest in PREI to a third party, Great Lakes Hydro Income Fund. [10] As Catalyst was concerned with whether its restructuring plan would affect the water rental rate, it sought advance confirmation from the Provincial Water Management Branch. The Branch advised Catalyst that under the proposed plan neither it nor PREI would qualify for the commercial rate. [11] After further discussions with the Branch, the plan was changed so that Catalyst would continue to have rights of possession with respect to the hydroelectric facilities under Possessory Interest Agreements entered into between Catalyst and PREI (one for each statutory right of way). The Branch advised Catalyst that with those agreements in place, both it and PREI would qualify as licensees entitled to the commercial water rental rate. [12] With the Branch's assurance in hand, Catalyst sold a 49.9% interest in PREI to the Great Lakes Hydro Income Fund. It also entered into a number of other agreements, including a Power Purchase Agreement with PREI to buy electricity for the mill. [13] The Possessory Interest Agreements were entered into on January 30, 2001 and took effect the next day. As consideration for each one, Catalyst paid PREI "the sum of One Dollar ($1.00) and other good and valuable consideration". The Possessory Interest Agreements expire on "the date on which the Power Purchase Agreement expires or terminates". It was a term of the agreements that they would not be registered against the title to the hydroelectric facility. [14] Catalyst covenanted in the Possessory Interest Agreements to "not use or exercise its rights in a manner which is inconsistent with its obligations under the Power Purchase Agreement and the Management Agreement", i.e., an agreement between Catalyst, PREI, and a third party with respect to that party assuming responsibility for the management, operations, and maintenance of the hydroelectric facility. [15] Each Possessory Interest Agreement requires Catalyst to pay PREI "Rent" in the amount of $1,166,666.67 per year, payable in equal monthly installments, for a total annual payment of $7 million. [16] Also on January 30, 2001, Catalyst and PREI entered into a "Shared Facilities Agreement", the consideration for which, paid by each, was "one ($1.00) Dollar and for other good and valuable consideration". [17] Under the Shared Facilities Agreement, PREI granted Catalyst a statutory right of way to provide it with access to process water. The areas covered by that right of way are also covered by two of the Possessory Interest Agreements. Catalyst and PREI also agreed to share the use of transmission lines located on Catalyst's property. The agreement also provided rights of access to a "shared control station", a substation, and other equipment. [18] The Power Purchase Agreement was entered into on January 31, 2001. Its initial term was ten years, with provision for a three-year extension. The price paid by Catalyst for electricity was an "Energy Rate" of 3.495¢ per kilowatt hour, subject to an annual Consumer Price Index adjustment. The agreement further provides that Catalyst "shall pay the Contract Price for Delivered Energy", with that price being equal to: [T]he product of: (a) the Energy Rate; (b) the Delivered Energy [defined as the total amount of energy delivered]; and (c) [an "Efficiency Charge" calculated in accordance with the agreement]; less (d) the amount of the lease payments under the Possessory Interest Agreements, not including any payment of Taxes thereunder, provided [Catalyst] has a personal possessory interest in [PREI's] Facilities under the Possessory Interest Agreements. [19] Catalyst was responsible for any increases in PREI's property taxes and in the water rental rate it pays to the Crown. [20] The Power Purchase Agreement further provided that if PREI defaulted under that agreement and Catalyst elected to discontinue purchasing electricity, then Catalyst's obligation to pay rent under the Possessory Interests Agreements would be discontinued until such time as it resumed purchasing electricity. If Catalyst did resume purchasing electricity, then its annual rent obligation would be adjusted pro rata. [21] From February 2001 until August 31, 2005, the amount owing on the invoices PREI sent to Catalyst for the electricity was based on (Energy Rate x Delivered Energy) minus Rent plus PST; there were no Efficiency Charges. PREI invoiced Catalyst separately for Rent. PST was not charged on the Rent. [22] On its annual internal financial statements, PREI reported the total amount it received from Catalyst as either "Electricity Sales" or "Energy Revenue". On its appeal to the Supreme Court, PREI tendered evidence from a person responsible for its financial reporting that these combined entries were a "mistake" that went unnoticed until PREI received a notice of assessment in early 2006. Following the receipt of the 2006 notice of assessment, PREI made changes to its internal financial statements to show separate entries for the electricity and rent payments made by Catalyst. [23] Both before and after the 2006 notice of assessment, the notes to PREI's annual audited financial statement stated its revenue from Catalyst was for "sales of electricity". Those notes also described how the price for the electricity was determined. For example, the 2005 statement contains the following: Pursuant to a Power Purchase Agreement ("PPA") in effect until January 31, 2011, PREI will sell one of its shareholders, Catalyst Paper Corporation all energy generated by the Power System. In 2005, the energy rate was $35.56 per MWh. The energy rate is subject to an annual adjustment of 20% of the increase in the CPI for the prior year. [24] On December 8, 2005, the Commissioner of Social Service Tax assessed Catalyst $1,057,780.41 for failure to pay PST on the Rent from February 1, 2001 to August 31, 2002. On January 17, 2006, the Commissioner assessed PREI a penalty of $1,715,882.48 for failure to collect PST on the Rent from September 1, 2002 to August 31, 2005. [25] The Commissioner's assessment was made on the following basis (as set out in the affidavit of a senior auditor with the Consumer Audit Branch of the Ministry of Finance): 13. I considered that the PST payable was determined by the purchase price as defined in the [Social Service Tax Act] which included all monetary compensation paid for electricity. I determined and assumed for Assessment as a matter of fact that: (a) Catalyst had paid for electricity delivered at the designated Mill delivery points and consumed on the basis of product energy rate and delivered energy, and (b) the "rent" payments or ["]Lease payments" had been paid as additional monetary consideration for electricity. [26] From September 1, 2005 to June 30, 2010, Catalyst paid PST on both the Contract Price and the Rent. [27] Catalyst and PREI unsuccessfully appealed their assessments to the Minister of Small Business and Revenue. Catalyst also filed several refund claims with respect to the PST it had paid on the Rent. Those claims were disallowed by the Commissioner, and the disallowance was confirmed by the Minister. [28] In his decisions with respect to the assessments and refund claims, the Minister stated: The rent payment is part of the consideration paid for the right to receive electricity. The payment for the rights of way is clearly tied to the delivery of electricity. This is reflected in the provisions of section 8.2 of the Power Purchase Agreement providing that if [PREI] defaults on the provision of electricity, then payments under the Possessory Interest Agreements are to be discontinued until such time as [PREI] recommences supplying Catalyst with electricity. As such, the payment of rent is contingent on the provision of the electricity and, thus, forms part of the purchase price of the electricity. Consequently, there is no basis for reducing the purchase price for the electricity provided by [PREI] by the amount stated as the lease price for rights of way to real property granted to Catalyst. As the Power Purchase Agreement confirms, the Energy Rate shown on the invoices (i.e. the charge for electricity exclusive of the rental payment) is a market rate. Tax must be collected on this amount. If it were necessary to invoke section 4.1 of the [Social Service Tax Act], which provides for a valuation by the commissioner in cases where a transaction does not appear to have been made at fair market value, this is the price that would be taken to represent the fair market value of the electricity. [29] Catalyst and PREI appealed the Minister's decisions to the Supreme Court of British Columbia pursuant to s. 119 of the Social Service Tax Act. Those appeals were allowed and the assessment set aside. [30] The Crown was granted leave to appeal to this Court: Powell River Energy Inc. v. British Columbia, 2014 BCCA 216. Chambers Judge's Decision [31] The chambers judge rejected the Crown's argument that the "purchase price" consisted of the total payments made under the Power Purchase Agreement and the Possessory Interest Agreements. He held that the cost of the electricity was limited to the Contract Price. [32] In reaching this conclusion, the chambers judge had regard to the "entire agreement" clause in the Power Purchase Agreement, the separate invoices, and what he described as the "real and substantial" interests acquired by Catalyst under the Possessory Interest Agreements. With respect to the manner in which PREI recorded the combined payments, the judge noted there was evidence before him that doing so was consistent with Generally Accepted Accounting Principles. He referred to Canderal Limited v. Canada, [1998] 1 S.C.R. 147 at paras. 33-37, for the proposition that, in any event, how payments are characterized for accounting purposes will not necessarily be determinative as to how they are to be characterized for tax purposes. [33] The chambers judge opined that the characterization of the rent payments was not affected by a clause in the Power Purchase Agreement which provided that if PREI defaulted in specified ways and Catalyst elected to discontinue purchasing electricity, then Catalyst's payments under the Possessory Interest Agreements would also be discontinued until such time as it resumed purchasing electricity. The judge said this "simply underscores the obvious point that the agreements are inter-related": para. 79. [34] With respect to the fact that by being able to deduct the Rent payments Catalyst was able to purchase electricity below market value, the chambers judge said this: [81] I am mindful of the fact that the formula for determining the Contract Price, by which the Rent payable under the [Possessory Interest Agreements] is deducted from the amount derived by multiplying the Energy Rate by the Delivered Energy, results in [Catalyst] paying well below the market rate for electricity. On this point, counsel for [Catalyst] did not adequately explain why the Rent amounts were deducted from the amount that would otherwise be paid for the electricity. One would think that if the interests granted under the [Possessory Interest Agreements] were in fact different from and in addition to the sale of the electricity, the Rent paid for those interests would increase rather than decrease the total amounts paid by [Catalyst] to PREI. [82] However, there is no requirement that electricity be sold at fair market value and indeed, as submitted by [Catalyst], it is not uncommon for property to be sold at less than market value in non-arm's length transactions (at the time the [Power Purchase Agreement] was entered into, [Catalyst] owned 51.1% of PREI). I accept [Catalyst's] submission that the deduction of the Rent reflects an agreed discount on the cost of the electricity. [83] I would note on this point that pursuant to [an agreement between PREI and a limited partnership], the electricity generated by PREI that is sold to other entities and not pursuant to the [Power Purchase Agreement] is sold at a price that equals the product of the Energy Rate and the amount of additional electricity sold. Thus the overall scheme contemplates that electricity sold to [Catalyst] will be at a discounted price, whereas any surplus electricity will be sold at market rates. [35] The chambers judge also expressed the view that if the Crown was concerned about the electricity not being sold at fair market value, then the Commissioner could have determined a fair market value under the authority of s. 4.1(1) of the Social Services Tax Act, and assessed PST on that basis: para. 84. [36] In summarizing his conclusion, the chambers judge stated, with reference to Sussex Square Apartments Limited v. Canada, [1999] 2 C.T.C. 2143 (T.C.C.), aff'd [2000] 4 C.T.C. 203 (F.C.A.), that "the legal relationships and structures created by the [Power Purchase Agreement], the [Possessory Interest Agreements] and the related agreements are 'valid, binding and real' and there is no basis for the court not to give effect to them": para. 88. Grounds of Appeal [37] In its factum the Crown contends the chambers judge "fell into error" in nine different ways. I do not think there is any useful purpose in separately addressing each one. As I see this case, there is really only one issue, namely, whether, having regard to the various agreements, is the Rent payment part of the consideration Catalyst paid for the electricity it purchased from PREI. Analysis [38] At its core, Catalyst's position is that "form matters": see The Queen v. Friedberg, 92 D.T.C. 6031 at 6032 (F.C.A.), aff'd [1993] 4 S.C.R. 285. It says it was open to it and PREI to strike a bargain in which the Contract Price for electricity under the Power Purchase Agreement is calculated on the basis of a deduction for Rent paid under the Possessory Interest Agreements. It further says that having struck that bargain, it is not open to the Crown to treat the Rent as part of the purchase price of the electricity. Catalyst cites authorities that stand for the proposition that absent a sham, the legal form chosen by a taxpayer in managing its affairs must be respected: Shell Canada Ltd. v. Canada, [1999] 3 S.C.R. 622 at para. 39; Terasen Gas Inc. v. British Columbia, 2010 BCCA 255 at para. 22, 5 B.C.L.R. (5th) 112; Sussex Square Apartments Ltd. v. R., [1999] 2 C.T.C. 2143 at paras. 27-29 (T.C.C.), aff'd [2000] 4 C.T.C. 203 (F.C.A.). [39] The difficulty with Catalyst's position is that it ignores the fundamental nature of the transaction underlying the Power Purchase Agreement and the Possessory Interest Agreements, as well as their undeniable interconnectedness and integration. It also overlooks the fact that the issue is not whether there were rent payments, but whether, in the circumstances under which those payments were made, they fall within the definition of "purchase price" in the Social Service Tax Act. [40] In Sussex Square Apartments at para. 28, Judge Bowman, as he then was, in discussing what he described as the "substance versus form doctrine" quoted the following from his judgment in Continental Bank of Canada v. R., [1995] 1 C.T.C. 2135 (T.C.C.), aff'd [1998] 2 S.C.R. 298: [T]he essential nature of a transaction cannot be altered for income tax purposes by calling it by a different name. It is the true legal relationship, not the nomenclature that governs. [41] The essential nature of the transaction giving rise to all of the agreements entered into by Catalyst and PREI is the purchase and sale of electricity for use in Catalyst's mill. The singular purpose of the Possessory Interest Agreements was to maintain the lowest water rental rate for PREI's benefit; a savings to PREI of approximately $2 million per year. There is no support in the record for the chambers judge's conclusion that by reason of the Possessory Interest Agreements, Catalyst acquired "real and substantial" property interests in PREI's lands and facilities. At most, Catalyst acquired a nominal interest which, without the Power Purchase Agreement, was of no benefit to it. [42] Further, the record does not support the chambers judge's finding that the Rent deduction in the "Contract Price" formula reflected an agreed discount on the cost of the electricity. As the judge acknowledged, Catalyst "did not adequately explain why the Rent amounts were deducted from the amounts that would otherwise be paid for the electricity." Given the absence of any evidence with respect to the reason for the deduction, it was not open to the judge to find, based only on Catalyst's submissions, that it negotiated a below-market price for the electricity. [43] Catalyst seeks to support its position with reference to Singleton v. Canada, 2001 SCC 61, [2001] 2 S.C.R. 1046. Mr. Singleton, a partner in a law firm, withdrew $300,000 from his capital account with the firm, used that money to assist in purchasing a home, and, on the same day, borrowed approximately $300,000 from a bank which he paid back into his capital account. He claimed the interest on the loan as a deduction pursuant to s. 20(1)(c)(i) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.), on the basis the borrowed money was "used for the purpose of earning income". The Minister of National Revenue disallowed the deduction on the basis the borrowed money was used to finance the purchase of the house and was not a business investment. [44] The Supreme Court of Canada upheld the deduction. In his reasons for judgment, Mr. Justice Major stated the money originally in the capital account was not "frozen for all time" and that Mr. Singleton was "free to change his mind and decide whether to use his own money or borrowed money to finance the business of his law firm: para. 32. In the passage of the reasons relied on by Catalyst, Major J. said the transactions engaged in by Mr. Singleton "must be viewed independently": para. 34. [45] I do not read Singleton as standing for the proposition that when there are multiple transactions or agreements, each must always be treated as being in its own watertight compartment for taxation purposes. In Singleton the question was whether the borrowed money was used in a way that entitled Mr. Singleton to deduct interest. Notwithstanding why and how that money came to be borrowed, the answer was "yes". [46] Here, there is but one effective transaction between Catalyst and PREI, the purchase and sale of electricity. Their true legal relationship is that of buyer and seller, and they entered into the Power Purchase Agreement, the Possessory Interest Agreements, and the Shared Facilities Agreement for no other purpose. Regardless of how monies paid under the Power Purchase Agreement and Possessory Interest Agreements are labeled, they collectively constitute the "purchase price" of the electricity and are subject to PST. Disposition [47] For these reasons, the appeals were allowed, the orders of the chambers judge set aside, and the petitions dismissed. [48] The Crown is entitled to costs in both this Court and the Supreme Court. "The Honourable Mr. Justice Frankel" I AGREE: "The Honourable Mr. Justice Chiasson" I AGREE: "The Honourable Madam Justice MacKenzie'