Supreme Court Decides That Cash-Settled Hedging Contracts Constitute "Hedging" Under The Mining Tax Act

On May 25, 2006, the Supreme Court of Canada decided unanimously that mining companies must include income for mining tax purposes gains from cash-settled forward contracts and options entered into as hedges. In doing so it reversed a split decision to the contrary by the Ontario Court of Appeal. While the decision revolved around a definition of "hedging" unique to the Mining Tax Act, the reasoning of Mr. Justice LeBel is of considerable interest.

Under the Mining Tax Act, mine operators pay tax on their profit, defined to include (i) total consideration from the output of the mine, (ii) all consideration from hedging, and (iii) all consideration from future or forward sales of the mine’s output. "Hedging" is defined under the Act as "the fixing of a price for output of a mine before delivery by means of a forward contract or a futures contract on a recognized commodity exchange", in addition to the non-speculative "purchase or sale forward of a foreign currency related directly to the proceeds of the output of a mine."

Until 1998, the Ontario Ministry of Finance interpreted the hedging definition to apply only to physically settled hedging transactions. Placer Dome Canada (PDC), the respondent in this appeal, accordingly omitted income from cash-settled transactions entered into on its behalf by its parent Placer Dome International (PDI). In 1998, however, the Ministry reversed its policy and a couple of years later it reassessed PDC’s pre-1999 returns accordingly.

The case raised a number of issues of statutory interpretation, particularly of tax statutes. While we need not dwell on all of these here, it is interesting that the Supreme Court declined to draw any adverse inference from the Ministry’s sudden and retroactive change of policy and disavowed the notion that ambiguous tax legislation is automatically to be interpreted in favour of the taxpayer.

The decisive interpretive principle, in the court’s view, was that to interpret "hedging" to exclude cash-settled transactions would make part (ii) of the definition of "proceeds" superfluous, since part (i) would appear to include physically-settled futures contracts and options already. In other words, the reference to hedging could only have been necessary if the legislature had intended to include as "profit" proceeds not directly derived from the physical output of a mine.

At the Ontario Superior Court, Mr. Justice Cullity had found in the Minister’s favour on just this basis: there was, he wrote, a sufficient "nexus" or "link" between PDC’s hedging transactions and the output in virtue of (i) the underlying purpose of the transactions, (ii) the existence and terms of the agency agreement between PDI and PDC, (iii) the allocation of transactions to PDC pursuant to that agreement and (iv) PDC’s treatment of the gains and losses for the purpose of its internal accounting and corporate tax returns. The Supreme Court agreed with Cullity J. that, practically speaking, synthetic derivative transactions with "some link" to output do serve to "fix the price" of the underlying commodity even though no physical delivery ensues. LeBel J. agreed with Cullity J. that there is no essential difference in this respect between forward contracts and options, the latter being a subset of the former providing for "contingent forward sales" that are conditional on the exercise of the option. Unfortunately for PDC, its argument on this point at the Supreme Court was undermined when the Ministry’s lawyers pointed out a reference in one of the company’s own Annual Reports to "forward sales contracts including spot deferred contracts and options".

A final issue was the legislation’s reference to the inclusion of "all consideration" from a hedging transaction. "All consideration", LeBel J. admitted, would normally be taken to refer to a "gross" rather than "net" amount, which in the context of the taxation of a cash-settled hedge transaction would obviously be unfair. Rejecting PDC’s argument that the presence of this language was strong evidence that only physically-settled forwards and options were intended, he held that in the context of a definition of "proceeds" it was proper to interpret "consideration" as "net consideration".

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