Texasgulf, Inc. v. Commissioner

*52 COLVIN, Judge: Respondent determined deficiencies in petitioner's Federal income tax of $ 563,127 for 1979, $ 10,998,770 for 1980, and $ 1,794,073 for 1981. The sole issue for decision is whether the Ontario Mining Tax (OMT) is creditable under section 901. We hold that it is.

Unless otherwise indicated, section references are to the Internal Revenue Code in effect for*38 the years in issue. Rule references are to the Tax Court Rules of Practice and Procedure.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

*53 A. Petitioner and Kidd Creek Mine

Petitioner was a Delaware corporation the principal place of business of which was in Stamford, Connecticut, when it filed the petition.

Petitioner is the successor in interest to Texasgulf, Inc., a Texas corporation which filed consolidated Federal income tax returns for taxable years 1978, 1979, 1980, and 1981, as the parent of Texasgulf Canada. Texasgulf Canada discovered the Kidd Creek mineral reserves near Timmins, Ontario, Canada, in 1964. Texasgulf Canada explored the reserves, acquired some land claims from current owners, and began to develop the reserves.

Texasgulf Canada was incorporated in Delaware in 1965 as Ecstall Mining Ltd. (Ecstall). In 1966, Texasgulf Canada transferred the Kidd Creek land claims to Ecstall. At that time, the property had a significant amount of mineral reserves and substantial value. Ecstall began mining and concentrating operations at Kidd Creek Mine in 1966. Kidd Creek Mine is an open pit mine at which ore from a copper, zinc, lead, and*39 silver deposit is produced. In 1966, Kidd Creek Mine had a concentrator which was about 17 miles from the mine. A railroad connected them.

Texasgulf Canada owned and operated the Kidd Creek Mine from 1968 to 1981. From 1968 to 1980, Texasgulf Canada crushed the ore from Kidd Creek Mine into pieces 7 1/2 inches or smaller. Texasgulf Canada then put the ore in storage bins and carried it by rail to the concentrator for further processing. The concentrator further crushed, pulverized, and concentrated the ore.

Ecstall changed its name to Texasgulf Canada Ltd. in 1975 and to Kidd Creek Mines Ltd. in 1981. Texasgulf Canada was subject to the OMT because it mined and processed ore at Kidd Creek Mine. Texasgulf Canada paid OMT of $ 934,238 for 1978, $ 12,437,280 for 1979, and $ 18,307,052 for 1980.

B. The Ontario Mining Industry and the Production of Metal

Many metallic and nonmetallic minerals are mined and produced in Ontario. Metallic minerals mined in Ontario include base metals such as nickel, copper, and zinc, and precious metals such as gold, silver, and platinum. Nonmetallic *54 minerals mined in Ontario include asbestos, peat, gypsum, talc, and salt.

Generally, metal production*40 in Ontario and elsewhere has four phases: (1) Exploration; (2) development; (3) mining; and (4) processing.

1. Exploration

The exploration phase consists of finding and delineating ore reserves. These activities range from prospecting to exploring by aircraft with advanced scientific techniques such as electromagnetic and seismic surveying. Texasgulf Canada discovered minerals near the Kidd Creek Mine by using airborne exploration techniques.

2. Development

The development phase includes activities needed to bring a mineral reserve into production. For an underground mine, development activities include sinking a shaft, adit (an almost horizontal entrance to a mine), or ramp from the surface of the ground into the mineral reserves. For an open pit mine, such as the Kidd Creek Mine, development activities include removing waste rock that separates the ore from the surface.

3. Mining

The mining phase is the process of extracting ore from the ground, typically by blasting and mechanical removal.

4. Processing

The processing phase generally includes three different stages: (a) Milling or concentrating; (b) smelting; and (c) refining. Milling is the process of separating*41 waste rock from ore, generally through chemical treatment, to produce "concentrate". Copper concentrate, for example, is approximately 20-25 percent copper. A mill or concentrator is built at or near virtually every mine in Ontario.

Smelting is the process of converting concentrate into a relatively pure product. A copper smelter, for example, produces about 99 percent pure copper.

Refining is the process of producing pure metal from smelted product by heat-induced chemical reactions, electrolytic *55 methods, solvent extraction, hydro metallurgical methods, or vapometallurigical methods.

It is rare for a mining company to buy mineral property outright in Ontario. For this reason, Ontario mining companies typically do not incur high costs to acquire reserves and, consequently, do not have high cost depletion.

Small entities called junior exploration companies do much of the exploring for new mining properties in Ontario. Typically, junior exploration companies do not have enough financial resources to produce the ore they find. The junior company, once it has identified a body of ore, usually enters into an agreement with an established producer under which the producer does additional*42 work on the property in exchange for an ownership interest in it. If the additional work by the senior company shows that the property should be developed, the junior company and the senior company typically agree for the junior company to keep an ownership interest in the property.

C. The Ontario Mining Tax (OMT)

1. Application of the OMT

The OMT applies to every mine in Ontario to the extent that its OMT profits exceed a statutory exemption. Mining Tax Act (MTA), Rev. Stat. Ont. (R.S.O.), ch. 140, sec. 3 (1972). In most cases, the OMT is imposed on the mine operator. Id. sec. 2(2). The mine operator is the party that has the right to produce and sell minerals from the mine. Id. sec. 1(g). The OMT does not apply to holders of royalties.

2. OMT Profit

Profit for OMT purposes is the difference between either gross receipts from production or pit's mouth value and certain expenses, payments, allowances, and deductions. Id. sec. 3(3). Under the MTA, there are three ways to calculate the amount from which deductions and allowances are subtracted to compute profit for OMT purposes. Id. sec. 3(3)(a), (b), and (c). First, if an OMT taxpayer sells ore without*43 processing it, gross revenues are the total receipts from selling the ore. Id. sec. 3(3)(a). Second, if an OMT taxpayer processes ore before selling it, the OMT taxpayer subtracts deductions and allowances from the market value at the pit's *56 mouth of the mined minerals. Id. sec. (3)(3)(b). Third, if an OMT taxpayer does not know the market value of the output at the pit's mouth, deductions and allowances are subtracted from the value of the ore at the pit's mouth as appraised by the mine assessor to compute profit for OMT purposes. Id. sec. (3)(3)(c).

Most OMT taxpayers use the third method, also known as the "appraisal" method, to calculate profit for OMT purposes. This method is not based on the on-site value of ore; it is based on financial statements and other information included on an OMT return.

The OMT exempts some taxable profit. Ontario has increased the exemption over the years. The statutory exemption was (a) $ 10,000 before 1969, MTA, R.S.O., ch. 242, sec. 3(1) (1960); (b) $ 50,000 from 1969 to 1973, An Act to Amend The Mining Tax Act, R.S.O. ch. 69, sec. 2(1) (1969); (c) $ 100,000 from 1974 to 1979, An Act to Amend The Mining Tax Act of 1972, R.S.O. ch. *44 132, sec. 2(1) (1975); and (d) $ 250,000 beginning in 1979, An Act to Amend The Mining Tax Act of 1972, R.S.O. ch. 40, sec. 1 (1979).

3. Deductions for Expenses

An OMT taxpayer calculates its profit for OMT purposes by deducting specified expenses from either the pit's mouth value or its gross receipts from production. MTA, R.S.O., ch. 140, sec. 3(3). The MTA allows an OMT taxpayer to deduct expenses for: (a) Scientific research in Canada relating to mining in Ontario (added MTA, R.S.O., ch. 269, sec. 3(7)(d) (1980)); (b) working the mine above and below the ground, including salaries and wages for miners and office workers; (c) operations and maintenance (added MTA, R.S.O., ch. 269, sec. 3(7)(d) (1980)); (d) power and light for mining; (e) transportation of minerals; (f) food and provisions; (g) explosives, fuel, and other supplies; (h) safeguarding the mine and its output; (i) insurance on the output, mining plant, machinery, equipment, and buildings; (j) depreciation of the mining plant, machinery, equipment, and buildings; (k) charitable donations; and (1) certain costs of developing a mine. Id. sec. 3(3)(d) through (n). In 1978, 1979 and 1980, an OMT operator could claim*45 a depreciation allowance from 5 to 15 percent of *57 the remaining undepreciated cost of its depreciable assets. Id. sec. 3(3)(k) (1972).

An OMT taxpayer may not deduct expenses for (a) plant, machinery, equipment, or buildings except as described above; (b) investment capital, investment interest, or stock dividends; (c) depreciation in the value of the mine, mining land, or mining property due to exhaustion of the ore or mineral; (d) royalties paid for the output of a mine on private (i.e., non-Crown) land; and (e) the cost of developing a mine, except as described above. Id. sec. 3(4). Exploration expenses were not recoverable in 1965, but are recoverable in the years in issue.

4. Processing Allowance

Most OMT taxpayers can deduct a processing allowance under the third method for calculating OMT profit. ¹Id. sec. 3(3)(c)(i) and (ii) (as amended in 1975); Ont. Rev. Regs. 126/75, sec. 4 (1975). During the years in issue, the processing allowance was calculated at a rate prescribed by the regulations or determined by the mine assessor. MTA, R.S.O., ch. 269, sec. 3(7)(c)(ii). The processing allowance was a percentage of the cost of assets used to process a mined product*46 (asset cost basis) or a percentage of profits from mining and processing activities (combined profits). Ont. Rev. Regs. 126/75, sec. 5 (1975). An OMT taxpayer which used the asset cost basis method multiplied the original cost of assets by a percentage which varied based on which processing assets the mine operator owned (e.g., concentrator, smelter, refinery, and semi-fabricating plant) and where those assets were located (e.g., in Northern Ontario). Id.

The minimum processing allowance was 15 percent of combined profits. Id. sec. 5(5). The maximum processing allowance was 65 percent of the OMT taxpayer's combined profits. Id.

Most mine operators claimed the 65 percent amount. The processing allowance was zero if an operator had no taxable profits or had a loss for a taxable year. There is nothing analogous to the*47 processing allowance in financial accounting.

*58 5. Calculating OMT Liability

Most OMT taxpayers started to calculate the OMT with net income from mining and processing reported on their financial statements. OMT taxpayers adjusted their financial statement net income by adding expenses which the MTA did not allow to be recovered and subtracting items of income not related to Ontario mining and processing. OMT taxpayers made these adjustments by reconciling OMT taxable income and financial statement net income. OMT taxpayers computed taxable profit by deducting specified expenses, payments, allowances, and deductions as described above. MTA, R.S.O., ch. 140, sec. 3(3) (1972).

D. The Mine Assessor

During the years in issue, the Mine Assessor was responsible for enforcing the Mining Tax Act. The Mine Assessor encouraged taxpayers to comply with the MTA, administered the MTA, interpreted and applied the MTA and its regulations, recommended policy related to mineral taxation, and developed and implemented tax assessment standards. The Mine Assessor reviewed all OMT returns, either confirmed or changed the liability that the OMT taxpayer reported, and assessed the OMT due from*48 operators.

Mine operators who disagreed with the Mine Assessor's determinations could appeal to the Minister of Natural Resources. The Minister of Natural Resources referred the appeal to the Mining Commissioner or the Ontario Municipal Board to be tried and decided.

In 1986, the position of Mine Assessor was renamed Senior Manager of the Mining Tax. In 1993, it was renamed Manager of the Mining Tax. The duties of these positions are the same as those of the Mine Assessor described above.

Kumara Rachamalla (Rachamalla) was appointed Mine Assessor in 1980 and served in that position (as renamed) until the date of trial.

E. Texasgulf Canada's OMT Liability, Nonrecoverable Expenses, and Processing Allowance

Texasgulf Canada's total processing allowance for 1968 to 1980 was Can$ 468,106,000, and its nonrecoverable expenses were Can$ 340,787,000. Texasgulf Canada had financial *59 statement net income, OMT profit and depreciation, nonrecoverable expenses, and processing allowances as follows:

*49 The nonrecoverable expenses are as follows:

F. Comparison of Processing Allowances and Nonrecoverable Expenses for Other OMT Taxpayers

From 1968 to 1980, the processing allowance exceeded nonrecoverable expenses for most OMT taxpayers. For those years, total processing allowances claimed by OMT taxpayers were more than three times greater than nonrecoverable expenses. Total processing allowances exceeded nonrecoverable expenses each year from 1968 to 1980 except 1971 and 1977.

*50 *60 G. Respondent's Determination and Petitioner's Election

On March 29, 1989, respondent issued a notice of deficiency to petitioner for 1979, 1980, and 1981. Respondent did not determine a deficiency for 1978, but adjusted petitioner's net operating loss to be carried forward from 1978 to 1979. Petitioner timely elected for section 1.901-2, Income Tax Regs., to apply in deciding whether its OMT and other Canadian taxes are creditable under section 901.

OPINION

A. Background and Contentions of the Parties

The parties dispute whether the OMT is creditable under section 901. Our decision on this issue depends on whether the OMT is an income tax under section 1.901-2, Income Tax Regs.

A taxpayer may deduct foreign taxes unless the taxpayer elects and is entitled to use the foreign tax credit. Sec. 901(a). If a taxpayer is a citizen or a domestic corporation, the taxpayer may be entitled to a credit for any income, war profits, and excess profits tax paid or accrued during the taxable year to a foreign country or possession of the United States. Sec. 901(b)(1). ²

*51 The purpose of the foreign tax credit is to "mitigate the evil of double taxation" of domestic corporations on income from foreign sources. Burnet v. Chicago Portrait Co., 285 U.S. 1, 7 (1932); New York & Honduras Rosario Mining Co. v. Commissioner, 168 F.2d 745, 747 (2d Cir. 1948), revg. and remanding 8 T.C. 1232 (1947). A credit against U.S. income tax is, in effect, an exemption from taxation, and is dependent upon legislative grace. Keasbey & Mattison Co. v. Rothensies, 133 F.2d 894, 898 (3d Cir. 1943). A taxpayer who claims a foreign tax credit must show that it clearly comes within the statute that allows the credit. Id. Petitioner bears the burden of proof. Rule 142(a). The "reaches of the word 'income' *61 in section 901(b)(1) have been the subject of a long and tortuous history" in terms of legislative background, the decided cases, and respondent's rulings, which history is "permeated" with "vagaries, confusion, and * * * contradictions". Bank of America Natl. Trust & Sav. Association v. Commissioner, 61 T.C. 752, 759 (1974),*52 affd. without published opinion 538 F.2d 334 (9th Cir. 1976). In Bank of America Natl. Trust & Sav. Association v. United States, 198 Ct. Cl. 263, 459 F.2d 513, 523 (1972), the U.S. Court of Claims concluded that an income tax for purposes of section 901(b):

covers all foreign income taxes designed to fall on some net gain or profit, and includes a gross income tax if, but only if, that impost is almost sure, or very likely, to reach some net gain because costs or expenses will not be so high as to offset the net profit. [Fn. ref. and citation omitted.]