COURT FILE NO.: CV-21-00670477-00CL and CV-21-00670475-00CL
DATE: 20220517
SUPERIOR COURT OF JUSTICE – ONTARIO
(COMMERCIAL LIST)
RE: Genak Enterprises Inc., M. Pilla Professional Corporation, 4527054 Canada Inc., Sisbro Investments Limited, 1799101 Ontario Inc. and Nova Steel Inc., Applicants
and
Lake Shore Gold Corp., Respondent
AND RE: Paul Tompkins, Gordon Barr, Ellis Jacob and Anthony Graham, Applicants
and
Lake Shore Gold Corp., Respondent
BEFORE: Conway J.
COUNSEL: Paul-Erik Veel, Aoife Quinn and Amy Sherrard for Genak Enterprises Inc., M. Pilla Professional Corporation, 4527054 Canada Inc., Sisbro Investments Limited, 1799101 Ontario Inc., Nova Steel Inc., Paul Tompkins, Gordon Barr, Ellis Jacob and Anthony Graham
Caitlin Sainsbury, Megan Hodges and Brianne Taylor for Lake Shore Gold Corp.
HEARD: April 29, 2022
REASONS FOR DECISION
[1] These Applications concern the interpretation of indemnity provisions in two share subscription agreements for “flow-through shares” issued by Lake Shore Gold Corp. (“Lake Shore”) and Temex Resources Corp. (“Temex”).
Background
[2] Lake Shore is a Canadian mining company. In 2019, it was acquired by Pan American Silver Corp., a publicly traded company with net earnings of USD $176 million in 2020.[^1]
[3] The Applicants are ten philanthropists, each of whom participated in one of two flow-through donation financing transactions in 2014. The four individual Applicants subscribed for 17,757,000 flow-through shares in Temex for a price of $1,953,270. The six corporate Applicants subscribed for 2,565,000 flow-through shares in Lake Shore for a price of $3,001,050. Temex has since amalgamated with Lake Shore.
[4] Flow-through shares are shares issued by a corporation to a subscriber pursuant to an agreement in which the corporation agrees to incur eligible Canadian exploration expenses (“CEE”) listed in s. 66.1(6) of the Income Tax Act, R.S.C. 1985, c. 1 (5th Supp.) (the “Act”) and in turn renounce those expenses to the subscriber. The subscriber can then deduct 100% of those expenses from their own income.
[5] In a flow-through donation financing transaction, the shares are donated to a charity. Flow-through donation financing allows parties to give more money to charity than they would otherwise be able to, because of the additional tax credits they are able to obtain.[^2]
Lake Shore’s Drilling Expenses
[6] Lake Shore owns a mineral property located near Timmins, Ontario and operates the Timmins West Mine. The mine began producing from the “Timmins Deposit” in 2011 and was extended to the nearby “Thunder Creek Deposit” in 2012.
[7] In 2014 and 2015, Lake Shore conducted an exploration program on three other areas of the mineral property known as 144 Gap, 144 North, and 144 South, which are located southwest of the Thunder Creek Deposit. The exploration expenses were primarily for surface and underground drilling undertaken to locate gold deposits.
[8] Lake Shore filed its tax return on the basis, in part, that the drilling expenses qualified as CEE because they were incurred for the required purpose of determining the existence, location, extent, or quality of a mineral resource in Canada. Temex filed its tax return on the same basis. Lake Shore did not discover find any viable gold deposits at 144 North or 144 South but found one at 144 Gap. As a result, in 2016 Lake Shore decided to extend the Timmins West Mine to the new deposit at 144 Gap.
Canada Revenue Agency Audit and Reassessments
[9] In March 2018, the Canada Revenue Agency (“CRA”) commenced an audit of Lake Shore’s 2014, 2015, and 2016 taxation years. In the course of the audit, a CRA auditor considered whether the drilling expenses qualified as CEE under the Act. In July 2019, the CRA Audit Division proposed to re-characterize substantially all of the drilling expenses as expenditures that were not CEE and therefore not renounceable.
[10] The CRA reassessed Lake Shore in April 2021 and Temex in August 2021 on the basis that substantially all of the drilling expenses failed to qualify as CEE and were therefore not renounceable. Lake Shore has been assessed as owing approximately $2.15 million in tax plus interest. As a “large corporation” under the Act, Lake Shore was obliged to pay half of this amount.
[11] Lake Shore has appealed the reassessment by way of notice of objection to the Chief of Appeals, CRA Appeals Branch. The notice of objection has not yet been considered by the CRA Appeals Branch or the Tax Court of Canada. The appeal process is referred to in these reasons as the “Appeal”.
[12] In Spring 2021, the Applicants received consequential reassessments from the CRA, proposing to reduce the amount of CEE renounced to them. The reassessments include both additional tax payable by the Applicants for the years in question plus interest assessed by the CRA to the date of the notices of reassessment. Because the CRA charges high interest rates compounded daily, and the taxation years were several years earlier, the amount of interest was significant. For example, in the case of Genak Enterprises Inc., the additional tax payable was $174,464.00 and the interest component was $59,994.32, for a total of $234,458.32.
[13] The Applicants each filed notices of objection in the form provided by Lake Shore.[^3] They had first sought payment from Lake Shore under the indemnities in their share subscription agreements (discussed below). Lake Shore took the position that the indemnities were not yet engaged and that it would honour the indemnities once the Appeal was resolved. Lake Shore also noted that the indemnities did not cover interest and that Lake Shore would not cover anything more than the tax payable if the Appeal was unsuccessful.
[14] Eight of the Applicants chose to pay the amount indicated on their notices of reassessment. This had the effect of stopping the CRA from charging them additional interest on the amounts payable. If Lake Shore is successful in the Appeal, the Applicants will receive their payments back from the CRA, along with interest at the rate payable by the CRA (which is relatively low).[^4] If Lake Shore is unsuccessful, Lake Shore will indemnify the Applicants for the tax payable, but not the interest.
The Indemnities
[15] The subscription agreements each contain indemnity provisions (the “Indemnities”) for taxes payable by subscribers if the CEE renounced to them is reduced by the CRA pursuant to s. 66(12.73) of the Act:
Excerpt of the Lake Shore Indemnity
In the event that the renounced Resource Expenses are reduced pursuant to subsection 66(12.73) of the Tax Act, the Corporation shall indemnify and hold harmless the Indemnified Person as to, and pay in settlement thereof to the Indemnified Person, an amount equal to the amount of any tax payable (within the meaning of “excluded obligation” in paragraph 6202.1(5)(c) of the regulations to the Tax Act) under the Tax Act (and under any corresponding provincial legislation) by the Indemnified Person as a consequence of such reduction, which payment shall be made on a timely basis once the amount is definitively determined.
Notwithstanding the foregoing, this indemnity shall have no force or effect and the Subscriber shall not have any recourse or rights of action to the extent that such indemnity would otherwise cause the Common Shares to be “prescribed shares” within the meaning of section 6202.1 of the regulations to the Tax Act.
Excerpt of the Temex Indemnity
In the event that the amount renounced by the Company to the Purchaser is reduced pursuant to subsection 66(12.73) of the Tax Act, the Company shall indemnify and hold harmless each Indemnified Person as to, and pay in settlement thereof to the Indemnified Person, an amount equal to the amount of any tax (as referenced in paragraph (c) of the definition of an “excluded obligation” in subparagraph 6202.1(5) of the regulations to the Tax Act) payable under the Tax Act (and under any corresponding provincial legislation) by the Indemnified Person as a consequence of such reduction on or before the twentieth business day following the date the amount is determined.
Notwithstanding the foregoing, this indemnity shall have no force or effect and the Purchaser shall not have any recourse or rights of action to the extent that such indemnity, recourse or rights of action would otherwise cause the FT Shares or the FT Warrants to be “prescribed shares” or “prescribed rights” within the meaning of section 6202.1 of the regulations to the Tax Act.
[16] The Indemnities refer to “prescribed shares” as defined in s. 6202.1 of the Income Tax Regulations, C.R.C., c. 945. As set out in the record, a prescribed share is not a flow-through share, and the corporation is not entitled to renounce any expenses to the subscriber in relation to them. The Income Tax Regulations provide that certain indemnities will result in flow-through shares becoming prescribed shares. However, payments that are “excluded obligations” in s. 6202.1(5) of the Income Tax Regulations will not result in the shares becoming prescribed shares. There is no dispute between the parties that a contractual indemnity for taxes payable because of the company’s failure to properly spend the money on eligible CEE is an “excluded obligation”. However, a contractual indemnity for interest on unpaid taxes is not an excluded obligation.
[17] The Applicants point out that because the Indemnities do not contractually require Lake Shore to indemnify the Applicants for interest, the amount that Lake Shore is contractually obligated to pay under the Indemnities will always be the same (not including any pre-judgment interest). They argue that Lake Shore’s economic incentive is therefore to hold out payment for as long as possible. At present, it is uncertain how long it will take for the Appeal to be resolved.
[18] As noted, the Applicants sought to have Lake Shore indemnify them for the taxes payable under their reassessments. When Lake Shore declined to do so, the Applicants brought these Applications seeking a declaration that Lake Shore is required to indemnify them for the taxes payable under the notices of reassessment, together with pre-judgment interest from the date the taxes became due. They also seek a declaration that if they withdraw or do not proceed with their notices of objection, Lake Shore is required to indemnify them for the taxes payable under the reassessments.
Lake Shore’s Stay Motion
[19] Lake Shore has brought a motion for a temporary stay of the Applications pending the disposition of the Appeal. The following factors are to be considered in determining whether to grant a temporary stay of one proceeding pending the resolution of another: (i) whether there is substantial overlap of issues in the two proceedings; (ii) whether the two cases share the same factual background; (iii) whether issuing a temporary stay will prevent unnecessary and costly duplication of judicial and legal resources; and (iv) whether the temporary stay will result in an injustice to the party resisting the stay: Hollinger International Inc. v. Hollinger Inc., 2004 CarswellOnt 3442 (S.C.), at para. 5, leave to appeal refused, 2005 CanLII 4582 (Ont. Div. Ct.).
[20] At the conclusion of argument, I dismissed the stay motion. There are separate issues to be determined on these Applications and on the Appeal. The issues on these Applications are how the Indemnities are to be interpreted and whether the Applicants are entitled to be indemnified now or at a later date. These are contractual interpretation issues. The issues in the Appeal, on the other hand, are whether the drilling expenses qualify as CEE and whether they were properly renounced to the Applicants. These are tax issues. I therefore do not consider there to be substantial overlap of issues in the two proceedings. Nor do I think that a temporary stay will prevent unnecessary duplication of resources.
[21] Further, most of the Applicants have already paid the CRA under their notices of reassessment. At this time, they are entitled to have this court determine when they are entitled to repayment from Lake Shore under the Indemnities. In my view, preventing the court from making this determination now would cause the Applicants prejudice.
The Applications
[22] There are three issues raised in the Applications:
Are the Applicants entitled to be indemnified now for the taxes paid to the CRA under the notices of reassessment?
If the Applicants are successful on issue (1), are they entitled to receive pre-judgment interest from the date that their taxes became payable?
If the Applicants withdraw their notices of objection, is Lake Shore required under the Indemnities to pay the Applicants the taxes owing to the CRA?
Issue #1 – Are the Applicants entitled to be Indemnified for the Taxes Now?
[23] The Applicants submit that they are entitled to be indemnified immediately for the taxes paid to the CRA for three reasons.
[24] First, they submit that the “hold harmless” language in the Indemnities entitles them to an advance payment on the Indemnities. They rely on case law in which the words “hold harmless” in an indemnity have been interpreted as requiring a defendant to make an advance on the indemnity even before the underlying indemnity obligation has been determined: Mewburn v. Mackelcan, [1892] O.J. No. 75 (C.A.); Stewart Title Guaranty Co. v. Zeppieri (2009), 2009 CanLII 2329 (ON SC), 94 O.R. (3d) 196 (S.C.); Kelly v. Eldridge, 2006 NBQB 426, 315 N.B.R. (2d) 32. See also, Ruetz v. Metro Canada Inc. et al., 2021 ONSC 20; Queen (in Right of Ontario) v. Turn-Key Construction Inc., 2016 ONSC 5350.
[25] I do not accept that the words “hold harmless” entitle the Applicants to receive an advance on the Indemnities in this case for three reasons. First, the cases that the Applicants rely on are generally insurance cases in which the court held that the words “indemnify and save harmless” required the insurance company to pay the insured’s defence costs up front. They do not establish a general principle that the words “indemnify and save harmless” in a commercial contract automatically entitles the indemnified party to receive an advance on the indemnity.
[26] Second, even if I accept the Applicants’ submission that the term “hold harmless” might require an advance on an indemnity in an appropriate case, in the case at bar the Indemnities themselves specifically address the timing of when the Applicants are entitled to receive payment. The Lake Shore indemnity says that “payment shall be made on a timely basis once the amount is definitively determined”. The Temex indemnity says that it is “on or before the twentieth business day following the date the amount is determined.” There is no basis to read in an obligation to advance funds when the parties have turned their minds to the timing of payment and expressly provided for it in the contract.
[27] Third, the “notwithstanding” language at the end of each Indemnity refers only to “this indemnity” and “such indemnity”, referring back to the indemnity in the first paragraph. This language is designed, under the Income Tax Regulations set out above, to ensure that the Indemnities do not cause the flow-through shares to be characterized as prescribed shares. Given that the contract and the Indemnities were drafted in the context of this known risk, there is no basis to interpret the words “hold harmless” as having any separate meaning from the word “indemnify”, whether on timing of the payment or otherwise.
[28] Alternatively, the Applicants submit that the Indemnities are payable immediately because the amount of the Applicants’ taxes have been “definitively determined” or “determined”.[^5] I reject that submission. While the CRA has recharacterized the drilling expenses as non-CEE (and therefore not renounceable to the Applicants), that characterization is in dispute and has not yet been determined by an adjudicative body. It is CRA’s position only and has not been considered by either the CRA Appeals Branch or the Tax Court of Canada. It is only when a definitive determination is made as to whether (and the extent to which) the drilling expenses are or are not CEE that the amount of the taxes payable by the Applicants will have been determined.[^6]
[29] In support of their argument on this point, the Applicants rely on the decision of Penny J. in Boliden Mineral AB v. FQM Kevitsa Sweden Holdings AB, 2021 ONSC 6844. In that case, the parties signed a share purchase agreement containing an indemnity for taxes. After the deal closed, the Finnish tax authority reassessed the taxes owing. The vendor appealed the reassessment. The purchaser brought an application to enforce the indemnity. The court partially granted judgment on the indemnity.
[30] Boliden is distinguishable from the case at bar on several bases. Boliden concerned an indemnity for money that the applicants had been “forced to pay” and which had already been collected by the relevant tax authority: at para. 30. In this case, the Applicants have voluntarily agreed to pay the alleged taxes owing.[^7] While it may have been prudent or advisable to do so, the Applicants were not required pay the taxes.
[31] In Boliden, Justice Penny also explicitly declined to extend judgment to any amounts owing under the reassessments that were under appeal and had not yet been required to be paid: at paras. 112-114. He said: “Granting judgment under the contractual indemnities for amounts assessed but not yet payable because of a pending appeal is premature”: at para. 113. In my view, Justice Penny’s reasoning supports, rather than undermines, Lake Shore’s position.
[32] In addition, the indemnity in Boliden applied to a broad range of losses, including “liabilities or obligations of any kind, whether accrued, contingent, absolute, or otherwise”: see para. 36. It also did not include language clarifying that reimbursements were payable when the tax payable is “definitively determined” (Lake Shore) or “determined” (Temex). Based on the language of the respective indemnity provisions alone, the cases are distinguishable.
[33] I also note that in Boliden, there had already been one level of adjudication – or “determination” – concerning taxes owing: see paras. 27-31. In this case, and as noted earlier, Lake Shore’s notice of objection has not yet been considered by either the CRA Appeals Branch or the Tax Court of Canada.
[34] In their final submission on this issue, the Applicants submit that their interpretation is the commercially reasonable outcome because Lake Shore controls both the expenditure of the funds invested by them as well as the Appeal process. With respect, that is exactly what the Applicants bargained for. They could have provided that the Indemnities would be triggered within days following receipt of a notice of reassessment. Lake Shore included examples of contracts with other issuers of flow-through shares in which that has been done. Instead, the Applicants agreed that payment would be made when the amount of the taxes was determined. I am not prepared to rewrite the terms of the subscription agreements to which the Applicants agreed.
[35] The Applicants’ request for a declaration that they are entitled to be indemnified immediately for the taxes paid to the CRA under the notices of reassessment is dismissed.
Issue #2 – Are the Applicants entitled to Pre-Judgment Interest?
[36] The Applicants claim pre-judgment interest under the Courts of Justice Act, R.S.O. 1990, c. C.43 if this court orders Lake Shore to make an immediate payment of taxes under the Indemnities. Since I have concluded that the Applicants are not entitled to immediate payment of those taxes, I do not need to consider this issue.
[37] However, I observe that this is a claim for interest back to the date that the taxes were due. The Applicants concede that they could not, under the flow-through share rules, be contractually indemnified for anything more than the taxes payable to the CRA – i.e., they acknowledge that they are not entitled to recover interest under the Indemnities. In my view, their claim for pre-judgment interest under the Courts of Justice Act appears to be an indirect way of recovering interest for which they did not contract and could not reasonably expect to receive.
Issue #3 – Declaration re Withdrawal of Notices of Objection
[38] The Applicants seek a declaration that Lake Shore must indemnify them for any taxes payable in the event that the Applicants withdraw their notice of objection in the future. At the conclusion of argument, I dismissed the request for this declaration.
[39] The Applicants are asking this court to consider a hypothetical scenario. They have not withdrawn their notices of objection and are asking for a declaration of what is to occur if they decide to do so.[^8] Further, they do not require this court’s declaration in order to withdraw their notices of objection. They are free to make those withdrawals without the court’s declaration and can seek tax and legal advice on the effect and implications of doing so. Finally, and as noted at para. 28 above, I am not persuaded that while the Appeal is pending, the amount of the taxes will have been “definitively determined” (Lake Shore) or “determined” (Temex) for the purposes of the Indemnities.
Decision and Costs
[40] Lake Shore’s motions for a stay are dismissed.
[41] The Applications are dismissed.
[42] If the parties are unable to come to an agreement on costs, they may schedule a half-hour case conference before me (through the Commercial List office) to discuss the process for determining them.
Conway J.
Date: May 17, 2022
[^1]: The facts set out in these reasons are undisputed, unless otherwise noted. [^2]: In this case, PearTree Financial Services Ltd. and PearTree Securities Inc. (collectively, “PearTree”) arranged the donation transactions relating to the Lake Shore and the Temex share issuances. [^3]: Pan American told investors that they “should” file a notice of objection and provided instruction on how to do so. The evidence of Lisa Davis of PearTree is that the Applicants only filed the notices because of Lake Shore’s direction. However, in examinations conducted under r. 39.03 of the Rules of Civil Procedure, R.R.O. 1990, Reg. 194, some of the Applicants also said that they also filed the notices to recover interest if the Appeal is successful. [^4]: For corporations, the present rate is 1%. For individuals, the present rate is 3%. [^5]: The Applicants did not submit that there is a distinction to be made between the two provisions on the basis that the Lake Shore indemnity includes the word “definitively”. [^6]: In addition, Lake Shore points out that each investor’s unique circumstances will have to be considered before the amount of tax payable by that investor will have been determined. [^7]: The Applicants’ expert Mr. Nitikman explained that the CRA is prohibited from collecting tax after an objection is filed, subject to certain exceptions. He does not suggest that the exceptions apply to any of the Applicants nor is there any evidence that the exceptions would apply to them. [^8]: There was an issue as to whether Lake Shore would refuse to honour the Indemnities if an Applicant withdrew a notice of objection. Lake Shore conceded at the hearing that it was not taking the position that it would necessarily refuse to honour the Indemnities in that situation.