Iula v. The Queen, 94 DTC 6614, [1994] 2 CTC 328 (FCTD)

Mackay J.:—In these actions the taxpayers appeal from the decision of the Tax Court of Canada, rendered July 26, 1988, which dismissed their appeal from reassessments of income for tax purposes by the Minister of National Revenue in relation to the income of each of the taxpayers for 1979.

The Minister’s reassessments, the Tax Court decision, and these appeals arise from transactions in which each of the taxpayers was engaged, participating with each of the others, in the purchase, development and sale of a lot of land in the city of Saskatoon. The same facts give rise to the issue of liability for tax in all four cases. On motion of the plaintiffs and with consent, the Court ordered that the four actions be consolidated,that the appeal of Angela lula and the others be heard on common evidence, and evidence taken on her appeal be applied in the appeals of Giuseppe lula, Marie lula and Rocco lula, and the judgment of this Court on the appeal of Angela lula then apply to each of the other appeals.

In argument an issue arose concerning the significance for the trial of testimony of the plaintiffs in the nearing of the Tax Court, which, it was urged, differed from that adduced as evidence before this Court at trial.

The actions raise the issue whether a land transaction in which the taxpayers were involved in 1979, the sale of property, resulted in profits from sale which are properly classed as capital gains or as income arising from a business or a venture in the nature of trade. By his reassessments the Minister classed the revenue as income from a business in the case of each of the taxpayers, on the basis that sale of the property was an adventure in the nature of trade rather than a capital disposition.

The problem is not new, and the jurisprudence has well settled that in cases of this sort, each case depends upon its particular facts (Regal Heights Ltd. v. M.N.R., [1960] S.C.R. 902, [1960] C.T.C. 384, 60 D.T.C. 1270, at page 907 (C.T.C. 390, D.T.C. 1273), per Judson J.), and in each case the taxpayer bears the onus of disproving assumptions of the Minister of National Revenue concerning the nature of the proceeds of sale of property as arising from a capital disposition or from business in the nature of trade (See e.g., Lee v. The Queen, [1992] 1 C.T.C. 64, 92 D.T.C. 6067, at page 65 (D.T.C. 6068) per Pinard J.).

When the plaintiffs were reassessed by the Minister of National Revenue, he did so relying upon the following assumptions of fact:

(a) On September 12, 1977, the plaintiff and three others [naming then the other three plaintiffs in the other actions heard together with that of Angela lula] (the others) acquired land situated at 113 U Avenue South in the City of Saskatoon, each having a one-quarter interest;

(b) In April 1978, financing by way of a mortgage was obtained and construction of a 17- suite apartment building was started by the defendant and the others;

(c) During the month of September 1978 the building was substantially completed and tenants started occupying some of the suites;

(d) Prior to December 18, 1978 the plaintiff or someone on her behalf caused to be published in the Star-Phoenix, a newspaper circulated in Saskatoon and Northern Saskatchewan, a classified advertisement offering the subject property for sale;

(e) As a result of the publication of that advertisement, Dr. S. Naidoo contacted Joe lula and offered to purchase the property at a price which was rejected by the plaintiff but a counter offer was accepted on the 6th day of January, 1979;

(f) On January 6, 1979, the property described in paragraph 2 above was sold to Dr. Naidoo for $459,000;

(g) Prior to December 1978 the plaintiff and the three others decided to start a construction business and eventually in February 1979 incorporated Valentino Construction Ltd. which acquired land, built and resold apartment buildings and other buildings at a profit;

(h) At the time of the acquisition of the land and of the construction of the apartment building, one of the main motivating factors for the plaintiff was the possibility of reselling the land at a profit or of developing it by erecting thereon an apartment building and reselling them at a profit.

The evidence before the Court

As earlier noted, counsel for Her Majesty submitted in argument that in some respects the testimony of the plaintiffs, each of whom testified under oath as a witness when these actions were heard, might be seen to be different, and more self-serving, than testimony each had offered at the hearing before the Tax Court. It was urged that where this was the case the Court should rely on the evidence offered on the same matter at the Tax Court hearing, since it was closer in time to the events giving rise to the claims of the plaintiffs and it might be presumed to be more reliable than later, differing evidence.

This seemed to me a novel suggestion and counsel were invited to, and they did following trial, present written submissions on the matter. For the defendant, counsel urged that the decision of the Supreme Court of Canada in R. v. B.(K.G.), [1993] 1 S.C.R. 740, 19 C.R. (4th) 1, supported the use of previous inconsistent statements to prove the truth where requirements of reliability and necessity are met. In the circumstances of this case sworn testimony from the Tax Court hearing met the test of reliability; and, it was urged, the plaintiffs’ recanting of or variation of prior testimony precludes evidence of the same value as that at the Tax Court getting before this Court; thus the criterion of necessity is met.

Counsel for the plaintiffs urged that there really were no inconsistencies of significance or of substance in the testimony at the Tax Court hearing and before me; any differences were explicable by the differences in the questions asked. Moreover, it was urged that R. v. B.(K.G.) was a criminal case and the application of the rule in that case related to witnesses other than the accused, while here the defendant sought to apply that principle to the evidence of the plaintiff, the principal party who stood to gain or lose from these proceedings, not to the evidence of some other witness. In the circumstances of this case, where plaintiffs were available and did testify at trial, it was open to counsel to test their credibility in these proceedings by reference to prior inconsistent statements, particularly if those were provided in discovery in this action, but it was not appropriate for the Court to rely on evidence given earlier at the Tax Court, in preference to the evidence adduced before this Court, concerning the truth of matters dealt with in that evidence.

I am not persuaded that in this case there is any necessity to look to evidence provided by testimony at the Tax Court. If that differed in substance from that offered by plaintiffs in this trial there was full opportunity to explore that difference in cross-examination. In my view, there was no direct recanting of inconsistent evidence of significance earlier given at the Tax Court by any of the plaintiffs.

The trial of these actions, though they are appeals from decisions of the Tax Court, are trials de novo. The parties have the normal obligation of adducing evidence before this Court upon which they would each seek to persuade the Court to reach a result favourable to their position. It would be extraordinary for the Court, in the absence of consent of the parties, to turn to evidence adduced earlier at the Tax Court rather than to consider the evidence here presented. There was consent to the reading in, and to reliance upon, the evidence offered at the Tax Court by Dr. Naidoo, who purchased the property in question from the plaintiffs. Dr. Naidoo had died since the Tax Court hearing and it was agreed that is evidence as there presented should be a part of the record in these proceedings. In the absence of consent, I am not persuaded this Court should consider in any way, other evidence as it was presented to the Tax Court in an earlier stage in resolution of the tax liability of the plaintiffs.

It is the evidence adduced before this Court which I consider as the basis upon which the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") is to be applied in this trial. This has been the practice in this Court as I understand it (see Snell Farms Ltd. v. M.N.R., [1990] 1 C.T.C. 5, 90 D.T.C. 6693 (F.C.T.D.) and Mel-Bar Ranches Ltd. v. M.N.R., [1989] 1 C.T.C. 309 (F.C.T.D.)). This case does not raise circumstances which would warrant departure from that practice.

The factual background

Before considering the factors relevant to determination of this case, it is useful to describe generally the factual background. The personal background of each of the plaintiffs and their respective activities in relation to the property in question has some significance. All are members of one family. The plaintiff Angela lula is the wife of the plaintiff Giuseppe, or Joe, lula. Joe is the younger brother of the plaintiff Rocco and the plaintiff Marie is Rocco's wife.

In 1977, when the property in question was purchased, Angela lula, who had come to Canada as an infant and had been raised and educated in this country before her marriage earlier in 1977 to Joe, was a legal secretary working in a law office in Saskatoon. Joe lula, who had come to Canada as a teenager a decade earlier, was a meat cutter, who had worked with Empire Meats for some six years in 1977. Rocco lula, who had come to Canada in 1959, was a tile setter, a trade he followed until a year or two before trial of this action, and his wife, Marie, was a seamstress working at The Bay, a position she continued to hold for some ten years thereafter. Only Angela lula is literate in terms of ability to read and write in English and the others admit inability to read and write in English and demonstrate limited ability in oral communication in English even though that ability may have improved since 1977.

At the time the property here in question was purchased, both Joe and Rocco lula owned other residential properties including in Joe’s case a "four plex” in which he and Angela resided. These properties were rented to others, except the units occupied by the two families, to supplement their employment incomes.

In September 1977 Joe lula noticed a real estate agent erecting a sign on the property at 113 U Avenue South, a property apparently comprising three original city lots which together provided a 75-foot lot, somewhat larger than lots generally in the area, and located within a couple of blocks of the respective homes of the brothers. Joe, without consulting the others made an offer to purchase the lot, an offer which was not accepted. Rocco, who was out of town at the time, was consulted on his return, as were Angela and Marie, and a subsequent offer to purchase the lot at $53,000. was accepted by the vendor. Agreement was reached in September and by mid-October the transaction was concluded, with transfer of title to the four lulas, all named, each with an individual one-quarter interest in the lot, and with possession taken on October 15, 1977.

All four testified as to their intent at the time of purchase, to hold the property as an investment, renting the house situate on the property. The possibility of ultimately having a “four plex" on the property was a factor, at least for the longer term, in Joe’s mind at the time. All four were considered purchasers since all four contributed to the purchase price. Rocco advanced $16,000. to Joe for the latter's share, and an agreement drafted by Angela using precedents from the law office where she worked was signed by both Joe and Rocco. It was intended, according to Joe and Angela, to provide some protection for Rocco's loan in the event of Joe’s death. The agreement provided for Rocco to make the loan in the amount of $16,000. and for Joe to pay interest, and further that the full amount of the loan plus accrued interest should be paid to Rocco “immediately upon the sale of the property located at 113 Avenue U South. . . .”

Despite that reference to possible sale all four plaintiffs were clear in their testimony that each had no intention to sell the property, rather it was to be a longterm investment for rental income. Angela testified that she had merely utilized a precedent from her office without instructions or thinking about any significance for words referring to possible sale. Neither Joe nor Rocco could read the document though each signed it as his own in reliance upon Angela's ability to produce an appropriate document to protect Rocco’s special investment in the property, by way of loan to Joe.

After taking possession in mid-October, the lulas worked together, after hours of their regular employment, to put the property in shape for renting. They had some inquiries and were completing repairs and refurbishing when Joe learned from announcements by the city that changes were to be introduced affecting land use in the area. He did not understand these, so made inquiries at city hall, where from further explanation he understood that the city was to change the zoning in the area from R4 to R2, and that the lot, which at the time of its purchase could have been developed with a multi-unit apartment block, would be limited to a duplex or equivalent development. Obviously, such a change had a negative impact on the value of the lot. The proposed city arrangements apparently provided a window of opportunity for owners of lands that would be affected by the zoning to apply for exemption within a given time frame.

After consultation among themselves, led by Joe, the lulas decided to apply for permission to build an apartment block on the land. They submitted plans for such a development: these were approved and a building permit issued in mid-April 1978. In the same month financing for construction of the apartment block was arranged with a life insurance company, and the apartment block was constructed from May to September in 1978. Apartments were in demand and the 17 units in the lulas’ new building were rented virtually as they were finished.

In December 1978, Joe lula asked his wife to insert in the Saskatoon Star- Phoenix an advertisement indicating the apartment block was for sale. He did not discuss this with Rocco and Marie. He testified that he had no intention of selling the building, rather he says the ad was intended to gain some indication of what market there might be for such a building for, after their apparent success with completing and renting the apartment units, Joe had begun to think about a new career, in property development rather than in meat cutting. Angela lula arranged for a brief classified ad which was published for two or three days, which said:

17 Suite Apartment for sale. Four months old. Fully occupied.

Excellent Mortgage. Westside. [telephone number] after five.

The telephone number included was the home number of Joe and Angela lula.

The ad resulted in some five or six telephone inquiries. One was from a Dr. Naidoo, who followed up his inquiry, arranging to view the building and then initiating negotiations for its purchase. Joe lula dealt with all inquiries and he testified that he indicated he did not want to sell the building and said it would only be sold for $30,000 per unit, a price which he did not believe any purchaser would offer. When Dr. Naidoo did offer to purchase the lot and building for $27,000 per unit, a total price of $459,000, Joe then for the first time discussed sale of the property with his co-owners. The other plaintiffs all testified they did not want to sell, they preferred to stick with their original plan to retain the apartment as an investment, providing rental income for them. Nevertheless, they ultimately agreed with Joe that Dr. Naidoo’s offer was too good to turn down and that they would accept it.

An agreement of sale was concluded on January 6, 1979, and in accord with its terms the property was transferred and the transaction concluded on February 20. Dr. Naidoo’s evidence at the Tax Court hearing, read in at trial by agreement as earlier noted, was that in his view the purchase price was a fair market price, and further, he had no recollection of Joe lula saying at any stage of their negotiations that the owners did not want to sell the building.

In the same month that sale of the building was completed, February 1979, Valentino Construction Ltd. was incorporated. Thereafter it engaged in construction of houses and apartment buildings. Joe lula did leave his trade as a meat cutter some months, perhaps six, after the incorporation of the company, to devote his time and energy to the construction business. The company was owned by the plaintiffs in these actions and apparently it and its successors have been quite successful. The principal business of its main successor, operated by Joe and Angela lula, is construction of houses. There was some uncertainty from testimony whether the company formed in February 1979 was funded in part by proceeds of the sale of the apartment block at 113 U Avenue South. It would be surprising if that were not so, but in my view it is unnecessary for this case to resolve that issue.

The lulas retained a chartered accountant for purposes of completing their income tax returns from 1978 on. In the 1979 return, the accountant, relying on his understanding of the circumstances, had reported, as business income, rents of the apartments for the first two months of the year, and he reported the profit on sale of the apartment block as a capital gain, for tax purposes. In 1984, following an audit by Revenue Canada, the plaintiffs were reassessed and the profit was deemed by the reassessment to be income from a sale in the nature of trade. The accountant, who testified at trial, was clear that his understanding of the circumstances when he completed the tax returns of the plaintiffs was that they had purchased the property in question with the intent of holding it for rental of the nouse situated on the lot, an intent consistent with their practice in regard to other lots they held. Only after its purchase, when the city proposed rezoning did the plaintiffs decide to try to develop the property and when permitted to do so they built the apartment block with the intention of holding it for investment and earning of rental income. The subsequent sale was a result of receipt of an offer to purchase that was too good to turn down, and the subsequent development of the construction company was a result of the satisfactory sale, not its cause. Admittedly the source of his understanding was Angela lula, the record keeper and contact for the accountant on behalf of the four lu las.

Analysis

The factors of significance in determining this case are the following, with my assessment of them.

First, on the testimony of all the plaintiffs I conclude that Joe lula was the directing mind, the motivator, for all four plaintiffs. 1 do not mean that he ordered what they should do, rather he initiated every step in the purchase, the development of the apartment block and its sale, and he was able to persuade the others to agree to those steps. His actions and his intentions are those of primary concern here, for the others ultimately followed his lead and must be considered to be bound by the intentions of Joe lula. (See, Sardo v. The Queen, [1988] 2 C.T.C. 290, D.T.C. 6464 (F.C.T.D.)).

Second, the taxpayers’ intentions at the time of acquisition of the property, and any secondary intention at that time must be assessed. Here the evidence of all the plaintiffs is clearly that at the time of purchase, all intended the property would be held as an investment with income to be derived from rent of the house. That was consistent with the only experience in acquiring real estate that Joe and his brother Rocco had; it is consistent with Rocco's aspirations of the time to ultimately be able to retire from his trade as a tile setter and live on the income from rental properties. It is supported as well by their actions, after acquiring the property in September 1977 for they devoted considerable time and effort and no doubt some expense to refurbishing the house on the property for rental, before learning of the proposed rezoning of the land. Their subsequent decision to construct an apartment block on the land, once the city approved, was not inconsistent with their original intent; all were clear in their testimony that the apartment project was undertaken still with the intent to hold the property as an investment for purposes of deriving rental income.

There was no direct evidence of secondary intent, to sell the property, at the time it was purchased. In cross-examination of Joe lula, counsel queried him about evidence given at the Tax Court hearing, evidence upon which the judge determined that there was a secondary intent. That evidence acknowledged by Joe lula that with a motel property adjacent to the lot purchased it could be that the value of the property would be enhanced if the motel were to be expanded. At trial of this action, he denied he had intended to indicate any secondary intention, at the time of purchase, to sell the property. I accept his sworn testimony, and that of all other plaintiffs, that there was at the time of purchase no secondary intent to sell the property.

Third, the relation between the purchase and ultimate sale transactions and the taxpayers’ business is, in my view, unusual in this case. At the time of purchase of the property the intention for the purchase which I have accepted was entirely consistent with the business of both Joe and Rocco in acquiring properties for investment and return of rental income; however, the subsequent sale of the property was inconsistent with their prior experience in acquisition of real property but consistent with their subsequent experience as shareholders in the property development company established in February 1979. That consistency of the sale with their later experience, was however not experience as individuals which is the basis of their reassessments for 1979 here in issue. As individuals, they had no prior or subsequent experience, at least on the evidence before me, in selling real estate either for capital gain or for trading income.

Fourth, the duration of holding the asset, here 15 months, is relatively short, particularly in view of the transformation of the property from one with a reason- ably attractive house to one with a 17-unit apartment block. Moreover, the time following completion of the apartment, until its sale, was only four months. A brief period of land holding may support a conclusion that its purchase and subsequent sale was undertaken as a trading venture, but that is only one of the factors to be weighed.

Fifth, the circumstances of the sale in this case included the following. Joe lula professes that the advertisement for sale of the property was placed merely to gain some sense of the market for the apartment building. In N.L. Brousseau Realty Co. v. M.N.R., [1986] 1 C.T.C. 2277, 86 D.T.C. 1186, Sarchuk J.T.C.C., of the Tax Court found, in somewhat different circumstances, that the placing of an advertisement for sale of real property was solely for a similar purpose and was not indicative of trading. In this case I have no doubt Joe lula was seeking to gain a sense of the market, but I also have no doubt that, whether the others were so inclined at that stage or not, he would have been prepared to sell the property if the price offered were right. In other words, I do not believe that he considered selling only after an offer too good to refuse was made. I infer that at the time the ad was placed he was prepared to sell if such an offer were made. That happened, but I am not persuaded that there was any intention, even on Joe lula’s part, prior to the placing of the advertisement to sell the property.

Counsel for the Crown urged that there was here a secondary intention to sell the property and such an inference was said to be supported by the short time the property was held by the plaintiffs, by the agreement between Joe and Rocco concerning repayment of the loan made by Rocco to finance the purchase of the property, and the provision of that agreement that the loan was repayable immediately upon sale of the property, by the decision to develop the property and erect an apartment block, by the larger than normal size of the lot in its neighbourhood, by the terms of the financing agreement which provided the mortgagee/ insurer had authority to approve the purchaser in the event of sale, by the classified ad which specified the building was for sale, and by the evidence of Dr. Naidoo read in at trial that the purchase price was in his view a fair market price, not an extraordinary price ana that there was no indication from Joe lula of a desire not to sell the property. I am not persuaded that the factors urged by counsel are persuasive that at the time of purchase of the lot the taxpayers, led by Joe lula, had any secondary intention to sell the property—nor that prior to placing the ad in December 1978, Joe had any intention of selling even if the purchase price offered were right.

Counsel for the Crown also urged that the nature of the sale transaction was similar to the business that the parties continued to follow through an incorporated company immediately following the sale of the property in question. That may be, and if so it raises the question of when the taxpayers, as individuals, for that is how they have been reassessed in this case, entered into trading in real estate so that the profit is properly classed as income from a business. The sale here in question was the first made by them as individuals, and the last, so far as the record shows. All subsequent sales and trading were done by the corporations of which they were shareholders and officers. In my view, it was their satisfactory experience with development and sale of the property that led them into that activity as a business, but they were not engaged in that activity as a business or for trade prior to the sale of the property. The proceeds of the sale, in my opinion, are properly classified as capital gains.

I reach that opinion because I find no direct evidence of a secondary intent at the time of purchase to sell the property and insufficient evidence to warrant an inference of such intention. The agreement between the brothers, concerning repayment of Rocco's loan, neither could read and I accept Angela lula’s testimony that she simply prepared the agreement based on a precedent at her office without much thought to its terms. The plaintiffs were not sophisticated investors or real estate developers or managers in 1977, though they may have subsequently become so.

In my view, the evidence here clearly supports the conclusion that two of the Minister’s assumptions underlying the reassessment of the plaintiffs are in error, at least in part. Contrary to paragraph (g) of his assumptions, earlier set out, there is no evidence that prior to December 1978 the plaintiffs decided to start a construction business. The only evidence before me is that the construction company was incorporated in February 1979. Secondly, as I have noted, I conclude there is no evidence and no basis for an inference that "at the time of acquisition of the land and of the construction of the apartment building one of the main motivating factors for the plaintiff[s] was the possibility of reselling the land at a profit or of developing it by erecting thereon an apartment building and reselling them at a profit".

Conclusion

In these circumstances, I conclude that the plaintiff Angela lula succeeds in her appeal and that decision, by agreement of the parties, applies in the case of each of the actions by the other plaintiffs. In short, they succeed in their appeals.

In requesting relief the plaintiff sought a declaration that profit from the sale of the apartment block at 113 Avenue U South, in Saskatoon, is a capital gain and not business income within the meaning of the Income Tax Act and accordingly the plaintiff was wrongly reassessed. Effectively the same result is achieved more directly by judgment vacating the reassessment, as section 177 of the Income Tax Act provided when the Act provided specifically for appeals from the Tax Court to the Trial Division of this Court. Judgment issues, vacating the reassessment, dated June 22, 1984 in the case of Angela lula (T-2509-88), which determined that the proceeds from disposal of the property were income from a venture in the nature of trade and not capital gain as claimed by the plaintiff.

A separate judgment is filed in relation to each of these actions, together with a copy of these reasons in the files of actions by Giuseppe lula (T-2510-88), Rocco lula (T-2511-88) and Marie lula (T-2512-88).

The plaintiff, and each of the plaintiffs, is entitled to costs on a basis reasonably reflecting consolidation of the actions for purposes of trial.

Appeals allowed.

Coopers & Lybrand Limited in its capacity as Trustee in Bankruptcy of

[Indexed as: Hawboldt Hydraulics Inc. Estate (Trustee of) v. Canada]

Federal Court of Appeal (Isaac C.J., Pratte and Heald, JJ.A.), August 19, 1994 (Court File No. A-1280-92), on appeal from a decision of the Federal Court-Trial Division reported at [1992] 2 C.T.C. 363.

Income tax—Federal—Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

The taxpayer's business included the repairing and remanufacturing of hydraulic systems for customers. This work consisted of the replacement of a part or parts of a customer's hydraulic system with a part or parts manufactured by the taxpayer. The issue was whether the goods manufactured as a result of these activities were "manufactured for sale” within the meaning of subparagraph 127(10)(c)(i) and Clause (i) of paragraph (a) of Class 29 so as to entitle the taxpayer to capital cost allowance and an investment tax credit in respect of the machinery and equipment used for the activities. The Federal Court-Trial Division allowed the taxpayer's appeal and the Crown appealed to the Federal Court of Appeal. The Crown’s position was that the activities in question did not constitute the manufacture of goods for sale because the contract between the taxpayer and the customer in each case was a contract for a repair service, i.e., for providing work and materials.

HELD:

At common law, “for sale" does not mean "for use in a repair process”. Furthermore, it was doubtful that any informed commercial person would seriously say that the manufacture of parts to be used to repair a customer’s defective equipment was a manufacture of the those parts for sale. In the result, the Minister’s reassessment was restored. Appeal allowed.

John C. Tait, Q.C., for the appellant.

Kitz Patterson for the respondent.

Cases referred to:

Crown Tire Service Ltd. v. The Queen, [1983] C.T.C. 412, 83 D.T.C. 5427;

Lyons v. The Queen, [1984] 2 S.C.R. 633;

The Queen v. Morgentaler, [1993] 3 S.C.R. 463;

Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, [1984] C.T.C. 294, 84

D.T.C. 6305:

Golden v. The Queen, [1986] 1 S.C.R. 209, [1986] 1 C.T.C. 274, 86 D.T.C. 6138;

Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32, [1987] 1 C.T.C. 117, 87 D.T.C.

5059;

Atco et al. v. Calgary Power Ltd., [1982] 1 S.C.R. 557;

The Queen v. Nowsco Well Service Ltd., [1990] 1 C.T.C. 416, 90 D.T.C. 6312

(F.C.A.), aff’g [1988] 2 C.T.C. 24, 88 D.T.C. 6300 (F.C.T.D.);

The Queen v. Halliburton Services Ltd., [1990] 1 C.T.C. 427, 90 D.T.C. 6320

(F.C.A.), aff’g [1985] 2 C.T.C. 52, 85 D.T.C. 5336 (F.C.T.D.);

Rolls Royce (Canada) Ltd. v. The Queen, [1993] 1 C.T.C. 272, 93 D.T.C. 5031;

Canadian Wirevision Ltd. v. The Queen, [1979] C.T.C. 122, 79 D.T.C. 5101.

Isaac C.J.:— This is an appeal from a judgment of the Trial Division reported at [1992] 2 C.T.C. 363, 92 D.T.C. 6452, which reversed a decision of the Tax Court of Canada that dismissed an appeal by the respondent's predecessor in title ("the taxpayer") from reassessments of its income tax liability for the taxation years 1982 and 1983.

The issue in the appeal is whether the taxpayer's activities in repairing and remanufacturing hydraulic and pneumatic components, for use in industry, amounted to a manufacturing of goods for sale such that the taxpayer is eligible in those taxation years for capital cost allowance under Class 29 of Schedule II of the Income Tax Regulations ("the Regulations”) and for investment tax credit under subsection 127(5) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

Background

1. The Facts

The facts are not in dispute. At the material times, the taxpayer (Maritime Hydraulic Repair Centre Limited) carried on the business of manufacturing, selling, “repairing and remanufacturing” hydraulic and pneumatic components for equipment used in industry. The business included the following categories of activities:

(a) selling hydraulic parts and accessories manufactured by others;

(b) replacing defective parts in hydraulic systems with parts manufactured by others;

(c) manufacturing, with its own raw materials and machinery, hydraulic components or systems and selling them to customers by sample or according to their specifications (custom-made); and

(d) repairing and “remanufacturing” hydraulic systems for customers. The activities in this category included the replacement of a part or parts of a customer's hydraulic system with a part or parts manufactured by the taxpayer. In his reasons, the trial judge described the category (d) activities as follows (Appeal Book Vol. VIII, page 1505):

In the category of its work that the taxpayer described as “repair and remanufacture” the evidence is that a customer would bring to the taxpayer and leave for repair equipment with hydraulic components, or the components themselves. The hydraulic component would be taken apart or “disassembled” and some part of it, either the cylinder, or a piston or a rod, or some other part, would be replaced with a corresponding part manufactured to fit the component from raw materials held in inventory or acquired by the taxpayer. In the manufacture of the required parts the equipment in question was used, as it was in the manufacture of hydraulic components to meet customers' specifications (category (c) above), which is not here in issue. When the new part was manufactured, the component or the customer's equipment was reassembled and tested. No issue is raised in this appeal in respect of the activities mentioned in categories (a) or (b). In respect of the activities mentioned in category (c), it is common ground that the taxpayer’s machinery and equipment were used primarily for the purpose of manufacturing or processing goods for sale within the meaning of the relevant statutory provisions.

In the taxation years 1982 and 1983, the taxpayer purchased the machinery and equipment that were used for the activities mentioned in categories (c) and (d). Some were new, others were used. It was agreed that only the new ones were eligible for the deductions claimed. The cost of those purchased in the 1982 taxation year was $340,942 and of those purchased in the taxation year 1983, $97,249.

The taxpayer's revenues from “manufacturing and processing", using its own machinery and equipment, in the relevant taxation years are indicated below:

Taxation

Activities

Year

The revenues from repair and remanufacturing represented approximately 52 per cent and 72 per cent, respectively, of the total revenues received by the taxpayer in the 1982 and 1983 taxation years from manufacturing or processing (including "chrome applications”) for work described in categories (c) and (d).

Counsel for the appellant admits that, the category (d) activities involved manufacturing; but he contends vigorously that the goods so manufactured were not for sale within the meaning of the relevant statutory provisions.

2. History of the Litigation

(a) The Tax Court of Canada

The Tax Court was concerned with the taxpayer's appeal from the reassessment of its tax liability for the taxation years 1982 and 1983.

Before that Court, as before the Trial Division, the evidence was that in the 1982 taxation year the taxpayer's revenues from category (c) activities, i.e., from manufacturing, were $213,751, while revenues from category (d) activities, i.e., repairing and remanufacturing, were $238,649 or $20,898 in excess of revenues from category (c). Similarly, for the taxation year 1983, revenues from category (c) activities were $121,524 and from category (d) activities $368,183 or $246,659 in excess of revenues from category (c).

On this evidence, the Associate Chief Judge of the Tax Court, considering himself bound by the judgment of Strayer J. in Crown Tire Service Ltd. v. The Queen, [1983] C.T.C. 412, 83 D.T.C. 5426, held that in respect of category (d) activities, the taxpayer did not use its machinery and equipment to manufacture or process goods for sale within the meaning of relevant statutory provisions. He held further that the machinery and equipment were so used in respect of category (c) activities. He noted that the machinery and equipment were used just as freely for category (d) as for category (c) activities and that the revenues from the former were greater than those from the latter. He therefore concluded that the machinery and equi ment were not used primarily in the manufacturing or processing of goods for sale within the meaning of the relevant statutory provisions and ne dismissed the appeal.

(b) The Trial Division

The taxpayer appealed that decision to the Trial Division of this Court by trial de novo. BY the time the appeal came on for hearing, the taxpayer had been adjudged a bankrupt. At the commencement of the hearing of the appeal, the trial judge, by order, authorized amendment of the statement of claim including the style of cause, to permit the present respondent to prosecute the appeal in the place of the taxpayer.

The appeal was argued on the record before the Tax Court which was admitted in evidence by consent order. No new evidence was called or tendered.

The issue before the Trial Division was the same as it was before the Tax Court, namely, whether the machinery and equipment which the taxpayer had acquired in the 1982 and 1983 taxation years were used primarily in the manufacturing or processing of goods for sale.

At page 2 of his reasons (Appeal Book Vol. VIII, page 1502), the trial judge noted that counsel were agreed that “the sole issue [before him] was whether, particularly in light of subsequent decisions of this Court, the Crown Tire decision" governed the appeal. They also agreed that the appeal should be dismissed if he concluded that it was; otherwise, the appeal should be allowed.

After an extensive canvass of the jurisprudence of both Divisions of this Court and a review of the facts, the learned trial judge concluded that Crown Tire was distinguishable and did not govern. He therefore allowed the appeal for reasons with which I will deal later.

Issue

Although, in his memorandum of fact and law, the appellant took several objections to the judgment in appeal, nevertheless, the only issue argued before us was whether the goods manufactured as a result of the category (d) activities, i.e., repair and remanufacture, were “manufactured for sale" within the meaning of the relevant statutory provisions.

In oral argument, counsel for the appellant admitted that the activities of repair and remanufacture involved manufacturing. However, he submitted that such manufacturing was not for sale as required by the relevant statutory provisions, but was part of a repair service. Hence, in his view, the machinery and equipment did not qualify and were not eligible for the deductions claimed. He submitted further that the appeal was governed by Crown Tire and should succeed or fail on Our acceptance or rejection of this submission.

Since the answer to the question posed in the appeal must turn on the proper construction of the relevant statutory provisions, I find it useful to reproduce them, in relevant part, before proceeding to an assessment of the submissions of the parties.

Relevant statutory provisions

Paragraph 20(1 )(a) of the Act provides for the deduction of capital cost allowances by taxpayers in the following terms:

20(1) Notwithstanding paragraphs 18(1 )(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

CAPITAL COST OF PROPERTY

(a) such part of the capital cost to the taxpayer of property, or such amount in respect

of the capital cost to the taxpayer of property, if any, as is allowed by regulation;

Subsection 127(5) of the Act provides for the deduction from tax otherwise payable by a taxpayer for a taxation year, an amount that relates to his investment tax credit at the end of the year. Subsection 127(5) reads:

INVESTMENT TAX CREDIT

127(5) There may be deducted from the tax otherwise payable by a taxpayer under this Part for a taxation year an amount not exceeding the lesser of

(a) his investment tax credit at the end of the year, and

(b) the aggregate of

(i) $15,000 and

(ii) 1/2 the amount, if any, by which the tax otherwise payable by him under this Part for the year exceeds $15,000.

In order to qualify for an investment tax credit, a taxpayer must have incurred a capital cost in qualified property described in subsection 127(9) of the Act. Subsections 127(9) and (10) define investment tax credit and qualified property as follows:

"INVESTMENT TAX CREDIT” DEFINED

(9) For the purposes of subsections (5) to (8) and subject to subsection (11.1), “investment tax credit” of a taxpayer at the end of a taxation year means the amount, if any, by which the aggregate of

(a) an amount equal to five per cent of the aggregate of all amounts, each of which is the capital cost to him of a qualified property, determined without reference to subsection 13(7.1). . . .

“QUALIFIED PROPERTY”

(10) For the purposes of subsection (9), a “qualified property" of a taxpayer means a property.... that is

(a) a prescribed building to the extent that it is acquired by the taxpayer after June 23, 1975, or

(b) prescribed machinery and equipment acquired by the taxpayer after June 23, 1975, that has not been used,or acquired for use or lease, for any purpose whatever before it was acquired by the taxpayer and that is

(c) to be used by him in Canada primarily for the purpose of

(i) manufacturing or processing of goods for sale or lease. . . .

[Emphasis added.]

For present purposes, paragraph 4600(2)(k) of the Regulations describes the property eligible for investment tax credit as follows:

QUALIFIED PROPERTY

(2) Property is prescribed machinery and equipment for the purposes of paragraph 127(10)(b) of the Act if it is depreciable property. . . that is

(k) a property included in. . .Class[es]. . .29. . .in Schedule II.

Schedule II deals with the rates of capital cost allowance applicable to various classes of property. Class 29 reads:

Class 29

50 per cent

Property that would otherwise be included in another class in this Schedule

(a) that is property manufactured by the taxpayer, the manufacture of which was completed by him after May 8, 1972, or other property acquired by the taxpayer after May 8, 1972,

(i) to be used directly or indirectly by him in Canada primarily in the manufacturing or processing of goods for sale or lease;

[Emphasis added.]

It is plain that both subsection 127(1 )(b) and (c)(i) of the Act and Class 29 of Schedule II to the Regulations provide that machinery and equipment are qualified property if used for the purpose of “manufacturing of goods for sale or lease".

Legislative history of the statutory provisions

It is now well settled that in construing legislation courts may consider, as part of the external context, materials such as Reports of House of Commons Debates or of Committees of the House of Commons as aids to discovering the aims of the legislating body, the evils or mischief with which it was contending at the time of enactment, and the background and purpose of the legislation. See, Lyons v. The Queen, [1984] 2 S.C.R. 633 at page 684, per Estey J., The Queen v. Morgentaler, [1993] 3 S.C.R. 463 at 484-85, per Sopinka J.

Subsections 127(5), (9) and (10) of the Act were first introduced into the House of Commons in 1973 as part of Bill C-65, to amend the Income Tax Act. They formed part of a package of legislative amendments enacted by Parliament to encourage industrial development in Canada by providing tax incentives to the manufacturing and processing sectors of the Canadian economy. Section 125.1 of the Act, which provided for a reduction of tax on corporate profits from manufacturing and processing in Canada, also formed part of the package and was introduced into the House earlier by Bill C-192.

In opening the debate on second reading of Bill C-192, the Minister of Finance spoke to the objectives of the government in introducing the legislation, as follows:

Mr. Speaker, the basic objectives of the measures before the House for its consideration this afternoon are twofold: they are to protect the millions of jobs that today depend directly and indirectly on maintaining the international competitiveness of our vitally important manufacturing and processing industries. . . .

I believe, that whatever may need to be done in the future to meet changing world conditions, parliament should adopt the measures we are now proposing to help our manufacturing and processing industries to meet and match the increasingly intense competition they face from foreign companies both in our own home market and in markets abroad.

. . . . the measures now being considered by the House provide a concrete and positive means of helping to overcome the critical problems confronting Canada’s manufacturing and processing industries over the medium and longer term. The legislation before the House for second reading, Bill C-192, provides for tne reduction effective at the beginning of 1973 of the top rate of corporate tax on manufacturing and processing profits to 40 per cent, and the reduction of the rate on manufacturing and processing profits of smaller, Canadian-owned enterprises to 20 per cent. A companion proposal, the fast two-year write-off of equipment and machinery acquired by manufacturers and processors between May 8, 1972, and December 31, 1974, is subject to implementation through changes in capital cost allowance regulations under authority provided by parliament.

On May 29 I tabled a draft of the proposed regulations, which form an integral part of the plan put forward by the government, so that the House would be in a position to consider and debate the whole program in a meaningful and comprehensive way. As soon as parliament has approved this bill, it is the government's intention to introduce these regulations by order in council. . . . [1]

The proposed reduction in the tax burden borne by Canadian manufacturers and processors is designed to assist them to meet increasingly intense foreign competition in a variety of ways: to increase the efficiency of their operations and lower costs; to undertake more research so as to develop new and better products and technologies; to finance increased capital investment both to modernize their operations and to expand productive capacity and employment; and to increase their price competitiveness with foreign producers both at home and abroad. . . .

. . . . In all parts of Canada, and especially in the eastern and western regions of the country, an increasingly intense effort is being made by governments at all levels to broaden industrial development, to extend production beyond the raw and semiprocessed stage to the output of fully manufactured or processed goods for sale across Canada and around the world.? [2]

Enacted as An Act to amend the Income Tax Act (No.2), S.C. 1973-74, c. 29, s.1, Bill C-192 received Royal Assent on July 27, 1973.

Similar statements were made by the Minister of Finance and by his Parliamentary Secretary during the debate on the second reading of Bill C-65, [3] which was enacted as An Act to amend the statute law relating to income tax (No.2), S.C. 1974-75-76, c.71 subsection 9(1) and received Royal Assent on December 2, 1975.

Analysis

It is now well accepted that the modern principle of interpretation of statutes is that the words of the statute are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament: Driedger, Construction of Statutes (2nd ed., Butterworths, Toronto, 1983), at page 8. This is the so-called words-in-total context approach. As regards the interpretation of taxing statutes Courts have been instructed to interpret the words of the statutes in light of the object and spirit of the taxing provisions and in the context of the economic and commerciality of the transaction giving rise to the dispute. Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305 at page 576 (C.T.C. 315 D.T.C. 6322); Golden v. The Queen, [1986] 1 S.C.R. 209, [1986] 1 C.T.C. 274, 86 D.T.C. 6138 at pages 214-15 (C.T.C. 277 D.T.C. 6140); Bronfman Trust v. The Queen, [1987] 1 S.C.R. 32, [1987] 1 C.T.C. 117, 87 D.T.C. 5059, at pages 52-53 (C.T.C. 128 D.T.C. 5066-67). But these principles are not invitations to Courts to ignore other well-accepted rules of construction, such as that which requires Courts to construe statutes so as "to ascribe some meaning to each word used by the legislature”. Atco et al. v. Calgary Power Ltd., [1982] 1 S.C.R. 557 at page 569.

I must therefore construe the clause "to be used by him in Canada primarily for the purpose of manufacturing goods for sale or lease”, as they appear in subpara- graph 127(10)(c)(i) and in Clause (i) of paragraph (a) of Class 29, in light of these principles. The words are not defined in the legislation. How then should their meaning be ascertained?

I start with context. One external context is, of course, the debates on second reading in the House of Commons to which I have made reference. They speak clearly and eloquently of the purpose of the legislation and the “mischief” with which Parliament was contending at the time of its enactment. The provisions were obviously part of a national industrial development strategy designed to stimulate employment in industry. The means used were legislated tax incentives of various kinds to encourage investment in new machinery and equipment for the manufacture or processing of goods in Canada for sale or lease in Canada and elsewhere in competition with foreign manufacturers and processors.

A second external context is the body of jurisprudence of this Court interpreting the legislation. The clause has received extensive judicial notice in this Court and two lines of authority have emerged as to the meaning of the phrase "manufacturing goods for sale or lease". One has its origins in Crown Tire, upon which the appellant relies: the other in The Queen v. Nowsco Well Service Ltd., [1990] 1

C. T.C. 416, 90 D.T.C. 6312 (F.C.A.), aff'g [1988] 2 C.T.C. 24, 88 D.T.C. 6300 (F.C.T.D.), and The Queen v. Halliburton Services Ltd., [1990] 1 C.T.C. 427, 90 D.T.C. 6320 (F.C.A.), aff’g [1985] 2 C.T.C. 52, 85 D.T.C. 5336 (F.C.T.D.), upon which the respondent relies.

I find no need to embark upon another review of the jurisprudence since that has been done extensively in the reported decisions cited to us, the latest being the decision of this Court in Rolls Royce (Canada) Ltd. v. The Queen, [1993] 1 C.T.C. 272, 93 D.T.C. 5031, where the Court applied Crown Tire and dismissed the taxpayer's appeal. It will be sufficient to state the different approaches. In Crown Tire, Strayer J. was required to construe the phrase as it is used in paragraph 125.1 (3)(a) of the Act. He approached construction on the basis that by using the phrase "goods for sale” without defining it, Parliament must have intended that its meaning should be derived from the general law of contract and sale. In that case he applied the common law distinction between contracts for sale and contracts for work and materials and reached a conclusion based upon it. In Nowsco and Halliburton, both supra, Urie J.A., for the Court, adopted a passage from the reasons of Reed J. in Halliburton in which she rejected the meaning based upon the common law distinction, opting instead for one based upon a literal construction of the word sale, such that any transfer of property manufactured by a taxpayer to a customer for a consideration, regardless of the nature of the contract between them, would amount to a sale within the meaning of the legislation. In adopting that approach Urie J.A. distinguished on its facts an earlier decision of this Court in Canadian Wirevision Ltd. v. The Queen, [1979] C.T.C. 122, 79 D.T.C. 5101 (F.C.A.), in which Pratte J.A., for the Court, clearly applied the common law distinction articulated in Crown Tire, albeit in obiter.

These, in summary, are the two approaches to the interpretation which the trial judge had before him when he decided the appeal. He chose one. Basing himself on an analysis which emphasized the nature of "the functions carried on by the taxpayer in using the equipment” and on his view that the purposes of the relevant statutory provisions are to provide incentives related to expenditures on equipment and machinery acquired for use in manufacturing goods for sale or lease, he chose the Nowsco, Halliburton approach. Critical to his conclusion is the following passage at page 372 (D.T.C. 1515) of his reasons:

Since it is the acquisition of equipment for use in manufacture of goods for sale that is assisted by the incentives under the Act, when the relationship between the parties is for both work and materials, or service, as well as for property to pass, the use of the equipment in production of discrete products before their adhesion or affixing to a customer's property would seem to be of significance for the application of the incen- tives. In Halliburton, Nowsco and Stowe-Woodward the equipment in question was found to be used to produce a product which was then sold to a customer. However that sale is made in terms of the forms or involving practices of the parties, or however the taxpayer's product is priced for sale, has no significance for the ultimate transfer of property in the product produced. Nor should these have significance for the assessment of the inherent nature of the taxpayer's functions in use of the equipment.

The trial judge had earlier observed at pages 371-72 (D.T.C. 1514-15) of his reasons:

It seems to me a formalistic splitting of the taxpayer's business activity, using the equipment in question, to recognize for incentive purposes the use of the equipment where the taxpayer manufactured parts as specified by a customer, including an entire hydraulic component by manufacture and assembly of its parts, but not to do so where the customer leaves defective hydraulic components for repair and the taxpayer's equipment is used in exactly the same manner to produce a part or parts for replacement of defective parts. In both cases the equipment is used in the same manner to make products, to manufacture goods.

Reduced to essentials, it is the position of counsel for the appellant that the taxpayer's category (d) activities did not constitute the manufacture of goods for sale, because the contract between the taxpayer and its customer in each case was one for work and materials. That was, he said, the common sense and businesslike appreciation of the arrangement between them. He contends that the trial judge was wrong in failing to distinguish between a contract for sale and one for a repair service, i.e., for providing work and materials. In his view, the effect of the judgment in appeal is that every repair except one for labour only would be a sale, thus entitling every repairman who manufactures a good to be incorporated in the repair process to the incentives offered by the statutory provisions. He asserted that the analysis in Crown Tire was valid and applicable to the facts of this case. When so applied, he says, the machinery used in the taxpayer's category (d) activities were not engaged Primarily in the manufacture of goods for sale. Consequently, the taxpayer did not qualify for the incentives claimed.

For his part, counsel for the respondent supported the judgment of the Trial Division. Like counsel for the appellant, he admitted that his position could not be sustained if this Court approved the Crown Tire approach. But he maintained that the Crown Tire approach was not valid and, in any event, was overtaken by the reasoning in Rolls Royce where MacGuigan J.A., in obiter, sought to reconcile Crown Tire and Nowsco, Halliburton on the basis that in the former case the processing “did not involve the creation of a good antecedent to its use in the provision of a service". Based on that statement, counsel submitted that, in respect of category (d) activities, the taxpayer did use its equipment to manufacture components which it then placed in the customer's machinery in substitution for defective components, for a consideration. This, he said, constituted manufacture of goods for sale within the relevant statutory provisions.

I am of the opinion that the appeal should succeed and the submissions of the respondent be rejected for the following reasons. First, it is clear from the total context of the legislation, including the passages from the House of Commons Debates to which I have referred, that Parliament's objective in enacting the legislation was encouragement of increased production of manufactured and processed goods to be placed on the domestic and international markets in competition with foreign manufacturers. That that is the activity which Parliament sought to encourage is, to my mind, plain from the debates. It is equally plain that Parliament intended to benefit manufacturers and processors who engaged in those activities. In other words, the relevant statutory provisions were designed to give Canadian manufacturers and processors an advantage over their foreign competitors in the domestic and foreign markets. It is also clear that Parliament had in mind specific target groups and specific target activities. The legislation was not intended to benefit every manufacturing activity or every manufacturer. The language of the statute is clear that the activities to be benefitted were the manufacture of goods for sale or lease and the beneficiaries, the manufacturers engaged in that activity. This is the short answer to those who say that the Crown Tire approach yields illogical results or results in a formalistic splitting of taxpayers' activities. In my view, that is the background against which the clause should be understood and construed.

As I have said, Parliament did not define the phrase “for sale or lease" in the legislation. How then should its meaning be determined? We are invited by the modern rule of statutory interpretation to give those words their ordinary meaning. But we are dealing with a commercial statute and in commerce the words have a meaning that is well understood. In the common law, “for sale” does not mean “for use in a repair process”. And I doubt that any informed commercial person would seriously say that the manufacture of parts to be used to repair a customer's defective equipment was a manufacture of those parts for sale. Strayer J. was right, in my respectful view, to say in Crown Tire at page 415 (D.T.C. 5428) that

. . . .one must assume that Parliament, in speaking of “goods for sale or lease" had reference to the general law of sale or lease to give greater precision to this phrase in particular cases.

On this approach, the taxpayer’s category (d) activities did not constitute the manufacture of goods for sale. To conclude otherwise would obscure the well known distinction between manufacturing for the purpose of sale and manufacturing for the purpose of repair services, and be contrary to the plain intention of Parliament in enacting the legislation—an intention which the authorities say a proper construction of legislation must give effect to. Furthermore, it would be at odds with the taxpayer's own categorization, for I note that the taxpayer was at pains to separate its records for category (c) activities from those for category (d) activities. There would be no reason for the separation if the taxpayer itself did not appreciate the distinction: it would have been easy to keep one set of records for all the goods manufactured without distinguishing between category (c) and (d) activities. But the taxpayer did not. It kept separate records for each of those activities, even though, as the trial judge found, the same machinery and equipment were used for both activities. This, in my view, is a telling indication that the taxpayer did appreciate the distinction.

Conclusion

In sum, the clause should be interpreted as suggested in Crown Tire. Even though the section of the Act in issue there was different, the language is the same and has the same purpose and intent as the relevant statutory provisions in issue here. The taxpayer's category (d) activities, i.e., repairing and remanufacturing, do not constitute the manufacturing of goods for sale. On the evidence, the taxpayer’s machinery and equipment were used primarily for those activities. The taxpayer is, therefore, not entitled to the deductions claimed.

For these reasons, I would allow the appeal with costs both here and in the Trial Division, set aside the judgment of the Trial Division and restore the reassessment made by the Minister.

Appeal allowed