Cullen, J.: —This is an appeal from reassessments of tax for the plaintiff's 1977, 1978 and 1979 taxation years. In these reassessments the Minister of National Revenue (the Minister):
1. reduced the manufacturing and processing tax deduction claimed by the plaintiff under section 125.1 of the Income Tax Act (the Act) in respect of the plaintiff's 1977 taxation year and disallowed the same deduction in respect of the plaintiff's 1978 and 1979 taxation years;
2. disallowed in part the investment tax credits claimed by the plaintiff under section 127 of the Act, in respect of the plaintiff's 1977, 1978 and 1979 taxation years; and
3. disallowed accelerated capital cost allowance on a portion of the plaintiff's machinery and equipment in respect of the plaintiff's 1977, 1978 and 1979 taxation years.
The plaintiff is a corporation constituted under the laws of the Province of Alberta by certificate of amalgamation dated August 1, 1970. The plaintiff is in the business of oil well servicing and in the evidence and statement of claim, the plaintiff described its business activities as including the preparation and sale of special mixtures of cement, fracturing materials, acid and nitrogen. The defendant disputes that the plaintiff's business activities included the preparation and sale of these special mixtures.
In calculating. its income for 1977, 1978 and 1979 the plaintiff claimed a manufacturing and processing deduction under section 125.1 of the Act, an investment tax credit under section 127 of the Act, and accelerated capital cost allowance on machinery and equipment as assets, included in class 29 of Schedule B to the Act (now Schedule 11).
Plaintiff's Position:
The plaintiff maintains that it carried on a manufacturing and processing business the profits of which qualified for the deduction provided for in section 125.1 of the Act, and further, that its business activities, namely the preparing and sale of special mixtures, constitute manufacturing or processing in Canada of goods for sale or lease within the meaning of section 125.1 of the Act.
In its notice of objection, the plaintiff argued that its products were "goods" and that the preparation of these products constitutes the manufacturing and processing in Canada of goods for sale. The plaintiff also maintained that it derived ten per cent or more of its gross revenue from all active business carried on in Canada from the selling or leasing of the products.
The plaintiff contends that it made expenditures on qualified property within the meaning of subsection 127(10) of the Act and therefore was entitled to investment tax credit provided for in the said section.
Finally, the plaintiff contends that it owned depreciable property (equipment and machinery) which it had acquired for use in its business (i. e., the manufacturing or processing in Canada of goods for sale or lease) such that it falls within the depreciable property described in class 29 of Schedule B to the Regulations under the Act.
Defendant's Position:
In reassessing the plaintiff, the defendant proceeded on the basis that the plaintiff carried on the business of “a well servicing company". As indicated earlier the defendant disputes that the plaintiff's business activities included the preparation and sale of special mixtures of cement, fracturing materials, acid and nitrogen.
The defendant contends that the plaintiff did not manufacture or process goods for sale or lease and therefore does not qualify for the manufacturing and processing tax deduction provided for by section 125.1 of the Act. In the alternative, the defendant submits that during the taxation years in question the plaintiff's active business income did not include income attributable to manufacturing or processing as less than ten per cent of its gross revenues from the selling or leasing of goods manufactured or processed in Canada by it, and the manufacturing and processing in Canada of goods for sale or lease other than goods for sale or lease by it. Thus, the defendant maintains, the plaintiff does not qualify for the tax deduction provided for by section 125.1 of the Act.
The defendant further contends that the plaintiff did not own or acquire any property to be used primarily for the purpose of manufacturing or processing of goods for sale or lease or any other qualified property within the meaning of subsection 127(10) of the Act and therefore the plaintiff's claim for investment tax credit was properly disallowed.
The defendant also maintains that the plaintiff did not own or acquire any property to be used directly or indirectly by it primarily in the manufacturing or processing of goods for sale or lease or any other property properly included in class 29 of Schedule B and therefore that portion of the accelerated capital cost allowance relating to class 29 assets was properly disallowed.
The Main Issues:
I cannot put it more succinctly than counsel for the plaintiff describes it in Volume 1, page 11 of the transcript of the trial:
My Lord, the characterization of the nature of the business carried on by Nowsco is a fundamental and underlying issue in this case.
In the plaintiffs submission, that business constitutes the processing of products for sale. And I think it is fair to say that the difference of opinion with Her Majesty relates to the fact that, in Her view, the business of Nowsco constitutes the rendering of service or services to which the passage of title to goods is incidental rather than the actual subject matter of the business relationship.
Common to all the issues is the question whether the business carried on by Nowsco in Canada involved the manufacturing or processing of goods for sale, and is of course a conclusion of law to be based on all the evidence.
Background:
Both parties to this action accept that, for the purposes of these appeals, the oil industry in Canada may be divided into three sectors:
(a) the operators of wells, oil and gas wells, those being the persons who own the right to take the oil and gas from the well;
(2) the service sector which includes a wide range of companies with its business ancillary to the actual operation of oil wells, and are constituted the service sector; counsel for the plaintiff at page 20, Volume 1 of the transcript:
While it would not be entirely correct to say that a service company is one which, by and large, carries on its business at the well site, I am instructed that that is, generally speaking, a significant characteristic of a well service company.
I mean to say that they have certain other ancillary activities that are not necessarily carried on at the well site but, by and large, the activities, apart from the actual pumping of oil and gas, are conducted by service companies on behalf of the owners and operators.
(3) the third sector is the supply sector, which companies are in the business of supplying "hardware" to both the operators and, to some extent, the service companies.
It was evident to me that counsel for both the plaintiff and the defendant had admirably prepared for this interesting and important case. We are dealing here with the taxation years 1977, 1978 and 1979, but as counsel declared,
However, the issues that are raised in these appeals have continuing importance to the taxpayer, as I will try to indicate in a moment. There are claims for deductions that have relevance in subsequent periods.
And accordingly, there will be some evidence, with agreement with my friend, that touches on later years, it being the hope of the parties that the resolution of the issues for these years will, in fact, form the basis for resolving the similar issues in subsequent years.
It is therefore not surprising that the introductory comments by counsel for the plaintiff covered the issues in a most comprehensive manner, and although counsel for the defendant did not of course agree with the submissions vis-a-vis the nature of the plaintiff's business activities, there was no real dispute with respect to the terminology used by the plaintiff's counsel in his introduction. Rather than paraphrase these comments I will simply incorporate them here as the basis for the evidence and the argument of both counsel:
Nowsco was formed to carry on the business of what is referred to in the oil industry [as] a well service company. Its original business involved the specialized use of nitrogen gas in what is referred to as “well stimulation”.
And just perhaps, as an aside, the name "Nowsco", the initials, stand for Nitrogen Oil Well Service Company. . . . Having been formed for the purpose of promoting the use of nitrogen in subsequent years, Nowsco expanded into elated well stimulation and well cementing businesses.
In the case of stimulation, if Your Lordship would imagine a hole or well that has been bored to some considerable depth in the hope and expectation of tapping a deposit of oil or gas, you could then imagine certain types of activities that the owners or operators of the wells might find useful in promoting or stimulating the flow of the hydrocarbons from that formation.
Now there are a number of very sophisticated techniques for achieving that stimulation. They will be described in the evidence. They include a process described or referred to as “fracturing” pursuant to which a specially mixed fluid is pumped into the well under pressure and which fractures or splits the hydrocarbon-bearing deposit or formation in such a way that that split is propped open with what is referred to as a "proppant" so that following that process there are channels in the formation through which the oil can flow.
A second activity designed to stimulate production is referred to as “acidizing”. The purpose of acidizing is similar to that of fracturing; that is to say, to stimulate production from the well.
But generally speaking in the case of acidizing, the process or the stimulation is achieved by reason of the action or interaction of the acid with certain materials in the formation so as to dissolve certain of those materials thereby providing the channels through which oil and gas might flow.
That is the second of the activities that fall under the heading of stimulation.
There is a third. That involves the use of a gas, nitrogen, and again, the history of the use of nitrogen is one which has shown an increasing sophistication as to the applications or uses to which it may be put.
In its simplest form, nitrogen which is transported to the well site is a super cold liquid.
That liquid nitrogen is subjected to pressure; is heated and converted to a gas; the gas is pumped down the well and, in the course of that, debris and other matter in the well that might be restricting production is removed.
More commonly, I believe, My Lord, nitrogen is used in combination with other fluids and chemicals, particularly in those activities that I described as acidizing, to give the other fluids and chemicals special properties which enhances the stimulation process.
Thus there are three major activities that fall under the heading of stimulation or well stimulation. The other major area of activity is well cementing. There are various types of cementing:
. . . cementing is a process which is designed to fill the cavity that exists between the hole that is drilled in the ground, into the formation, and the steel casing that is inserted into that hole in order to solidify and protect the casing; in order to prevent the interaction of various fluids that might be in the formation or find their way into the formation with other parts of the well; and, on occasion, to close off non-producing sections of a well from producing sections.
And as was the case with the evolution of the technology of fracturing and acidizing, so has been the case with techniques for cementing. Again, these are processes which take place at the well site.
Typically cement, dry powder cement, is transported to the well site. Possibly that dry cement has had added to it, at an earlier stage, dry additives of one or more types. That mixture of dry cement and additives is then subjected to further mixing and processing at the well site.
Water is added. Other chemicals may be added to produce what is referred to in the industry as a "slurry", s-l-u-r-r-y. That slurry is then pumped into the well under pressure and depending on the particular job at hand, to use one or other of the results that I described a moment ago.
Business Activities of the Plaintiff:
Certainly the plaintiff is a well service company and a most successful member of this most competitive sector. In the course of presenting its evidence, the plaintiff, with the assistance of a video presentation, made it clear that expensive, custom-fabricated machinery was essential to the success of a well service company. This equipment requires highly skilled people if it is to be both safe and effective in its operation. As stated earlier, when material is pumped into the well, be it for stimulation or cementing, it must be done under pressure which is carefully calibrated so that damage will not be done to the casing or the well. Similarly the quantity of the product must be carefully tabulated so there is no shortfall of requirement.
Mixing and blending is a sophisticated operation requiring constant attention by all personnel on the job. Safety meetings before commencing are obligatory and where problems arise personnel must be properly trained to take appropriate action, be it reducing the pressure or shutting down the whole operation. The proper organizing of personnel and equipment is essential if the service is to be performed effectively.
It was clear from the evidence that the party in charge is the operator or the representative of the operator because, in the final analysis, the operator's investment and risk is significantly higher than that of the service company. But, if the service company is to be retained, it must establish a high degree of competency in all activities. Skilled engineers and highly trained, experienced technicians were the norm for this plaintiff.
The types of equipment used are impressive certainly but without the deft hand of skilled, educated, trained, and experienced people, the equipment would not be sufficient to convince the operator that a well service company should be retained.
Mr. S.P. Shouldice (Shouldice), chief executive officer of the plaintiff, describes the service sector as being "those companies that provide, to the operator, what he requires at the well site during the drilling and production of his well". (Transcript p. 102). Later, in reply to his counsel's question, "We are in the service sector. We don't own any reserve. We doesn't [sic] sell rope, soap and dope (jargon in the industry for supplies). So we are a service company”. Shouldice also referred to the significant number of competitors, who operate in the same range of activities, naming Halliburton and Dowell as large companies also in the service sector. Nowsco's customers are the owner-operators of oil and gas wells.
Videos showing the men and equipment at work at well sites left no room for doubt that the service sector is capital intensive. To be more specific, a foamed acidizing activity had a considerable string of frac pumpers hooked up to blenders as well as several nitrogen trucks. Exhibit P-1, Tab 16 shows the amount of equipment required at a "foamed acidizing jobsite" [see page 29].
Business Activities Prior to Securing a Contract:
The greater part of the plaintiff's business occurs at well sites in the province of Alberta. In order to operate as they do with the heavy sophisticated equipment, it is necessary for the plaintiff to establish field stations. Shouldice, at page 113 of the transcript:
The field station is the home for the equipment and the operators of that equipment that is dispatched to the well site when the customer has the need.
Q. Are those field stations, as far as Canada is concerned, they are distributed geographically in proximity to some oil territory?
A. That's right. They are generally located in areas of oil activity. It is a very competitive business we are in, and the client is accustomed to calling, sometimes, on very short notice. So it is desirous for us to have our people and equipment located as close as possible to the customer's needs.
The plaintiff maintains many field stations and lists them in Exhibit P-1, Tab 1, Shedule "A". Shouldice also gave evidence that the plaintiff has operating segments with the head office which include the sales department, engineering department, information systems and a research library.
At page 112 of the transcript, Shouldice in reply to his counsel:
Q. You referred, Mr. Shouldice, to sales function and an engineering function. What would those departments or divisions be principally engaged in?
A. The sales function, of course, is to make contact with the customer to make sure that Nowsco gets its fair share or more of the business that is available to be had.
The engineering function is to provide the end user with the up-to-date technology that is expected of us to help him develop the optimum method of expanding or completing his well.
Q. And is there some degree of communication then between engineering at head office and the field station?
A. Yes, Sir. They prepare what we refer to as a program which is sent to the field station to set the pattern as to how to perform the job at the well site.
[Emphasis added.]
Later, in cross-examination, Mr. R.G. Macdonald (Macdonald), Manager of Engineering Systems for the plaintiff, stated at page 358 of the transcript that the terms "treatment proposals", "treatment recommendations" and "treatment programs" are interchangeable and that the plaintiff and its competition prepare treatment proposals, recommendations and/or programs for operators. Macdonald confirmed that the plaintiff had a separate group for sales and a separate group for engineering, and at page 359 of the transcript stated:
There are two separate groups. There is also crossover in that there is [sic] some engineers that are in the sales group and some engineers that do selling, although they are still in the engineering group.
We heard that the preparation of the proposal is often done in consultation with the operator. The sales people would call on potential customers in the context of developing treatment proposals for that particular customer. Assistance was usually sought from the engineering group and the research and development group of the plaintiff. The proposal is the final step on the part of the plaintiff in presenting a well workover or a cementing job prior to the acceptance of that proposal by the customer.
It is probably trite to add that, prior to securing a contract, the plaintiff must have available the specially fabricated equipment which will do the job of transporting materials from the field station and perform their specialized functions at the well site.
The Business Activities at the Well Site:
Many functions are performed by the plaintiff at the well site including cementing, fracturing, acidizing, nitrogen, carbon dioxide, and endless tubing. There is what is called primary and secondary cements or remedial cementing. Also, within the categories named, the plaintiff could be called upon from time to time to do a job that might fit within more than one category, e.g. a foamed acid frac which involves acid, fracturing and nitrogen. It is probably appropriate here to elaborate on some of the terminology.
"Fracturing": the use of fluid under pressure, splitting open rocks to stimulate productivity from a well.
"Proppant": once a rock is split, to prop open that frac in the formation, a special fluid of certain viscosity is necessary to transport the proppant to the formation. As its name implies, the proppant is used to prop open the frac. "Acidizing": the use of acid to dissolve parts of the formation or any other debris that may be soluble in acid to enable the formation to produce better to the surface.
Matrix acidizing: an acidizing treatment that does not crack open the rock (as fracturing treatment does). It is meant to be fed into the formation and then flow through the formations matrix through the porosity of the matrix of the formation to dissolve parts of that porosity and part of the rock.
Foamed acidizing: the use of three activities of the plaintiff: one is the addition of nitrogen and carbon dioxide; the second is the use of acid; and the third is the use of fracturing to acquire the pressures in order to perform the job.
Endless tubing: A hollow steel tube that is made of a particular kind of steel that is able to bend and is reeled on to a large reel. It can be up to 4,000 metres in length. On a job described in evidence by Macdonald, the operator wanted to clean out some debris in the bottom of the well and an easy and economical way of cleaning out was to run endless tubing into the well, pump nitrogen gas through it to create turbulence and some lifting velocity to carry the debris from the bottom of the well out of the well to the surface. Nitrogen: an inert, odourless, colourless gas suitable for a lot of applications in the oil field. It is versatile in that it can be brought to the well site in liquid form and then converted to a warm gas that can be used for a variety of operations.
Cementing: this is the placing of a cement slurry to secure the casing into the ground. There are at least two cement jobs in every well and it can also be done on the production life of a well in the form of remedial cementing. Surface cementing relates to placing surface casing or cementing surface casing in the well. The product that goes down the inside of the casing and up the annular space is a "cement slurry" which is a mixture of water and dry powder additives.
As indicated earlier, we saw four videos showing various tasks done for the operator by the plaintiff: (1) fracturing; (2) matrix acidizing; (3) foamed acidizing; (4) cementing. In order not to belabour the matter, I will use but one instance of work done at the site, which to my mind is indicative of all the activities performed at the well site by the plaintiff. I have already shown in these reasons the diagram of a foamed acidizing jobsite. For the purpose of describing activity at the job site I have reproduced Tab 7 of Exhibit P-1 entitled “Fracturing Jobsite” [opposite].
This diagram clearly illustrates the job site with the location and type of equipment used.
When the plaintiff arrives at the lease, the well head and two tanks (oil and water) which the operator arranges for in advance, are already there. The first piece of equipment on the site is the blender. It must be there to start mixing chemical almost immediately and needs to be close to access the fluid readily. Macdonald at page 257 of the transcript (the colours to which he alludes cannot course be shown here but can be seen on the original Exhibit P-1, Tab 7):
So part of the initial operation is the blender gets set up in a position next to the tanks and then it immediately starts drawing water via a suction pump on the blender and circulating it through this mix tub, which is in green, back into the blue water tank. It’s — the chemicals are added to this mix tub and circulated from the water tank through the mix tub and back into the water tank to make sure that we have a good, consistent blend of gelled water, in this case.
While that mixing is going on, the next pieces of equipment to move into place are the frac pumpers, which are here and here. There are two of them, in this case. They are called — they are model numbers VT-12005. And also, the crew cab, which will be — which hold some of the fittings and also some of the monitoring equipment for the job.
While the blender is still mixing the gelled water, the rest of the treating iron is put in place, and these green lines coming from the blender are typically hoses that go into the frac pumpers and then these pink lines coming out and going down to the wellhead are steel, high pressure lines that we put together.
Q. That's the treating iron?
A. That is what I have referred to as the treating iron. And you can see the iron truck, it’s parked over here during the job. But it is the one that has supplied all the joints of pipe that are strung together to the wellhead.
And incidentally, the chemical truck sitting down here is the one that has unloaded its chemicals to this mix tub for the gelling of this job.
The third party equipment that I referred to, here is the fire truck. Its position is quite close to where the flammable oil can be pumped and also close to the blender, as that is where the fluid itself is exposed to the atmosphere.
And also, as the job gets set up and our conveyor belts are swung into position, we have the sand trucks getting into position to gravity-feed the sand on the back of a sand hopper which is conveyored up to the mix tub and added into the mix tub through what is called the blender.
Q. I understand, Mr. Macdonald, in the years in question in this litigation, that the conveyor system that we see in the video was different?
A. Yes. That's correct. This orange conveyor system that you see here, in fact, didn't exist on our blenders in the years in question. And the sand was then dumped from these trucks just strictly by gravity into the mix tube. If I could follow the fluid process —
Q. Yes, please.
A. Once the — at the end of the setup, we then do a pressure test, which tests all the steel lines, and at this point, we are ready to have a safety meeting which discusses some of the limitations of the job, pressure limitations, any constraints in terms of rates and pressures that the customers may place. And also the job procedures are discussed at that time.
And when we start pumping, we are drawing from this oil tank and from this water tank to create this polyemulsion fluid. The polyemulsion fluid is a patented process that was developed by Exxon.
And it is quite unique, in that we use two-thirds oil and one-third gelled water, which now has this surfactant and emulsion recipe in it. so, two-third/one-third blend are mixed on the fly, or during pumping, in this mix tub and then distributed to the frac pumpers.
So, what we have attempted to show here is that the oil comes out as oil, the gelled water is fed to the pumper, and it becomes this green polyemulsion fluid — that's why we have shown this mix tub in green — and then that polyemulsion fluid is fed to the frac pumpers where it is pressured up.
To backtrack a little bit, the typical pressure that it would be fed from the blender to the frac pumper is about 80 pounds per square inch. So, a relatively low pressure fluid, and then that is increased in pressure as it is pumped through the frac pumper and down the well.
The frac pumpers are responsible for controlling the rate that the fluid is delivered as well as creating the corrct pressure to fracture the rock and deliver the product. It is then pumped through, in this case, there are three different wellhead valves we are pumping through, so that is why it is split into a stream of three, and it is delivered to the wellhead and down the well.
In viewing the video entitled "fracturing", Macdonald made mention of the chemical truck, stating, "and it's the one that contains all the various sacked chemicals that will be used on the job. He mentioned, at page 266 of the transcript, the initial operation, namely:
These are the hoses that are hooked from the tanks to the suction manifold of the blender. First, so we can get set up and be able to draw oil and water from the tank and also get mixing the chemicals into the gelled water.
He pointed out in the video, that the blending tub after that procedure takes place, is sitting on the ground, and the chemical truck moves into position. Macdonald at page 266 of the transcript:
So water is circulated through the blender mix tub and back into the tank at a very high rate to enable all these chemicals to be mixed very quickly and very consistently.
The first chemical added is this potassium chloride salt or KCL. Several bags of this are added directly into the mix tub. You will start to notice there is the water and the impeller inside the mix tub that helps mix up the chemical with the water.
And you will notice the consistency of the water starts to change as we add the chemicals. This is this LSR Guar gel that is being added, and you can see the water has already taken on a more viscous quality. This is the DL-15 emulsifier that is added to the water.
And the benefit of a polyemulsion job is that you can add all the chemicals to the water phase without having the oil.
While we are mixing that and circulating that through the water tank, we position the pumpers. The rubber hose comes from the discharge manifold of the blender to feed the inlet of the frac pumpers. You can see the steel lines coming out of the pumpers and they have all been joined together and connected toward the wellhead.
The customer's blue wellhead is being connected by our red treating iron, and you can see the hammer unions being hammered to put everything together. And this is the rather elaborate three-way system of hooking the iron to the wellhead.
Once we are still mixing the water, the Cardium sand trucks pull into position to be able to feed the back end of the hoppers of the conveyor belts. You can see the conveyor belts are positioned together in this case for ease of sand feed. And there is the body-mounted unit being pulled into place as well.
We run our frac pumpers remotely from these boxes which rest on the back of the tailgate of the crew cab truck. And they are fixed to the pump — to the controls by this piece of equipment there. And once we have all the treating iron together, we do the pressure test. You can see the rising spikes of pressure on this circular pressure Chart.
Once pressure-tested, we get set for the safety meeting, and you can see in the background, you can see the sand trucks have been elevated to provide that gravity feed into the back end of the conveyor belts. We have a safety meeting, at this point, which involves discussing the pressure limits, other job procedures and safety related to the job.
There is our field engineer discussing some of the details of the job, and our customer representative is the one in the blue jeans with the hard hat. He is just giving us some instructions as to rate and pressure from the job itself.
This is the polyemulsion fluid. Now, it looks like kind of a chocolate milkshake. This is the two-thirds oil and the one-third gelled water. And there is what we call the blender tender. He is the one who is controlling the mix of that polyemulsion fluid through the blender.
Here is the sand being added to the hopper of the sand belts, and this is the sand being dumped directly into that mix tub and being mixed with the polyemulsion fluid.
Things are loud enough on the job that we need headsets and communication that way, simply because it is too loud. One of the monitoring pieces of equipment we have is measuring the kilograms of sand added per litre of fluid.
This shows the pumper operators monitoring the job and controlling their pumpers, and that — this is — the gauge they are looking at that shows the pressure the job is being pumped at.
Those are the pumper strokes being shown, and this is the feed line from the blender to the steel line which is going down the wellhead.
To displace this sand-laden fluid out of the pipe, out of the casing and into the formation, we used, in this case, oil from the tank, and we displaced all of that sand-laden fluid into the formation.
This gives you an idea of the overall setup of the job on location with respect to the wellhead. We then break out our treating iron, pack up the hoses on the blender.
We have some documents we call a service order and treatment report which the customer representative signs. He gets a copy of the service order, and he also gets a copy of the treatment report. And then we leave in the same convoy fashion as we arrived at the lease.
I regret the necessity of this comprehensive coverage of "the business activities at the well site” but as the business activity of the plaintiff is the most important feature of these appeals, evidence must be incorporated into the reasons to show the work done by the plaintiff.
Matrix Acidizing:
Following the initial video presentation on fracturing, we viewed the other three. It is mercifully unnecessary to deal with these in the same detail, but some comment is necessary. Exhibit P-1, Tab 11 shows the Equipment on Site and Products required to matrix acidizing.
The products are — | |
Description | Quantity |
15% Hydrochloric Acid | 4.0 cubic metres |
AI-250 Acid Inhibitor | 16 litres |
WS-50 Surfactant | 4 litres |
DL-22 Demulsifier | 16 litres |
IS-600 Iron Sequesterant | 40 kilograms |
Ball Sealers | 39 |
Here, in addition to 15 per cent hydrochloric acid which is a diluted form of the plaintiff's normal 37 per cent bulk acid, the plaintiff used an acid inhibitor to prevent the acid from reacting with the steel of the casing as it is pumped down the well. The plaintiff also used a surfactant which is added to the acid to enable it to clean up after the job. In the job described on the video they used a demulsifier which is added to the acid to prevent an emulsion that might be created between the acid or the spent acid and the formations oil. Also, on this job the plaintiff used an iron sequesterant which helps any iron that the acid comes into contact with. As Macdonald says at page 275 of the transcript,
In a typical acid reaction, I'm told that iron will tend to precipitate out, which could create more debris in your acid job. And this sequesterant keeps it in solution so that it can be cleaned out of the wellbore, cleaned out of the formation.
Exhibit P-1, Tab 13 is an illustration of the Matrix Acidizing Jobsite. The acid hauler offloads the acid (with additives) into the two tanks of the T.P. (truck powered) Pumper. Only three of the additives were added to the acid. The fourth one, the IS-600 is in a 40-kilogram sack and has to be added on site. “It is kind of in a flake or a crystal form and is only dispersed through the acid when it is augered with the T.P. pumper's augers in the tanks. Once that is done and we now have the acid with the IS-600 and all the other additives in the two tanks we feed the acid through the pump. It is now a high pressure fluid, . . . and the balls (ball sealers) are added to the acid during the pumping so the ball injector is capable of feeding these balls into the acid blend under pressure. And then it is fed to the well head".
Foamed Acidizing:
Here again at Exhibit P-1, Tab 15 we have a listing of the equipment and products on site, together with the quantity of product used. Having earlier defined what foamed acidizing is, no more real detail is required. The products at the site and the quantities (large in this case) were enumerated by Macdonald at pages 287 and 288 of the transcript. This process incidentally was well stimulation. Some indication of the complexity of the job can be garnered through observing Exhibit P-1, Tab 16. Here again one question and answer gives some idea about products. At page 309 Macdonald is asked:
Q. And just a couple of things: Chemically, if you can, what does the SF-2 do when it is added?
A. The SF-2 changes or — changes characteristics of the acid to make it susceptible to an addition of this high-pressure nitrogen to create this foamed structure that we want in this foamed acid.
Nitrogen:
As mentioned earlier, nitrogen can be brought to a lease site in liquid form and then converted to gas. Macdonald mentions its suitability in the “oil patch” and how they had used it in a "foamed frac”. Today there is a foamed cement available.
At page 315 of the transcript Macdonald, referring to a blowup of Exhibit P-1, Tab 19, says of the product:
Product flow starts at this green nitrogen tank. It starts as a super-cold liquid, as I have said, at about minus 320 degrees Fahrenheit. And somewhere between 0 and 15 p.s.i., it is first fed to the pump that is outlined in orange here, and that is what we call a cryogenic pump, or a pump that is able to handle super-cold liquids. It is pumped through this cryogenic pump and fed down a a line to this heater where a thermodynamic process takes place. The liquid nitrogen via this heater is turned into a gas as a — typically in this heater, it is a fired glycol unit or, in other words, we use a big burner, and it heats up some tubes full of gycol alcohol which, in turn, pass their heat on to the liquid nitrogen and heat it up to a warm, about 80 degrees Fahrenheit, gas.
From the heater, it is pumped down a line that is parallel to the liquid one, and it comes to the end of the unit and is pumped down the main treating line toward the reel.
Q. And then through the reel
A. Through the reel and down inside the tubing and into the wellbore.
Conclusion:
In these reasons I have endeavoured to point out, probably in too much detail, the business activities of the plaintiff. It is clear that in order to be a part of the “service sector", a corporation must have field stations, raw products at the field stations, and equipment able to deliver the service, which involves a processing capability. Nothing could be clearer than the fact that the plaintiff is involved, and must be involved, in processing if it is to be an effective, successful well service operator. Mr. Farries (the plaintiff's expert witness) at page 695 and following of the transcript, says:
A. No. I think when we design, when you are referring to an acid job, for example, we are not just buying ordinary regular acid. We are buying acid mixed with various compounds and we are interested in all these products that go into the final mixture.
Q. And just focussing on inhibitors for a moment, do you, in evaluating, in a tender situation the different proposals, do you look to see whether each proposal contains an inhibitor, and in your experience, are there sort of a family of inhibitors that one typically finds?
A. Yes, there are different types of inhibitors, and we would examine competing proposals, not only that they had a suitable inhibitor, but the concentration or amount of that inhibitor.
Q. Was to your liking?
A. To our specifications or desires, yes.
Q. And does the answer apply to a surfactant, if the proposal in contemplation requires a surfactant?
A. Yes.
Q. A foaming agent?
A. Yes.
Q. A breaker, a gelling agent, whatever it happens to be?
A. That's correct.
Each function performed at the well site involves some form of processing. Proppant, a “special fluid” of "a certain viscosity” is necessary (supra). Foamed acidizing is “use of three activities".
We examined earlier Exhibit P-1, Tab 7 Fracturing Job Site, and from the description by Macdonald, no room is left for doubt that a process operation is taking place, that goods are being processed in Canada for sale within the meaning of subsection 125.1 of the Act.
Having listened to the evidence and having had the benefit of reading the transcript which was delivered daily, I am satisfied that the evidence leaves no other alternative than the one pronounced above — the plaintiff processes goods for sale or lease. There is no need to dwell at length with the myriad of examples. One can look, however, to a few factors. Fracturing requires "a specially mixed" fluid. Proppant is a “special fluid of certain viscosity". Foam acidizing has three activities, two of which are addition of nitrogen and carbon dioxide, the use of acid (and not raw acid). Nitrogen in liquid form is processed through special pumps until it becomes a gas and often used in combination with other fluids and chemicals.
Certainly, as conceded by the plaintiff, a well service company by and large carries on its business at the well site. There are other ancillary activities, e.g. field station operation, laboratory work, computer data inventories, and of course sales staff, some with and some without engineering degrees. To me, the activities at the well head are conducted by a “mobile factory", and this mobility should not disentitle the plaintiff to the tax benefits enjoyed by a processing plant which is always situate at one location.
Reed, J. in Halliburton Services Limited v. The Queen, [1985] 2 C.T.C. 52; 85 D.T.C. 336, was also of the view that Halliburton, a large well service operator, was entitled to treat the profits it received from processing of specialized products as manufacturing or processing profits. However, having had the benefit of some eight days of evidence and argument, I have reached a different conclusion about the said operation. In my view, a factory exists for the processing of goods for sale or lease and that factory is a combination of the field station and the unit or units that operate at the well head. We heard that when a "treatment proposal" is sent to the field station, the job begins and the pattern is established as to how to perform the job at the well site. Earlier in these reasons we indicated what takes place, for example, at the fracturing jobsite. Maintenance of pressure, and the correct pressure, is crucial to any operation at the well head so that no harm comes to the operator's well. This work, i.e. maintaining pressure, is carried on until the task is finished and hopefully the oil flows more freely due to the stimulation. Pressure for cementing requires that it be maintained to move the slurry to the area or areas intended and that does not stop until the assignment is finished.
Earlier, I had indicated the considerable amount of activity at a "foamed acidizing jobsite" (Exhibit P-1, Tab 16) and a “fracturing jobsite” (Exhibit P-1, Tab 7) as illustrative of but two well service operations. It is here therefore that I must disagree with my colleague Reed, J. I do not regard mixing and blending aspects of the activity as being separate and distinct from the pressurizing and pumping aspects so as to constitute them respectively as separate and distinct activities. In foamed acidizing activity the operation is one continuous process designed to deliver the foamed acid to the well head at a pre-determined and agreed-upon rate of flow. This is definitely a more business-like, common sense approach to the issue rather than a theoretical one. The latter approach, in my view, leads to many inappropriate implications both in fact and in law. By adopting, for example, the theoretical approach, when the blending has been completed, there is a finished good, and that pumping constitutes the delivery of the finished good, and the delivery of a finished good is not an activity that qualifies. Also, the practical problem that would beset the well service operator and the Minister e.g., page 947 of transcript:
It becomes necessary, for example, to determine what portion of the labour cost that is involved in the job includes pumping, running the pumps, since the cost of that labour is excluded from the M & P calculation or, more accurately, My Lord, the cost of that labour is excluded in taking into account the formula in Regulation 5200.
Therefore, the time that the employee responsible for running the pumping part of the job, the time employed becomes very important as opposed to the amount of time that is spent on the blending side of the activity, the setting-up of the job, getting there and so on.
How does one really focus on which employees on the site had responsibility for which activities and the extent to which one might be able to determine from the material that appeared with the invoices, e.g. pressure charts, what portion of the total job time was reflected in pumping as opposed to blending.
To wrap up, counsel for the plaintiff states and I agree:
. . . this problem disappears, if one accepts what I call the practical, business like approach, because in my submission, the activities in question constitute a continuous process and all aspects — the blending, mixing, pressurizing, and pumping — are really, when one looks at it from the point of view of participants, part of the same continuous process. . . . The practical approach is one which accords with the business reality. It's one that can be readily understood and applied, both by the taxpayer and the tax department.
Thus the plaintiff is engaged in processing of goods for sale or lease and is entitled to the taxation benefits of section 125.1 of the Act. Second, mixing and blending are not separate and distinct from pressurizing and pumping. Counsel for the defendant advanced five submissions in his argument, with the first and principal submission being, "that Nowsco supplies a service to the oil and gas industry and is not engaged in the manufacturing and processing in Canada of goods for sale or lease within the meaning of paragraph 125.1 (3)(a) of the Income Tax Act. I have dealt with that submission.
The defendant also submitted that:
Section 125.1 does not extend to afford taxpayers, such as Nowsco, a manufacturing and processing profits deduction where they are operating an oil and gas well within the meaning of Section 125.1(3)(b) of the Income Tax Act or are engaged in supplying supporting activities or services on behalf of oil and gas well operation.
The overwhelming weight of evidence clearly shows that the oil and gas industry is divided into three sectors and the plaintiff is NOT an operator but is a well service corporation. Tax benefits accrue to oil and gas well operators which I'm satisfied do not and would not accrue to the plaintiff if it applied for these benefits.
Another submission by the defendant offered as an alternative argument IS:
. . . that if Nowsco is engaged in manufacturing and processing goods for sale or lease, then the deduction is confined to those activities of the taxpayer which involve mixing and blending as opposed to pumping and placement.
This I have already decided is not the case for the reasons given. The budget of May 1972 proposed a special rate deduction for companies engaged in the manufacturing and processing of goods for sale or lease. Also, that budget proposed an accelerated rate of capital cost allowance within a certain framework.
In the budget of June 1975, provisions were added granting an investment tax credit, for business activities that qualified.
In the beginning it was difficult to determine the extent of the plaintiff's entitlement to the incentives. The Department of National Revenue itself, after a careful scrutiny of a submission made by the plaintiff, expressed its view to one effect and then later changed that view to one one diametrically different, despite no changes in the plaintiff's activities. We also heard that there were no changes in case law or legislation.
In any event, both budgets were clearly meant to stimulate investment and a capital-intensive corporation engaged in manufacturing and processing was meant to benefit.
Having determined that the plaintiff is engaged in processing of products in Canada for sale or lease, does the property in question fall into Class 8 or Class 10? Class 29, which was engrafted on to pre-existing series of classes and those pre-existing series of classes include Class 10 paragraph (a) and paragraph (h), limits, in my view, the wide scope that the defendant suggests for "automotive equipment".
Although a person might be moved to believe and suggest that this equipment was "automotive equipment”, the evidence clearly indicates how and for what reason the equipment was manufactured and/or fabricated. There is no question, given its mobility, that the equipment used the roads and highways and is powered by an engine but only as a means of getting to the work site. Licenses had to be secured if the equipment moved on the highway and sometimes “special permits" or both depending on the size of the equipment or the particular raw product carried (e.g. acid) but these were not vehicles designed for use on the highway, but really designed for use off the highway.
This equipment was designed and fabricated for a particular purpose, that is, functioning equipment at the job or well site. None of its equipment ought to be included in Class 10(a). Also, to divide the equipment into what has been called front end and back end engines fails to give effect to the basic purpose for which the equipment was designed. Often, at the job site, the machinery is powered by the same engine that moves the equipment on the highway. Even when trailers are used, the evidence was clear that the same trailer is used with the same equipment whenever possible.
I note in passing that Reed, J. in Halliburton,supra, so regarded the equipment as falling into Class 10 but there was no guidance in her reasons for judgment as to how she arrived at that conclusion. In this case, I looked very carefully at several cases advanced by the plaintiff, plus interpretive bulletins directed to the issue, and with respect cannot agree with my colleague Reed, J. As stated earlier, I accept the contention of the plaintiff, that "for the purposes of Class 29, one includes all equipment that is both necessary and ancillary to the processing operation”. It is not described in paragraph 10(a) nor 10(h). The defendant concedes that the plaintiff is not in the business of construction and upon a careful examination of the Interpretation Bulletin produced there is a clear inference that what is intended to be included in Class 10(h) is equipment that is used in what is normally regarded as construction.
The plaintiff's equipment, not falling within Class 10(a) or 10(h), falls into the residual Class 8(d) — “a tangible capital asset that is not included in another class”.
The seemingly meandering trip through portions only of the Income Tax Act reveals how necessary it is that some simplification of drafting is necessary. Even this new legislation, meant to be an incentive, leaves one exhausted trying to interpret its language and intent.
As counsel put it, "therefore it is equipment that is to be regarded as falling into the residual Class 8, paragraph (d) unless it falls into Class 22". Counsel is given to ruminate, "now Class 22 ... happily it’s short, and unlike many of the provisions of the Act and Regulations, is almost understandable". (Emphasis added.)
In any event, we are dealing with property that is power-operated, moveable equipment designed for a particular purpose, “excavating, moving, placing or compacting earth, rock, concrete or asphalt, and not including a property in Class 7".
Argument revealed that Mr. St.-Onge in Dominic Supports and Forms Ltd. v. M.N.R., [1971] Tax A.B.C. 144; 71 D.T.C. 117, referred to "the history of this class [i.e. Class 22] introduced into law in 1964 to show what the Minister had in mind when he drafted that class was to grant to the road construction business an accelerated depreciation because these contractors were complaining about the enormous wear and tear on their equipment . . .". This gives a clear indication of the scope of Class 22, and the plaintiff's equipment does not fall within Class 22.
Investment Tax Credit:
It must be clear at this stage that I cannot find any basis on the evidence and argument I heard for deciding that the plaintiff has front end and back end equipment. The equipment is specially designed for a particular job of work and requires all the equipment including iron trucks that bring out the treating iron, bulkers that bring out cement, liquid gases or the acids. They are part of the process and qualify for the investment tax credit.
The appeals are allowed and the subject matter is to be referred back to the Minister for reassessment based on the following points:
1. the income earned by the plaintiff is attributable to its activities, namely: fracturing, acidizing, nitrogen, endless tubing and cementing and those activities constitute Canadian manufacturing and processing for the purpose of section 125.1 of the Act and Regulation 5200;
2. the equipment of the plaintiff listed at Exhibit P-1, Tab 47 is used directly or indirectly in the processing of goods for sale and as such is to be included in Class 29 of Schedule B to the Regulations. For the purposes of Class 29 no distinction is to be made between the so-called front and back end;
3. the plaintiff is entitled to investment tax credits in respect of the same equipment that is used primarily in the processing of goods for sale in Canada and is property included in Class 29, and again no distinction between the so-called front end and back end.
The plaintiff is entitled to its costs of this action.
Appeals allowed.