Mont-Sutton Inc. v. The Queen, 96 DTC 1472, [1996] 3 CTC 2492 (TCC)

Archambault J.T.C.C.: — Mont-Sutton Inc. (Sutton) operates a well- known ski resort in the Eastern Townships. Sutton must make snow in order to provide skiing of excellent quality to its customers. The issue raised in Sutton’s appeal is essentially the following: does Sutton manufacture artificial snow for sale or lease? The Minister of National Revenue (Minister) did not believe so and therefore disallowed the manufacturing and processing profits tax credit provided for in section 125.1 of the Income Tax Act (Act) for the 1986, 1987, 1988 and 1989 taxation years. Even if the Court were to rule that Sutton manufactured artificial snow for sale or lease, the Minister claims that less than 10 per cent of gross revenues of the active business carried on in Canada came from the sale or lease of artificial snow.

Furthermore, the Minister considered that Class 29 of Schedule II of the Income Tax Regulations (Regulations) did not include artificial snowmaking equipment and that that equipment did not constitute qualified property within the meaning of subsection 127(9) of the Act. He therefore disallowed the investment tax credit in respect of that equipment.

Lastly, the Minister refused to recognize the costs of developing ski trails as part of the cost of depreciable property described in Class 17 of Schedule II of the Regulations.

Facts

Sutton has operated its ski resort in the Eastern Townships since 1960. Its ski season begins around mid-November and ends around mid- April. Sutton has 53 trails over 40 kilometres, all made accessible by nine chair lifts. The resort offers the following services: four restaurants, two at the base and two at the summit, a day care centre, a ski school, a professional ski patrol, a ski store for equipment sales, rentals and repairs, an automatic electronic timing system, 1,500 ski and boot lockers and a medical clinic. The skiable surface represents 70 hectares, 60 per cent of which is covered with artificial snow. Sutton offers a skiable vertical drop of 460 meters.

To operate this business, Sutton has a number of employees including a general manager, a director of marketing and employees responsible for ticketing, ski lift operation (at the base and at the summit of the mountain), trail maintenance, trail patrol and the medical clinic.

The financial statements to June 30, 1989 show capital assets and a total cost of $14,839,867:

The capital assets for the fiscal year to June 30, 1986 were described as follows:

As is practical in this industry, Sutton offered flexible rates to meet the needs of its clientele. Skiers could pay by the run, by the half- day or by the day. There were also passes for several days and season’s passes. The season’s pass contract stipulates that customers are not entitled to a credit or refund if there is a shortage of snow. A day pass sold for $21 in 1986. Its price had risen to $28 in 1989. Sutton could change its rates during a season depending on the period and snow conditions.

To illustrate this practice, Denis Boulanger, Sutton’s general manager, cited the 1994-1995 season as an example. The price of a day pass was $38. At the start of the season, when only one trail was open, Sutton charged only $15. As the number of trails increased, the price rose from $15 to $20, to $25, to $30 and then to $38. When a warming trend occurred shortly before its appeal was heard, Sutton had to halt its operations temporarily. Sutton charged a rate of $15 when the resort reopened.

However, even if Sutton does not operate all its ski lifts during the week, its rate during the week is the same as on weekends. The ski pass or the season’s pass provides access to the chair lifts and a number of services, including use of the chalets and parking areas. Customers must obviously pay for lockers, the equipment rentals and repairs, restaurants and the day care centre. A person is allowed to use the parking lot and chalets even without a ski pass.

Sutton operates a lift service during the fall to provide access to spectacular look-out points. The price of the lift is $3. People are allowed to walk about the site during that season and the rest of the year without paying any admission charge. Sutton achieves a turnover of about $12,000 during the fall season.

Mr. Boulanger filed the following table to describe the source of Sutton’s income:

June 30, 1989

Locker rentals	$ 68,764
Building rentals	$ 70,015
Commission from restaurants	$ 71,168
Day care centre	$ 6.054
Interest	$ 38,117
Miscellaneous	$	469

Capital gain	$ 68,103
SUB-TOTAL	$ 326,590
(Season's passes)	$1,318,702
Day and weekly passes	$3,129,786
TOTAL	$4,775,078

The financial statements to June 30, 1989 showed $3,018,620 in operating expenses, including $1,028,700 in depreciation expense and $821,877 in ski lift expenses, to which must be added maintenance and repair costs of $262,669, artificial snow-making expenses of $138,307 and ski patrol expenses of $56,764. Not included in these operating expenses are advertising expenses of $395,030 and administrative expenses of $437,608.

A record of precipitation in the Mont-Sutton area shows an increase in precipitation between 1960 and 1970. Since 1970, however, it has generally declined. This trend brought Sutton to purchase artificial snowmaking equipment in order to ensure a higher quality snow cover on its trails. Major investments were made in the mid-1980s. Mont-Sutton was the first resort to install detachable quadruple chair lifts. This type of ski lift makes it possible to carry about 2,000 skiers per hour, whereas a fixed chair lift system has a capacity of only 700 persons per hour. Government grants brought Sutton to invest in this type of ski lift and in snow-making equipment. Artificial snow-making capacity is an important factor in attracting customers. With this kind of equipment, it is easier to sell season’s passes and ski passes in September for the Christmas holiday period.

To expand the skiable surface, Sutton added new trails. To develop those trails, trees had to be cut, the surface reformed with the use of power shovels and the land levelled with logs and sand. It might be necessary to blast, build underground conduits to divert brooks, dig drains to control the water run-off and spread hay to limit the effects of erosion. Mr. Boulanger stated that it cost between $10,000 and $15,000 per acre to develop the ski trails. By way of illustration, Mr. Boulanger described the costs incurred to develop the “Exile” trail representing 5.07 acres: 30 meters of piping at $1,682, trees at a cost of $150 and hay at a cost of $1,140. These costs did not include either the cost of transporting and installing the material or the cost of spreading it. Mr. Boulanger estimated the transportation costs of 20 bales of hay by helicopter at $3,000, the cost of the power shovel at $1,000 and the spreading cost at $1,500.

Sutton’s Claims

Counsel for Sutton claimed that the artificial snow manufactured by Sutton was intended for lease. He emphasized the fact that, when a skier goes to the ski resort, he and Sutton enter into a snow lease contract. In his view, this was the essence of the contract entered into. The other services such as the ski lifts, chalets, parking areas, lockers and stores were merely accessories to this snow lease contract. Without snow, skiers do not go to the ski resort. It is snow conditions that affects attendance at the ski resort. The rate schedule adopted by Sutton depends on snow conditions. At the start of the season, when few trails are open, the price is considerably lower. When a warming trend occurs, the rate schedule also takes snow conditions into account. Anyone can have access to the chalets and parking areas. There is no cost for these services. Consequently, when a skier pays $28 for his ticket, it is essentially to use the snow. The ski lift is merely an accessory to this contract. Evidence of this is the fact that during the week, a number of ski lifts are not in use, whereas the price of a pass remains the same as on weekends. As to the source of revenue, the revenue schedule very clearly shows that more than 90 per cent of revenue in 1989 came from the sale of season’s tickets and day and weekly passes. The fact that the lift costs only $3 during the fall, whereas it costs $28 during the season, clearly indicates that a small portion of the price of the ticket (approximately 10 per cent) represents the cost of the ski lift. The rest represents the lease of snow. This therefore shows that Sutton received more than 10 per cent of this revenue from the lease of snow.

As to the costs of fitting up the ski trails, counsel for Sutton contended that they represented the cost of a surface structure similar to that of a parking lot, as described under Class 17 of Schedule II. Laying out a ski trail entails surface levelling, installing culverts, digging trenches and spreading hay. He did not see the difference between a ski trail and a parking lot covered with gravel.

Minister’s Claims

The Minister claimed that the contract was not a contract of lease, but rather a contract for services. A ski pass or a season’s pass entitles its holder to a number of services, including the use of the ski lifts, the chalets, restaurants, lockers, ski stores, day care centre and parking areas. The object of the contract between the skier and Sutton is the whole of these services.

Even if the Court were to rule that the contract was a snow lease contract, Sutton would not be entitled to a deduction of the credit for manufacturing profits because Sutton did not give evidence concerning the source of its rental income. One does not know what portion of the income was attributable to the lease of artificial snow and to the lease of natural snow. As to the costs of developing the ski trails, counsel for the Minister contended that they were not costs of surface construction included in Class

17. If the ejusdem generis rule is applied, a ski trail does not constitute a artery of travel as do a road or a runway. Furthermore, in Hampton Golf Club Ltd. v. Minister of National Revenue) [1] McNair J. held that the greens and tees of a golf course did not constitute a surface construction within the meaning of Class 17.

Analysis

(A) Did Sutton manufacture or process goods for sale or lease?

In his assessment, the Minister disallowed (i) the credit in respect of manufacturing and processing profits provided for at section 125.1 of the Act, (ii) the investment tax credit in respect of the artificial snow-making equipment and (iii) the capital cost allowance in respect of property described under Class 29 of Schedule II of the Regulations. The Minister disallowed all three in very large part for the same reason: Sutton did not manufacture or process goods for sale or lease. Section 125.1 of the Act allows a corporation to deduct from tax a sum computed on the basis of its manufacturing and processing profits. Paragraph 125.1(3)(a) provides as follows:

(3) In this section,

(a) “Canadian manufacturing and processing profits” of a corporation for a taxation year means such portion of the aggregate of all amounts each of which is the income of the corporation for the year from an active business carried on in Canada as is determined under rules prescribed for that purpose by regulation made on the recommendation of the Minister of Finance to be applicable to the manufacturing or processing in Canada of goods for sale or lease.

[Emphasis added.]

Subsection 127(5) of the Act allows a taxpayer to deduct from the tax otherwise payable an amount in respect of an investment tax credit computed on the basis of the capital cost of qualified property. Subsection 127(9) of the Act defines “qualified property” as follows:

“qualified property” of a taxpayer means property (other than an approved project property or a certified property) that is

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

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

[Emphasis added. I

Paragraph 20(1 )(a) of the Act allows a taxpayer to deduct from his income part of his capital cost of property as authorized by the Regulations. Paragraph 1100(l)(ta) provides for a deduction of 50 per cent in respect of property described under Class 29 of Schedule II of the Regulations. Subparagraph (a)(i) of Class 29 provides:

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.]

The main question that arises is whether the artificial snow-making consisted in “the manufacturing or processing of goods for sale or lease”. Counsel for Sutton contended in his argument that his client had manufactured artificial snow for lease. He admitted that Sutton had not sold snow. The interpretation of this expression has caused a case law controversy. A first case law trend adopted Strayer J.’s approach in Crown Tire Service Ltd. v. R. [2] In that decision, Strayer J. adopted a strict interpretation of the notion of sale, that recognized in common law with respect to contracts of sale. A distinction had to be drawn between contracts of sale of goods and contracts of work, labour and materials. Strayer J. concluded in Crown Tire that the contract in issue was a contract that fell in the second category and that the taxpayer had not been manufacturing goods for sale.

The second case law trend adopted the interpretation of Reed J. in Halliburton Services Ltd. v. R. [3] In that case, she rejected the close construction and relied instead on a broader interpretation of the notion of sale, that there is a sale from the moment there is a transfer of goods, regardless of the nature of the contract under which the transfer of ownership was made. The Federal Court of Appeal first followed Reed J.’s broader interpretation in confirming her decision on April 10, 1990, [4] then in rendering its decision on the same day in Nowsco Well Service Ltd. v. Canada [5] In a decision dated August 19, 1994, however, Hawboldt Hydraulics (Canada) Inc. (Trustee of) v. Canada [6] the Federal Court of Appeal abandoned the broad interpretation and adopted Strayer J.’s strict interpretation in Crown Tire. After analysing the two case law trends, Isaac C.J., writing the Court’s unanimous opinion, set out the reasons why it had adopted the strict rule, as follows:

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 benefited were the manufacture of goods for sale or lease and the beneficiaries, the manufacturers engaged in those activities. 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 J 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 5428 that

...one must assume that Parliament, in speaking of “goods forsale or lease” had reference to the general law of sale or leaseto give greater precision to this phrase in particular cases. [7]

[Emphasis added. ]

In Dixie X-ray Associates Ltd. v. Æ., [8] McNair J. also adopted the strict approach of Strayer J. in Crown Tire. In his judgement, he described the approach that the courts should take in distinguishing a contract for the sale of goods from a contract for the supply of services. He wrote as follows at page 74:

The test for determining whether a contract is one for the sale of goods or for the supply of services is to ask the question: What is the substance of the contract? If the substance of the contract is the production of something to be sold and the transference of property therein to a buyer then the contract is a sale of goods. But if the real substance of the contract is the skill and labour of the supplier in the performance of work for another then that is a contract for work and labour, notwithstanding that property in some materials may pass under the contract as accessory thereto.

Even though the above comment describes the common law, I do not believe that there is a marked difference under the civil law of Quebec. A study by François Goré [9] contains the following statement:

When a contractor supplies the material for the object that he undertakes to manufacture, is there a business or sale, a mixed contract or a sui generis contract?

The answer to this question has raised much controversy, but the case law has held that the entire matter depends on the importance of the supplies relative to the work performed. If the materials supplied are merely of an accessory and secondary nature, the operation is on the whole a business. In the opposite case, it is a sale. Thus where the case law admits the existence of a sale with future delivery, it concludes that the transmission of ownership takes place only at the time of delivery and that it is delivery that triggers the transfer.

[Translation.]

If we take the approach adopted by Strayer J. and the Federal Court of Appeal in Coopers & Lybrand, we must rely on the civil law of Quebec in order to determine to what extent Sutton made profits from the “manufacturing of goods for lease”. During the relevant period, the Civil Code of Lower Canada recognized as contracts of lease or hire a contract of lease of things and a contract of lease and hire of work. Article 1600 of the Civil Code of Lower Canada defines the contract of lease of things as follows:

1600. The lease of things is a contract by which the lessor binds himself towards the lessee to grant him the enjoyment of a thing during a certain time, for a consideration, the rent.

Article 1665a of the Civil Code of Lower Canada defines the lease and hire of work as follows:

1665a. The lease and hire of work is a contract by which the lessor undertakes to do something for the lessee for a price.

Among the contracts of lease and hire of work, the Civil Code recognizes that respecting carriers. [10]

Let us consider the nature of the contractual relationship between Sutton and its clientele. When a skier purchases a season’s pass or a day pass, Sutton is required to provide him with the use of the facilities and services. The most important of its facilities are the developed ski trails. To these facilities must be added the chalet where the skier may change and deposit his personal effects in a locker. Sutton must also provide a number of services, the most important being the transportation of the skier by ski lift. Sutton must also provide other services, including a ski patrol, a medical clinic, restaurant services and a day care centre. In addition to services which are provided directly to skiers, there are those which are provided indirectly to them such as trail maintenance, including packing and snowing-up the trails. All these services require a large staff. In my view, the contract that binds a skier to Sutton is a mixed contract of lease of things and of lease and hire of work.

With respect to the object of the contract of lease of things, there is no doubt that this contract relates to an immoveable. In Snowlarks Ski School Inc. c. Mont Gabriel Lodge (1973) Inc., [1975] C.S. 790 the Court had to determine whether a contract binding a ski school to a ski resort constituted a contract of lease of things. Following is an excerpt from the summary of the decision rendered by the Superior Court of Quebec:

It is the Court’s view that this contract possessed all the essential characteristics that article 1600 of the Civil Code gives to the contract of lease of things, that is the enjoyment of things for a price. It also provided for the lease of immoveable things, the trails and the premises providing shelter for the purpose of conducting the business of ski instruction being immoveables and the ski lifts being at least immoveables by destination.

[Translation.]

One need not consult a dictionary in order to conclude that the lease of an immoveable does not constitute the lease “of goods”. As the principal object of the contract binding a skier and Sutton concerns the use of immoveable property and the supply of services, one may not conclude that Sutton manufactured “goods for lease” within the meaning of the relevant provisions. In my view, the most that can be said is that the supply of artificial snow by Sutton constituted an accessory obligation for Sutton. Moreover, one could compare the supply of artificial snow to the use of parts manufactured by the taxpayer in Coopers & Lybrand under its contracts for the repair of machinery belonging to its customers. To use Isaac C.J.’s test in this case, I do not believe that a typical skier who purchases a day pass can seriously state that he has leased artificial snow and that Sutton’s business consists in manufacturing goods for lease. He would conclude instead that Sutton uses its equipment to manufacture artificial snow as part of its ski resort operation.

I therefore conclude that the equipment used to manufacture snow was not used for the manufacturing or processing of goods for sale or lease and consequently that Sutton was not entitled to the manufacturing and processing profits tax credit, the investment tax credit in respect of this equipment or to the capital cost allowance provided for in paragraph 1100(l)(ta) of the Regulations.

(B) Cost of developing ski trails

Sutton claimed that its costs to develop ski trails constituted costs of depreciable property described in Class 17 of Schedule II of the Regulations. Paragraph (c) of Class 17 reads as follows:

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

(c) a road, sidewalk, airplane runway, parking area, storage area or similar surface construction.

The point for determination in this case is essentially whether a ski trail developed by Sutton constitutes a surface construction similar to a road, sidewalk, airplane runway, parking area or storage area. The evidence showed that, in order to fit up its trails, Sutton had to fell trees and reform the surface with the use of power shovels, which in certain cases required blasting and levelling the land with logs and sand. It was further necessary to ensure proper irrigation of the trails, build underground conduits, divert brooks, dig trenches and install culverts. The evidence showed that it cost between $10,000 and $15,000 per acre to carry out this kind of trail development. In my view, such development constitutes a “surface construction”.

Was this surface construction similar to a road, sidewalk, airplane runway, parking area or storage area? Counsel for the Minister contended that the ski trails were not because they were not arteries of travel. I believe it is possible to conclude that the ski trails are arteries of travel such as a road, sidewalk and airplane runway. However, this is beside the point. I believe that counsel for the Minister improperly applied the ejusdem generis rule in his interpretation of paragraph (c) of Class 17. The enumeration therein is not limited to arteries of travel. A storage area and parking area are not arteries of travel.

What do all the elements of this enumeration have in common? They are all levelled and developed lands that required man’s intervention. To maximize the desired use of those lands, they had to be levelled and developed. Furthermore, the result of this work can easily be seen in nature. Land that has undergone surface construction can be easily distinguished from other land in its natural state. Surface constructions may deteriorate through the use that is made of them and through erosion. A piece of land does not constitute depreciable property within the meaning of the Act because it is not described in any class of Schedule IT. It may be supposed that Parliament decided thus because it generally does not deteriorate or diminish in value through its use as part of the activities of the business. However, the case is quite different for improvements made to a piece of land such as a building erected thereon or surface constructions developed on it. In my view, the improvement of the trails described here constituted a surface construction described in paragraph (c) of Class

17. This result seems to me consistent with the object of the Act, which permits the depreciation of property that is used in a business and deteriorates with use and time.

In support of his claims, counsel for the Minister cited the judgment rendered by McNair J. in Hampton Golf Club Limited.^ [11] In that case, the Federal Court heard by trial de novo an appeal from a decision by the Tax Review Board in which the deputy chairman Mr. Dubrule had concluded that greens and tees of a golf course constituted a surface construction as described in paragraph (g) of Class 1 of Schedule B of the Regulations. [12]

The Deputy Chairman explained his decision as follows at page 709: [13]

When one considers the words in that class, one cannot say that they could not include a dirt road, a gravel sidewalk or dirt parking area. All of them it is assumed are constructed, that is, build or man-made, and it is the cost of so building the road, sidewalk, etc. on which the person may claim four per cent capital cost allowance. Having listened to the evidence in this appeal and the somewhat detailed description of the construction of a green and tee I am satisfied that they are a surface construction and consequently the appellant is entitled to capital cost allowance on the cost of building them as a Class 1 property.

In the reasons for his judgment, McNair J. devoted most of his comments to the question as to whether the greens and tees constituted a “building or other structure”, as this property is described in Class 3 of Schedule B of the Regulations. Following a lengthy analysis, McNair J. came to the conclusion that it was not a “building or other structure”. As to the application of paragraph (g) of Class 1, the only comments he made were as follows, at pages 325 and 326:

Turning to Class 1 of the Regulations, I am unable to conclude that the greens and tees come within the terminology of surface construction similar to a road, sidewalk, airplane runway, etc., as used therein. It is my opinion therefore that the greens and tees are not similar surface constructions within the meaning of Class 1.

The reasons that led him to adopt this conclusion cannot be determined. It is possible that the evidence brought before him was not sufficient to show that the tees and greens represented a “surface construction”. In this case, Sutton convinced me that the development of its trails required surface construction work sufficiently extensive to conclude that its development costs represented costs of depreciable property described in Class 17 of Schedule IT of the Regulations.

For these reasons, Sutton’s appeals in respect of the 1986, 1987, 1988 and 1989 taxation years are allowed and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that Sutton is entitled neither to the manufacturing or processing profits tax credit nor to the investment tax credit in respect of the snowmaking equipment and that that equipment is not included in Class 29 of Schedule II of the Regulations. However, the development costs of its ski trails constitute costs of depreciable property included in Class 17 of Schedule II of the Income Tax Regulations. The respondent is entitled to 75 per cent of costs.

Appeal allowed in part.