Dixie X-Ray Associates Ltd. v. The Queen, 88 DTC 6076, [1988] 1 CTC 69 (FCTD)

MacNair, J.:—This action and T-2941-83 are appeals by the plaintiff from reassessments of its income for the 1978 and 1979 taxation years which, by agreement, are to be heard and tried on common evidence.

The issue for determination on this appeal is whether the taxpayer's business during its 1978 taxation year was that of developing and processing medical x-ray films for sale, thereby making such business a manufacturing and processing of goods for sale or lease within the meaning of paragraph 125.1(3)(b) of the Income Tax Act and Part LIT of the Income Tax Regulations.

In computing its income tax for the 1978 taxation year, the claimant claimed a deduction of $5,644 in respect of its Canadian manufacturing and processing profits pursuant to the relevant statutory provisions. By notice of reassessment dated August 31, 1981, the Minister disallowed the deduction.

The basis of disallowance was simply that the plaintiff was not selling or leasing goods but rather was engaged in the business of rendering a service to the medical profession and their patients. The Minister assumed as a fact that the production of a tangible piece of property, that is, the x-ray film was merely incidental to the providing of the service and that the primary purpose of having the x-rays taken, and indeed the end result of the whole exercise, was the radiologist’s diagnostic report based on his interpretation of the particular x-ray film or radiologist in question. The final assumption was that the radiograph remained the property of the x-ray laboratory and did not become the property of the patient or the radiologist.

Dr. James E. Mergelas and two other radiologist associates incorporated Dixie X-Ray Associates Limited as an Ontario corporation on June 27, 1977. The corporation has business premises in Mississauga, Etobicoke and Downsview and by its fiscal year-end of June 30, 1978 had the equipment and staff necessary for processing and developing x-ray films or radiographs of patients for diagnostic purposes. The actual x-ray films were taken and developed in most cases by properly qualified technicians employed by the plaintiff corporation. The doctor radiologist only comes into the picture at the professional and diagnostic stage of interpretation of the x-ray film. He prepares a written report which is sent in most cases to the patient's referring physician. The fees for these professional and technical services are billed to OHIP in 90 per cent of the cases. The remaining ten per cent represent billings to chiropractors, insurance companies, U.S. citizens and other persons not covered by OHIP. This small category is billed by the plaintiff directly. In contrast, the OHIP billings go out on a computer card under the name of one of the radiologists. Both billings contain a column for a breakdown between the technical and professional components of the particular bill. The actual, average breakdown of fees is calculated by OHIP at 73 per cent technical and 27 per cent professional. On receipt of the OHIP billings, the radiologists retain the professional fees and pay over to the corporation the technical component portion. The situation is just the reverse with the corporate billings, the plaintiff keeps the technical fee and pays the professional fee component to the doctor entitled.

The radiographs or x-ray films are placed in a large manilla envelope, marked with the patient's name and other identifying data, and are stored by the plaintiff corporation. They are not given to the patient or the referring physician but will be surrendered on request on the understanding that they are to be returned to the plaintiff. The period of storage varies, depending on the type of x-ray. X-ray films of the chest and those showing abnormal conditions are stored for five years. All others are stored for one year. At the end of the storage periods, the discarded x-ray films are sold by the plaintiff to another firm or corporation for silver recovery, followed by their total destruction, and the plaintiff is paid a monetary amount for the value of the recovered silver.

In the plaintiff’s invoices for x-rays not covered by OHIP the billing terminology employed is “For Services Rendered". On the other hand, in the computer card billings to OHIP under the name and number of a radiologist the word "Fee" is employed. In the financial statements of the plaintiff the statement of income makes no reference to sales revenue or the expendi ture costs thereof. Instead, the income is shown as fees, which is the largest item, followed by management fees, rentals and sundry or silver recovery. As to the business arrangement between the plaintiff corporation and the three radiologist partners, Dixie X-Ray does everything concerning x-rays except the interpretation of the radiographs. This function is performed by the radiologists. The corporation charges them for the use of their office space. The professional component of all billings is paid to the medical partners who report it in their income tax returns. The corporation performs all the technical functions and leaves the diagnostic professional work to the radiologists. The fees are allocated accordingly on the 73 per cent to 27 per cent ratio basis.

The crux of the case, as I see it, is whether the business carried on by the plaintiff during its 1978 taxation year constituted the "manufacturing or processing in Canada of goods for sale or lease” within the meaning of section 125.1 of the Income Tax Act and Part LII of the Income Tax Regulations so as to entitle the plaintiff to the deduction claimed from its manufacturing and processing profits. It is common ground that the amount of the deduction, if allowable, is $5,644. The defendant has admitted that the developing of x-ray film is “processing” and that the end product resulting from the processing, namely, the x-ray film or radiograph is "a good". That being so, the real issue from the defendant's standpoint is whether the plaintiff's business activity amounts to the processing in Canada of goods for sale. There is no question of any leasing of goods.

Section 125.1 of the Act makes provision for a tax reduction on Canadian manufacturing and processing profits for the 1973 and subsequent taxation years and the statutory scheme contained therein may provide a tax credit. The calculation of Canadian manufacturing and processing profits is determined under a formula prescribed by Regulations 5200 to 5204 (Part LII).

Paragraph 125.1(3)(b) of the Act provides that "manufacturing or processing" does not include those business activities specifically described and enumerated in subparagraphs (i) to (x) thereof.

Section 5202 defines “qualified activities" to mean and include a number of business activities performed in Canada in connection with manufacturing or processing in Canada of goods for sale or lease (not including activities listed in subparagraphs 152.1(3)(b)(i) to (ix) of the Act) and as not including certain others specified in paragraphs (d) to (i) of the Regulation. Paragraph (b) of Regulation 5202 reads as follows:

(b) all other activities that are performed in Canada directly in connection with manufacturing or processing (not including the activities listed in subparagraphs 125.1 (3)(b)(i) to (ix) of the Act) in Canada of goods for sale or lease, . . .

The gist of the plaintiff's contention is simply this: given the admissions by the defendant that the developing of x-ray film is a processing and that the film itself is a good, the transaction is one involving a sale of goods whereby the property in the radiographs passes to the patient as the person paying for them. It is argued that the real function of Dixie X-Ray is the production of the radiographs and nothing more by reason that the plaintiff is precluded by statutory enactment from practising medicine. The diagnostic function of interpreting the x-ray films or radiographs is necessarily left to the radiologist doctors. The plaintiff's practice of retaining the x-ray films for a time and not handing them over to the patients does not derogate from the fact that the property in them has passed to the patients. As to the ultimate disposition of the x-ray films and monetary compensation to the plaintiff for the residual silver recovery, the contention is that any property in them at that time must be taken to have been abandoned by the patients. In summary, it is the plaintiff's submission that it was carrying on at the material time an active business involving the processing of goods for sale with the result that it is entitled to the deduction claimed pursuant to section 125.1 of the Act and the relevant regulations thereunder. Counsel for the plaintiff relies strongly on the recent case of Halliburton Services Ltd. v. The Queen, infra.

The Minister's basic factual assumptions have already been touched on. Essentially, the defendant's position is that there was no substratum of agreement or consensus ad idem between Dixie X-Ray and the patient for the sale of the x-ray film as a good or chattel. The point is pressed that there is no evidence of any contract between the plaintiff and the individual patient with respect to the passing of title in the x-ray film itself. The alternative submission is made that even if it should be found that the title in the x-ray film passes from the plaintiff to the patient or someone else then the contract is one for the supply of services to which the passing of property in the radiograph, if any, is merely ancillary or incidental. It is argued that the weight of evidence leads irresistibly to the conclusion that the relationship between the plaintiff and a patient connotes a contract for services in which the key feature from the patient's standpoint is the radiological diagnosis.

As for the Halliburton Services case, it is the defendant's position that the case must be confined to its particular facts and should not be taken as authority for the general proposition that there is no need to draw any distinction between contracts for the sale of goods and contracts for services, labour and material in determining the applicability of section 125.1 of the Income Tax Act with respect to deductions for Canadian manufacturing and processing profits.

A brief review of the relevant authorities would be in order.

Crown Tire Service Limited v. The Queen, [1983] C.T.C. 412; 83 D.T.C. 5426 (F.C.T.D.), affg. [1981] C.T.C. 3013; 81 D.T.C. 931 (T.R.B.), held that the retreading of customers' tires by a taxpayer corporation engaged in the tire retreading business did not constitute manufacturing or processing for sale or lease within the meaning of section 125.1. In alluding to the distinction between the situation of work being done to a tire casing owned by the customer throughout and those cases where the customer had never previously owned any part of the end product, Mr. Justice Strayer made this statement at page 415 (D.T.C. 5429):

. . . 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.

The learned judge applied a general principle of Benjamin's Sale of Goods to reach his conclusion that the contracts with respect to the retreaded tires were contracts for work and materials and not contracts for the sale of goods.

MDS Health Group Limited v. The Queen, [1979] C.T.C. 337; 79 D.T.C. 5279 (F.C.T.D.) held that reports produced by medical laboratories of the taxpayer engaged in the analysis of specimens of human tissue and secretions, upon request by medical doctors, did not constitute the manufacturing or processing in Canada of goods for sale or lease within the meaning of section 125.1 of the Income Tax Act so as to qualify for any deduction thereunder.

Gibson, J., stated the rationale at page 340 (D.T.C. 5282):

In this case, the quality of the contents of the report produced by the plaintiff's various laboratories is the only thing of value. It is not an end product of the specimens after analysis in the sense required by the Act and Regulation, namely, goods as contemplated and within the meaning of section 125.1 of the Income Tax Act and Regulation 5200. The analysis of the specimens ends in nothing that can become the subject of a sale. Although after the analysis reports are prepared and such reports contain valuable information, such reports are not "goods" contemplated and meant in the context of the words “manufacturing or processing in Canada of goods for sale” in section 125.1 of the Act.

Canadian Wirevision Limited v. The Queen, [1979] C.T.C. 122; 79 D.T.C. 5101 (F.C.A.), affg. [1978] C.T.C. 69; 78 D.T.C. 6113 (F.C.T.D.), held that the reception and distribution of radio and television signals by a cable vision company to its customers did not constitute the manufacturing or processing of goods for sale within the meaning of section 125.1 on the ground that the signals were not "goods" within the common parlance usage of merchandise or wares or tangible movable property. Even if that conclusion were wrong, the court was still of the view that the taxpayer could not succeed because it did not sell signals to its subscribers. Moreover, the text of the contract with subscribers referred not to the sale of goods but to the supply of services.

In Tenneco Canada Inc. v. The Queen, [1987] 2 C.T.C. 231; 87 D.T.C. 5434, Dubé, J., held that the replacement or repair of customers' exhaust components by Speedy Muffler was not a manufacturing or processing of goods for sale within the meaning of section 125.1 of the Act but rather was essentially a contract for services whereby the ownership of any muffler components passed to the customers by accession.

In Halliburton Services Limited v. The Queen, [1985] 2 C.T.C. 52; 85 D.T.C. 5336 (F.C.T.D.), the taxpayer claimed a deduction under paragraph 125.1(3)(b) in respect of the profits arising from the manufacturing or processing of goods for sale. In addition to providing services related to the drilling of oil and gas wells, the taxpayer also provided a related specialized product for its customers. The court held that the profits received from the processing of the specialized product could be treated as manufacturing or processing profit within the meaning of paragraph 125.1(3)(b) on the ground that the specialized product in question was sold to customers. The court could not find on the particular facts of the case that the service aspect of the taxpayer's business activity was more important than the production of the specialized product required in connection therewith.

Madam Justice Reed made this statement at page 56 (D.T.C. 5338):

.. . I do not find that the wording [s. 125.1 (3)(b)] clearly requires a distinction to be made between profits arising out of a sale of goods and profits arising out of the sale of a good when that good is part of a larger contract including services and labour as well.

If that statement is meant to stand for a general proposition that the words "manufacturing or processing in Canada of goods for sale or lease" employed in paragraphs 125.1(3)(a) and 125.1(3)(b) of the Act and Regulation 5202 preclude the drawing of any distinction in every case between contracts for the sale of goods and contracts for work and materials or the supply of services then I must, with respect, disagree. Rather, it is my opinion that the words "goods for sale or lease” were clearly intended by Parliament to have meaning and function in terms of common mercantile or legal usage for the purpose of giving greater exactitude to the particular phraseology em- ployed, which may in many cases necessitate making a distinction between a contract for the sale of goods and a contract for the supply of services. Essentially, this is the same view expressed by Strayer, J., in Crown Tire Service Ltd. v. The Queen, supra.

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. See Atiyah, The Sale of Goods, 7th ed., pp. 23-24; Robinson v. Graves, [1935] 1 K.B. 579 (C.A.) per Greer, L.J., at page 587; and Sterling Engine Works v. Red Deer Lumber Co. (1920), 51 D.L.R. 509 (Man. C.A.).

Fridman, The Sale of Goods in Canada, (3rd ed.), agreeing that the better Canadian view was consonant with what the English Court of Appeal decided in Robinson v. Graves, states at page 22 as follows:

. . . if the primary object of the contract is the transference of property in something which was not originally the property of the "buyer", the contract will be one of sale of goods, but if the primary purpose of the parties is the performance of certain work, or the provision of services, incidentally to which property in goods is to pass from one party to the other, the contract will not be one of sale of goods.

Dr. James E. Mergelas was the plaintiff's principal witness. He testified that the relationship between the radiologist partners and Dixie X-Ray was a business relationship. The corporation charges the medical partners for the use of office space and they in turn charge the corporation for the use of the x-ray equipment. He went on to outline the plaintiff's normal procedure on patient referrals.

On arrival at the plaintiff's premises, the referred patient is interviewed by the receptionist, who records the relevant patient information, including the OHIP number. The patient is taken to a changing room and required to disrobe to the extent necessary for taking the x-ray. The patient is then brought into the x-ray room where a qualified technologist takes the appropriate x-ray film and has the patient wait while the film is developed in a processor. The developed radiograph is then marked and identified and put into a manila envelope to await the interpretation and report of the radiologist, which is required in the vast majority of cases. The evidence of Dr. Mergelas is quite explicit that the plaintiff at no time volunteers to the patient that the property in the radiograph is his for the taking and that it is only if the patient asks on his own initiative that he is told he may have it. The evidence is also clear that the billing terminology employed in all invoices of the plaintiff is that of "fees for services rendered".

Counsel for the plaintiff fairly and frankly admitted during the course of his argument that the patient is referred by his or her attending physician to Dr. Mergelas or one of his medical partners for a diagnostic report of the radiograph based on the attending physician's belief in the professional skill and competence of the radiologists rather than on the capability of Dixie X-Ray to properly process the x-ray film. Conceding the importance of the diagnostic report itself, he suggests that this is indicative of the fact that the referral is to the medical partners and that it is they who sub-contract the technical processing and development of the x-ray films to the plaintiff. I quite agree and indeed find that the evidence in its entirety points to no other logical conclusion than that all patient referrals in the first instance are to the medical partners by reason of their professional reputation in providing x-ray films of good quality and their skill and expertise in radiological diagnosis. This is what forms the basis of any contractual relationship vis-à- vis the patients and what happens thereafter as to the passing of any property in the radiograph itself is, in my view, of relatively secondary importance. In short, it is my opinion that the substance of the contract is the provision of services in which the passing of any property in the x-ray films is merely ancillary or incidental thereto, and that the contract is not one for the sale of goods per se. I am further of the opinion that the technological processing of the x-ray films by the plaintiff is but part of its overall function of providing service to the medical profession and their patients from which it follows that no essential differentiation can be made between the vast majority of cases where a diagnostic report is the end result of the whole process and those ten per cent of cases where the radiographs are delivered to others without any written report by a radiologist. Moreover, it is not without significance, in my view, that the definition of “qualified activities’ in paragraph (b) of Regulation 5202 makes specific reference to activities performed in Canada “directly in connection with manufacturing or processing . . . in Canada of goods for sale or lease” (My italics).

I find therefore that the plaintiff has failed to demolish the factual assumptions forming the basis of the Minister’s assessment with respect to the plaintiff's 1978 taxation year. In my opinion the plaintiff has not proven on the balance of probability that its business constitutes the processing of goods for sale within the meaning of section 125.1 of the Income Tax Act and Regulations 5200 and 5202. It goes without saying that the selfsame reasoning and result pertains to the other case tried herewith (T-2941-83).

For these reasons, the plaintiff's action by way of appeal is dismissed with costs.

Action dismissed.