Lehmann Bookbindings Ltd. v. MNR, 92 DTC 1308, [1992] 1 CTC 2766 (TCC)

Taylor, T.C.C.J.:—These are appeals heard in Toronto, Ontario on February 27,1991 against income assessments for the years 1983, 1984 and 1985 in which the Minister of National Revenue disallowed certain deductions claimed. The notice of appeal read in part:

— In calculating its tax for the years referred to in paragraph 1 hereof, the appellant deducted from its tax otherwise payable, an amount with respect to its manufacturing and processing profits pursuant to the provisions of section 125.1 of the Income Tax Act, (the "Act"), and an investment tax credit of 7% pursuant to section 127 of the Act. In calculating its income for the same years, it also deducted capital coat allowance on certain assets pursuant to clause 29 of Schedule II to the Income Tax Regulations.

—During its 1983-85 taxation years, inclusive, the appellant was entitled to claim capital cost allowance on certain Class 29 assets and was entitled to tax deductions pursuant to the provisions of section 125.1 and section 127 of the Act.

For the respondent the matter was made equally clear in the reply to the notice of appeal:

—at all material times, the appellant was a bookbinder whose activity was almost exclusively the binding of periodicals, textbooks and other material owned by libraries and government departments;

—covers were manufactured or processed by the appellant in the course of its providing binding services to its customers;

—at all material times, over 90% of the activities of the appellant relate to the service of binding periodicals, textbooks and other materials which at all times are owned by its customers;

—in binding its customers’ materials, the appellant was providing a service to its customers and not manufacturing or processing goods for sale or lease; and

—occasionally the appellant manufactured or produced goods for sale, such as portfolio boxes and pamphlets for sheet music, but these cases comprise less than 10% of the appellant's activity.

. . . The appellant is not entitled to the deductions provided for in section 125.1 and 127 of the Act nor to claim capital cost allowance under class 29 by virtue of the fact that it is not manufacturing or processing goods for sale or lease. In binding its customers’ materials the appellant is performing a service and not producing goods for sale. Those cases in which goods are produced for sale or lease represent less than 10% of the appellant's activity and, it is respectfully submitted, do not meet the de minimus test.

I do not wish the fact that I will be summarizing only briefly the evidence presented at the trial to be any reflection at all on either the quality of that evidence or the professional and informative presentation of it. That evidence consisted of testimony by the President of Lehmann Bookbinding Ltd. (“Lehmann”), Mr. William Lehmann himself, financial statements for the years in issue, lists of machinery and equipment required and used, price lists, documents regarding standards of performance and product in the industry and copies of correspondence related to the operation. This tended to illuminate and identify the details involved, but as I see it, the essence of the issue between the parties is adequately described and arises directly out of the perspectives recited by the respondent in the reply to the notice of appeal above. Stripped to its simple basics, the appellant took in material—books, periodicals, magazines, etc. from a wide range of customers which included libraries and universities as well as industry and government. That material could be in any condition—old, new, used, legible, less legible, tattered and torn or in the very best of appearance. Some customers merely wanted certain material (monthly magazines for example) bound into groupings—perhaps yearly—in which condition they could continue to be used or preserved. Other customers wanted virtually a complete restoration and rebuilding job done. Clearly there was routine work, and also very challenging, almost impossible tasks brought to the appellant. It was evident from the testimony of Mr. Lehmann that he was very proud of the work he did, particularity in the restructuring, restoring and preserving of some ancient historical research or vital documents which might otherwise be lost forever. But for purposes of this trial, the issue is simply whether the operation as described and identified meets the conditions required for the deductions sought. In my view it does fulfil the criteria, and the deductions are warranted. The fundamental point at issue in these appeals is whether the term "goods for sale” as it appears in subparagraph 125.1 (3)(a) of the Act has been met.

In argument

Counsel for the appellant relied substantially for support on the jurisprudence in Halliburton Services Ltd. v. The Queen, [1985] 2 C.T.C. 52, 85 D.T.C. 5336 (F.C.T.D.), [1990] 1 C.T.C. 427, 90 D.T.C. 6320 (F.C.A.) and Nowsco Well Service Ltd. v. The Queen, [1988] 2 C.T.C. 24, 88 D.T.C. 6300 (F.C.T.D.); [1990] 1

C. T.C. 416, 90 D.T.C. 6312. Such reliance however, was founded in large measure on counsel's interpretation of these cases to indicate that the point which was made in Crown Tire Retreaders Ltd. v. M.N.R., [1981] C.T.C. 3013, 81 D.T.C. 931 (T.R.B.) and Crown Tire Services Ltd. v. The Queen, [1983] C.T.C. 412, 83 D.T.C. 5426 (F.C.T.D.), essentially that the tire casings themselves, in Crown Tire, supra which were retreaded, had remained at all times the property of the customer, not the property of Crown Tire. In counsel's view, the cases of Halliburton, supra and Nowsco, supra cast serious doubt on the validity of this "proprietary interest" basis from Crown Tire, supra and his argument led to the conclusion that Crown Tire, supra thereby had been overtaken to the extent that the ownership by the customer of the tire casing in Crown Tire, supra could no longer be an impediment to that appellant. Accordingly, in this instant matter the continued ownership of the books or magazines by the customer should not militate against a favourable decision for Lehmann in the opinion of counsel for the appellant.

In argument also

Counsel for the respondent on the other hand, did not view the results in Halliburton, supra and Nowsco, supra in such a dramatic way. In his view there had been no such effect on the Crown Tire, supra case, and the customer's proprietary interest in the goods was still a problem for this appellant. Counsel reviewed arguments made in Crown Tire, supra regarding the impact of laws dealing with sale of goods, and indicated that the relevance of such legislation to this matter should not be overlooked.

Analysis

In my view, the relevance of Crown Tire, supra must be seen in the light of the decisions in Halliburton, supra and Nowsco, supra. To that extent, I am in agreement with counsel for the appellant in this matter. It may overstate the case to say, as does counsel for the appellant, that Halliburton, supra and Nowsco, supra have overturned Crown Tire, supra. But I need make no determination on that point—I need only point out that the Courts in both Halliburton, supra and Nowsco, supra had no difficulty in rejecting the contention of the respondent therein, that "service and products are inseparable". The "processing" of the goods to the point of a sale therefore met the conditions outlined in the Act. The Court in the Federal Court of Appeal judgment in Halliburton, supra left open for consideration any possible argument that a distinction should still be made between "services" and "goods"— but the Court did not deny to the taxpayer the benefit of the processing being done"for sale” on any profit arising from this processing. I would note:

Accordingly, while the distinction between contracts for the sale of goods and contracts for work, labour and materials may have been significant in the Crown Tire Service case, I do not think it is applicable in the present one.

The allocation of the plaintiffs profits as between its service operation and its processing operation is a matter for the plaintiff's accountant and Revenue Canada to determine in the first instance. [Page 58 of Halliburton, supra (D.T.C. 5340 and 5341)]

I would make reference to another case, one in which Halliburton at the Federal Court-Trial Division level, supra was used as support—BXL Bulk Explosives Ltd. v. M.N.R., [1985] 2 C.T.C. 2256, 85 D.T.C. 579 ("BXL"). One of the questions I faced in BXL, supra, was whether the appellant's contention that it was "processing. . .goods for sale" should be upheld. As had been done in Halliburton, supra—although admittedly an extension of the "goods" and "services" distinction—I concluded that it was possible to visualize the processing of the BXL raw materials and the sale of the resultant mixture to the customer at the mine site in such a way that the conditions required in the Act would be met—irrespective of the fact that a major ingredient added to this mixture was fuel oil owned by the customer. Simply put, I did not look at the "explosive mixture” in total as the"goods for sale”, but only the appellant's raw materials combined (processed) into the product it sold. I would mention at this point that while there is no clear indication in Nowsco, supra (F.C.T.D.), that the oil used therein was the property of the customer, the following comments are to be found at page 33 (D.T.C. 6308):

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.

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

[Emphasis added.]

These comments together with the configuration of the "job sites" detailed in the diagrams of exhibits provided to that Court, and reproduced on pages 29 and 32 of Nowsco, supra, F.C.T.D. (D.T.C. 6305 and 6307), would tend strongly to support a view that the oil and water parts of the mixture are the property of the customer on the job site. If so, there is little if any difference I can detect between the operation detailed in Halliburton, supra and Nowsco, supra, on the one hand and BXL, supra, on the other hand. Accordingly, I feel quite comfortable in visualizing the processing in BXL, supra regardless of the presence of the customer's fuel oil as not violating the conditions in the Act as interpreted in these two cases from the higher Courts. As some further comfort for this view, I would note from Nowsco (F.C.A.), supra, at page 424 (D.T.C. 6317):

Suffice it to say that to focus on the fact, as did counsel for the appellant in this case, relying on the Crown Tire Service, supra, pages 414 to 415 (D.T.C. 5428 and 5429), case for support, that the work having been done to the property of the respondent's customers involving the use or affixing of materials thereto was the provision of a service to the customers, misconstrued the nature of the relationship between the parties.

Contrary to the argument of counsel for the respondent, I believe that determining the particular time at which and where title to the goods passes, is of little importance, on the facts of this case, in the determination of the relationship between the parties. However, what is of some significance, I think, is that since the products furnished are produced to the particular specifications of the operator/customer and must be paid for by it whether completely used or not (subject to some limited contractual exceptions), it may well be that title passes when the mixing and blending is effected.

The conclusion in BXL, supra, regarding the continued existence of the customer's proprietary interest throughout the processing up to the point of sale, in a part of the end product may have similarity to the view of counsel for the appellant in this matter—that such a basic distinction apparently arising out of Crown Tire, supra, does not survive the tests from Halliburton, supra and Nowsco, supra. But I need not comment further on that, nor make any determination thereof. Indeed there may well be a distinction remaining to be made between Crown Tire, supra and BXL, supra, as indicated on page 2263 (D.T.C. 584) of BXL, supra:

I am prepared to see in Crown Tire, supra that the appellant therein did something to the property of the customers thereby providing the customers with a service resulting in a retreaded tire, even though in doing something to the customer's casing, Crown Tire was providing its own materials. In the instant case, I do not see as clearly that the materials belonging to BXL were used in doing something to the fuel oil owned by the customers. The learned Justice noted in Crown Tire, supra that his distinction may have been“ technical and remote", and I accept that this distinction I am making in this case, may be even somewhat more exotic. Nevertheless, I am prepared to give the appellant BXL the benefit of the doubt on this aspect of the matter, and agree that the Company was "processing. . . goods for sale”.

But there is the equally noted comparison which could arise in reviewing these instant appeals with that of Crown Tire, supra—the cover and binding materials used and provided by Lehmann to wrap-up, recondition and preserve the books and magazines provided by the customer are glaringly similar in utilization to the new tread attached to the customer's tire casings in Crown Tire, supra. But I leave it at that—since now I am prepared to examine the facts of these instant appeals from the same perspective that I reviewed the facts in BXL, supra.

To me the analogy between BXL, supra and these appeals seems to be adequate and appropriate. In this situation, a customer's books, periodicals and magazines remain the customer's throughout the processing by Lehmann, and continue to exist in the final product—perhaps reconditioned, cleaned, repaired, etc. However, there has been added the raw materials, skills and labour provided by Lehmann—which I have described as the result of "processing . . . goods for sale". I am not persuaded that the distinctions made by the respondent in this matter are persuasive enough to deny this appellant the benefits sought. I also agree with the reservations expressed in Halliburton, supra, regarding the relevance of other legislation—particularly that dealing with sale of goods, to the point at issue here. In the circumstances of this case, neither one of the two major facts upon which the assessment was struck and argued by the respondent—(a) the continued ownership of the books, etc. by the customer, and (b) the provision of some element of "services" by Lehmann in the processing are sufficient to uphold the assessment as I read the relevant jurisprudence.

I do accept that I have relied to a substantial degree on the examination of somewhat similar facts in BXL, supra while that case was not raised at the hearing by either party. Neither did counsel for the appellant raise the point that in Halliburton, supra and Nowsco, supra the materials added by the appellants at the job site, appeared to survive the processing to form the basis of the "sale", irrespective of any client's proprietary interest, as referenced in BXL, (supra. Nevertheless, I am satisfied BXL, supra should enter into my review of this matter, particularly since in BXL, supra both major support cases referenced in these appeals (Halliburton for the appellant and Crown Tire for the respondent) were raised and utilized in BXL, supra for that decision—in allowing these appeals—from which decision the Minister of National Revenue chose not to launch further appeals.

The appeals are allowed. The appellant is accorded costs.

Appeals allowed.