Modern Miss Sportswear Ltd. v. The Queen, 80 DTC 6390, [1980] CTC 521 (FCTD)

Dube, J:—These three appeals dealing with the plaintiff’s 1973,1974 and 1975 taxation years have been heard together on common evidence.

The plaintiff is a Quebec corporation engaged in the business of manufacturing garments for women in Montreal since 1966. It employs about 25 persons, some 20 of whom are directly involved in the manufacturing and processing functions. Those employees, however, do not perform the sewing operations which are farmed out by the plaintiff to several contractors. There were some 25 such contractors in 1975, mostly located in the Montreal garment district, with one in Nicolet and others as far away as the Beauce region.

The plaintiff claimed manufacturing and processing deductions pursuant to section 125.1 of the Income Tax Act for the three taxation years in question. The amounts of the deductions claimed were calculated on the plaintiff’s manufacturing and processing costs including the cost of contracting.

The contracting costs were disallowed by the Minister on the ground that they were not part of plaintiff’s “cost of labour’’ nor of its “cost of manufacturing labour’’ within the meaning of section 5202 of the Income Tax Regulations.

The relevant portion of the definition of “cost of labour” under section 5202 reads as follows:

“cost of labour” of a corporation for a taxation year means an amount equal to the aggregate of

(a) the salaries and wages paid or payable during the year to all employees of the corporation for services performed during the year, and

(b) all other amounts each of which is an amount paid or payable during the year for the performance during the year, by any person other than an employee of the corporation, of functions relating to

(i) the managment or administration of the corporation,

(ii) scientific research as defined in section 2900, or

(iii) a service or function that would normally be performed by an employee of the corporation,

In its income tax report plaintiff claimed the contracting costs as amounts paid for “a service or function that would normally be performed by an employee of the corporation” under subparagraph (b)(iii), but counsel at the hearing did not content that the sewing was normally performed at the plaintiff’s plant. He argued that the employeesof the several contractors were employees of the plaintiff as well when they performed sewing operations upon the plaintiff’s garments (paragraph (a)).

According to the evidence at the hearing, the Quebec garment industry, or the needle trade as it is called, is differently structured than most of the other manufacturing businesses. With a view to minimize their liability and increase their efficiency, most manufacturers limit themselves to key operations at their own plant and parcel out sewing contracts to several Small contractors who employ local women to operate their sewing machines.

According to Lazar Peters, the executive director of the Montreal Dress and Sportswear Manufacturer’s Guild, the contractors become “an extension” of the manufacturer and the latter controls to a very high degree the activities of the former. The manufacturer sends technical people ‘‘to supervise, train and instruct” the operators who work on their garments at the contractors’ plants.

Javier Montero, now president of the plaintiff and its secretary-treasurer during the taxation years in question, personally visited the contractors’ plants and monitored the sewing operations during the relevant period, and Still does at times.

Normally, contractors provide their own equipment, but on occasions the manufacturer loans sewing machines or other tools to the contractors at no costs, or at costs to be recovered from the contracts. On one occasion Montero made a personal loan to one specific contractor to allow her to launch her own business.

Generally speaking, the role of the manufacturer is to seek fabric information, to design new lines of clothing for each season, to obtain new styles from Europe or elsewhere, to prepare patterns, to produce samples, to purchase fabric from supplier and to cut the fabric. At that state the fabric is taken to the contractors by an independent carrier rented by the manufacturer. The parcels are accompanied by “markers” (patterns), cutting slips and trimming check-out sheets. The latter documents, made in three copies, allow the manufacturer to check the work performed on the garments.

The manufacturer pays the contractor by the unit, upon completion, according to prices agreed to orally by the two parties.

The sewing operations are hired by the contractor, but if any particular operator is not efficient, or satisfactory to the manufacturer, the latter may use his considerable power of persuasion upon the contractor to have that person fired.

Wages, of course, are paid by the contractor to the operators and he deducts from their paychecks the standard payments for unemployment insurance, income tax, pension, etc. The manufacturer, however, has an ultimate responsibility in the matter, as prescribed by the Decree relating to the Dress Industry. Article 14 of Annex C of the said Decree reads as follows:

14. Every professional employer contracting with a sub-entrepreneur or a subcontractor, directly or through an intermediary, shall be jointly and severally responsible with such sub-entrepreneur or sub-contractor and any intermediary, for the payment of the wage fixed by the decree. RS 1941, c 163, s 14.

The responsibility of the manufacturer for the contractor is also outlined in the “Convention collective de travail” between the Montreal Dress and Sportswear Manufacturers’ Guild and the Joint Commission (Comité conjoint de Montreal, Union des ouvriers de la robe), and the Union Internationale des Ouvriers du Vêtement pour Dames, which stipulates as follows:

90.02 Each Employer, a member of the Guild, shall be jointly and severally responsible together with each contractor and sub-contractor to which each such Employer shall furnish work falling under the jurisdiction of this Agreement, for the payment of wages, and for payments into the Welfare Funds, and for due compliance with working conditions, the whole as set out in the present Agreement.

Article 50.01 of the Convention provides that the manufacturer, described as the “Employer-Supplier” who supplies a contractor with work to be performed by such contractor called “Employer-Contractor”, shall, at the request of the Union, make two separate payments for such work to the contractor, that is 90% to be paid to the contractor and the balance of 10% payable to the Trustees of the Union Welfare Funds.

Should contractors fail to pay their employees, or should they go bankrupt (and it would appear that the latter occurrence is not uncommon in the silk trade), then the manufacturer is notified by the Joint Commission and he has to pay the Commission moneys owing to the sewing operators. There is evidence that the plaintiff has had to pay factory wages and holidays unpaid by contractor Dopinjay Fashions Inc.

It is obvious, therefore, that there is a close rapport between the manufacturers and the contractors: their respective successes and failures are almost inextricably enmeshed. The contractors look up to the manufacturers as their source of revenue, the manufacturers rely totally on the pro- duction of the contractors. This high degree of interdependence and mutual reliance is vital to such a fragile industry as the Quebec textile trade.

The plaintiff invites the Court to conclude from such a close business intimacy that the employees of the contractors become the employees of the manufacturer when they work on the garments of the latter.

Although there is a degree of control exercised by the manufacturer upon the sewing machine operators and although he is ultimately legally responsible for their unpaid wages and benefits, I cannot find that there exists a master and servant relationship between them.

Firstly, there is no contract of service, no contractual link whatsoever, oral or written, between the two. The workers are hired by the contractors and fired by them. Of course, because of the economic dependence of the contractors upon the manufacturer, the latter may carry sufficient leverage to obtain the firing of an incompetent operator. That result is not obtained by the exercise of a legal right. It is the reality of economic clout.

Secondly, the salaries are not paid to the operators by the manufacturer, but by the contractors. One essential condition to the existence of a contract of service is that the servant agrees to provide his skill and work to a master in exchange of a wage or other remuneration (Vide Ready Mixed Concrete v Min of Pensions, [1968] 1 All ER 433 at 439 and 440).

Thirdly, the equipment and the tools used by the operators are usually owned by the contractors, not by the manufacturer.

Fourthly, all the usual deductions from the employee’s paychecks are made by the contractors.

Fifthly the operators basically take their general instructions from the contractor who hired them, not from the manufacturer. The contractor decides which manufacturer’s garments will be sewed in his shop. On any given day his employees may be working on the merchandise of several different manufacturers. It is difficult to conceive how these operators would successively become the servants of different masters in the course of a week, or even within a day, most likely without the knowledge of either the masters or the servants.

If the contractors were deemed to be agents of the manufacturers, then one might consider the sewing operators as being in reality the employees of the principals, the manufacturers. Such is not the case. Contractors do not consider themselves agents of the manufacturers. They file their own income tax reports, wherein they claim their own deductions for manufacturing and processing costs. The scheme of the Act does not contemplate such a double deduction.

In any event if I were to consider the employees of several contractors as servants of the plaintiff, which I do not, still the cost of labour in relation to them could not be considered as “cost of labour” as defined under section 5202 of the Regulations. Under that definition such costs relate only to “the salaries and wages” paid to the employees, whereas the plaintiff has not paid salaries and wages to the sewing operators in question. He has paid to the contractors invoices submitted by the contractors, which invoices charge the total costs for units of garments completed, not the wages paid to sewing operators.

It is a well established rule that the exempting provisions of a taxing Statute must be construed strictly and that the burden is on the taxpayer to place himself squarely within the four corners of the exemption.

Under the circumstances the three appeals must be dismissed with costs.