Roy Legumex Inc. v. MNR, 90 DTC 1858, [1990] 2 CTC 2389 (TCC)

Rip, T.C.J.: —Roy Legumex Inc. ("Roy"), the appellant, appeals from reassessments for its 1982, 1983 and 1984 taxation years and an assessment for its 1986 taxation year. In assessing, the Minister of National Revenue, the respondent, reclassified properties acquired in 1982 and 1984 to Class 3 for purposes of capital cost allowance in accordance with paragraph 20(1)(a) of the Income Tax Act ("Act"), Schedule II of the Regulations to the Act and section 1100 of the Regulations. [1] The amounts of the deductions claimed by the appellant for capital cost allowance purposes were reduced by the respondent.

At all relevant times Roy owned a processing facility for peas and other legumes, and in order to carry on the business erected certain containers in which to dry the product for processing; it is the classification of these containers or units for capital cost allowance purposes that is the issue in appeal.

Roy is a leading Canadian supplier of whole and split yellow peas, whole, "dehulled" or split faba beans, lentils and canaryseed. The appellant was incorporated in 1978 and its facility was built in that year. Product is delivered to Roy's plant in St. Jean Baptiste, Manitoba for processing from its contract producers. Whole pulses, the edible seeds of leguminous plants, are usually sold on the basis of grades set by the Canadian Grain Commission; however, since there are no grades for dehulled or split products, they are offered for sale on a sample basis.

Mr. Robert Lafond ("Lafond"), general manager of Roy, recalled that the appellant and its predecessors (its shareholders who carried on the business prior to 1978) did substantial research and development to find a process to more efficiently split peas and beans which it sells. A whole pea loses moisture at a different rate from its hull; at a point in the process "separation" takes place and the hull, the outer skin of the pea, comes off and the product, the pea, is split.

The previous owners and Lafond designed a plant in response to a need it saw at the time; the new plant now uses natural means rather than fossil fuels to dry the produce which, in the case of split peas, has very high moisture content, between 60 to 70 per cent. Roy has gained a competitive edge because of the money saved in not using fossil fuels in the drying process carried on in the containers.

The drying of the legume is necessary before the actual processing can begin; without the drying there would be no product. The purpose of these containers or units is to dry the product naturally.

The legumes arrive at the plant by trucks owned by Roy or by the producers themselves. The produce is then placed into a bucket elevator, partially enclosed by a building in which the produce is processed; it is then deposited into the units for drying.

The units are made of galvanized steel and are cylindrical in shape and are from 40 to 45 feet high. Two were acquired in 1982 and have a capacity of 30,000 bushels each; the one acquired in 1984 has a capacity of 65,000 bushels. The units are described by its manufacturer as “stiffened grain tanks". Two of the units rest on a concrete foundation on piers; a third does not have a pier. The piers are 50 to 60 feet deep; the concrete pads are only inches thick and contain reinforcements.

The units were built to Roy's specifications. At the bottom of each unit is a fan which draws air from outside into the unit. Within the tank is a floor raised about two or three feet from the main floor of the tank on which the legumes are placed for aeration. The raised floor is a type of screen, a floor with little holes, to permit air drawn into the lower portion of the unit to enter and ventilate the upper chamber where the product is stored. In the space between the floor and subfloor is equipment for the fan. A bean ladder is built in the centre of the interior in two of the tanks to slow down the flow of the fragile product as it is deposited into the unit; each ladder extends from the aeration floor to the top of the unit. On top of each tank are large down spouts through which the product enters the unit.

A conveyer belt connects the interior of the tank to the main building or plant where the processing is carried out. The belt is used to transfer product to and from the building. It takes approximately 20 to 25 days between receipt of delivery of the product and the time it goes to the plant for processing. During this time the peas are aerated in the units. Once the product is aerated, it is conveyed to the plant for processing; the peas are cleaned, dehulled and split. Once split, the peas are polished for marketing. Polishing takes place in large drums; steam, water and additives such as glucose are used to give the product an attractive appearance. The product is then taken back to the unit without the bean ladder for further dehydration since the moisture content had been increased during the polishing procedure. The unit without the bean ladder is used because once the product has been split breakage is no longer an issue. The product is then returned to the plant for packaging.

Roy sometimes sells whole peas that have been cleaned but 85 per cent of Roy's business is in split legumes.

Counsel for the respondent asked Lafond whether the units are simply storage units. He replied that product is being stored as it is being conditioned or dried. Later he explained that when product is not in motion it is being stored; storage, to Lafond, was an essential part of the process.

In its income tax return for its 1982 taxation year the appellant claimed a deduction for capital cost allowance with respect to the units acquired in 1982 on the basis they were Class 8 assets. For its 1983 (amended return) and 1984 taxation years the claim was based on the units being Class 29 assets. The 1984 acquisition was originally reported as a Class 6 asset. The appellant appeals on the basis the three units acquired in 1982 and 1984 were Class 29 assets.

Schedule Il to the Regulations of the Act describes Class 3 assets, in part, as follows:

Property not included in any other class that is

(a) a building or other structure, including component parts . . . .

Class 8 property is defined, in part, as follows:

Property not included in Class 2, 7, 9 or 30 that is

(a) a structure that is manufacturing or processing machinery or equipment;

(b) tangible property attached to a building and acquired solely for the purpose of

(i) servicing, supporting or providing access to or egress from, machinery or equipment,

(ii) manufacturing or processing, or

(iii) any combination of the functions described in subparagraphs (i) and (ii);

(c) a building that is a kiln, tank or vat, acquired for the purpose of manufacturing or processing . . . .

Property in Class 29 includes:

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,

(b) that is

(i) property that, but for this class, would be included in Class 8 . . . .

In assessing, the respondent classified the units as Class 3 assets for the following reasons:

(a) Either before or after the course of the appellant's processing activities certain products were stored outside of the appellant's plant in large storage bins.

(b) Peas or beans (hereinafter the "stored product") would be stored for several months, either until needed in the appellant's processing plant or until shipped to the appellant’s customers.

(c) The storage bins were erected on an underground concrete foundation and were connected to the appellant's main plant by conveyors for moving the stored product.

(d) The storage bins were purchased as "stock grain bins" and modified slightly to receive the stored product.

(e) The storage bins were not manufactured or designed as part of the appellant's processing operation.

(f) The storage bins were not machinery or equipment, nor a kiln, tank or vat

as contemplated by Class 8 of Schedule Il of the Income Tax Regulations.

(g) The purpose of acquiring the storage bins was only for storage, it was not for the purpose of manufacturing or processing goods for sale.

Counsel for the appellant submitted that the units were acquired by the appellant to be used directly or indirectly by it in Canada primarily for processing of goods for sale. The units would ordinarily be Class 8 property were it not for the existence of Class 29.

The business of the appellant is the processing of legumes from a raw product to a product for sale. The units were built in 1982 and 1984 as part of the processing operation. The appellant designed a procedure to enhance the processing of the product which was novel and economical. The dehulling of the product facilitated by the dehydration procedure designed by the appellant was essential to the processing of the product. If moisture content is not reduced the product is not sellable. The units are receptacles which held the legumes during the drying process, both at the beginning of the process and after the finished product had been polished. The units, counsel added, play an important and integral part of the process since processing is not possible without the initial drying.

Counsel referred the Court to the reasons for judgment of the Federal Court-Trial Division and Appeal Division in Nowsco Well Service Ltd. v. The Queen, [1990] 1 C.T.C. 416; 90 D.T.C. 6312 (F.C.A.); affg [1988] 2 C.T.C. 24; 88 D.T.C. 6300. Cullen, J. accepted the plaintiff's contention in that appeal that “for the purposes of Class 29, one includes all equipment that is both necessary and ancillary to the processing operation" (F.C.T.D. judgment, page 41 (D.T.C. 6313)). The Court of Appeal dismissed the Crown's appeal without commenting on the "necessary and ancillary” test.

Appellant's counsel also referred to two other decisions: B.C. Ice and Cold Storage Ltd. v. M.N.R., [1981] C.T.C. 2563; 81 D.T.C. 508 (T.R.B.) and Woods Harbour Lobster Co. v. M.N.R., [1989] 2 C.T.C. 2032; 89 D.T.C. 303, a decision of this Court, as well as Interpretation Bulletin IT-147R2, published by the respondent. In the first case a freezing plant was held to be processing equipment used directly or indirectly by the taxpayer primarily in the processing of goods for sale and was properly included in Class 29. In the latter case the appellant operated a lobster pond. Its business consisted of buying lobsters in bulk, sorting them by size and grade and culling the unsatisfactory ones, fixing the claws and crating and shipping after selling. The taxpayer's facilities included outdoor holding ponds and indoor holding tanks in which the lobsters were held awaiting sale or shipment. Kempo, T.C.J. held the point of the taxpayer's operation was to add value to the inventory which it received in bulk form and which it sold in a very different and enhanced, albeit bulk, form. The taxpayer's equipment was classified as Class 29.

In paragraph 6 of the Interpretation Bulletin, the respondent interprets the term "to be used directly or indirectly” in the description of Class 29 property to refer "to assets which are acquired by the taxpayer for the purpose of being an integral and essential part of the taxpayer's. . .processing activities as well as any ancillary equipment. . .acquired for use in those activities.”

In the appellant's view, therefore, the units were necessary for processing the legumes. If the dehydration or drying was not part and parcel of the processing of the legumes, it was an essential step for the processing itself; without the aeration of the legumes, there could be no processing.

The respondent's counsel stated that Lafond testified the purpose of the units was to bring down the moisture content levels of the legumes so that they may be processed. He inferred that drying is not part of processing but preparatory to it.

Counsel relied on the reasons for judgment of the Supreme Court of Canada in British Columbia Forest Products Ltd. v. M.N.R., [1971] C.T.C. 270; 71 D.T.C. 5178 (“B.C. Forest Products"). The disputed assets, component parts in three main mill buildings and a series of storage tanks, in that case formed part of the taxpayer's paper mill and consisted of three categories, i.e. those used in the production process; e.g. chests and tanks; those used to provide access to the equipment, e.g. stairs, handrails; and those which supply sup- port for the equipment, e.g. piers, concrete pads and supports and walls of the tanks. The tanks were located outside the mill building and were used for the storage and treatment of the stock. Martland, J., at page 5183, found the tanks to be structures. [2] He also held that:

If the disputed assets are within the words “building or other structure" in Class 3 they would be tangible capital assets "included in another class” and so would be excluded from Class 8. Accordingly, even though they may form a part of the manufacturing process, that does not necessarily mean that they fall within Class 8.

I note that with respect to the taxation years in issue in B.C. Forest Products the description of property in Class 8 was different from that in Class 8 for the years in appeal. [3] Thus, for 1982, 1983, 1984 and 1986, Class 8 property includes a structure that is processing machinery or equipment, tangible property attached to a building and a tank.

In Nova Scotia Sand and Gravel Ltd. v. The Queen, [1978] C.T.C. 279; 78 D.T.C. 6192; revd [1980] C.T.C. 378; 80 D.T.C. 6298, the Federal Court-Trial Division considered the meaning of the word "process" at page 289 (D.T.C. 6198-99). Dubinsky, D.J. referred the comments of Cattanach, J. in Federal Farms Ltd. v. M.N.R., (No. 2), [1966] Ex. C.R. 410; [1966] C.T.C. 62; 66 D.T.C. 5068 at 67 (D.T.C. 5071-72), where, inter alia he states:

The word "process" is defined in The Shorter Oxford English Dictionary, Third Edition as "To treat by a special process; e.g. to reproduce (a drawing, etc.) by a mechanical or photographic process."

In Webster's Third New International Dictionary published in 1964 the word "process" is defined as follows, "to subject to a particular method, system or technique of preparation, handling or other treatment designed to effect a particular result: put through a special process as (1) to prepare for market, manufacture or other commercial use by subjecting to some process (-ing cattle by slaughtering them) (-ed milk by pasteurizing it) (-ing grain by milling) (-ing cotton by spinning)."

The evidence of the appellant as to its operations convinces me that those operations were a process or series of processes to prepare the product for retail market. There is no doubt that quite apart from the grading of the vegetables, a clean and attractive appearance is an important factor in marketing vegetables and especially so in the present day methods of retail marketing. Although the product sold remains a vegetable, nevertheless, it is not a vegetable as it came from the ground but rather one that has been cleaned, with improved keeping qualities and thereby rendered more attractive and convenient to the consumer.

The appellant in Federal Farms, supra, was successful in his appeal before the Exchequer Court; the decision was upheld by the Supreme Court of Canada without written reasons. In Nova Scotia Sand and Gravel Ltd., supra, the Court held that the taxpayer was engaged in the production of industrial minerals; manufacturing or processing "does not include producing industrial minerals": subsection 1104(9) of the Regulations to the Act.

The respondent's counsel invited me to read out of the term “tangible property" in the opening words of paragraph (b) describing Class 8 assets, any reference to "structure" or “building” that may be attached to a building. In other words, I was asked to rule that for the purposes of Class 8 property “tangible property" does not include a structure; that is, “tangible property" is something other than a structure or building. Counsel for the respondent admitted he had no authority to support his submission, and I am not prepared to accept his novel submission. A structure, building or anything else capable of being touched is tangible.

The respondent's counsel stated that the units are not machinery or equipment. He said, and I agree, that conceivably the different assets, the conveyor, the bean ladder, different buildings used in the same operation, may be of different classes. I assume he advanced this proposition in support of his client's assessment that while the bean ladder and fans, for example, are Class 29 assets, it need not follow the tank in which they are found is a Class 29 asset.

The Oxford English Dictionary (2nd ed.) defines the word "tank" as "an artificial receptacle, usually rectangular or cylindrical and often of plate iron, used for storing water, oil or other liquids in large quantities”. Thus since the units in issue were used to store legumes, a solid, it cannot be a tank,counsel argued.

Counsel for the appellant submitted the units are described in any of paragraph (a), (b)(ii) or (c) of the description of Class 8 property. He dealt firstly with subparagraph (b)(ii). He stated that there is no doubt the units were attached to the building where processing takes place and the units were acquired solely for the purpose of processing. The attachment of the units to the buildings was by way of the conveyor. The units were used to dry out the product in two phases of the process to get the product to market. Thus, counsel concludes, since the units are attached to the main building and were acquired for the purpose of processing, the units are property described in subparagraph (b)(ii).

The Shorter Oxford Dictionary on Historical Principles (3rd ed.) defines the word "attach" as follows: "III. To tack on; to fasten or join (to) by tacking, tying, sticking, etc. . . .".

The word "attached" in subparagraph (b)(ii) contemplates more than a simple connection. It is likely the tanks are connected to the main building but they are not joined to the building as required by subparagraph (b)(ii). In the French language the introductory words of subparagraph (b)(ii) are: "des bien corporels faisant partie d'un immeuble. . .”. The phrase "faisant partie" confirms that the word "attached" in the English language version of subparagraph (b)(ii) means more than a mere connection; the tangible property must be so attached to the building that it more or less becomes part of it. This is not the case in the appeal at Bar.

The second point argued by appellant's counsel was that the units are structures that are processing machinery or equipment within the meaning of paragraph (a). I agree the units were structures: B.C. Forest Products (page 5183). They were of substantial size, built up from component parts and intended to remain permanently on a permanent foundation.

The question is whether they are processing machinery or equipment. The evidence indicates that whether or not the units are by themselves processing machinery or equipment it is obvious that they are used in a necessary initial step in the processing of the legumes; without the dehydration of the legumes carried on in the units, processing of the legumes is not possible. The respondent has agreed that the equipment in the units, i.e. the bean ladders, fans, conveyors, are properly included in Class 29 but the unit itself is a Class 3 asset. I cannot imagine how the fan can draw in the air from the outside to aerate the legumes without the unit being so constructed that not only the product but the air as well is contained; the wall of each unit permits the air to circulate within a given limited area that is the interior of the unit. This is necessary for the drying process to function with any practical effect. The bean ladder in two of the units, the aeration flow and the conveyor are built into the unit and together with the shell of the unit become machinery or equipment used in the processing of the legumes. If the units were not an integral and essential part of Roy's processing activities, they surely constituted ancillary machinery or equipment acquired for use in Roy's processing activities. The aeration flow, bean ladder, conveyor and each unit would ordinarily be included as Class 8 assets but since they were acquired after 1972 to be used directly or indirectly by Roy in Canada primarily in the processing of goods for sale, they are included in Class 29 for purposes of capital cost allowance.

I need not determine whether the containers or units were tanks within the meaning of paragraph (c) of Class 8 property. The appeals are allowed with costs.

Appeals allowed.