International Petrodata Inc. v. The Queen, 93 DTC 110, [1993] 1 CTC 2189 (TCC)

Bell, T.C.C.J.:—The issue in this case is whether the appellant is entitled, in respect of its 1987 and 1988 taxation years, to a deduction under section 125.1 of the Income Tax Act of Canada, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") in respect of Canadian manufacturing and processing profits for its 1987 and 1988 taxation years. The appellant's returns of income for those two years show that its taxation year in each case ended on August 31.

Appellant's counsel stated, at the commencement of the hearing, that such deduction was not claimed by the appellant when it filed its returns for the 1987 and 1988 taxation years. Rather, in the course of a Department of National Revenue (the "Department") audit with respect to branch profit tax calculations, appellant's accountant requested that such manufacturing and processing profits deduction be allowed. Upon the issue of notices of reassessment respecting the branch profits’ calculation and upon the Department's refusal to allow a manufacturing and processing profits deduction, the appellant objected to the reassessments claiming entitlement to same. Upon the issue of notification of confirmation by the Minister for the two taxation years in question stating,

you had no Canadian manufacturing and processing profits for the years within the meaning of paragraph 125.1(3)(a) of the Act and Section 5200 and 5201 of the Income Tax Regulations and accordingly you are not entitled to a deduction under subsection 125.1(1) of the Act from the tax payable.

The appellant filed appeals to the Tax Court of Canada. These are the appeals presently under consideration.

Counsel for both parties tendered as evidence a joint book of documents containing, inter alia, copies of contracts between the appellant and various oil and gas companies and invoices arising out of the implementation of the provisions of those contracts. It was the execution of those contracts that gave rise to the profits in respect of which the appellant seeks the manufacturing and processing deduction.

The appellant’s only witness was Mr. Clark Hamilton Smith, President of the appellant. The appellant was incorporated in the state of Delaware, USA and had one subsidiary corporation, namely International Petrodata Ltd. which was incorporated in Alberta. This Alberta company did not conduct any business and did not report any income. It was simply used for marketing purposes, its name being on all marketing literature and in all communication with customers. Although invoices were issued in its name, it was, in fact, acting on behalf of the appellant which conducted all business.

Mr. Smith described in detail the business carried on by the appellant during the taxation years in question. In essence, it was the gathering, editing and interpretation of technical data for wells drilled for oil and gas in Canada. Such data consisted of well locations, critical dates, formation tops, reference elevations and total depth, log types run, initial potential tests, perforations, treatments, cored intervals, drill stem test data, pressures, recoveries, gross porosities, oil, gas and water analyses, and core analyses. Although Mr. Smith described each of these concepts in detail, it seems not necessary for the purpose of this judgment to record those descriptions. Suffice it to say that they constituted a large amount of information concerning the wells to which they related.

The appellant had data for all wells drilled in Canada for oil and gas with the exception of those drilled in Ontario and Quebec. Most of such information was purchased from government agencies such as the Energy Resources Conservation Board for the four western provinces and from two federal departments with respect to the Northwest Territories, Yukon, Hudson's Bay and the east and west coast. In addition, the appellant had standing orders with these suppliers for new data as they became available, generally on a monthly basis.

Mr. Smith explained the appellant's editing and interpreting of "the raw well data that it receives.” He said that the purchased data is in many different forms, some on magnetic tape, some on paper, and some on microfiche and that well logs may be on paper or microfiche. He stated that the appellant's primary objective was to obtain the most accurate and reliable data possible and in so doing attempted to obtain the original documents available relating to well data. He stated that even though the appellant obtained the government agency's record of information from reports on oil, gas and water analyses, drill stem test data and core analyses which were produced by service companies specializing in those matters, it also attempted to obtain the original reports. He stated further that the data which it put in its file was from such Original reports.

Mr. Smith testified that the appellant had about 17 employees in the years under appeal and about three consulting geologists performing interpretation functions. He also stated that since that time the appellant had employed, virtually full time, four geologists to reinterpret many thousands of wells in order to improve the quality of the interpretive data, primarily formation tops. Eight of the employees were engaged in gathering and entering data in the appellant's computer file of well data. This involved some information going into that file directly off computer tape and showing up on a screen in front of the operator and then the addition to that computer file of analyses which may have been on paper or on a microfiche screen beside them. In addition, there were, according to Mr. Smith, four people doing computer work of one sort or another, described as "computer operation or computer systems work.” He then stated,

There is always ongoing work to be done in our own programs or in supplying computer output for our customers in one form or another.

Mr. Smith explained that for each person there are a number of machine runs to be done each month,

. . . and then it must all be put together at the end of the month. And then the tapes must be created to send to each of our customers who purchased data on tape. And there must be also, there must be tapes generated to send to the service company that creates the microfiche for us to send to other customers

We do machine runs for customers periodically to give them output on paper or maps, whatever. And all of these activities take somebody to do the operation and very often programming on our part.

Mr. Smith then stated that the Petrodata file is the trade name for the entire computer file itself which holds all well data. The Petrodata subscriber received initially a copy of the historical data in the file for the area to which it subscribed including all of the wells drilled up to that time. Thereafter, on a monthly basis, that subscriber would receive a tape with all of the well data which became available in the previous month for all new wells plus copies of complete well data for any wells for which the data was corrected during the month. He stated that during the two taxation years in question, the appellant had about 12 customers for the Petrodata file. All of them received the data on tapes.

Mr. Smith then referred to the Petrofiche file which included a standard format of data summary provided to customers on microfiche that consisted of about half a tray of microfiche, about 700 individual sheets on film, 3 x 5, with 280 pages on each one and data for a single well appearing on one or two or three pages. By using microfiche in a reader it was possible to reach the data summary for any of 200,000 wells in a matter of seconds.

Petrofiche customers initially received a tray of fiche and on a monthly basis that tray was replaced with a new set of fiche, updated by one month. The appellant had about 90 customers who received data on microfiche. Mr. Smith stated that whereas tapes were sold to the Petrodata file customers, the microfiche were leased to the Petrofiche file customers. The arrangement was that the microfiche must be returned to the appellant when they were replaced by a new set of microfiche or the contract would be terminated. Tab 10 in the joint book of documents contained a standard form of contract entitled Petrofiche System Contract. The terms of such agreement are reproduced as follows:

PETROFICHE SYSTEM CONTRACT

International Petrodata Ltd. (" IPL") hereby agrees to lease to the customer named below (” lessee"), effective as of the date of this agreement, microfiche files for the rental charge stated:

No.	$ per month
Alberta Microfiche File	$410

1

This amount, payable, in advance, is due at the beginning of each calendar month.

These microfiche files will be replaced with updated files each month, if the corresponding Petrodata file is updated, at which time the old files will be returned to IPL.

The lessee agrees that title to all books and files leased remains with IPL, and that in the event of default in payment or termination of this contract, all such books and files will be returned immediately and in good order to IPL.

It is also agreed that these microfiche files, and any paper copies made therefrom, are provided for the exclusive use of the lessee's employees and authorized agents and will not be removed form the lessee's usual place of business. Duplication of these microfiche is prohibited.

IPL does not warrant or guarantee the accuracy or completeness of any of its data, and assumes no liability for its use, and these provisions shall survive any termination of this agreement.

The term of this contract is 12 months, after which it is automatically renewed for each succeeding one calendar month period in turn, unless cancelled as of the end of such a contract period by either party upon one month's written notice.

Mr. Smith testified that all fiche subscribers executed a contract such as above set out. He explained that in this case the subscription was to the Alberta Microfiche File and that would cover all wells in Alberta. He explained that the initial microfiche would have to be returned in order for the customer to receive the next month's fiche. The customer was not allowed to make film reproductions of the fiche. Customers were entitled to retain paper copies of parts of the data, those customers owning the data. They were still, however, obliged to use such data for their purposes and not to sell or otherwise dispose of same. The witness also explained that the fiche file is more of a summary than the Petrodata file. What a customer received on a Petrodata file was the complete data for every well in digital form on tape, that is to say the complete data base. The fiche contained

. . . a major portion of the data but not all. It contains summaries of some types of data, and some types are not there altogether.

In short, the fiche file was a summary of the complete data base.

In the Petrodata subscription, at the end of the contract, all the data remained with the customer who had no obligation to remove data which had been “unloaded onto its computers" and send it back to the appellant. However, in the case of Petrofiche subscription, the customers had, rather than digital data, data on microfiche that must be returned. In explaining the difference in these obligations, Mr. Smith said that in the one case the customer had purchased the data and had paid for the digital data in digital form and in the other case, the microfiche, the customer had leased the data only. He explained that the value in the fiche is primarily in their currency — "the fact that they are right up to date" — and that in one place a customer could see a summary of all the information and find it all in one place.

Mr. Smith then explained that in many cases the Petrodata subscriber would also be a Petrofiche subscriber because the fiche are used for information on a single well or a group of wells in the same area to look at a number of different data items under any one well whereas the digital data in the computer were used

for . . . extracting all of the formation tops in a given area or all of the tests in a given area, and very frequently either listing them all or mapping them. It is a — it's on a large scale involving hundreds or thousands of wells, which is — which simply cannot be done in a reasonable length of time manually.

But the use of the information manually on the fiche is very, very common for both engineering and geological purposes because it's such a convenient summary of the information.

Mr. Smith was referred to the Amoco Canada Petroleum Company Ltd. contract with the appellant being found at Tab 1 of the joint book of documents. It provided, inter alia:

1. I.P.I. (appellant) hereby agrees to provide Amoco Canada with update well magnetic tapes (hereinafter called “the tapes"), for which Amoco Canada hereby agrees to pay a rate of ten cents per card image for those data supplied to Amoco Canada and which are being entered into the data file for the first time.

2. Amoco Canada agrees to pay I.P.I. $75 per month for each month that I.P.I. produces tapes containing information updating existing well information and/or containing new well information.

3. The tapes shall be made available to Amoco Canada at the offices of 1.P.1. Amoco Canada will be responsible for picking up and returning the tapes to the I.P.I. office. A charge of $15 per day will be assessed on the second and subsequent working days that Amoco Canada has the tapes.

Mr. Smith explained that the charge to Amoco, as to other customers was per card image”, the card basis being the quantity of data and it actually being "card space on a computer tape". In other words, these were not cards but magnetic tape, the data being on the tape in sequence the same way as they would be on cards, one after the other.

Counsel for the appellant referred Mr. Smith to paragraph 12 of the Amoco Canada contract which reads as follows:

I.P.I. shall invoice Amoco Canada for all services rendered during the preceding month within 25 days from the end of the said month and Amoco Canada shall pay for said services within twenty days after being billed for said services by I.P.I.

In response to counsel's question as to whether any services were rendered under this contract, Mr. Smith clearly stated that he was not aware of any services which would be billed to Amoco, but that the charges were for the tapes and the data and that this was the card image charge to which reference has been made above.

Counsel for the appellant also referred Mr. Smith to the sale and purchase agreement between Conoco Canada Ltd. and the appellant which provided, inter alia

As at the effective date, Petrodata hereby sells to CCL and CCL hereby purchases from Petrodata the Petrodata Well File. The price to be paid by CCL to Petrodata hereunder shall be six hundred and fifty-three thousand, five hundred and eighteen dollars and forty-seven cents ($653,518.47), in Canadian currency.

The definitions section of that agreement defines a Petrodata Well File to mean

. . . two (2) magnetic computer tape copies concerning petroleum and natural gas wells drilled in the Yukon, Northwest Territories, British Columbia, Alberta, Saskatchewan, Manitoba and East Coast Offshore of Canada containing the following information on one hundred and thirty-three thousand two hundred and eighty- five (133,285) wells:

location, critical dates, formation tops, reference elevations and total depths, log types run, initial potential tests, perforations, treatments, cored intervals, DST data, pressures, recoveries, gross porosities, oil, gas, water analyses and core analyses,

all of which is found on computer tapes.

Counsel for the appellant also referred Mr. Smith to paragraph 10 of the appellant's notice of appeal. It reads as follows:

10. During its 1987 and 1988 taxation years, the aforesaid Canadian business activities of the taxpayer resulted in the following revenues being earned by the taxpayer:

	1988	1987
Income derived from sales of backlog Petrodata files	$ 112,750	$ 467,834
Income derived from sales of Petrodata monthly
updates	1,305,875	1,255,594
Income derived from leasing Petrofiche files	561,522	501,099
Income derived from Petrodata retrievals	97,950	53,979

Mr. Smith described the first category as

. . . Sales of backlog Petrodata files . . . the historical data which is purchased by a subscriber when they initially start to use our data so that it is all of the data on all of the wells drilled up to that time for whatever province or area they're subscribing to.

He described the second category of income as derived

. . . from sales of Petrodata monthly up-date and is what we referred to as updates. It’s the data sent to the subscribers each month for new wells or for old wells where data has been corrected.

He then described the third category as

. . . income derived from leasing Petrofiche files . . . the income from the microfiche data . . . that is provided on a monthly basis.

He described the fourth category as

. . . income derived from Petrodata retrievals. Relatively few companies actually purchased the data from us in digital form, that is, on tapes. Those are the, primarily, the major companies, Amoco, Petro Canada, Shell Oil, and so on, who have their own computer systems departments. They write their own programs to process the data to use it in their own offices. We only provide the data for them. We provide no computer service otherwise. They do that work themselves. But we make the data in our file available to other companies who may do what we call retrievals from the file by — the results of which are not in digital form but are on paper print outs or maps, and those are what we call retrievals.

In cross-examination, respondent's counsel attempted to characterize the subject matter of the appellant's contracts with various oil companies as services. Mr. Smith was clear in his response to this suggestion. He said, "service to us is providing data in some medium", and,

As far as we're concerned, its — if you call it a service, it is providing data on magnetic tape; that's it.

You can’t provide data without providing it in a medium of some sort. We provide it on tape, paper, microfiche.

Paragraph 125.1(1)(a) provides a deduction from tax computed by reference to a corporation's "Canadian manufacturing and processing profits for the year”.

Paragraph 125.1(3)(a) defines "Canadian manufacturing and processing profits":

"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 . . .

The term" manufacturing or processing” is defined also in that paragraph to exclude certain activities. Neither counsel referred to this definition and that fact, together with the evidence adduced, seems to indicate that it is not relevant in the determination of the issue herein.

Section 5200 of the Income Tax Regulations ("the Regulations"), applicable to the 1987 and 1988 taxation years read as follows:

Subject to section 5201, for the purposes of paragraph 125.1(3)(a) of the Act, "Canadian manufacturing and processing profits" of a corporation for a taxation year are hereby prescribed to be that proportion of the corporation’s adjusted business income for the year that

(a) the aggregate of its cost of manufacturing and processing capital for the year and its cost of manufacturing and processing labour for the year,

is of

(b) the aggregate of its cost of capital for the year and its cost of labour for the year.

Section 5202 of the Regulations defines "adjusted business income", “ cost of manufacturing and processing capital" and "cost of manufacturing and processing labour”. Both of the latter terms include the phrase “ qualified activities". “ Qualified activities” is defined to mean, inter alia

. . . 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 . . .

It is essential that, as counsel for the appellant submitted, the activities carried on by it were “ qualified activities” within the meaning of the definition above set forth.

Counsel for the appellant, at the commencement of argument, stated his case as follows:

. . . it's the position of the appellant first that its activities of collecting well data, editing it, interpreting it and compiling a comprehensive database, all constitutes processing within the meaning of the Act.

Second, it is our position that the means by which the information is conveyed to its customers, namely computer tapes, the microfiche cards that we've heard about, the computer print-outs and maps all constitute goods, which are processed or produced by the appellant, tangible goods.

And third, it is the position of the appellant that such goods are for sale . . . or lease as required by the provisions of the Income Tax Act.

He referred to the case of M.N.R. v. Federal Farms Ltd., [1966] Ex. C.R. 410, C.T.C. 62, 66 D.T.C. 5068 (affirmed by the Supreme Court of Canada without written reasons, 67 D.T.C. 5311). The evidence in this case showed that, in addition to packaging carrots and potatoes, the company's operations included such steps as washing, brushing, spraying, drying, sizing, culling and grading the vegetables. In finding that the carrots and potatoes were processed by the company, Cattanach, J., at page 415 (C.T.C. 66, D.T.C. 5071) said,

It is the golden rule of interpretation that words used in a statute are used in their ordinary sense unless that would lead to some absurdity, or some repugnancy or inconsistency with the rest of the statute in which event the ordinary sense of the words used may be modified so as to avoid that absurdity or inconsistency, but no farther. I think it is sound to say that in the absence of a clear expression to the contrary words in the Income Tax Act should receive their ordinary meaning, but if it appears from the context in which they are used that they have a special technical meaning then they should be read with such meaning.

Here it is plain that section 40A of the Income Tax Act is dealing with manufacturing and processing corporations generally and that the words,“ manufacturing” and "processing" as used in subsection (2)(a) of section 40A are used in their ordinary unrestricted senses. If this were not the case and the words were not intended to be used in their unrestricted senses, then it was obviously unnecessary to make a specific enumeration of those types of businesses in which certain corporations are engaged as being excluded from the meaning of the words, “manufacturing and processing corporation”.

In the McGraw-Hill Ryerson Ltd. v. The Queen, [1980] C.T.C. 280, 80 D.T.C. 6211 (F.C.T.D.), (upheld by the Federal Court of Appeal, [1982] C.T.C. 167, 82 D.T.C. 6142), Mahoney, J. found that the extensive involvement and control of the taxpayer in the production of books from inception to final sale constituted manufacturing and processing and further that the taxpayer sold not only the information contained in the books, but the books themselves. In allowing the taxpayer's appeal, the learned Justice said, at page 283 (D.T.C. 6214):

The plaintiff does not sell only the information contained in the books it sells any more than an automobile manufacturer sells only the transportation capability of the vehicles it sells. The plaintiff sells the books. Those books are goods. It may be that it is the information content that gives a book its value, as it is the transportation capability that gives a motor vehicle its value, but the subject matter of sale is the book, as it is the vehicle. The textbooks the plaintiff publishes itself are goods manufactured and processed in Canada for sale. In the ordinary meaning of the words "manufacturing" and“ processing”, the plaintiff's activities with respect to a cover and a manuscript, from the point in time it is turned over, by the sponsoring editor, to the copy editor to the point in time the vandyke is returned, approved, to the printer, are integral elements of physically manufacturing or processing a book. The plaintiff, in publishing books, does manufacture or process, in Canada, goods for sale.

In Industrial Forestry Service Ltd. v. M.N.R., [1992] 1 C.T.C. 2182, 92 D.T.C. 1060 (T.C.C.), the appellant went through a series of operations to produce a map. It took the digital framework obtained from aerial triangulation and modified it by adding more information from which a map was drawn. The computer tape with the modified aerial triangulation was delivered to the customer in a changed form. As a result, Judge Brulé found that notwithstanding that it was the data content that gave the goods produced by them their value, the subject matter of their sales were the maps and the frameworks and not merely a service with respect thereto as the Minister had contended. Specifically, at pages 2188-89 (D.T.C. 1064) the learned Judge said:

I believe that both appellants are processing goods. Exhibits A-5 and A-8 placed in evidence show that I.F.S. is producing tangible, moveable property while Exhibits A-6 and A-7 show the same for the DPI. In contrast to MDS Health Group v. The Queen, [1979] C.T.C. 337, 341, 79 D.T.C. 5279, 5282 (F.C.T.D.), the framework is the end product of the process of aerial triangulation and the maps are the end product of the processing of the framework. The analysis of the data here does end in something that can become the subject of a sale. And in keeping with McGraw-Hill, supra, the appellants are not only selling data or the manipulation of data. They are selling maps and frameworks. Notwithstanding that it is the data content that gives these goods their value, the subject matter of the sales are the maps and the frameworks.

Counsel for the appellant submitted that the appellant was processing information and as part of its activities was also processing goods. He stated that the goods for sale or lease in this case were the computer tapes, the microfiche cards, the computer paper printouts that are sent on retrieval service or the maps that were sent to clients on retrieval service. He submitted blank computer tape that had this information put on it had been processed to increase the value of that good. He stated that there is an end product which can be delivered to the customer and that that was a tape or a microfiche. He submitted that neither was an article of commerce-something tangible. He submitted, by analogy, that no one would rent a video for a movie or buy a cassette for music and suggest that they were not goods or indeed that someone would be buying entertainment and not goods.

In Tenneco Canada Inc. v. Canada, [1991] 1 C.T.C. 323, 91 D.T.C. 5207 (F.C.A.), Linden, J., at page 326 (D.T.C. 5209) said

The two tests for determining whether a taxpayer processes goods are (i) whether there is a change in the form, appearance or other characteristics of the goods subject to the operation, and (ii) whether the product becomes more marketable . . . .

Processing occurs when raw or natural materials are transformed into saleable items. Such raw or natural materials are unsaleable, or would sell for a lesser price, in their unprocessed state . . . .

Counsel for the respondent, referring to the case of Harvey C. Smith Drugs Ltd. v. M.N.R., [1992] 1 C.T.C. 325, 92 D.T.C. 6349, quoted Reed, J., in saying at page 332 (D.T.C. 6354)

. . . there must at the least be a change in form or appearance of the product being processed.

He then submitted that the activities of the appellant were the collecting of data, the assembling of the data, running it through programs on its computer that edit the data and then selling the data. He submitted, following this statement, that there was no change in the form or appearance of the data. He then added that there may have been some changes to it when they had to correct some of the numbers but that they do not change the form or the appearance of the information.

Counsel then referred to Tenneco Canada, supra, where Linden, J., at page 327 (D.T.C. 5209-10) said:

The benefit of the incentives cannot be claimed by each of the handlers merely because they altered the goods in some small way. Only those operations which significantly change the character of the goods can truly be described as "manufacturing" or "processing" so as to qualify for the special tax incentives.

Counsel then stated that the Court makes it clear that there must be some significant change in the character of the goods and submitted that this did not occur in the appellants activity.

Respondent's counsel then referred to the comments of Reed, J. in the Harvey C. Smith case, supra, where at pages 333-34 (D.T.C. 6355) the learned Justice said:

I place little reliance on the fact that sale of the drugs, in counsel for the respondent's words, is effected when the doctor writes a prescription. I have some difficulty with the idea that a processing activity loses its character as such, if it occurs after an order is made rather than before. This argument seems to flow from the assumption that processing for section 125.1 purposes is synonymous with any activity which "makes the product more marketable”. I do not read the jurisprudence as establishing this criterion as an independent test. Such a test would be very broad indeed. An activity which makes the product more marketable in my view, can encompass much that would not fall under the concept processing.

It should be pointed out that in the Harvey C. Smith Drugs Ltd. case the activity involved simply the dispensing of prescription drugs and the argument that regardless of the lack of any change to the form or appearance of the actual tablets and capsules, packaging itself was a process. That appeal was dismissed.

Counsel then submitted that the editing and interpretation of information were "not necessarily changing the information and that the information remained the same.” He then made further submissions to the effect that the appellant was performing a service only.

The thrust of the argument of counsel for the respondent was that the appellant provided a service to its customers by furnishing them with information which had not been changed in form following receipt of that information by the appellant. I do not agree with this analysis of the evidence. In my view the appellant sold computer tapes and leased fiche to its customers, both tapes and fiche being goods in the sense of being physical and tangible objects. The appellant's activities resulted in the alteration both in character and value of these goods by the addition of information which made them commercially desirable. To find otherwise would be inconsistent with the principle stated clearly by Mahoney, J., in the McGraw-Hill Ryerson Ltd. case, supra, his enunciation of such principle having been hereinbefore set forth.

The appellant, in my opinion, in conducting its business as described herein, was performing activities in 1987 and 1988 which were primarily manufacturing or processing in Canada of goods for sale or lease.

Although counsel for the appellant provided the Court with a photocopy of the relevant portions of section 125.1 of the Act, neither he nor counsel for the respondent pointed out that subsection 125.1(1) had been amended and was not the same in its application to the 1988 taxation year as it was for the preceding year. I mention this because I will be making a direction pursuant to section 169 of the Tax Court of Canada Rules, General Procedure, that counsel for the appellant prepare a draft of an appropriate judgment to implement this decision and this may be of assistance in that regard.

The appellant's appeal herein for its 1987 and 1988 taxation years are allowed with costs.

Appeal allowed.