Rothstein J.:—This is an appeal by way of trial de novo from a decision dated February 26, 1992 of Judge Taylor of the Tax Court of Canada, in which he allowed the appeal of the taxpayer ("Lehmann") against assessments made by The Queen (the Minister of National Revenue) ("the Minister") for Lehmann’s fiscal years ended September 30, 1983, 1984 and 1985.
The issue is whether Lehmann’s profits are applicable to the manufacturing or processing in Canada of goods for sale. If they are, Lehmann, a Canadian-controlled private corporation, is entitled to a reduced rate of tax under paragraph 125.1(1)(b) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), an investment tax credit under subsection 127(5) of the said Act in respect of the investment in qualified property, that is, property to be used primarily for the purposes of manufacturing or processing of goods for sale in Canada, and accelerated Capital cost allowance in respect of qualified property under the Income Tax Regulations, C.R.C. 1978, c. 945, Schedule II, Class 29.
These provisions are income tax incentives designed to encourage the production of Canadian manufactured and processed goods to be placed on domestic and foreign markets in competition with foreign manufacturers. The government’s reasons for enacting the provisions, as enunciated by the Minister of Finance are described in Hawboldt Hydraulics Inc. Estate (Trustee of) v. Canada (sub nom Coopers & Lybrand Ltd. v. Canada, [1994] 2 C.T.C. 2244, 94 D.T.C. 6541 (F.C.A.).
Canadian manufacturing and processing profits are defined in subsection 125.1 (3) of the Income Tax Act:
125.1 (3) Definitions .-In this section,
"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; and....
[Emphasis added.]
In the case at bar, the parties are agreed that Lehmann’s profits in question are applicable to manufacturing or processing in Canada. The issue is whether Lehmann manufactures or processes goods for sale. Lehmann says its profits arise from the manufacturing and processing in Canada of goods for sale. The Minister says that Lehmann sells labour and material. As such, he says, the lower rate of tax, investment tax credit and accelerated capital cost allowance applicable to manufacturing or producing in Canada of goods for sale is not applicable to Lehmann.
Lehmann’s business is commercial bookbinding. Approximately 70 per cent of its business involves the binding of issues or volumes of periodicals such as law reports or newspapers for libraries, educational institutions and other businesses or governments. Approximately 25 per cent of its business involves the binding of monographs, that is, printed material not in a series, such as a novel or thesis. Less than 5 per cent of its business is the restoration of old books such as old bibles. In all cases, the material to be ’’hard bound" is owned by the customer. If Lehmann loses or destroys a periodical, Lehmann must replace it. Where a customer’s material cannot be bound because of its condition, Lehmann manufactures and sells containers to hold the material, although, it appears this constitutes a very small proportion of Lehmann’s business.
Commercial bookbinding involves the examination and collating of all incoming customers’ volumes or periodicals, attaching leaves by sewing or the use of adhesives, trimming, rounding and backing of text blocks to form a smooth convex spine and the making of covers by cutting boards and covering them with cloth, leather or other material and affixing the covers to the customers’ material. Of course, the process is much more detailed and involves many intricate stages and the use of sophisticated machinery, equipment and personnel. Lehmann presented a videotape produced by the Library of Congress of the United States in conjunction with the Library Binding Institute, to which Lehmann belongs, which, together with the evidence of Mr. William Lehmann, described the book binding process in detail.
Lehmann has been in business since 1917. It is located in Kitchener, Ontario. In 1985, its sales approximated $1.3 million annually and it had approximately $700,000 in assets. Today, its annual revenues exceed $3 million and its assets are $1.6 to $1.7 million. It has 71 full and part-time employees.
At the relevant time, Lehmann was not exporting to the US or experiencing import competition from the US. However, at least one of Lehmann’s Canadian competitors does export to the US at this time.
Until August 1994, there were two lines of cases in respect of ’’the goods for sale" issue. One line arose from cases such as Nows co Well Service Ltd. v. The Queen, [1990] 1 C.T.C. 416, 90 D.T.C. 6312 (F.C.A.). Under this approach, as long as there was a sale of some goods produced by the taxpayer, the fact that work or labour was also included, did not exclude application of the relevant incentive provisions of the Income Tax Act. The reasoning of Reed J. in Halliburton Services Ltd. v. The Queen, [1985] 2 C.T.C. 52, 85 D.T.C. 5336 (F.C.T.D.); aff d [1990] 1 C.T.C. 427, 90 D.T.C. 6320 (F.C.A.), was adopted by Urie J.A. in Nowsco, supra.
1. The relevant provisions of the Income Tax Act do not require that a taxpayer’s profits arise out of contracts for the sale of goods as defined by provincial Sale of Goods Acts;
2. There is no requirement that the contract be limited to the sale of goods and not be one of a more extensive nature involving work and labour as well as the supply of goods.
In essence, their view was that as long as there were some goods produced by the taxpayer which were included in the contract of sale, the relevant requirements of the Income Tax Act were met.
The other line of thinking originated with Crown Tire Service Ltd. v. The Queen, [1983] C.T.C. 412, 83 D.T.C. 5426 (F.C.T.D.), in which the distinction between a contract for sale of goods and a contract for work and materials was recognized as relevant to a determination of eligibility under section 125.1. In that case Strayer J., as he then was, concluded that Parliament, in using the words "goods for sale or lease" in the relevant provisions of the Income Tax Act, must have had reference to the general law of sale or lease in order to give precision to that phrase in a particular case.
In Hawboldt Hydraulics Inc., supra, the Federal Court of Appeal has now adopted the approach of Strayer J. in Crown Tire, supra. The Court held that Parliament, in using the term "goods for sale or lease" had reference to the general law of sale or lease. Isaac C.J., at page 344-45 (D.T.C.
6548) of Hawboldt Hydraulics Inc. states:
I am of the opinion that the appeal should succeed and the submissions of the respondent be rejected for the following reasons. First, it is clear from the total context of the legislation, including the passages from the House of Commons Debates to which I have referred, that Parliament’s objective in enacting the legislation was encouragement of increased production of manufactured and processed goods to be placed on the domestic and international markets in competition with foreign manufacturers. That that is the activity which Parliament sought to encourage is, to my mind, plain from the debates. It is equally plain that Parliament intended to benefit manufacturers and processors who engaged in those activities. In other words, the relevant statutory provisions were designed to give Canadian manufacturers and processors an advantage over their foreign competitors in the domestic and foreign markets. It is also clear that Parliament had in mind specific target groups and specific target activities. The legislation was not intended to benefit every manufacturing activity or every manufacturer. The language of the statute is clear that the activities to be benefitted were the manufacture of goods for sale or lease and the beneficiaries, the manufacturers engaged in that activity. This is the short answer to those who say that the Crown Tire approach yields illogical results or results in a formalistic splitting of taxpayers’ activities. In my view, that is the background against which the clause should be understood and construed.
As I have said, Parliament did not define the phrase "for sale or lease" in the legislation. How then should its meaning be determined? We are invited by the modern rule of statutory interpretation to give those words their ordinary meaning. But we are dealing with a commercial statute and in commerce the words have a meaning that is well understood. In the common law, "for sale" does not mean "for use in a repair process". And I doubt that any informed commercial person would seriously say that the manufacture of parts to be used to repair a customer’s defective equipment was a manufacture of those parts for sale. Strayer J. was right, in my respectful view, to say in Crown Tire at page 415 (D.T.C. 5428) that
...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.
It is readily apparent that the facts in the case at bar are very close to those in Crown Tire. In Crown Tire the taxpayer affixed new treads to old tire casings belonging to customers. In the case at bar, Lehmann affixes hard binding to journals, newspapers and monographs owned by its customers. The only difference of any significance might be that in the case of tire repairs, a customer’s defective or inadequate tires are being repaired while in the case of bookbinding, a customer’s "loose materials" are being upgraded or are being given a greater degree of permanence; repairs are not involved. This raises squarely the question of whether Lehmann’s circumstances may be distinguished from those in Crown Tire.
In Crown Tire, Strayer J. based his decision on the distinction between contracts for sale of goods and contracts for work and materials as explained in Benjamin’s Sale of Goods, now 4th ed., (London: Sweet & Maxwell, 1992), in which the following appears at page 37:
Chattel to be affixed to land or another chattel. Where work is to be done on the land of the employer or on a chattel belonging to him, which involves the use or affixing of materials belonging to the person employed, the contract will ordinarily be one for work and materials, the property in the latter passing to the employer by accession and not under any contract of sale. Sometimes, however, there may instead be a sale of an article with an additional and subsidiary agreement to affix it. The property then passes before the article is affixed, by virtue of the contract of sale itself or an appropriation made under it. Obviously, the question whether the intention of the parties is substantially one of improving the land or principal chattel (to which the furnishing of materials is incidental) on the one hand or one of making a sale (to which the agreement to affix is incidental) on the other hand is a matter of degree, which may be difficult to determine in practice; but there is no theoretical difficulty....
The general principle seems to be that where material is to be affixed to property belonging to a customer, the contract is one for work and materials, with the property in the material passing by accession. Sometimes, however, there may be a sale of an article with a subsidiary and incidental agreement to affix it to property owned by the customer, in which case the property in the material will pass under a contract of sale of goods.
In Crown Tire, Strayer J. found that tire retreading fit within the general principle as stated in Benjamin. He wrote at pages 414 (D.T.C. 5428-29):
I believe that the situation here fits within the general principle as stated in Benjamin. With respect to the retreading of tires owned by customers, it appears to me that the customers retain ownership throughout the process.... Where a tire was retreaded, it would be returned to the same customer who supplied it. This suggests to me that the casing was seen throughout as being the property of the customer and the work and materials provided by Crown Tire were applied to that casing. This involved essentially a contract for repairs. Once the rubber material was affixed to the casing it would become the property of the owner of the casing by accession. That material could therefore not be the subject of a contract of sale since it merged with the customer’s property at the time of adhesion to it.
It appears to me that the most relevant precedents support this interpretation. In Sterling Engine Works v. Red Deer Lumber Co. (1920), 51 D.L.R. 509 (Man. C.A.) the Manitoba Court of Appeal held that where two steel plates were attached by the plaintiff to the defendant’s locomotive to repair the fire box the title in the plates passed to the defendant not by sale but by accession. In reaching this conclusion Dennistoun J.A., noted that there was no evidence to suggest that the plaintiff was a vendor of, or dealer in, steel plates and that they merely used steel plates in the course of repairing the locomotive. Similarly in the present case the evidence indicated that the plaintiff company did not sell ’’tire treads" to anyone without them being affixed to a tire casing.
This reinforces the view that the provision of tire treads in the retreading process was not seen as a contract of sale.
The Sterling Engine Works case was followed by the Nova Scotia Supreme Court, Appeal Division in Scott Maritimes Pulp Ltd. v. B.F. Goodrich Canada Ltd. (1977), 72 D.L.R. (3d) 680 where it was held that a contract for replacing a rubber cover on a press roll is a contract for labour and materials and not for the sale of the rubber cover. More pertinent, perhaps, is the decision of the Exchequer Court of Canada in R v. Boultbee Ltd., [1938-39] C.T.C. 78, 1 D.T.C. 443. That case also involved a tire retreading business and the issue was whether the retreading of tires resulted in ’’goods produced or manufactured" by the defendant so as to make those tires subject to sales tax and excise tax....
The most important factor in establishing that Crown Tire’s contracts for retreading customers’ tires were contracts for work and material is, in my view, the fact that the work was done to a tire casing which the customer owned throughout. I think this distinguishes the present situation from those involved in many of the decided cases where the customer had never previously owned any part of the end product.
While the distinctions employed here may seem somewhat technical and remote from revenue law, 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.
I find it difficult to distinguish the facts of the case at bar from Strayer J.’s reasoning as outlined above. I therefore turn to the arguments made by counsel for the taxpayer.
Counsel for the taxpayer says that the general rule in Benjamin, upon which Stayer J. relied, is not absolute. I agree it applies only ’’ordinarily’’. But the exception seems to be fully accounted for by Benjamin. Where there is a contract for sale of goods and an additional or subsidiary agreement to affix them to the chattels of the customer, the contract may still be characterized as one of sale of goods. That is not the case here. No actual form of contract was introduced into evidence, but I infer from the evidence that was given that there is only one stage in the contractual relationship between Lehmann and its customers. The customer seeks the binding of loose material. The affixing of materials and the work of binding is considered as one for contractual purposes. The taxpayer’s price list makes no distinction between goods and labour, and if anything, emphasizes the importance of the skill and work to be provided by Lehmann and not the materials to be supplied.
Nothing in Lehmann’s invoices suggests a sale of goods as such. The taxpayer’s invoices and statements refer, for example, to ’’binding 2 vol. books", "making 1 portfolio", "imprinting 8 call nos.’’. I am unable to conclude that Lehmann’s situation is not the ordinary one envisaged by Benjamin.
It is then submitted that this is not an accession case but one in which the materials are supplied by both the customer and Lehmann and there is a transformation of the materials into a new product, 1.e., a hard bound book. Reliance is placed on Dixon v. London Small Arms Co., [1876] 1 A.C. 632 (H.L.). However, unlike the case in Dixon, as described in Benjamin at page 38, here there is no sale or supply of materials by the customer to Lehmann at an agreed price the amount of which 1s first included, and then deducted, from the selling price of the hard bound book. As with tire treads in Crown Tire, in the case at bar hard binding materials are affixed to the customers’ loose volumes. I must conclude that this case is, indeed, one of property passing by accession.
Counsel for Lehmann also argues that the Crown Tire approach is referable to "repair" cases and, indeed, many of the cases, and the terminology used by the Federal Court of Appeal in Hawboldt Hydraulics Inc., refer to repairs. However, the legal distinction here, based on the general law of sale or lease, 1s whether the contract between the purchaser and vendor is one for the sale of goods or one for the provision of work and materials. In Crown Tire, Strayer J. says that the most important factor was that the work was to be done to a tire casing which was owned by the customer throughout. In the case at bar, the journals and other documents to which hard binding is affixed are owned by the customers throughout. I am unable to attach legal significance to the distinction between repair and non-repair cases where the contracts covering each are for work and materials.
Counsel for Lehmann also argues that Lehmann paid provincial and federal sales tax at the relevant time and that such taxes are applicable to sales of goods. However, the liability for those taxes arises under their own Statutes. The precise provisions of those statutes were not provided to me. In any event, I do not think that it automatically follows that because a taxpayer pays provincial or federal sales tax, its profits are derived from the manufacturing or processing in Canada of goods for sale, as that term is used in the Income Tax Act.
Nor is it significant that Lehmann’s financial statements refer to "sales", "cost of goods sold" or "inventory". These are designations provided by Lehmann’s accountants. In circumstances such as in the case at bar, the designations used by accountants in financial statements have no bearing on whether or not Lehmann is entitled to the relevant incentives provided by the Income Tax Act.
Lehmann’s counsel says that Lehmann assumes a risk inherent in the sale of goods because its sales are based on a price list in which there is no breakdown between labour and materials. I acknowledge that Lehmann does assume a greater risk than if its sales were made on a cost plus or other basis in which the risk of not covering all costs would be reduced or eliminated. But I do not see how the assumption of risk associated with selling according to a price list, which does not distinguish between labour and materials, converts a sale from one of labour and materials to one of goods.
Lehmann’s counsel also argues that the warranty applicable to Lehmann’s contracts is indicative of a contract of sale of goods. The warranty states:
Warranty: We warrant that the binding represented by us as conforming to the Library Binding Institute Standard For Library Binding complies with all requirements of the Library Binding Institute Standard For Library Binding as amended. This statement is made pursuant to sections 2.0 and 3.0 of the Library Binding Institute Standard for Library Binding issued by the Library Binding Institute, and applicable federal and state laws relative to representations by a seller to a purchaser regarding the quality of a product and its adherence to a standard.
There is no doubt that what is normally being sold includes materials as well as labour. However, the fact that Lehmann sells according to a warranty that refers to a "product", does not mean that the sale is one of goods and not one for labour and materials. Warranties are often given to cover repairs or other services in which materials are also supplied. The fact that a warranty refers to "product" is not determinative.
Conclusion
Provisions of the Income Tax Act often involve "line drawing" by Parliament. The question in this case is where Parliament has drawn the line and whether Lehmann’s transactions fall on one side of the line or the other. As recognized by Isaac C.J. in Coopers & Lybrand, in using the words "goods for sale or lease" Parliament must have intended to exclude certain types of manufacturing and processing from the income tax incentives at issue here.
One approach to interpreting the words "goods for sale" is by reference to the general law of sale or lease. However, having regard to the purpose of the income tax incentives, it is not obvious to me why Parliament would have drawn the line between profits eligible for these incentives, and those not, based on the common law distinction between a contract for the sale of goods on the one hand, and contracts for labour and materials on the other. Nonetheless, I am bound by Hawboldt Hydraulics.
The Minister’s appeal must be allowed.
Appeal allowed.