Will-Care Paving & Contracting Ltd. v. The Queen, 97 DTC 506, [1996] 2 CTC 2426 (TCC)

Sarchuk J.T.C.C.: - This is an appeal by Will-Kare Paving & Contracting Limited from assessments of tax with respect to its 1988, 1989 and 1990 taxation years.

In the taxation years in issue, the Appellant included an asphalt plant and additions thereto (the plant) in Class 39 of Schedule II of the Income Tax Regulations on the basis that the plant was property used primarily in the manufacturing or processing of goods for sale and accordingly claimed capital cost allowance pursuant to paragraph 20(1 )(a) of the Income Tax Act (the “Act”). The Appellant also claimed deductions with respect to the plant pursuant to subsection 127(5) of the Act on the basis that the additions were qualified property within the meaning of subsection 127(9) of the Act. The Appellant further claimed the manufacturing and processing profits deduction under subsection 125.1(1) of the Act in its 1988 and 1989 taxation years pursuant to section 5201 of the Regulations which prescribes “Canadian manufacturing and processing profits” for the purpose of paragraph 125.1(3)(a) of the Act.

The Minister of National Revenue (the Minister) pursuant to section 1100 of the Regulations included the plant in Class 8 of Schedule II of the Act and reassessed a reduction in the deduction for capital cost allowance. The Minister further disallowed the Appellant any investment tax credit pursuant to subsection 127(5) of the Act on the basis that the plant and additions were not Class 39 assets and accordingly, did not constitute “qualified property” as defined in subsection 127(9) of the Act. Furthermore, by virtue of the inclusion of the plant in Class 8, the Appellant’s active business income was increased in each of its taxation years 1988 and 1989 to an amount exceeding the $200,000 limit stipulated by Regulation 5201(b) and accordingly, the Minister reassessed the Appellant’s manufacturing and processing profits deduction for each of those taxation years pursuant to the basic formulae provided by Regulation 5200.

The parties hereto have agreed that the following statements are true and accurate:

1. In the fiscal year ending March 31st, 1988 the appellant spent $371,791 to acquire an asphalt plant, related equipment and related controls.

2. In the fiscal year ending March 31st, 1989 the appellant spent $43,291 to acquire an asphalt plant, related equipment and related controls.

3. In the fiscal year ending March 31st, 1990 the appellant spent $18,453 to acquire an asphalt plant, related equipment and related controls.

4. The “scale house” referred to in paragraphs (2) and (5) of the material facts portion, designated “(c)”, of the notice of appeal is an integral part of the asphalt plant such that there is no distinction between the “scale house” and the rest of the plant of importance to this appeal.

The Appellant was incorporated in 1974 by William Lake (Lake), who was at all relevant times a director, the principal shareholder and its manager. The main business of the Appellant is asphalt paving of driveways, parking lots, and small public roadways for commercial and residential customers. The majority of its contracts relate to the installation of newly paved surfaces on prepared subsurfaces, and only 10 to 15 percent are contracts for repair, such as filling pot holes and recapping where a new surface is installed on still serviceable, old asphalt. The performance of these contracts involves two steps. First, the site is prepared by a crew in order to ensure that a proper subsurface is available. Asphalt is then provided according to the mixture and quantity required and a second crew dumps, spreads and compacts the asphalt.

Standard forms of contract are used for most contracts and no distinction between the price of the material and the price of labour is made. The contracts merely specify the depth of the asphalt and the size of the surface to be paved and the Appellant’s price for the job. Lake’s estimate was that material constituted 45 to 50 percent of the total cost with the major element being asphalt. Other elements taken into account in setting the price for the contract are the condition of the work site, its location and individual variables. It is Lake’s practice to attempt to produce a gross mark-up of 20 percent on all elements, i.e. labour, materials and cost of equipment. None of the contracts include a breakdown of the price set by the Appellant, the customer is merely provided with the end figure.

Until 1988, the Appellant purchased all of its asphalt from third-party suppliers and as a result considered itself at their mercy, both in terms of price and availability, since they were in actual fact competitors. In or about 1987, the Appellant considered its options. It knew how much asphalt it required each year and was able to estimate the cost of acquiring a plant to provide for its needs. Estimates were also made of the probable operating costs and the market for asphalt in the Truro area. From past experience, the Appellant was certain that owning a plant would increase its capability to bid on larger jobs. Although the Appellant’s previous consumption did not by itself justify the proposed construction of a plant, it was satisfied that sufficient third-party sales could be generated to warrant proceeding with the project. The plant was constructed and came into operation in 1988. Additions to the plant were made and completed by 1990. Lake said that following construction, the Appellant’s sales and revenues from paving contracts increased (and would have justified the cost even without third-party sales). In particular, he noted that third-party sales increased essentially as projected. In the taxation years at issue, approximately 25 percent of the asphalt produced by the plant was sold to third parties, with the balance of approximately 75 percent being used by the Appellant in its own paving business.

Appellant’s Position

The relevant provisions of the Act require that the plant be a property which is machinery or equipment acquired to be used by the Appellant primarily for the purpose of manufacturing or processing of goods for sale or lease. The Appellant’s position is that the phrase “property acquired by the taxpayer ... to be used” refers to the taxpayer’s intended uses for the property at the time it was acquired. In this particular case, one of the intended uses for the plant was the production of asphalt for sale to third parties. The other intended use was production of asphalt for use in the Appellant’s own paving contracts. Although there was to be a greater volume of asphalt to be dedicated to the second use, both the third-party market and the paving contract market were thought necessary to sustain the business decision. Without both intended uses, the plant would not have been acquired. Because both were necessary and because both were of equal importance, both were “primary to the decision to acquire the asphalt plant”. Each therefore was an intended primary use. That being the case, “the plant was acquired by the Appellant to be used” by it “primarily for the purpose of manufacturing...of goods for sale...”.

For the purposes of its alternative argument, the Appellant accepts that in light of the traditional distinctions made between contracts for sale and contracts for work and materials, the paving contracts fall or would ordinarily fall into the latter category. Nonetheless, it contends that the decision in the Federal Court of Appeal in Hawboldt Hydraulics (Canada) Inc. (Trustee of) v. Canada (sub nom. Hawboldt Hydraulics Inc. Estate (Trustee of) v. Canada), [1994] 2 C.T.C. 336 (sub nom R. v. Hawboldt Hydraulics (Canada) Inc.), 94 D.T.C. 6541 (F.C.A.), refusing leave to appeal to S.C.C. at (1995), 187 N.R. 237 (note) has no applicability to it and that the principles espoused by the Federal Court of Appeal in “non-repair” cases prior to Hawboldt (i.e. Nowsco Well Service Ltd. v. Canada, [1988] 2 C.T.C. 24, 88 D.T.C. 6300 (F.C.T.D.) affirmed by [1990] 1 C.T.C. 416 (sub nom. R. v. Nowsco Well Service Ltd.), 90 D.T.C. 6312 (F.C.A.) and Halliburton Services Ltd. v. R., [1985] 2 C.T.C. 52, 85 D.T.C. 5336 (F.C.T.D.) affirmed on appeal, (sub nom. Halliburton Services Ltd. v. Canada), [1990] 1 C.T.C. 427, (sub nom. R. v. Halliburton Services Ltd.) 90 D.T.C. 6320 (F.C.A.)) continue to apply.

The Appellant relies on the comments of Reid J. in Halliburton. In that case, the taxpayer was engaged in activities related to the drilling of oil wells. Some of these activities required material which the taxpayer produced in addition to providing the related services. It reported profits in respect of a portion of these activities as “manufacturing or processing” profits. The Minister’s argument, based on the distinction between contracts for the sale of goods and contracts for work, labour and materials which had been developed with respect to sales of goods legislation, was rejected by Reid J. as not applicable in that case. The Court noted that while it may have been significant in Crown Tire Service Ltd. v. R. (sub nom. Crown Tire Service Ltd. v. The Queen), [1983] C.T.C. 412, 83 D.T.C. 5426 (F.C.T.D.), it was not applicable in Halliburton, since in Halliburton the facts disclosed the creation of a good antecedent to its use in the provision of a service.

The Appellant contends that since the essential component of the Appellant’s paving contracts was the asphalt, it follows that from any perspective, an informed commercial person would consider that the Appellant was selling the asphalt and the customer was purchasing it whether or not the Appellant also spread the asphalt. The asphalt was not only manufactured antecedent to the provision of the service, but it also remained discrete product after the service was delivered to the customer. It was not consumed in the performance of the contract nor was its character changed. Consequently, the application of the principles in Nowsco and Halliburton to the Appellant’s case establishes that the asphalt employed in fulfilling the paving contracts is properly viewed as being the subject of a sale for the purposes of the relevant statutory provisions.

Respondent’s Position

The Respondent submits that the Appellant acquired the asphalt plant for use primarily in the manufacturing or processing of goods required in fulfilment of contracts for work and materials rather than in fulfilment of contracts for sale of goods. The reference to “goods for sale” at issue is to be interpreted in accordance with the general law of contract and sale which recognizes that a contract for work and materials is not a contract for sale of goods. The Federal Court of Appeal rejected an argument that assets otherwise qualifying that were used primarily to manufacture or process property that passed with performance of a contract for work and materials were eligible for the tax incentives at issue. [1] In so finding, the Federal Court of Appeal expressly approved the judgment of Strayer J. (as he then was), in Crown Tire.* [2] In that case, the question was whether contracts for retreading tires constituted contracts for manufacturing or processing goods for sale. Strayer J. held that they did not, but rather constituted contracts for work and materials. In so doing, Strayer J. drew on a passage from Benjamin’s Sale of Goods (London, 1974) to the effect that ordinarily a contract requiring work to be done on land of the employer involving the affixing of materials belonging to the person employed will be a contract for work and materials and not a contract for sale of goods. Since the Appellant’s paving contracts were virtually always done on land either owned or in some other way legally controlled (e.g. leased) by the employer, i.e. customer, and involved the affixing of materials belonging to the Appellant, this too could only be a contract for work and material.

According to the Respondent, the decisions relied upon by the Appellant, i.e. Nowsco and Halliburton? [3] were, clearly rejected by the Federal Court of Appeal in Hawboldt* [4] and were no longer applicable.

The Respondent contends that on a proper application of the “ordinary meaning” principle of statutory interpretation, the word “primarily” ought not to be given the expanded meaning sought by the Appellant. Reference to a dictionary establishes that the word “primary” means “primacy, the one thing, the most prominent or predominant thing” and “primarily” means “at first, originally, mainly and principally”. [5] The Respondent also argues that the evidence of actual use adduced by the Appellant fails to establish that the asphalt plant had been acquired by it to be used “primarily” for the purpose of manufactur ing or processing of goods for sale or lease.

Conclusion

The issues in this appeal are whether the Appellant is entitled to include the plant in Class 39 and whether it is entitled to an investment tax credit with respect to the acquisition of the plant pursuant to the provisions of subsection 127(5) of the Act. To qualify for the investment tax credit, the plant must be a Class 39 property and in addition, must have been “acquired by the taxpayer to be used by him in Canada primarily for the purpose of… manufacturing or processing goods for sale or lease. [6]

I turn first to the Appellant’s alternative argument. This issue was thoroughly canvassed by the Federal Court of Appeal in Hawboldt? [7] Speaking for the Court, Isaac C.J. stated:

Reduced to essentials, it is the position of counsel for the Appellant that the taxpayer’s category d) activities did not constitute the manufacture of goods for sale, because the contract between the taxpayer and its customer in each case was one for work and materials. That was, he said, the common sense and businesslike appreciation of the arrangement between them. He contends that the Trial Judge was wrong in failing to distinguish between a contract for sale and one for a repair service, i.e. for providing work and materials. In his view, the effect of the judgment in appeal is that every repair except one for labour only would be a sale, thus entitling every repairman who manufactures a good to be incorporated in the repair process to the incentives offered by the statutory provisions. He asserted that the analysis in Crown Tire was valid and applicable to the facts of this case. When so applied, he says, the machinery used in the taxpayer’s category (d) activities were not engaged primarily in the manufacture of goods for sale. Consequently, the taxpayer did not qualify for the incentives claimed.

For his part, counsel for the Respondent supported the judgment of the Trial Division. Like counsel for the Appellant, he admitted that his position could not be sustained if this Court approved the Crown Tire approach. But he maintained that the Crown Tire approach was not valid and, in any event, was overtaken by the reasoning in Rolls Royce where MacGuigan, J.A., in obiter, sought to reconcile Crown Tire and Nowsco, Halliburton on the basis that in the former case the processing “did not involve the creation of a good antecedent to its use in the provision of a service”. Based on that statement, counsel submitted that, in respect of category (d) activities, the taxpayer did use its equipment to manufacture components which it then placed in the customer’s machinery in substitution for defective components, for a consideration. This, he said, constituted manufacture of goods for sale within the relevant statutory provisions.

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 benefited were the manufacture of goods for sale or lease and the beneficiaries, the manufacturer engaged in those activities. 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 say. Stayer, J. was right, in my respectfully view, to say in Crown Tire at page 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 the phrase in particular cases.

On this approach, the taxpayer’s category (d) activities did not constitute the manufacture of goods for sale. To conclude otherwise would obscure the well-known distinction between manufacturing for the purpose of sale and manufacturing for the purpose of repair services, and be contrary to the plain intention of Parliament in enacting the legislation — an intention which the authorities say a proper construction of legislation must give effect to....

In my view, this decision was intended to overrode the rationale expressed in Nowsco and Halliburton. That is clear from the language used by Isaac C.J. This decision is binding upon me.

The Appellant’s main submission is that the meaning to be ascribed to words “to be used” in subsection 127(9) of the Act is prospective, i.e. it refers to the Appellant’s intended uses for the property at the time it was acquired. Since more than one “primary use” was contemplated, and since both were of equal importance in a financial sense, the Appellant says it follows that the acquisition was primarily for the purpose of manufacturing goods for sale.

Despite counsel’s innovative argument, I am not persuaded that the potential third-party sales and paving contract sales were of equal importance in the decision to acquire the asphalt plant as argued, and even if they were, such a finding would not in my view, satisfy the requirements of subsection 127(9) of the Act.

The words “acquired ... to be used ... primarily for the purpose of ...” in issue must be interpreted “in their entire context and in their grammatical and ordinary sense, harmoniously with the scheme of the Act, the object of the Act and the intention of Parliament.” Stubart Investments Ltd. v. R. (sub nom. Stubart Investments Ltd. v. The Queen), [1984] 1 S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305, at pages 577-79 (C.T.C. 315-16, D.T.C. 6323). The word “primary” (and thus, primarily) means first in order of time, or development, or in intention. The word “principal” (which is virtually interchangeable with the word “primary”) means chief; leading; most important or considerable; primary; original, highest in rank, authority, character, importance, or degree. [8]

In this case, the production of asphalt for third-party sales was projected to form only a small percentage of the total, both in volume and revenue, and indeed, on the facts, such sales never represented more than 25 per cent of the total. Such use of the property in question cannot be said to be its primary use. On the evidence, I have concluded that the property in issue was acquired by the Appellant to be used primarily for the purpose of producing asphalt for use in its paving contracts which were essentially for work and materials. To reach any other conclusion would be inconsistent with the relevant statutory words.

The appeal is dismissed, costs to the Respondent.

Appeal dismissed.