Tuyauteries Saglac Inc. v. MNR, 93 DTC 40, [1992] 2 CTC 2727 (TCC)

Couture, C.T.C.C.J.:—The assessments under appeal concern the 1986 and 1987 taxation years. The evidence revealed the following facts.

The appellant operated its business until 1987, when its shares were acquired by a company by the name of G.B. Mécanique Ltee (G.B.), [1] and its activities were subsequently continued by G.B.

According to the witness Bouchard, who was the appellants vice-president at the time, its operations consisted in “fabricating” (I use the word "fabricating" which the witness used, without, for the moment, attaching a legal meaning to it) and in installing industrial pipes and fittings in paper mills. For a paper machine to be able to operate, it must be linked to a source of the components that contribute to the manufacture of paper by a network of pipes and fittings which supplies it, inter alia, for example, with pulp, steam and water, etc. A machine which manufactures paper is an enormous piece of machinery which may measure up to 500 to 600 feet in length.

The appellant owned a workshop, the dimensions of which were 50 feet across the facade by 150 feet deep. According to the witness, 40 per cent of the work related to the carrying out of contracts was done in the workshop, while 60 per cent was done on the site, that is at the customer's plant. He explained that, because of the dimensions of a system of pipes and fittings, it was impossible to complete it in the workshop since it eventually had to be transported to the customer, an operation that was done in small sections. The workshop was equipped with tables, winches to transport the material, welding machines, torches and buffers, in fact all the equipment and tools necessary to enable employees to execute the work.

The appellant employed between 100 and 300 employees. Those at the workshop were what the witness called "pipefitters" and pipefitter-welders", specialists in their trade who had to be members of the Commission de construction du Quebec, an agency which has replaced the Office de la construction du Quebec. They were governed by the construction order.

The assembly of a system of pipes and fittings was a very complex operation, according to the witness. The operation did not merely entail joining lengths of pipe end to end, but they had to be cut and had to be joined to one another after they had been given the shape required by the specifications provided by the customer, then finally joined to the machine itself. This kind of system involved an enormous quantity of pipes joined at angles that varied in degrees as needs dictated and were then routed in more or less pronounced curves or shapes.

When the appellant obtained a contract, it purchased the pipes necessary for its execution on its own. Those pipes were ail 20 feet in length, but their diameters could be different. Its task was then to produce a system of pipes and fittings conforming to the requirements contained in the specifications provided by the customer. To do so, it had to handle them in such a way as to curve them as needs dictated or to join them to one another by variously angled joints. They were of different manufacture. They were made of cast iron, stainless steel or monel, an alloy mainly composed of copper and nickel which is acid-resistant. To obtain the curves and angles in the network of pipes, there was no question of bending them mechanically. This operation entailed a series of cuts at very specific angles and lengths accompanied by welding, which eventually made it possible to achieve the required curve or desired angle.

According to the witness, this effort was a matter of teamwork, which meant that, in order to prepare a pipe either at the shop or at the customer's plant, each cut required the contribution of three men, that is to say two "pipefitters" and one "pipefitter-welder". It was precision work, which took an enormous number of hours to perform. As an example, the witness mentioned that it took three men a period of three weeks to give an S-shape to a pipe 24 inches in diameter.

Without providing a more technical and detailed description of what this kind of work entailed, it is sufficient to mention that each cut required an isometric drawing, in addition to a pattern shaped by one of the team members to identify clearly the work that had to be done.

The witness explained that it was possible to purchase manufactured 90 degree elbows, which were standard parts supplied by pipe manufacturers, but very few could be used in that form because 90 degree angles were very rare in a system.

Counsel for the appellant argued that the respondent's position, as expressed in his reply to the notice of appeal, according to which the appellant's business was a construction business, was in flagrant contradiction with the official interpretation he states in his Interpretation Bulletin IT-411, dated March 23, 1978, in effect in 1986 and 1987 and also today. He cited the following excerpt:

3. As a general rule, the on-site fabrication, installation and erection of machinery and equipment, regardless of size, is not considered to be construction, unless it constitutes a component part of a building or structure (e.g.: heating system, air- conditioning equipment, sprinkler system, plumbing, wiring, etc.). Machinery or equipment which will form an integral part of a manufacturing or processing activity carried on inside a building is not regarded as a component part of the building, even though it may be firmly attached to it because of vibrations, weight, size, etc. In some cases, where the installation of machinery and equipment coincides with the construction and erection of a building or other structure, there may be practical difficulties in determining what activities are construction. In these cases, the following criteria apply:

(a) The installation and erection of the foundation, walls, floors, roof and infrastructure for the machinery or equipment (i.e.: pilings, footings, piers, pillars, pits, etc.) is [sic] regarded as construction.

(b) The fabrication, installation and erection of the machinery and equipment inside the structure (including related wiring, plumbing, ductwork, etc.) that is primarily for the purpose of a manufacturing or processing activity which will be carried on inside the structure is not regarded as construction.

He also cited the comments of Dickson, J. (as he was at the time) of the Supreme Court of Canada in Nowegijick v. The Queen, [1983] 1 S.C.R. 29, [1983] C.T.C. 20, 83 D.T.C. 5041, at page 37 (C.T.C. 24, D.T.C. 5044), where he States:

Administrative policy and interpretation are not determinative but are entitled to weight and can be an “important factor” in case of doubt about the meaning of legislation: per de Grandpré, J., Harel v. Deputy Minister of Revenue of Quebec, [1978] 1 1S.C.R. 851 at page 859.

He denied the respondent's contention in his reply to the notice of appeal that the appellant was a service business, which contention is made in paragraph 11 and reads as follows:

11. The respondent contends that, in substance, the customers of the appellant retain the latter's services to install in their plants industrial pipes and fittings which they have themselves acquired, and, furthermore, concerning the material acquired by the appellant on behalf of its customers in the execution of contracts, that material is not merchandise manufactured or processed by the appellant to be "sold" to the customer, but the customer becomes owner of it by accession.

[Translation.]

He challenged this contention in the following terms (Transcript vol. 2, page 66):

What the customer purchases at the outset is material, except that, given that this is an extremely particular industry and involves an extremely particular method of fabrication, it may indeed be considerable labour costs involved in the fabrication of a part. But the customer never becomes owner of the part by accession. It is the part which he purchases.

[Translation.]

Further on, he says at page 70:

What Tuyauterie Saglac fabricated during the 86-87 period was ultimately the missing link, the part that was missing between the paper machine that was manufactured by. the manufacturer and, ultimately, the supply, all the energy that was necessary, the energy or the raw materials that were necessary for the proper operation of that machinery.

It was ultimately the continuity of the manufacturer's machine that was fabricated by Tuyauterie Saglac at the time. At issue, once again, was a fabrication that was specialized, that is always made to measure. There are virtually no . . . possible standards, except a notion of the number of hours required to do certain types of work, but no two paper machines are the same, no two paper machines are identical, and each time a part is fabricated, it is fabricated to measure.

[Translation; emphasis added.]

Counsel based his argument on the Supreme Court of Canada judgment in The Queen v. York Marble, Tile and Terrazzo Ltd., [1968] C.T.C. 44, 68 D.T.C. 5001. The relevant facts were summarized as follows:

The respondent company installed marble walls, floors, etc., in various buildings as a subcontractor. The marble used by the company in its business was imported by it from Italy in large slabs. To fill its contracts the company selected suitable marble slabs, from its stock and subjected them to various processes including matching, grouting, roding, gluing, grinding, rough polishing, cutting and edge finishing. When assessed to sales tax on the basis that the processed marble constituted goods produced or manufactured in Canada” under paragraph 30(1)

(a) of the Excise Tax Act, the company paid the amount demanded under protest and sought a refund by petition of right. When the Exchequer Court ([1966] C.T.C. 355, 66 D.T.C. 5210) allowed the petition, the Crown appealed to the Supreme Court of Canada.

The Crown's appeal was allowed, and the passage in Spence, J.'s comments to which counsel drew the Court's attention appears on page 48 (D.T.C. 5003) and read as follows:

If one were to apply the latter test to the question at issue in this appeal, in my view, the finished marble slabs, which left the respondents plant had by work, both by hand and machinery, received new form, new quality and new properties. The form differed in that what had arrived were great slabs of raw marble sometimes as long as sixteen feet and of varying widths, and what left were exactly shaped pieces of polished marble much smaller in size cut with precision to fit the places into which they were to be installed. As to quality, what arrived was a greyish, nondescript slab of stone and what left was a highly polished marble facing whether it was to be installed in a wall, as a window sill, or as a post. As to properties, what arrived was in many cases a piece of unfilled stone and sometimes one which would be too fragile to use and what left in most cases was a piece of marble in which the rough unevenness had been filled in by grouting and where necessary the weakness had been remedied by rodding.

In my view, the application of this test alone would be sufficient justification to find that the marble pieces which left the respondent's plant had been "produced" or "manufactured" there from the raw material of the rough slabs of marble which had arrived.

Counsel for the respondent contended in his argument that Interpretation Bulletin IT-411 does not apply in the appellant's situation because its operations constituted construction and not manufacturing or processing. If I have correctly understood his thesis, he suggested that the respondent interpret this Bulletin as applying to manufacturers a part of whose operations constituted construction, that is to say, on the one hand, the fabrication of a machine, and, on the other hand, its installation. In his view, installation is purely and simply construction. He argued as follows: "So the purpose of the Bulletin is to benefit the manufacturer of the machine, who also does construction work" (transcript volume 2, page 85). This contention is difficult to accept given the wording of paragraph 3 of the Bulletin. I see nothing in that paragraph that could lead to such a conclusion. As praiseworthy as such an interpretation may be in favour of some taxpayers, it cannot be accepted. Paragraph 3 is to the following effect:

As a general rule, the on-site fabrication, installation and erection of machinery and equipment, regardless of size, is not considered to be construction, unless it constitutes a component part of a building or structure (e.g. — heating system, air- conditioning equipment, sprinkler system, plumbing, wiring, etc.).

In reading this paragraph, I cannot concur with counsel for the respondents claim that, in the circumstances described in the evidence, the operation carried out by the appellant in operating its business could constitute construction. This wording seems to me clear and precise, and nothing suggests, as counsel for the respondent contends, that it applies solely when the manufacturer of the machine himself erects and installs it.

Whatever Bulletin IT-411 says, and notwithstanding the interpretation given it by counsel for the respondent, it is up to me to determine whether the operations carried out by the appellant constituted or not manufacturing or processing within the meaning of section 125.1 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") and thus enabled him to claim the tax reduction provided in the said section.

The relevant provisions of section 125.1 read as follows:

There may be deducted from the tax otherwise payable under this Part by a corporation for a taxation year an amount equal to the aggregate of

(a) seven per cent of the lesser of

(i) the amount, if any, by which the corporation’s Canadian manufacturing and processing profits for the year exceed the least of the amounts determined under paragraphs 125(1)(a) to (c) in respect of the corporation for the year, and

(ii) the amount, if any, by which the corporation’s taxable income for the year exceeds the aggregate of

(A) (Repealed by 1976-77, c. 4, subsection 50(1).)

(B) the least of the amounts determined under paragraphs 125(1)(a) to (c) in respect of the corporation for the year,

(C) 2 times the aggregate of amounts deducted under subsection 126(2) from the tax for the year otherwise payable under this Part by the corporation, and

(D) the amount, if any, by which the aggregate of the corporation's Canadian investment income for the year and its foreign investment income for the year (within the meanings assigned by subsection 129(4)) exceeds the amount, if any, deducted under paragraph 111(1)(b) from the corporation’s income for the year; and

(a) five per cent of the lesser of

(i) the corporation's Canadian manufacturing and processing profits for the year, and

(ii) the least of the amounts determined under paragraphs 125(1)(a) to (c) in respect of the corporation for the year.

(3) Definitions. In this section,

(a) "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

(b) "Manufacturing or processing”’.—" manufacturing or processing” does not include

(i) farming or fishing,

(ii) logging,

(iii) construction,

(iv) to (x) do not apply.

The work performed by the appellant to install a system of pipes and to link a paper machine to energy sources to permit its use aid not consist in the mere joining of lengths of pipe end to end, but in a series of operations, cuts and welding to give those pipes a very special shape in order to incorporate them in that network. Each piece required work by experts in the trade and, because of its complexity, many hours were required in order to execute it. The final product no longer had the characteristics of shape or appearance of the pipe purchased from the supplier, but was a well identified part on its own to which a distinct shape had been given in accordance with very particular specifications.

The evidence shows that, apart from a few rare exceptions, these pipes could not be purchased in manufactured form and that they had to be made to measure. If it had been possible to purchase them in the form and dimensions

required by the specifications, that is to say ready to be incorporated in a network, the operation involved would clearly have constituted manufacturing for the person who produced them in that state.

To sum up, what the appellant sold his customer was a system of pipes and fittings which could not be purchased at the final stage of production, but which had to be assembled piece by piece, each being prepared according to particular specifications. To assemble such a system, the appellant had to modify the pipes which it purchased, by giving them a different shape, which enabled them to be incorporated in a system. In their final form for the purposes of a contract, they in no way resembled the pipes purchased from suppliers. I cannot understand how one can conclude that adding some kind of system or manufactured parts to a machine which is the product of manufacturing constitutes a construction activity. Counsel for the respondent submitted no authority to the Court in support of this claim, and, in the absence of any authority to that effect, I am not prepared to allow his assertion that the appellant's operations, as described in the evidence, constituted construction within the meaning of paragraph 125.1(3)(b). In my opinion, they constituted the fabrication of a system of pipes and fittings, or at the very least the processing of pipes.

Furthermore, counsel for the respondent submitted a certain number of decisions to the Court's attention concerning, in particular, contracts of service and the theory of accession. From those cases at law, however, I draw the principle stated by Reed, J., of the Federal Court-Trial Division, in Halliburton Services Ltd. v. Canada, [1990] 1 C.T.C. 427, 90 D.T.C. 6320, that, if an appellant is in fact a manufacturer or carries out processing, he thereby benefits from the application of section 125.1, that is to say from the tax reduction, no matter the nature of the contracts with his customers.

In Canada v. Nowsco Well Service Ltd, [1990] 1 C.T.C. 416, 90 D.T.C. 6313 a decision of the Federal Court of Appeal, Urie, J. cites the comments of Reed, J. in Hallibuton, supra, in which she stated at pages 55-56 (D.T.C. 5338):

Secondly, I do not find any requirement that the contract which gives rise to the taxpayer's profit must be of a particular nature, e.g.: one for the sale of goods and not one of a more extensive nature involving work and labour as well as the goods Or material supplied. In my view it is the source of the profit, (arising out of process) that is important for the purposes of section 125.1(3)(b), not the nature of the taxpayer’s contract with its customers.

[Emphasis added.]

And Urie, J. added at page 423 (D.T.C. 6319):

I wholly subscribe to what the learned Judge said in the foregoing passage and I do not think that I could improve on it by a prolonged analysis of it.

Having come to the conclusion that the appellant was engaged in manufacturing or, at the very least, processing operations, I am led by the application of Reed, J.'s comments to conclude that the appellant is entitled to the tax credit provided under section 125.1. Given this conclusion, the respondent's allegation in his reply that the appellant operated a service business cannot be allowed.

For the foregoing reasons, the appeals for the taxation years 1986 and 1987 are allowed, and the assessments are referred back to the respondent for reconsideration and reassessment.

The appellant is entitled to his party-and-party costs.

Appeal allowed.