Red Deer Adviser Publications Ltd. v. MNR, 89 DTC 520, [1989] 2 CTC 2315 (TCC)

Sarchuk, T.C.J.: — Red Deer Adviser Publications Ltd. appeals from a reassessment of income tax for its 1981 taxation year. Three issues are raised in this appeal, two are related, while the third will have to be determined separately.

The appellant is a corporation incorporated under the laws of the Province of Alberta and carries on business in the City of Red Deer as a publisher and distributor of a weekly and bi-weekly written newspaper. In calculating its 1981 taxable income the appellant deducted capital cost allowance under Regulation 1100(1)(y) of the Income Tax Regulation (the Regulations) in respect of depreciable properties which it included in Class 29 as described under Schedule II to the Regulations (manufacturing and processing machinery and equipment). Furthermore, in calculating the tax which was otherwise payable under Part I of the Income Tax Act (the Act) for the taxation year in issue the appellant deducted an investment tax credit pursuant to subsection 127(5) of the Act which credit was claimed in respect of depreciable properties used by the appellant in its business primarily for the purpose of manufacturing or processing of goods.

The respondent disallowed the deduction of capital cost allowance as claimed on the basis that the property was not primarily used for the manufacturing or processing of goods for sale with the result that it was properly determined to be included in Class 8 of Schedule ll of the Regulations.

The respondent further reassessed the appellant to deny its claim for an investment tax credit on the basis that the depreciable property was not qualified property within the meaning of subsection 127(10) and Regulation 4600(2) of the Act and more particularly that the property in issue, acquired by the appellant in its 1981 fiscal year, was not used by it primarily for the purpose of manufacturing or processing of goods for sale.

One witness testified on behalf of the appellant, Mr. Keith L. Rideout, its president.

The appellant was incorporated in 1977 and commenced carrying on business on January 1, 1981. Prior to that time Mr. Rideout was involved in a family business, Paul Humphrey Associates, Federation of Business Interests Ltd. (Humphrey), which published two or three weekly newspapers, and carried on commercial and graphic design businesses. As at January 1, 1981 the assets of Humphrey were transferred into three different companies. Some of the publishing assets went to the appellant; some were transferred to the Ponoka Herald (1980) Ltd., while the commercial printing assets were transferred to a company called Adviser Graphics Ltd. Humphrey transferred its printing and publishing assets to the appellant pursuant to the roll-over provisions contained in subsection 85(1) of the Act. Prior to the transfer, this property had been classified by Humphrey as Class 29 assets for the purpose of filing its income tax returns and such classification had never been challenged by the M.N.R.

In filing its 1981 return the appellant reported the sum of $94,886 relating to the publishing assets transferred from Humphrey and $9,123 in relation to new equipment acquired in that taxation year as the cost to it of additions to its Class 29 assets in that year. In reassessing the appellant, the respondent reclassified the assets as Class 8 assets and correspondingly reduced the capital cost allowance claimed by the appellant in respect thereof.

During the 1981 taxation year the appellant published a bi-weekly newspaper "The Red Deer Adviser" and a weekly paper "The Central Alberta Adviser". Although the two were completely different publications, their format was similar in that each publication consisted of local news and advertisements from businesses and private parties. In addition the appellant printed newspapers for other district publishers and printed advertising flyers. These flyers would typically be distributed by way of insertion into either one or both of the newspapers. Of its approximately 60 employees three or four were involved in news gathering; five in administration; four in classified advertising; 10 in display advertising; 15 in the typesetting, paste up and camera departments; and five in the press room.

In 1981 the Red Deer Adviser had a circulation of approximately 14,000 copies every Wednesday and Friday while the Central Alberta Adviser had a circulation of approximately 32,000 every week. The Red Deer Adviser was distributed within the corporate limits of the City of Red Deer while the Central Alberta Adviser was circulated in an area bounded by Rocky Mountain House, Stetler, Didsberry and LeDuc but was not distributed in the City of Red Deer. The Red Deer Adviser was distributed by way of carriers and was placed on news stands where it was available to be picked up free of charge. The Central Alberta Adviser, basically a rural publication, was, in that taxation year, distributed exclusively by mail.

Mr. Rideout said that basically these are newspapers which are produced to be distributed freely and that while there are some incidental sales, they are extremely small in relation to the total production and the revenues therefrom are minimal. No price is printed on either one. Of gross revenues of $3,063,875 in 1981, sales of the newspapers by way of subscriptions and from the appellant's office amounted to no more than $4,000. The appellant was admittedly not in the business of selling newspapers nor was that the focus of its business. The bulk of its income was derived from advertising and the sales revenue, which amounted to less than one per cent, was incidental to the operation as a whole.

The determination of the issues before me is governed by a number of provisions of the Act and Regulations. Pursuant to subsection 127(5) of the Act the appellant was entitled to deduct from tax otherwise payable its investment tax credit calculated in accordance with that subsection and in accordance with subsection 127(9) of the Act which subsection defines investment tax credit. Of particular relevance to these proceedings are the provisions of subsection 127(10) of the Act and of Regulation 4600(2). They read in part:

127(10) For the purposes of subsection (9), a “qualified property" of a taxpayer means a property (other than a certified property) that is

(b) prescribed machinery and equipment acquired by the taxpayer after June 23, 1975,

that has not been used, or acquired for use or lease, for any purpose whatever before it was acquired by the taxpayer and that is

(c) to be used by him in Canada primarily for the purpose of

(i) manufacturing or processing of goods for sale or lease,

4600(2) Property is prescribed machinery and equipment for the purposes of paragraph 127(10)(b) of the Act if it is depreciable property of the taxpayer (other than property referred to in subsection (1)) that is

(k) a property included in any of Classes 21, 24, 27, 29 nor 34 in Schedule II. (emphasis added)

Class 29 forms part of Schedule II of the Regulations and reads in part:

Class 29 (50 per cent)

Property that would otherwise be included in another class in this Schedule

(a) that is property acquired by the taxpayer after May 8, 1972,

(i) to be used directly or indirectly by him in Canada primarily in the manufacturing or processing of goods for sale or lease, . . .

With respect to the claim for capital cost allowance the appellant pursuant to the provisions of subparagraph 20(1)(a) of the Act, is, in computing its income entitled to deduct such amount in respect of the capital cost to it of property as is allowed by regulation. The deductions were claimed in this instance by the appellant pursuant to the provisions of paragraph 1100(1)(y) of the Income Tax Regulations in respect of property it alleges fell into Class 29, supra.

In this appeal in order for the appellant to be entitled to claim the investment tax credit and the accelerated Class 29 depreciation on the properties in question, it must establish that such properties were used by it in Canada primarily in the manufacturing or processing of goods for sale.

Counsel for the appellant submits that the appellant has done so. It is his position that in producing The Advisers, the appellant manufactures or processes goods in Canada and that these goods are manufactured by it for sale. That being the case, the depreciable properties which are the subject of the claim for capital cost allowance were acquired by the appellant to be used directly by it in Canada primarily in the manufacturing or processing of goods and were properly included in Class 29 under Schedule Il to the Regulations by the appellant. Furthermore, with respect to the claim for investment tax credits, the property acquired in 1981 was prescribed machin- ery and equipment within the meaning of Regulation 4600(2) of the Regulations and as such constituted qualified property within the meaning of subsection 127(10) of the Act.

This position, counsel argued, is premised on certain propositions which he says flow from a number of earlier judgments. The first proposition is that the publication of a newspaper is a manufacturing or processing operation with the published newspaper constituting goods for sale within the meaning of the statutory provisions in issue in this appeal. (See St. Catharines Standard Limited v. The Queen, [1978] C.T.C. 258; 78 D.T.C. 6168 (F.C.T.D.)).

The second proposition is found in the judgments of the Federal Court- Trial Division and the Federal Court of Appeal in Le Soleil Limitée v. M.N.R., [1972] C.T.C. 244; 72 D.T.C. 6207; (F.C.T.D.); [1973] F.C. 97; [1973] C.T.C. 91; 73 D.T.C. 5093 (F.C.A.). It is that where a newspaper derives income from advertising, such income does not generally constitute income from the sale of any goods but is regarded as income derived from providing services.

In this context counsel relies on the following comments of the Chief Justice at page 92 (73 D.T.C. 5094):

We are in complete agreement with the decision of the Associate Chief Justice on the appeal as it was argued before him and we should be content to adopt his reasons. As it seems to us, the appellant's argument was based on a view of the contract with its advertisers for which there is no support. The appellant dealt with its advertisers as a person whose business consisted in producing newspapers and selling them to the public. As such a person, for a consideration, it agreed to put an advertisement on behalf of the advertiser in its (the appellant's) newspaper so that, when a member of the public got the newspaper, the advertiser's message would, it might be hoped, be communicated to him. In this contract, there is no sale of anything to the advertiser. (If, in fact, there had been a contract under which the appellant sold things to an advertiser under terms that required the appellant to distribute those things among members of the public, we would have no doubt that there was a sale of those things to the advertiser even though there was no delivery to the advertiser; (emphasis added) but, as we have indicated, we can find no such contract in the ordinary business relationship between a newspaper operator and an advertiser.)

and the reasons expressed by Noël, J. at page 248 (at 72 D.T.C. 6210):

Although it may be difficult to distinguish the case of advertising circulars sold to an advertiser for distribution to the addressees from that of advertisements sold to the same advertiser for insertion in the newspaper, when both are produced by the same process and by the same workers or employees, using the same materials, the fact remains that the publication of advertisements in the newspaper does not constitute a true sale of "goods processed or manufactured", such as that which occurs on sale of the newspaper itself to the reader, or even on the sale of circulars to the advertiser, (emphasis added) In fact, one aspect is lacking which is essential in order to bring the amounts paid for advertisements inserted in the taxpayer's newspaper within its net income from the sale of processed or manufactured goods, in that it is paid for services rendered, and not for goods sold, since the advertiser receives no goods except the benefit of using the newspaper's facilities to get his information across to actual or potential customers. I feel I must come to this conclusion, even though the advertiser, through what might be called an advertising “subsidy”, is thereby contributing to the cost of the newspaper, and thus making it possible for the reader to pay a lower price than he would otherwise have to pay if he had to bear his full share of the cost of producing the newspaper.

It is not possible, in fact, without doing violence to the wording of (s)ection 40A, and without distorting the meaning of the words “sale of goods", to maintain that an “advertising contract” is a sale of goods. I feel, therefore, that it is more true to say that where advertisements are concerned, the newspaper only undertakes to perform certain services for the advertiser, namely that when the newspaper is printed and sold it will contain the advertisement ordered by the advertiser.

Counsel submits that from the foregoing a third principle emerges, applicable to a publisher who produces pure advertisements, that is advertising circulars or flyers, for sale to his advertisers. On the authority of Le Soleil such an operation results in the sale of goods to the advertiser notwithstanding that the advertiser may not take actual delivery of the flyers and may in fact contract with the publisher to deliver them.

Counsel went on to argue that although the Red Deer Adviser is in outward form a newspaper, in fact the appellant produces publications which can best be described as a multiple advertisement flyer consisting of commercial advertisements, classified advertisements, flyers or circular inserts, all in a format which incidently contains news, weather and sports within it.

Mr. Pyrcz submitted that it was an implied term of the contract between the appellant and its advertisers that the advertisements be distributed. He relied on the evidence of Mr. Rideout that in the course of selling advertising the appellant made representations as to its circulation figures and, for this purpose, is required to substantiate its circulation claims by way of an independent audit certificate. The appellant's sales staff sold such advertising on the basis that, in the case of the Red Deer Adviser, its distribution on each Wednesday and Friday was 14,000 copies. This, counsel said, established that an implied term of the contract was that each and every copy would be distributed free of charge to the public in a particular area. The advertisers entered into the contracts with the assurance that the publication with their message contained therein would be delivered or distributed within their market area. Counsel submits that the Chief Justice’s comments in Le Soleil, supra, clearly apply to the appellant's operations in that there was a sale of "things" (advertisements) to the advertisers even though there was no delivery to them.

Counsel for the respondent argued that by definition the two publications in issue were newspapers, a position she supported by citing a number of cases including F. W. Bickle Ltd. v. M.N.R., [1979] 2 F.C. 448; [1979] C.T.C. 228; 79 D.T.C. 5170; [[1981] 2 F.C. 613] and The King v. Montreal Stock Exchange, [1935] S.C.R. 614; [1935] 4 D.L.R. 630. In Bickle, supra, the M.N.R. decided that certain publications were not exempt from federal sales tax because they were not newspapers. The publications did not conform to the Minister's definition of "newspaper" primarily because each consisted mainly or wholly of advertising. The publications in issue were Buy, Sell and Trade, containing almost 100 per cent advertising; Real Estate Victoria, containing over 95 per cent advertising; Century 21 Gold Post, containing 100 per cent advertising and Rapid Auto Mart Magazine, containing 100 per cent advertising. The Federal Court of Appeal found that the publications were not mere advertising circulars but contained information or news as to what was available in particular fields of commerce even though such information was conveyed by way of advertising.

The decision in Bickle, supra, followed the principles enunciated in Montreal Stock Exchange, supra. The facts in this case, as set out by the Court, were:

For some years the Montreal Stock Exchange and later the Exchange Printing Company printed, about noon of each day that the Exchange was in session, a sheet showing the transactions on the Exchange during the morning, and in the afternoon a similar record of the transactions for the remainder of the day. In like manner were published the transactions on the Montreal Curb market. Each week was printed a “comparative review of transactions” on the Exchange and a "comparative review of transactions” on the curb.

These sheets from time to time contained notices of dividends, annual meetings and the loss of certificates, the connection with companies whose stock was listed on the Exchange. The weekly publications besides summaries of the week's business, contained a tabulation comparing the business of that particular week with the business of the corresponding week in the previous year.

The members of the Exchange formed the greater bulk of the users of these sheets for which they paid on a sliding scale but copies were also exchanged with similar institutions in Canada and the United States. Some were sold to outsiders and the result of the evidence of the acting secretary-treasurer of the Exchange is that any member of the public might become a subscriber.

In ruling that these sheets were a "newspaper" the Court stated:

In the instant case, the word under discussion is not defined in any statute in pari materia and it remains only to give to it the ordinary meaning that it usually bears. Webster's New International Dictionary may be taken as giving a definition of "newspaper" which is expressed in corresponding terms in other well recognized dictionaries:

“a paper printed and distributed at stated intervals to convey news and other matters of public interest".

The sheets in question meet these requirements; the mere fact that any particular publication is meant to interest only a section of the public does not limit the meaning of the expression as a reference to religious or fraternal publications will at once make clear. The sheets in question contain not merely a record of transactions on the Exchange or curb market but also information to those desiring it as to such transactions; and the other items from time to time included give “tidings, new information, fresh events reported", vide Concise Oxford Dictionary defining "news".

I am satisfied that the position taken by counsel for the respondent is correct. Although each publication is a saturation circulation product freely distributed to the public in a specific distribution area each is nonetheless a newspaper. The two publications are not advertising circulars. An examination of two sample editions (Exhibits A-2 and A-3) disclose that each has a substantial amount of information relating to community events, weather, local sports and other material that has the quality of being news. Furthermore I do not accept the appellant’s position that this publication is a hybrid between a newspaper and a flyer amounting to a circular that is sold by the appellant to its advertisers. To so find would be an improper characterization of what in fact is being produced.

I am satisfied that the appellant dealt with its advertisers in the same manner that the publishers of all newspapers do. Representations as to circulation are made by its sales people and no doubt, notwithstanding the absence of any expressed terms to that effect, the advertiser is entitled to assume the publication will be distributed or delivered as represented. In this case, to paraphrase the words of the Chief Justice in Le Soleil Limitée, supra, the appellant dealt with its advertisers as a person whose business consisted in producing newspapers and distributing them free of cost to the public. It agreed to put an advertisement on behalf of the advertiser in its newspaper through which the advertiser's message would be communicated to the recipient of the newspaper. As was stated in Le Soleil, in such à contract there is no sale of anything to the advertiser.

Since there was no sale of the newspaper I must conclude that the depreciable property which the appellant claimed to be within Class 29 was not primarily used for the manufacturing and processing of goods for sale. The same conclusion must be reached with respect to the property in respect of which the appellant claimed the investment tax credit.

In the alternative with respect to the property acquired by the appellant from Humphrey pursuant to subsection 85(1) of the Act, Mr. Pyrcz submitted that even if that property was not acquired "to be used directly or indirectly by it in Canada primarily in the manufacturing or processing of goods for sale or lease” such assets must still be properly regarded as Class 29 assets. He referred to the relevant provisions of subsection 1102(14) of the Regulations which, for the 1981 taxation year, read as follows:

1102(14) For the purposes of this Part and Schedule II, where a property is acquired by a taxpayer

(a) in a transaction in respect of which an election was made under subsection 85(1) or (2), 97(2) or 98(3) of the Act, . . .

the property, immediately before it was so acquired by the taxpayer, was property of a prescribed class or a separate prescribed class of the person from whom it was so acquired, the property shall be deemed to be property of that same prescribed class or separate prescribed class, as the case may be, of the taxpayer.

Counsel submitted that having regard to the fact that the property in issue was acquired by the appellant pursuant to subsection 85(1) of the Act, the provisions of the foregoing Regulations clearly and unambiguously mandate that the appellant classify such property in the same class in respect of which it was classified by Humphrey, that is Class 29.

Counsel further submitted that where Regulation 1102(14) is applicable the use to which the property in question is actually put by the taxpayer is not relevant in determining the classification thereof for capital cost allowance purposes. In fact counsel argued, if a taxpayer acquired Class 8 assets by way of a subsection 85(1) roll-over, Regulation 1102(14) would become operative so as to disentitle the taxpayer from classifying such assets as Class 29 assets even if they were clearly used by the taxpayer primarily in the manufacturing or processing of goods for sale or lease. Mr. Pyrcz noted that support for his position is found in paragraph 4 of Interpretation Bulletin IT-147R2 dated June 19,1985 wherein it states, in part:

(4) Pursuant to Regulation 1102(14), where a property is acquired by a taxpayer from a person

(a) in a transaction in respect of which an election was made under subsection 85(1) or (2), 97(2) or 98(3),

and that property was property of a prescribed class or separate prescribed class of the person from whom it was acquired, the property is deemed to be property of the same prescribed class or separate prescribed class of the taxpayer. For example, where Regulation 1102(14) applies, property that otherwise would qualify for class 29 of the taxpayer acquiring it will be deemed to be class 8 property if, immediately before it was acquired, it belonged to class 8 of the person from whom it was acquired.

The respondent's position is that by virtue of Regulation 1102(14) where property is acquired by a taxpayer in respect of listed transactions, including an election under subsection 85(1) of the Act and the property immediately prior to such acquisition was property of prescribed class of the person from whom it was so acquired, the property shall be deemed to be property of that same prescribed class of the taxpayer. This Regulation, it is argued, is directed toward the preservation of the capital cost allowance characteristics of depreciable property in a roll-over situation. It applies to ensure that certain classes of property that might otherwise lose their special characteristics will retain those characteristics following an amalgamation of rollover. It therefore maintains continuity.

However, counsel submitted whether a taxpayer may claim capital cost allowance in respect of a Class 29 asset for a taxation year, nonetheless depends on its use by the taxpayer. Since the appellant did not use the assets in question in the manner contemplated by Class 29, the M.N.R. was therefore entitled, pursuant to subsection 152(4) of the Act, to reassess the appellant to calculate capital cost allowance on the correct basis by classifying the asset as a Class 8 asset.

Counsel submitted that in the 1981 taxation year, there were specific provisions in the Act dealing with misclassifications of property, in particular subsection 13(6) of the Act. It was contended that the purpose of this subsection was to enable a transfer of depreciable property to be made from the wrong class to the correct class in any taxation year without reopening the returns for previous years to have such transfers treated as such for the purposes of subsection 13(5) of the Act. Accordingly, in the course of an audit when the Department finds the error, the Minister may direct that the earlier years not be reopened but that the previous classification be accepted for those years. When this happens the asset is considered to have been transferred from the wrong class to the correct class as of the beginning of the year being reassessed. The subsection contains rules to correct the capital cost allowance found to have been granted on the asset while it was part of the former class. Counsel contends that subsection 13(6) of the Act is invoked as required and generally where a misclassification of property has occurred over a number of years. In the case at bar the "misclassification" was corrected by assessment for the year in which the property was acquired by the appellant. No previous years were involved. Accordingly, counsel for the respondent submitted that the appellant's claim for capital cost allowance has been properly disallowed by reassessment pursuant to subsection 152(4) of the Act.

The appellant's position is supported in good measure by the Minister’s Interpretation Bulletin IT-147R2 and is consistent with a commentary found in the Tax Regulation Reports, Richard De Boo Publishers, Vol. 1, pp. 11-339/340 which reads, in part:

These Regulations establish rules designed to ensure that where a particular depreciable property is acquired in one of a number of specific tax-deferred transactions, the characterization of the property in the hands of a purchaser will be the same as it was in the vendor's hands. Thus, it will not be possible for a taxpayer to utilize one of the listed transactions to effect a characterization of depreciable properties for capital cost allowance purposes.

Reg. 1102(14) specifically applies where properties have been acquired as a consequence of transactions between parties related at the time the transaction was effected. . . The transactions to which this Regulation applies includes subsec. 85(1) (tax-deferred transfer of property to a corporation).

Where Reg. 1102(14) applies, the purchaser will be obligated to classify the property acquired either under the same class or the same separate prescribed class in respect of which it was classified in the hands of the vendor.

I am satisfied that the argument advanced is sound. Regulation 1102(14) is clear and unambiguous and as noted by the author of the commentary the continued classification of property so acquired is obligatory.

With respect to the Minister’s right to assess pursuant to subsection 152(4) of the Act I note that the Minister has a statutory duty to assess the amount of tax payable under the Act in accordance with the law. It has, for example, been held that he cannot assess for some amount designed to implement a compromise settlement, Cohen v. The Queen, [1980] C.T.C. 318; 80 D.T.C. 6250. In my view, in assessing the Minister must comply with the relevant statutory provisions which in this case clearly includes Regulation 1102(14). I am equally satisfied that subseciton 13(6) of the Act has no effect whatsoever so as to limit or modify the operation of Regulation 1102(14) and could not have been invoked by the Minister. It follows therefore that the respondent erred in determining that the depreciable property acquired by the appellant from Humphrey in taxation year 1981 was property included in Class 8 of Schedule II of the Regulations.

I turn now to the third issue raised in this appeal. In calculating its 1981 taxable income the appellant deducted a reserve for doubtful debts in the amount of $127,000 pursuant to subsection 20(1) of the Income Tax Act. In reassessing the appellant's 1981 taxation year the respondent allowed a reserve of $32,722.44 resulting in a net disallowance of its reserve for doubtful debts in the amount of $94,277.56. At trial the parties advised the Court that the respondent is now prepared to concede that the amount of $85,000 is a reasonable reserve for doubtful debts pursuant to subsection 20(1) of the Act.

The appeal is allowed and the matter is referred back to the Minister for reassessment in accordance with these reasons.

Appeal allowed.