Service Pause Café Mat Inc. v. The Queen, docket 97-2947-IT-G

Date: 19980326

Docket: 97-2947-IT-G

BETWEEN:

SERVICE PAUSE CAFÉ MAT INC.,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for judgment

P.R. Dussault, J.T.C.C.

[1] These are appeals from income tax assessments for the appellant's taxation years ending on January 31, 1992, 1993 and 1994.

[2] By these assessments, the Minister of National Revenue (the "Minister") refused to allow the appellant to include coffee vending machines as Class 29, 39 and 43 property but instead included the machines in Class 8 for capital cost allowance purposes (Income Tax Regulations, Part XI and Schedule II).

[3] The Minister also denied the appellant the investment tax credit and the refundable investment tax credit in respect of the acquisition of that same property.

[4] Counsel for the respondent admitted at the outset that the assessment for 1992 was issued after the time allowed for this and that the appeal for that year must be allowed.

[5] As to 1993 and 1994 taxation years, counsel for the respondent did not dispute that processing had occurred by means of the coffee vending machines, namely the processing of coffee beans or ground coffee into liquid coffee, but claimed that the appellant itself did not use the property acquired to process goods for sale.

[6] Classes 29, 39 and 43 of Schedule II all concern property acquired during various periods for manufacturing and processing activities. The point at issue in the instant appeals is whether the property should be included in one of these classes rather than Class 8.

[7] The following property is included in Class 29 of Schedule II under subparagraph (a)(i)of Class 29, which reads as follows:

(a) . . . property manufactured by the taxpayer, the manufacture of which was completed by him after May 8, 1972, or other 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, or

. . .

(My emphasis.)

[8] Moreover, in subsection 127(9) of the Income Tax Act (the "Act"), the relevant portion of the definition of "qualified property" for the purposes of the investment tax credit reads as follows:

"qualified property" — "qualified property" of a taxpayer means property (other than an approved project property or a certified property) that is

(a) . . .

(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 the taxpayer in Canada primarily for the purpose of

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

. . .

(My emphasis.)

[9] The only witness heard was Lise Emond, the appellant's general manager since 1996, who was in charge of data entry and accounting during the years in issue.

[10] Ms. Emond explained that the appellant, whose head office is in Matane, Quebec, carried on two lines of business: one selling coffee wholesale by the case to various restaurants and the other retailing liquid coffee by the cup. According to Ms. Emond, the latter line accounted for 80 percent of the appellant's activities and the appellant had acquired for that line 700 to 750 automatic coffee vending machines. The machines are placed in offices, employee lounges, convenience stores and service stations belonging to its clients on the north shore of the St. Lawrence River and on the south shore east of Rivière-du-Loup. The appellant has approximately 15 employees, including seven technician/delivery men and two persons assigned to technical services.

[11] Although the machines come in various models and sizes, their operating mechanisms are similar. Ground coffee is processed into fresh liquid coffee one cup at a time by an automatic brewing and filtering mechanism. Some machines have a grinder which makes it possible to provide coffee from beans freshly ground for each cup. A number of machines also offer a choice of other drinks such as hot chocolate or chicken broth. The appellant provides sugar and stirring sticks free of charge, while cups or containers are sold to the client separately.

[12] The appellant purchases supplies of coffee every three months through a coffee roasting business. Purchases total approximately 300,000 pounds of coffee per year.

[13] The vending machines installed on customers' premises remain the appellant's property and are simply lent to the customer under a no-charge loan contract. According to Ms. Emond, this contract affords protection for the appellant, which can recover the machine more easily should the customer declare bankruptcy, for example. It also facilitates the task of filing insurance claims in the event of theft or vandalism. The contract stipulates that the customer only has a right of normal use of the machine, that it is responsible for the equipment, accessories and incorporated devices and that it bears the risk of damage to the machine, regardless of the cause.

[14] The machines are installed by the appellant's technicians, generally on a small cabinet provided by the appellant in which it leaves bags of ground coffee or coffee beans to be used to fill the machine's container. Under the contract, electrical and plumbing work required for installation is done at the customer's expense and deemed to be done at its request. Before they are installed and put into service, the machines are adjusted and calibrated by the same technicians who afterwards fill and clean them and do general maintenance every 21 days. Some pieces of equipment, including water valves and coffee brewers must be changed quite frequently. In case of breakdowns or malfunction, the appellant's technicians come when called and make the necessary repairs or adjustments. At its head office, the appellant has a shop for repairing, altering and reconditioning machines, in addition to a warehouse.

[15] The appellant pays the cost of maintaining and repairing the machines. One or two responsible persons on the customer's premises may sometimes have to fill the coffee container if the coffee should run out. To do so, these individuals use the bags of coffee left on the premises by the technicians which are considered to be part of the appellant's inventory. That is all they are required to do. The appellant's technicians/delivery men handle everything else.

[16] The equipment loan contract also provides that the customer undertakes to purchase its supplies exclusively from the appellant. According to Ms. Emond, this provision is not very important since, in any case, the customer is billed on the basis of the number of cups of coffee as indicated by the counters.

[17] During their periodic maintenance visits, the appellant's technicians/delivery men also read the counters for billing purposes. Each customer is billed at a rate established by the appellant on the basis of the number of cups of coffee consumed during a 21-day period or at a price per cup negotiated in advance with the customer. Although most of the automatic vending machines contain a money changer, the technicians do not remove the money as it is considered the property of the appellant's customer, which has decided to charge coffee consumers—its employees, customers or other persons—a predetermined amount rather than offer them coffee free of charge. During or after installation, the money changer is simply programmed by the appellant's technicians on the basis of the price fixed by each of the appellant's customers.

[18] Counsel for the appellant contended that this part of the appellant's activities consists essentially in the sale of liquid coffee by the cup and that, to that end, the appellant uses the vending machines it has acquired, which process coffee beans or ground coffee into liquid coffee. According to counsel, the agreement with each customer is for the sale of coffee in liquid form and billing is a function of a price (one that has either been negotiated or is in accordance with the appellant's rate) based on the number of cups of liquid coffee consumed. In these circumstances, it is of little importance that the customer resells to the consumer at a determined price the coffee thus processed by the machine belonging to the appellant.

[19] Counsel for the appellant emphasized not only that the appellant at all times retains ownership of the vending machines lent and installed on the customer's premises, but also that it remains the operator of those machines through the work of its technicians and employees. It is they who install the machines after making the necessary adjustments and calibrations, who clean them on a regular basis, who repair them, change parts, refit them or even repaint them as necessary. Thus, even though the machines are placed at the customer's disposal, the appellant still controls their operation and is ultimately responsible for the processing necessary to the sale of liquid coffee, which is the object of the agreement with each customer. The appellant also bears maintenance and repair costs.

[20] Although it can be argued that the consumer uses the machine in the physical sense of the term—the consumer in fact merely gives the command by pressing the appropriate button—it is actually the appellant which uses the machine in the broader sense of being able to fill the order for liquid coffee, which is the object of its agreement with the client, by means of the machine whose operation is under its control. On this point, counsel for the appellant relies on the decision by this Court in Funtronix Amusements Ltd. v. M.N.R., 89 DTC 545.

[21] According to counsel for the appellant, the contractual relationship with the customer is clear: it has to do with the sale of liquid coffee. To sell this product, the appellant must therefore own and use the machines enabling it to do the necessary processing.

[22] In support of his arguments, counsel for the appellant also referred to this Court's decision in Versa Services Ltd. et al. v. M.N.R., 92 DTC 1769 (T.C.C.) and to Interpretation Bulletin IT-147R3, Capital cost allowance — Accelerated write-off of manufacturing and processing machinery and equipment.

[23] Counsel for the respondent contended that the appellant does not sell liquid coffee to its customers, only ground coffee. It is the customers who use the machines, agreeing to provide consumers with liquid coffee either by charging them a determined price or giving them the coffee. Thus, in counsel's view, since it is a manufactured product (liquid coffee) that must be sold, it is the appellant's customers, not the appellant itself, who make these sales or conduct these transactions with the consumers. According to counsel for the respondent, these customers in fact merely purchase ground coffee and use the machine lent by the appellant to carry out the operation of processing the liquid coffee required by the consumers. Thus, billing by the cup is simply a method of controlling the inventory of coffee sold by the appellant which could also bill on the basis of the number of measured amounts of ground coffee used or sell the coffee by the bag or by weight. Furthermore, under their agreement with the appellant, customers undertake to obtain their coffee exclusively from the appellant. The coffee is purchased in advance every three months and the appellant fixes the price on the basis of its own costs. In addition, argued counsel for the respondent, it is ultimately the consumer who uses the machine when the processing takes place, and he emphasized the fact that the appellant receives nothing from the consumer with respect to that processing.

[24] Counsel for the respondent also questioned whether the tax benefits claimed by the appellant were intended to encourage the activities of a service business.

[25] I agree with counsel for the appellant and believe that the appellant is entitled to the capital cost allowance and credits claimed because it acquired property which it uses to process goods for sale. The appellant's business of course consists in the sale of coffee. However, most of its operations are concentrated in a specific market and aimed at a special clientele. The appellant's customers are interested in being able at all times to provide their employees, customers or other persons with ready-to-drink coffee freshly brewed with every cup. This can be done through robotic devices programmed to produce this result. The appellant has acquired hundreds of these machines, which it installs on the premises of customers who want ready-to-drink coffee or other beverages. The appellant lends its machines to its customers and undertakes to clean and maintain them regularly and repair them and replace parts as necessary, all at its own expense. The machines remain its property and it retains control over their operation through the work of its employees, mainly its technicians/delivery men. The costs borne by the appellant in this regard are obviously reflected in the prices and the established rate very definitely takes these costs into account. The claim that the appellant only sells ground coffee to its customers is incorrect in my view. It in fact provides them with ready-to-drink liquid coffee processed by the machines which it supplies and whose proper operation requires regular intervention by its employees. In my opinion, the billing based on a rate per cup of liquid coffee is not unrelated to the fact that the processing is done by the machines which the appellant supplies, the proper functioning of which, even though automated, requires the regular intervention of its employees. In this sense, I believe that the appellant uses the coffee vending machines to process a product for sale. What the customer wants is coffee that is ready to drink. This is what the appellant provides and this is what the customer pays for at the agreed-upon rate per cup. Whether the client decides to resell its coffee to the consumer by having installed a money changer programmed on the basis of the price it wishes to charge does not alter its obligations toward the appellant in any way. The fact that the customer can thus be called the user of the machine, as can the consumer who pushes the button, in no way alters the fact that it is first and foremost the appellant who uses the devices or vending machines to provide and sell to its customers what they want: coffee that is ready to drink. The appellant can only meet this requirement of its clientele in one way: by purchasing the appropriate machines and installing and maintaining them on its customers' premises.

[26] The processing of ground coffee into liquid coffee takes place in the appellant's machine which is installed on the customer's premises. The customer definitely supplies the necessary electricity and water, but the machine does the processing and the machine is the appellant's property and its employees are the ones who regularly maintain the machine to ensure it operates properly. In this sense, the machines acquired by the appellant are used by it to process ground coffee into coffee in liquid form. Without the purchase and use of these machines, the appellant definitely could not sell ground coffee or coffee beans to the clientele concerned.

[27] It seems to me that this logical approach and this broader interpretation, which is broader than that proposed by counsel for the respondent, were adopted by Judge Garon of this Court in Funtronix, supra. In that case, one of the issues to be decided was who, for the purposes of paragraph 1104(2)(a) of the Income Tax Regulations, was the user of electronic games acquired by the appellant and installed on customers' premises. Although the circumstances were different and the condition stated in that provision was worded in different terms from those used in the provisions invoked by the appellant in the instant case, there is an obvious parallel between the two situations. I believe the approach taken by Judge Garon should be adopted here as well. He writes at pages 546 and 547:

Regarding the second requirement, the thrust of the argument was with regard to the definition of the term "user". Counsel for the Respondent argued that the user of the equipment was the patron of the machine, that is, the individual who played the machine. On the other hand, the proposition put forward on behalf of the Appellant was that within the context of the Income Tax Regulations relating to capital cost allowances the Appellant was the user of the equipment.

With respect to the requirement laid down in paragraph (b) of the above definition there are, therefore, two possible constructions of the term "user". According to a restricted meaning it would refer, in the case of the subject equipment to the individual players who are using the machines. There is no doubt that persons in that class are using in a very physical sense the electronic video games or the equipment in question. On the other hand, if a much broader consideration of the term "user" found in paragraph (b) of that definition is adopted, it could include owners of the equipment such as the Appellant.

I am of the view that owners of video equipment who make it available to individual players by making arrangements with persons having the ownership or possession of an amusement arcade by sharing with such persons the proceeds of the contributions of the individual players are using the video equipment for the purpose of earning income therefrom within the meaning of the Income Tax Act and the Income Tax Regulations. They are the user of the equipment in question in the context of the Act and Regulations.

In effect, it is entirely consonant with the scheme and language of the Income Tax Act and the Income Tax Regulations to say of an owner of property who makes it available to others for a fee that the owner is using property for the purpose of earning income therefrom although these other persons have the day-to-day use of the property. An illustration of this proposition could be found in subsection 13(7) of the Income Tax Act. Subsection 13(7) of the Act, by its express terms, is made applicable, inter alia, to regulations made under paragraph 20(1)(a) of the Act. It is under the latter enactment that Part XI of the Income Tax Regulations dealing with capital cost allowances was made. Paragraph (b) of this subsection reads as follows:

13. (7) For the purposes of this section, section 20 and any regulations made under paragraph 20(1)(a), the following rules apply:

(b) where a taxpayer, having acquired property for some other purpose, has commenced at a later time to use it for the purpose of gaining or producing income therefrom, or for the purpose of gaining or producing income from a business, he shall be deemed to have acquired it at that later time at its fair market value at that time.

The type of language adopted in the underlined portion of paragraph 13(7)(b) is found in many other paragraphs of subsection 13(7). Also subsection 45(1) of the Act is couched in some of its parts, in language which is virtually identical to subsection 13(7). It is generally recognized, I think, that the reference in such provisions to a taxpayer who uses property for the purpose of gaining or producing income therefrom, covers, for instance, the situation of a lessor who has rented his property.

According to the language of the Act, in a lease context, the lessor is using the property for the purpose of gaining income therefrom although during the term of the lease the day-to-day enjoyment of the property is that of the lessee. Likewise, the same leasehold premises may also be "used" in certain circumstances by the lessee for the purpose of gaining income therefrom.

The matter could also be looked at from another angle. In effect, the evidence clearly showed that the Appellant was the user of the property in the sense that it had access to such equipment at all times and could alter the computer programs stored in such equipment. In fact, it has been established that these video games depreciate very quickly and in order to earn revenue from such games, there was a requirement for the Appellant to change or alter the computer programs from time to time.

[28] I do not believe that counsel for the respondent's argument based on Parliament's intention can be accepted in the absence of any clear indication of an intent to exclude from the application of the provisions referred to the operations here at issue, which the respondent even conceded involved processing that she nevertheless refused to attribute to the appellant.

[29] As a consequence of the foregoing, the appeals for the appellant's 1992, 1993 and 1994 taxation years are allowed and the assessments referred back to the Minister for reconsideration and reassessment on the basis that the appellant is entitled to the capital cost allowance claimed and to the investment tax credit and refundable investment tax credit for the years in issue.

[30] The whole with costs.

Signed at Ottawa, Canada, this 26th day of March 1999.

"P.R. Dussault"

J.T.C.C.

[OFFICIAL ENGLISH TRANSLATION]

Translation certified true on this 24th day of January 2000.

Erich Klein, Revisor