Giesecke & Devrient Security Card Systems Inc. v. Canada, docket T-2728-95

Date: 19980703

Docket: T-2728-95

OTTAWA, ONTARIO, Friday, this 3rd day of July, 1998

PRESENT:    THE HONOURABLE MADAME JUSTICE MCGILLIS

BETWEEN:

                                      GIESECKE & DEVRIENT SECURITY CARD

                                                                SYSTEMS INC.

                                                                                                                                              Plaintiff

                                                                        - and -

                                                    HER MAJESTY THE QUEEN

                                                                                                                                        Defendant

                                                                   JUDGMENT

The style of cause is amended by deleting "Security Card Systems Inc." as plaintiff and replacing it with "Giesecke & Devrient Security Card Systems Inc."

The appeal is allowed in part. S.C.S. erroneously paid federal sales tax on the embossing and encoding services for plastic cards which it manufactured. However, S.C.S. was liable for and did not erroneously pay federal sales tax for embossing and encoding plastic cards provided to it by an unlicensed manufacturer under a contract for labour. In view

of the divided success on the appeal, there is no order as to costs.

_________________________

Judge

Date: 19980703

Docket: T-2728-95

BETWEEN:

                                      GIESECKE & DEVRIENT SECURITY CARD

                                                                SYSTEMS, INC.

                                                                                                                                              Plaintiff

                                                                        - and -

                                                    HER MAJESTY THE QUEEN   

                                                                                                                                        Defendant

                                                    REASONS FOR JUDGMENT

McGILLIS, J.

INTRODUCTION

[1]         The plaintiff Giesecke & Devrient Security Card Systems, Inc. ("S.C.S.") has alleged, on this appeal by way of trial de novo from a decision of the Canadian International Trade Tribunal, that it erroneously paid federal sales tax in 1990 on its embossing and encoding services.

FACTS

[2]         S.C.S. is a licensed manufacturer under the provisions of the Excise Tax Act, R.S.C. 1985, c. E-15, as amended, which manufactures or produces plastic cards for a variety of customers, including financial institutions, telephone, gas and transportation companies, and government departments. It also provides embossing and encoding services for plastic cards manufactured either by it or by its competitors. S.C.S.'s operations are divided into two discrete parts: the actual manufacturing of the plastic cards and the provision of embossing and encoding services. S.C.S. has a plant in Markham, Ontario, which does both manufacturing and embossing and encoding, and a plant in Vancouver which does only embossing and encoding.

[3]         The manufacturing process for the plastic cards begins with a customer placing an order and providing film negatives containing its proprietary artwork for the design of the card. In the case of a repeat customer, S.C.S. merely uses the artwork which it has on file. The artwork typically contains the name of the institution, its logo, the design of the card and any other information to be printed on the card in the manufacturing process. The artwork and the film negatives are owned by the customer; S.C.S. has no proprietary interest in the artwork or the film negatives. S.C.S. will send the film negatives to a competitor for manufacturing in the event that the customer requests it to do so. The customer also specifies the size and the thickness of the cards.

[4]         From the film negatives, S.C.S. prepares a graphic representation of the card in colour. Following approval by the customer, S.C.S. creates from the film negatives a printing plate, which is paid for by and becomes the property of the customer. The plate is mounted on the printing press, and is used to print the cards on sheets of blank plastic. After printing, S.C.S. applies magnetic strips to the back and laminates the sheets, which are then cut into individual cards and inspected for quality. Depending on a customer's requirements, a hologram and signature panel may be applied at that point in the process, and the cards re-inspected for quality. The cards are counted and placed in the customer's inventory in a vault on S.C.S.'s premises. S.C.S. considers that to be the end of the manufacturing process. S.C.S. monitors on a daily basis the cards in its vault, and permits its customers to conduct an audit at any time. The cards may be retained by S.C.S. in its vault for eventual embossing and encoding, or they may be shipped, on the customer's instructions, to a competitor or to the customer itself for embossing and encoding. A plastic card may not be used until it has been "personalized" in the embossing and encoding process.

[5]         Within a few days after placing the cards in the vault, S.C.S. sends an invoice to the customer, whether the cards are to be retained in the vault for eventual embossing and encoding or shipped to a competitor or to the customer itself for that purpose. S.C.S. pays federal sales tax on the cards invoiced to its customers. According to S.C.S., the property in the cards passes to the customer when the invoice is sent. S.C.S. also believes, based on its experience, that its customers consider the property in the cards to pass at that point in time. Customers normally pay the invoiced amount within thirty days. However, S.C.S. would deliver the cards to a competitor or to the customer for embossing and encoding either prior to or after the expiry of the normal payment period, even if the customer had not yet paid the invoice.

[6]         After S.C.S. has sent its invoice, the customer may remove the cards from the vault. In the event that the customer does not pay the invoice, S.C.S. will take the necessary steps to collect the money owed to it. However, S.C.S. cannot sell the cards to anyone else. In that regard, S.C.S. considers the cards to be "owned" by the customer.

[7]         The embossing and encoding services constitute, in S.C.S.'s view, a separate process in which the plastic cards prepared for a customer are personalized for use by the end-user. In S.C.S.'s plant in Markham, Ontario, the embossing and encoding services are performed by different employees in an area completely separated from the manufacturing area. As indicated earlier, its Vancouver plant performs only embossing and encoding services

[8]         In order to begin the embossing process, a customer provides S.C.S. with computer tapes containing the personalized information to be embossed and encoded on each card, such as the name, address, account number and expiry date, together with the information necessary for the delivery of the card. The customer also supplies S.C.S. with "carriers", to which the cards are affixed, envelopes, and any promotional material to be included in the envelopes. The customer owns the computer tapes and the information; S.C.S. cannot sell the information or use it for any purpose other than the embossing and encoding of the cards. The customer also owns the carriers, envelopes and promotional material provided to S.C.S.

[9]         After receiving the computer tapes from the customer, S.C.S. prepares a file for use on its embossing machines, and prints the name and address information on the carriers and envelopes. The S.C.S. embossing machines type on the cards the card holder information and encode the magnetic strip at the same time. The cards are affixed to the carriers, which are inserted in the envelopes, along with any promotional material. The envelopes are delivered to Canada Post for mailing. At the end of every month, the customer is invoiced for the embossing and encoding services provided by S.C.S.

[10]       At all relevant times, S.C.S. paid federal sales tax on the embossing and encoding services performed for its customers.

[11]       In 1990, the year in question, S.C.S.'s sales were as follows: 5% for plastic cards which it manufactured and sent to competitors or customers themselves for embossing and encoding; 10% for the provision of embossing and encoding services for plastic cards which it did not manufacture; and 85% for manufacturing plastic cards and performing embossing and encoding services for those cards. In order to secure the embossing and encoding contracts, S.C.S. must be competitive in terms of price, quality and service.

[12]       S.C.S. has three different types of contractual relationships with its customers: written contracts, purchase orders and order confirmations. S.C.S. enters into written contracts with its customers for approximately 40% of its business, while purchase orders and order confirmations account for 20% and 40% respectively. A written contract between S.C.S. and its customers would normally provide for both the manufacturing of the plastic cards and the provision of embossing and encoding services. However, a separate purchase order would almost always be prepared for each of the two different processes. S.C.S. uses order confirmations to confirm verbal instructions received from customers, but always prepares separate order confirmations for its manufacturing and embossing and encoding services.

[13]       The written contracts entered into between S.C.S. and its customers are negotiated separately and vary considerably in their terms. The four contracts that were tendered in evidence illustrate the wide divergence in contractual provisions. For example, two of the contracts provide that S.C.S. is an independent contractor and not a servant or agent of the customer, while the other contracts are silent on that question. Two of the contracts provide that the customer is the owner of the manufactured card, one contract contains completely contradictory provisions concerning title, and another contract does not address the issue. Three of the contracts indicate that separate invoices will be sent on completion of the manufacturing and on completion of the embossing and encoding or the mailing of the cards, and one contract specifies that the invoice will be sent when the completed cards are delivered to Canada Post. None of the contracts indicates that the plastic cards become the property of the customer when the invoice is sent at the completion of the manufacturing process, and prior to the embossing and code. Three of the contracts require S.C.S. to maintain insurance for the cards, and one of the contracts requires S.C.S. to indemnify the customer for any losses or damage to cards in its possession.

[14]       In all instances where S.C.S. manufactures and embosses cards, it invoices the customer separately after the completion of both the manufacturing phase and the provision of the embossing and encoding services, regardless of the nature of the contractual arrangement with the customer or the terms of a specific contract.

[15]       S.C.S.'s customers provide no management or financial control or any other form of supervision over its operations. Similarly, its customers do not provide it with any technical expertise. However, customers are permitted to audit the cards and to inspect for quality at any time.

[16]       In early 1992, S.C.S. retained Ninecan Management Inc. ("Ninecan") to provide advice on its liability for the payment of sales and commodity taxes. Following its review of S.C.S.'s records and other materials, Ninecan advised S.C.S. that it was not liable for the payment of federal sales tax on its embossing and encoding services, on the grounds that its clients were licensed manufacturers and that embossing was a professional service exempt from tax. In that regard, Ninecan determined that twenty-four out of S.C.S.'s thirty-one clients were licensed manufacturers under the provisions of the Excise Tax Act. It further determined that, in 1990, S.C.S. remitted federal sales tax in the amount of $329,165.00 on its total sales of $2,438,263.00.

[17]       On February 20, 1992, S.C.S. submitted to Revenue Canada (Customs and Excise) ("Revenue Canada") an application for the refund of federal sales taxes in the amount of $329,165.00, alleging that it had paid the taxes in error.

[18]       By Notice of Determination dated June 19, 1992, Revenue Canada disallowed the refund application on the basis that S.C.S. did not pay the taxes in error. S.C.S. objected to the Determination in a Notice of Objection dated September 4, 1992. The Minister of National Revenue disallowed the objection in a Notice of Decision dated February 3, 1993, which stated, in part, as follows:

Your objection is disallowed and the determination is confirmed.

The substance of your representation is that the process of embossing plastic cards according to your clients' instructions and specifications does not constitute manufacturing.

Section 45.1 of the [Excise Tax Act] Act reads as follows:

"For the purposes of this Part, a person who, pursuant to a contract for labour, manufactures or produces goods from any article or material supplied by another person, other than a licensed manufacturer, for delivery to that other person shall be deemed to have sold the goods, at a sale price equal to the charge made under the contract in respect of the goods, at the time they are delivered to that other person."

The evidence indicates that you are engage [sic] in a contract for labour. Therefore, you are deemed to have sold the goods in question in accordance with section 45.1. Accordingly, you have paid the correct amount of sales tax as required under section 50 of the Act and, therefore, you have not paid any moneys in error to receive a tax refund under section 68 of the Act.

In the circumstances, there is no basis upon which to vary or vacate the determination.

[19]       On August 12, 1994, S.C.S. appealed the Notice of Determination to the Canadian International Trade Tribunal ("Tribunal"), pursuant to section 81.19 of the Excise Tax Act. In a decision dated August 28, 1995, the Tribunal allowed the appeal solely in relation to transactions in which S.C.S. embossed and encoded plastic cards manufactured by another licensed manufacturer. In all other respects, it dismissed the appeal. In its decision, the Tribunal concluded that the manufacturing of the cards and the embossing and encoding were not two distinct operations for the purposes of determining tax liability, but rather were a single, continuous process which resulted in the creation of credit or other cards. The Tribunal based its conclusion, in part, on its finding that property in the cards did not pass to the customer upon completion of the manufacturing process. In that regard, the Tribunal relied on three written contracts tendered with the post-hearing submissions, all of which contained clauses that suggested, in the Tribunal's opinion, that title to the cards did not pass to the customer at the end of the manufacturing stage. The Tribunal found that it was artificial and improper to view the process as two separate and distinct operations, with the embossing and encoding activities constituting a contract for labour governed by section 45.1 of the Excise Tax Act. The Tribunal found that the invoicing for the cards at the end of the manufacturing stage was properly characterized as a form of progress payment, as opposed to consideration for the sale of the cards. As a result, the entire process was taxable under subsection 50(1) of the Excise Tax Act when S.C.S. performed both the manufacturing and embossing and encoding services. The Tribunal also found that S.C.S.'s customers did not qualify as "manufacturers or producers", as defined in paragraph 2(1)(b) of the Excise Tax Act, and that S.C.S. was the manufacturer. Furthermore, the Tribunal was not convinced that S.C.S.'s customers were engaged in any activities described in paragraph 2(1)(f) of the Excise Tax Act during the embossing process. Thus, where S.C.S. entered into contracts for embossing and encoding services with persons other than licensed manufacturers, it was liable to pay federal sales tax on the amount charged under those contracts. S.C.S. was only entitled to a refund in circumstances where a contract for embossing and encoding services was entered into with a licensed manufacturer.

[20]       On December 22, 1995, S.C.S. instituted the present appeal by filing a Statement of Claim with the Court, pursuant to section 81.24 of the Excise Tax Act.

[21]       At trial, S.C.S. alleged that it erroneously paid federal sales tax on the embossing and encoding services for cards manufactured by it for a customer. As indicated previously, 85% of S.C.S.'s sales for the 1990 refund period related to cards which it had manufactured, embossed and encoded. S.C.S. further alleged that it erroneously paid federal sales tax on the embossing and encoding of plastic cards provided to it by an unlicensed manufacturer under a contract of labour for that sole purpose.

ISSUES

[22]       In order to determine whether S.C.S. erroneously paid the federal sales tax for plastic cards manufactured, embossed and encoded by it, the following issues must be considered:

i)           whether the embossing and encoding services provided by S.C.S. for cards which it manufactured constituted part of the "manufacture" of the cards for the purpose of the imposition of federal sales tax under subsection 50(1) of the Excise Tax Act;

ii)          whether the customers of S.C.S. were the "manufacturers or producers" of the cards, within the meaning of that term in paragraph 2(1)(b) of the Excise Tax Act; and,

iii)         alternatively, whether S.C.S. was nevertheless liable for the payment of the federal sales tax as a "marginal manufacturer", within the meaning of paragraph 2(1)(f) of the Excise Tax Act.

[23]       With respect to the plastic cards provided to S.C.S. by an unlicensed manufacturer under a contract of labour for the purposes of embossing and encoding, the following questions must be determined in order to assess the federal sales tax liability of S.C.S.:

i)           whether S.C.S. provided its embossing and encoding services pursuant to a contract of labour, within the meaning of section 45.1 of the Excise Tax Act, on cards given to it by its customers who are unlicensed manufacturers; and,

ii)         if so, whether its unlicensed manufacturer customers are "manufacturers or producers" within the meaning of that term in paragraph 2(1)(b) of theExcise Tax Act.

ANALYSIS

I.           Federal sales tax liability for cards manufactured, embossed and encoded by S.C.S.

i) whether S.C.S.'s embossing and encoding services on cards which it manufactured constituted part of the "manufacture" of the cards

[24]       By virtue of subsection 50(1) of the Excise Tax Act, the liability for the payment of federal sales tax rests on the "manufacturer or producer." The question of S.C.S.'s liability to pay federal sales tax on the embossing and encoding of cards manufactured by it therefore requires, at the outset, an analysis of whether those services constituted part of the manufacture or production of the plastic cards.

[25]       The term "manufacture" was defined in [1968] S.C.R. 140">The Queen v. York Marble, Tile & Terrazzo Ltd., [1968] S.C.R. 140, in the following terms, at page 145:

For the present purposes, I wish to note and to adopt one of the definitions cited by the learned judge, i.e. that manufacture is the production of articles for use from raw or prepared material by giving to these materials new forms, qualities and properties or combinations whether by hand or machinery.^[1]

[26]       The jurisprudence applying the definition of "manufacture" in [1968] S.C.R. 140">The Queen v. York Marble, Tile & Terrazzo Ltd., supra, is extensive. For the purposes of the present case, it is necessary to refer to some of the overriding principles established in that jurisprudence.

[27]       In Coca-Cola Ltd. v. Canada (Deputy M.N.R.) et al., [1984] 1 F.C. 447 (F.C.A.), the Federal Court of Appeal applied the definition of "manufacture" in [1968] S.C.R. 140">The Queen v. York Marble, Tile & Terrazzo Ltd., supra, in determining whether the cases and hand carriers used to remove bottles of soft drinks from the production equipment constituted part of the manufacturing process. Thurlow C.J. concluded that the portion of the process involving the use of the cases and hand carriers fell within the definition of "manufacture", even though the soft drink product had already been manufactured. In that regard, Thurlow C.J., writing for the Court, stated as follows, at pages 457 to 458:

In an operation of this kind means for removal of the product from the production equipment is as essential as any other part of the machinery or apparatus used in the manufacture or production of the product and is used as directly in the manufacture or production of the product as any of the other parts. The cases and carriers here in question fall easily within the meaning of "apparatus" and are used in the production process at a time when the distribution and warehousing operations have not yet begun. The fact that the cases and carriers are subsequently used in the warehousing and distribution processes in not relevant to the question under discussion.

Moreover, the cases and carriers serve a further function in the "manufacture and production" process in being used to put bottles on the conveyor, to hold them while being conveyed to the point where they are removed and to hold them in position for removal by the apparatus which carries out that function. Again, these cases and carriers are carrying out an essential function of the manufacture or production of the product and are used directly in it. The system requires a supply of empty bottles to be brought to the washing apparatus. In the system described it is not conceivable that the procedure could be carried out by putting or dumping individual bottles on the rollers of the conveyor.

[28]       In short, Thurlow C.J. held that the completion of the manufacture of the bottled product did not preclude subsequent activities in the process from being classified as "manufacture or production."

[29]       In Canada (Minister of Natural Revenue - Customs & Excise) v. Skega Canada Ltd. (1986), 72 N.R. 280 (F.C.A.), Heald J.A., with Stone J.A. concurring, emphasized that the definition of "manufacture" in [1968] S.C.R. 140">The Queen v. York Marble, Tile & Terrazzo Ltd., supra, required the creation of articles for use. In that regard, he stated as follows, at page 285:

The York Marble test refers to "... the production of articles for use from raw or prepared materials ..." (Emphasis added). It seems clear, then, that the reference to prepared materials contemplates that the material employed in the production of a final end use product may be raw materials or intermediate materials such as the goods in issue which, according to Mr. Persson's evidence, had no end use of their own.

[30]       Finally, other cases have emphasized the requirement that the "manufacture" must result in the creation of an article that has "... new forms, qualities and properties or combinations". In that regard, the Federal Court of Appeal considered, in Enseignes Imperial Signs Ltée v. Canada (M.N.R.)(1990), 116 N.R. 235 (F.C.A.), whether the activity of reconditioning used signs for sale constituted "manufacture or production". Pratte J.A., writing for the Court, referred to the definition of "manufacture" in [1968] S.C.R. 140">The Queen v. York Marble, Tile & Terrazzo Ltd., supra, and concluded that the activity was "manufacture or production", in that it transformed the signs into something new or something capable of performing a different function. In that regard, he stated as follows, at page 239:

[7] Spence, J., concluded that, in the circumstances, there had been manufacture because the marble slabs imported from Italy had been given a new form, new quality and new properties. The judge then added that, even if this first conclusion was wrong, the marble squares in question must be said to have been produced in Canada. In Spence, J.'s, opinion, the verbs "produce" and "manufacture", as used in the Excise Tax Act, are not synonymous so that a thing which was not manufactured in Canada may still have been produced there. In this regard the judge cited with approval a judgment of the Ontario High Court that someone importing watch cases and movements separately is producing watches in Canada, though he is not manufacturing them, when he places the movements in the cases.

[8] The latter decision shows that a thing can be produced by carrying out a very simple operation. What matters is not the complexity of the operation but its result. A thing is produced if what a person does has the result of producing something new; and a thing is new when it can perform a function that could not be performed by the things which existed previously.

[9] In the case at bar I have no difficulty concluding that, contrary to what the trial judge held, the respondent produced the used signs which it sold. The respondent not only renewed these signs, it transformed them so they could transmit a new advertising message. Transforming a restaurant's sign into a sign advertising a grocery or a pharmacy is in my opinion producing a new sign.

[10] Counsel for the respondent argued that, by recycling the used signs, his client had played a role similar that of a mechanic who resells used cars after repairing and repainting them. That is not correct. A car which a mechanic has repaired and repainted has exactly the same function as before, it is the same car; the respondent's used signs, once remade, no longer perform the same role as before; they are new signs. [Footnotes omitted]

[31]       The Federal Court of Appeal recently confirmed in Ford Motor Co. of Canada, Ltd. v. M.N.R., [1997] 3 F.C. 103 (C.A.), at pages 114 to 115, that "...for a good to be considered manufactured by an individual, it had to be given new form, qualities or properties by the activities of that individual".

[32]       The jurisprudence pertaining to the definition of "manufacture" has therefore established that the manufacturing process may have more than one constituent part. Furthermore, the "manufacture" must result in the creation of an article which has a use or which is capable of performing a new or different function.

[33]       In applying the principles enunciated in the jurisprudence to the facts of the present case, I have no hesitation whatsoever in concluding that the embossing and encoding services provided by S.C.S. on cards which it manufactured fall within the definition of "manufacture" as enunciated by the Supreme Court of Canada in [1968] S.C.R. 140">The Queen v. York Marble, Tile & Terrazzo Ltd., supra. In the S.C.S. system, the plastic cards created in the initial stage of the manufacturing process could perform no useful function. However, as a result of the embossing and encoding process, the card acquired new characteristics which enabled it to perform functions that could not previously be performed. In other words, the embossing and encoding process resulted in the creation of a fully functional card, personalized for use by the end-user. The embossing and encoding services provided by S.C.S. therefore constituted an integral part of the manufacture of the plastic cards. In the circumstances, S.C.S. could not artificially sever the embossing and encoding services from the manufacturing process by means of its accounting and invoicing practices or otherwise. In other words, the fact that S.C.S. recorded a sale for its internal accounting purposes at the end of what it considered to be the manufacturing process does not establish that the customer became the legal owner of the cards at that point in time.^[2] Furthermore, the evidence in the record, when viewed objectively and in its totality, does not support the general position advanced by counsel for S.C.S. that the title in the cards always passed to the customer at the time of invoicing, and that the embossing and encoding services constituted a separate and distinct commercial activity in relation to goods owned by the customer. In short, I am satisfied, on the basis of all of the evidence adduced at trial, that S.C.S. was the actual or physical manufacturer of the end-use, embossed and encoded plastic cards.

ii) whether S.C.S.'s customers were "manufacturers or producers" within the meaning of paragraph 2(1)(b)

[34]       The next question to be considered is whether S.C.S.'s customers were liable to pay federal sales tax on the plastic cards physically manufactured, embossed and encoded by S.C.S. on the basis that they were "manufacturers or producers" within the meaning of the extended definition contained in paragraph 2(1)(b) of the Excise Tax Act.

[35]       Paragraph 2(1)(b) of the Excise Tax Act provides as follows:

[36]       In order to determine whether S.C.S's customers were "manufacturers or producers", the jurisprudence relating to paragraph 2(1)(b) of the Excise Tax Act must be reviewed. Although the relevant cases all dealt with the predecessor sections to paragraph 2(1)(b), the extended meaning of "manufacturer or producer" in those sections was identical in all material respects to the definition in the current Excise Tax Act.

[37]       In The King v. Shore, [1949] Ex. C.R. 225, Cameron J. considered whether the defendant Shore, who had purchased manufactured toy irons under contract for the purpose of sale to department stores and jobbers, was a "manufacturer or producer", within the meaning of subparagraph 2(c)(ii) of the Excise Tax Act, R.S.C. 1927, c. 179.^[3] Cameron J. concluded that there was "no doubt" that Shore fell within the extended meaning of the definition of a "manufacturer or producer" on the basis that he held a "sales or other right" to the goods which were manufactured on his behalf. In his analysis, Cameron J. stated as follows, at page 228:

It is clear from the contract and the evidence that English and Metcalf were manufacturing the toys for [Shore] only. The dies to be used in their manufacture were made by English and Metcalf upon the instructions and at the expense of [Shore] and they are still [Shore's] property. English and Metcalf could not sell the toys to anyone but [Shore], and for a period of two years from the completion of the contract could not manufacture a similar article... [Shore] held a sales or other right to the goods being manufactured on his behalf by English and Metcalf and therefore, in my opinion, was the manufacturer or producer of such goods.

[38]       In [1958] S.C.R. 577">Rexair of Canada Ltd. v. The Queen, [1958] S.C.R. 577, the Supreme Court of Canada dealt with an appeal from a judgment of the Exchequer Court of Canada which had followed the decision in The King v. Shore, supra. In determining whether Rexair was a "manufacturer or producer", within the meaning of subparagraph 2(a)(ii) of the Excise Tax Act, R.S.C. 1952, c. 100, Kerwin C.J.C., writing for the majority, examined the contract under which Canadian Radio Manufacturing Corporation Limited ("Canadian Radio") had agreed to manufacture vacuums for Rexair.^[4] The contract specified, among other things, that all tools required for the manufacturing would become the property of Rexair, and would only be used in the production of its goods. Furthermore, no change in material or design could be made without Rexair's approval. Rexair was also entitled to maintain in Canadian Radio's plant an inspector, who had authority to reject any parts or completed machines which did not conform to certain standards of finish and specifications. Finally, Rexair agreed to indemnify Canadian Radio against all patent infringement claims. Kerwin C.J.C. also noted that the evidence in the record established that Rexair's parent company had permitted Rexair and Canadian Radio to use its Canadian patent and trade-mark rights.

[39]       In concluding that Rexair was the "manufacturer or producer", within the meaning of the extended definition, Kerwin C.J.C. relied on the contractual agreement of Canadian Radio to manufacture the goods for Rexair, the control of Rexair over the production, and the intellectual property rights of Rexair in the manufactured goods. In that regard, Kerwin C.J.C. stated as follows, at page 580:

On the evidence referred to above that question must be answered in the affirmative. Canadian Radio agreed to manufacture them "for" the appellant and the control exercisable and in fact exercised by the appellant over the production leads to the same conclusion. Even if the appellant did not own or hold a patent right (which is an affirmative, and not merely a negative, right) it used a patent right and also an "other right" being the trade-mark right; and both of these are rights to goods being manufactured for or on their behalf by Canadian Radio and so bring the appellant within the extended meaning of "manufacturer or producer".

[40]       Kerwin C.J.C. also stated, at page 581, that the decision in The King v. Shore, supra, was correct.

[41]       In Turnbull Elevator Co. of Canada Ltd. v. The Queen, [1963] Ex. C.R. 221, Cameron J. once again considered the extended definition of "manufacturer or producer". In examining the contract between the parties in that case, Cameron J. noted that Dominion Rubber Co. Ltd. ("Dominion") had agreed to manufacture footwear for Turnbull. The contract contained, among other things, warranties in relation to quality, a formula for pricing, a right of audit by Turnbull, invoicing and shipping clauses, an indemnification provision, and a clause requiring Turnbull to purchase all footwear and related materials which it ordered. Cameron J. also noted that Turnbull supplied equipment to Dominion on occasion, but retained title to the equipment and paid for insurance on it.

[42]       Cameron J. had no difficulty in concluding that Turnbull was the "manufacturer" of the footwear, within the extended meaning of that term in subparagraph 2(a)(ii) of the Excise Tax Act. In particular, he found that Dominion manufactured the goods "for or on behalf of" Turnbull, which had "a proprietary, sales or other right" to the footwear. He further found that Turnbull had another right to the goods based on its trade-mark rights which were used at its direction on all of the footwear manufactured for it by Dominion. In his analysis, Cameron J. stated as follows, at page 229:

On this evidence there can be no doubt that Dominion, in manufacturing all the footwear, was manufacturing such goods for or on behalf of [Turnbull]. I have also reached the conclusion that [Turnbull] was the "manufacturer" of all the footwear within the extended meaning of "manufacturer" as in s. 2(a)(ii) (supra), as being a corporation that owns, holds or uses a proprietary, sales or other right to the footwear being manufactured.

In the first place, I think [Turnbull] held a sales right to the goods being manufactured. From what I have said above, it is clear that Dominion could not sell the goods to others, but was required by the contract to sell them to [Turnbull] only, and to deliver them to [Turnbull] or to [Turnbull's] customers, if directed to do so. Likewise, [Turnbull] not only had the right to buy the goods being manufactured, but was bound by contract to do so. It is particularly significant that [Turnbull] financed the inventory of the goods held by Dominion after thirty days. The essential facts here are similar in many ways to those in The King v. Shore, [1949] Ex. C.R. 225 [49 DTC 570], in which I held that [Shore] had a sales or other right in the goods being manufactured for him by a corporation, and that he was therefore the manufacturer or producer of such goods. That decision was expressly approved in the Rexair case.

But in my view, [Turnbull] also used another right to the goods, namely, its trade mark rights, which were used by its direction on all the footwear manufactured for it by Dominion.

[43]       The jurisprudence dealing with the predecessor sections to paragraph 2(1)(b) of the Excise Tax Act has confirmed that the existence of a "sales or other right" is one of the predominant considerations in determining whether the purchaser of manufactured goods is a "manufacturer or producer", within the meaning of the extended definition. In particular, a "sales right" has been found to exist where the circumstances established that the purchaser of the manufactured goods had the exclusive right to purchase the goods in question. Other relevant considerations in determining the existence of a sales right were the extent to which the purchaser provided specific instructions, purchased or provided equipment used in the manufacture of the goods, or otherwise exercised control over the process.

[44]       In the present case, the facts establish unequivocally that S.C.S.'s customers had the sole and exclusive right to purchase the embossed and encoded plastic cards manufactured by it. S.C.S. could not sell the cards to anyone else. Indeed, S.C.S. could only sell the cards to the customer who ordered them, and was required to deliver them in accordance with its instructions. Furthermore, the customer exercised a high degree of control over the entire manufacturing process, including the embossing and encoding stage. For example, it provided a film negative, owned by it, containing its proprietary design artwork for the cards, specified the size and thickness of the cards, and indicated whether a hologram and signature panel would be required. The graphic representation of the card, prepared by S.C.S., had to be approved by the customer before the printing process began. The printing plate used to make the cards was paid for and owned by the customer, who could inspect for quality or conduct an audit at any time. For the purposes of the embossing and encoding, the customer provided S.C.S. with its computer tapes containing the personalized information for each card, as well as the information necessary for delivery. The customer owned the computer tapes and the information; S.C.S. could not sell the information or use it for any other purpose other than the embossing and encoding of the cards. The customer also owned and provided S.C.S. with the "carriers" to which the cards were affixed, envelopes and any promotional material to be included in the envelopes. In short, proprietary artwork, information, material and equipment owned by the customer figured prominently throughout the embossing and encoding stage of the manufacturing process.

[45]       During the course of the trial, counsel for the defendant submitted that paragraph 2(1)(b) of the Excise Tax Act requires the existence of an agency relationship between the S.C.S. and its customers in order for the latter to fall within the extended definition of "manufacturer or producer". I cannot accept that submission. In my opinion, there is nothing in either the plain wording of paragraph 2(1)(b) of the Excise Tax Act or in the jurisprudence to require proof of the existence of an agency relationship as an element of the extended definition of "manufacturer or producer".

[46]       In the circumstances, I am satisfied that S.C.S.'s customers were "manufacturers or producers", within the extended meaning of that term in paragraph 2(1)(b) of the Excise Tax Act, on the basis that they had a sales right to the goods. I have therefore concluded that S.C.S. erroneously paid federal sales tax on the embossing and encoding services for the cards which it manufactured.

iii) was S.C.S. liable as a "marginal manufacturer" to pay federal sales tax on the cards which it manufactured, embossed and encoded

[47]       Counsel for the defendant submitted, in the alternative, that S.C.S. was deemed to be the "marginal manufacturer" of the cards, within the meaning of paragraph 2(1)(f) of the

Excise Tax Act, which provides as follows:

[48]       The legislative purpose of paragraph 2(1)(f) of the Excise Tax Act was outlined in Ford Motor Co. of Canada, Ltd. v. M.N.R., supra, by Linden and McDonald JJ.A., at page 108:

Effective January 1, 1981, the definition of "manufacturer or producer" in the Act was expanded to include what are generally referred to as "marginal manufacturers". The amendment was intended to rectify what the government perceived to be an inequity resulting from different points of taxation for importers and domestic manufacturers. Prior to the amendment, importers paid tax on the basis of the duty paid value of the goods, and were not subject to tax for any work done on the goods once they were imported into Canada. Domestic manufacturers who often performed all of the work themselves, however, paid tax on the basis of the sale price of manufactured goods, and were unable to escape tax on any value added from finishing-off work performed in preparation for sale. The discriminatory effect of this inequity, according to the Budget Papers which introduced the amendment, were twofold:

First, it discriminates against manufacturers who perform these activities themselves, as opposed to others who sell their goods in bulk or unassembled or unpackaged form. Second, it puts domestic producers at a competitive disadvantage relative to importers, as the practice of marginal manufacturing is more prevalent in the case of imported goods.

[49]       Counsel for the plaintiff submitted that S.C.S.'s embossing and encoding activities "...constitute a process of applying a finish to the cards and preparing goods for sale." I cannot accept that submission on the basis that it is unsupported by the evidence at trial, and is inconsistent with the express legislative purpose of paragraph 2(1)(f) of the Excise Tax Act.

II.          Federal sales tax liability for cards provided to S.C.S. by an unlicensed manufacturer    customer for embossing and encoding services.

i) contract for labour

[50]       Counsel for the parties agreed during the course of the trial that section 45.1 of the Excise Tax Act applied in circumstances where S.C.S. embossed and encoded cards provided to it by an unlicensed manufacturer customer. Section 45.1 of the Excise Tax Act provides as follows:

ii) were the unlicensed manufacturer customers "manufacturers or producers" of cards provided to S.C.S. pursuant to a contract for labour

[51]       Section 45.1 of the Excise Tax Act imposes the liability for the payment of federal sales tax on a physical manufacturer in circumstances where, pursuant to a contract for labour, an unlicensed manufacturer supplies the article or material from which goods are manufactured or produced. In order to achieve that legislative purpose, section 45.1 deems the sale price of the goods to equal the cost of the labour under the contract.

[52]       Counsel for S.C.S. submitted that section 45.1 of the Excise Tax Act does not address the identity of the legal manufacturer for the purposes of liability to pay federal sales tax. He therefore submitted that, by virtue of the definition in paragraph 2(1)(b) of the Excise Tax Act, the unlicensed customers providing cards to S.C.S. for embossing and encoding were "manufacturers or producers". I cannot accept that submission on the basis that it would render the words "other than a licensed manufacturer " in section 45.1 of the Excise Tax Act meaningless, in that both licensed and unlicensed manufacturers would be liable for the payment of the federal sales tax in a contract for labour situation, despite the clear legislative intent to the contrary. Furthermore, the interpretation urged by counsel for S.C.S. is inconsistent with the express legislative intent in section 45.1 to impose the federal sales tax liability on the physical manufacturer in the circumstances specified.

[53]       For these reasons, I am satisfied that section 45.1 of the Excise Tax Act imposes on S.C.S. the liability for payment of federal sales tax where a contract for labour was entered into between it and an unlicensed manufacturer for embossing and encoding services. I have therefore concluded that S.C.S. did not erroneously pay federal sales tax for embossing and encoding plastic cards provided to it by an unlicensed manufacturer under a contract of labour.

DECISION

[54]       The appeal is allowed in part. S.C.S. erroneously paid federal sales tax on the embossing and encoding services for plastic cards which it manufactured. However, S.C.S. was liable for and did not erroneously pay federal sales tax for embossing and encoding plastic cards provided to it by an unlicensed manufacturer under a contract for labour. In view of the divided success on the appeal, there is no order as to costs.

OTTAWA                                                                                            ______________________

July 3, 1998                                                                                                                Judge

FEDERAL COURT OF CANADA TRIAL DIVISION

NAMES OF SOLICITORS AND SOLICITORS ON THE RECORD

COURT FILE NO.:                      T-2728-95

STYLE OF CAUSE:                   GIESECKE & DEVRIENT SECURITY CARD SYSTEMS, INC. v. HER MAJESTY THE QUEEN

PLACE OF HEARING:              TORONTO, ONTARIO

DATE OF HEARING:                 JUNE 15, 1998

REASONS FOR JUDGMENT OF THE HONOURABLE MADAME JUSTICE McGILLIS DATED:    JULY 3, 1998

APPEARANCES

Robert Taylor Paul E. Hawa

Brian Tittemore

FOR PLAINTIFF

FOR DEFENDANT

SOLICITORS OF RECORD:

GARDINER ROBERTS                                                         FOR PLAINTIFF                             40 King Street West

Suite 3100 Toronto, Ontario M5H 3Y2                   

Mr. Morris Rosenberg

Deputy Attorney General of Canada                                    FOR DEFENDANT