Range Grain Company Limited v. Canada, docket T-411-88

     T-411-88

BETWEEN:

     RANGE GRAIN COMPANY LIMITED,

     Appellant,

     - and -

     HER MAJESTY THE QUEEN,

     Respondent.

     REASONS FOR DECISION

WETSTON J.:

     This is an appeal by the tax payer, Range Grain Company Limited ("Range Grain"), from the reassessment of tax for the taxation years 1978, 1979, 1980, 1981, 1982, 1983 and 1984. During these years, the appellant earned income from its business as a purchaser of grain and through a joint-venture of a grain elevator located in Port-Cartier, Quebec. In computing its income tax for the 1978 to 1984 taxation years, the appellant claimed a deduction for manufacturing and processing profits, pursuant to section 125.1 of the Income Tax Act, S.C. 1970-71-72, c. 63 (the "Act"). The appellant did so on the basis that part of the income from the grain elevator operation in Port-Cartier was derived from manufacturing and processing.

     During the years in question, the appellant earned a portion of its income through the purchase of grain for other companies. In calculating its net business income Range Grain included in its gross income the commissions it was paid for this service and not the sale price of the wheat. The respondent, Revenue Canada, disallowed the section 125.1 tax credit in each taxation year on the grounds that the appellant did not meet the 10% de minimus required by statute; that is, that manufacturing and processing profits were not at least 10% of the company's total profits. The credit was also disallowed on the grounds that the activities carried out at the elevator, except grain cleaning, were not manufacturing and processing within the meaning of section 125.1. Range Grain now appeals that decision.

     There are three issues raised in this appeal.

1.      What are the gross revenues of the appellant Range Grain?

2.      Which of the activities carried out at the Port-Cartier elevator, if any, qualify as manufacturing or processing profits?

3.      Did the elevator carry out any activities that qualify as "manufacturing or processing goods for sale or lease in Canada" within the meaning of section 125.1 of the Act ?

Range Grain revenues

     The appellant is located in Winnipeg, Manitoba, and acts as an agent and buyer of wheat. The company operates a small two-person office and is an accredited agent with the Canadian Wheat Board, a member of the Winnipeg Commodity Exchange, and a member of the Lakeshipper's Association. These memberships are required to purchase grain in Canada.

     The appellant claims that wheat that is purchased from the Canadian Wheat Board is on behalf of other companies. The process for purchasing wheat was described in the following manner. First, the appellant would be contacted by a company, usually American, and advised that the company wanted to buy a certain amount of wheat. The American company would be unable to purchase the wheat directly because of the licensing requirements in Canada. After being contacted by the company, the appellant would contact the Canadian Wheat board and facilitate negotiations between the parties to arrive at an agreed price. The appellant would only agree to the purchase of the wheat once the buyer had agreed to the price and amount of wheat. At that time a sale would be concluded in the name of the appellant. The American company would forward the amount of the purchase price directly to the appellant several days before the date for payment. In the event that the money was not received in time the appellant had a line of credit with a financial institution. In return for these services the appellant would be paid a commission of 2.5% per metric tonne.

     The appellant was not involved in any speculation or risk in purchasing the wheat. Range Grain did, however, receive money representing the purchase price of the grain. Contracts and other documentation regarding the grain purchased for the American company all identified Range Grain as the buyer and owner of the wheat. The appellant explained that this was a requirement since the Canadian Wheat Board could only sell to duly accredited agents in Canada.

     The appellant's deduction for manufacturing and processing profits was disallowed on the ground that the manufacturing and processing profits were not at least 10 percent of the gross revenue of the company. In calculating the gross revenue of the company the Crown considered income from grain sales to include the purchase price of the grain and the commission earned. The appellant disputes this characterization of its gross income on the ground that "income" from grain sales is not the price for which the grain was sold but, rather, the commission the company was paid for purchases of grain on behalf of third parties.

     The respondent maintains that the appellant purchased grain and resold that grain to another company. In support of this position the respondent notes that all contracts name Range Grain as the buyer of the wheat and that the company accounts for the money received for the wheat purchased as income. Furthermore, the respondent submits that the appellant describes its income as including grain sales and commissions. Simply put, the respondent claims that the purchase price of the wheat is an amount that was received by the appellant and must be reported as income under section 248(1) of the Act.

     I do not accept the respondent's position regarding this issue. I am satisfied that the income earned by Range Grain due to the purchase of wheat was solely the commission earned and not the price of the wheat advanced by the American company. The evidence was clear that Range Grain did not engage in any speculation on the price of wheat nor was there any commercial risk of losing money due to the purchase. The only net gain was the commission. The money received for the wheat purchase, therefore, did not increase in any way the net worth of the company; it simply flowed through the company.

     Indeed, the appellant was acting in all respects as an agent on behalf of the American company and could do so by virtue of its accreditation and membership in the appropriate associations. The fact that Range Grain was listed as the buyer on official documents was only due to the licensing requirements in Canada. The relationship is one which may be characterized as principal/agent and, therefore, the revenues generated are strictly commission sales and do not include the purchase price of the wheat.

     While the inclusion of only the commission income would, at first blush, allow the appellants to meet the requirements under section 125.1 of the Act, the respondent further submits that Range Grain does not qualify since the amount currently included as manufacturing and processing income does not reflect activities that actually qualify as manufacturing and processing.

Port-Cartier elevator activities

     The respondent's objections regarding the activities at the Port-Cartier elevator are twofold. First, the respondent argues that the processing which was carried out at the elevator was not at least 10 percent of the elevator's gross revenues. The respondent contends that the appellant incorrectly included activities that do not qualify as manufacturing or processing. Secondly, the respondent argues that, irrespective of the de minimus requirements under the Act, the appellant was not carrying on manufacturing or processing of goods for sale or lease in Canada. In short, the respondent argues that the appellant was operating a transportation service and was not involved in the production of goods for sale.

     To consider the nature of the activities carried out at the Port-Cartier elevator it is important to understand the role of this elevator and its functions. There are four different types of grain elevators in Canada. The first is a primary elevator which receives grain directly from a producer and is used for storage and forwarding the grain. The second is a process elevator which receives grain and processes it into a different product, such as flour. The third is a terminal elevator, which officially weighs grain and where it is inspected by the Canadian Grain Commission. The fourth type of elevator is a transfer elevator which receives grain and facilitates the transfer to ocean going vessels for shipping overseas. All grain elevators in Canada are licensed by the Canadian Grain Commission, a regulatory body who has the responsibility to establish and maintain the quality of Canadian grain and to regulate the Canadian grain handling system.

     The Port-Cartier elevator is licensed as a transfer elevator. It is located on the St. Lawrence seaway and receives wheat from Lake Bound ships ("lakers") and facilitates the transfer to ocean going vessels for export. Upon arrival at Port-Cartier, the grain is delivered to receiving belts and cleaned. Cleaning involves the removal of excess materials, such as metal, by large magnets installed at the beginning of the transfer belt. Canadian wheat is cleaned before arrival at a transfer elevator and, therefore, it was only American grain which required cleaning at the elevator. Following cleaning, the grain is moved into a receiving gallery and then into storage bins where it is stored until it is transferred to an ocean going vessel. Once the grain is delivered to the ship, any undelivered quantity of grain is returned to the Canadian Wheat Board.

     During storage the elevator may be required to fumigate, ventilate or blend the wheat. Fumigation will be required in three instances. Firstly, where the wheat is discovered to be infested before unloading, pesticides will be added during the transfer process. Secondly, if the wheat is found to be infested with insects after having entered the storage bins it is treated with chemicals in the storage bin and moved to a clean bin. All equipment which was in contact with the infested wheat is also treated with chemicals. Finally, wheat that is destined for a country which requires pesticide treatment before arrival will be treated during the removal process. Mr. Kloss, comptroller for the elevator, estimated that fumigation would occur approximately five to ten times a year, although usually only a small portion of the shipment would require fumigation.

     Ventilation, also called drying or turning, is required in the case of wheat which is received wet or where internal temperatures in a storage bin rise to such a point that the wheat may be in jeopardy. Ventilation essentially involves the moving of wheat from one bin to another and, on occasion, blending the wheat with other dry wheat. Mr. Kloss estimated that ventilation would be required less often than fumigation, approximately twice a year.

     Finally, the transfer elevator may occasionally be required to blend the wheat. Blending is essentially the mixing of various grains of wheat to achieve a different mix of grade. This is done during the removal process. Essentially, different qualities of grain from various bins would be released onto the conveyor belt simultaneously in order to mix the grain. The elevator does not charge for the blending procedure carried out on its premises.

     The three processes of cleaning, fumigating and ventilating are billed as conditioning. No additional equipment is required for blending nor are any extra labour costs associated with the process. Similarly, no extra equipment is required for ventilating, although thermometers are situated in all of the bins to monitor the temperature and condition of the wheat. Cleaning and fumigating require additional equipment including magnets and sprayers.

     Throughout the transportation process ownership of the grain remains with the Canadian Wheat Board until transfer to the buyer. Range Grain described its function as the handling and transfer of grain. Counsel for the appellant argued that the question of ownership is essentially legal in nature and that the grain is often co-mingled, therefore, making it difficult to ascertain ownership of the grain. In other words, while a buyer may receive a guaranteed quantity of wheat, it may not receive the actual grain which is delivered by the Canadian Wheat Board. Moreover, at no time during the transportation of the wheat does title in the wheat transfer to the elevator. The relationship is one of bailee-bailor in which the elevator maintains possession of the wheat on behalf of the Canadian Wheat Board until transfer to the purchaser takes place.

     On the basis of the above, the appellant claims a manufacturing and processing deduction for the years in question. The relevant statutory provisions are as follows:

Section 125.1:

(1) There may be deducted form the tax otherwise payable under this Part by a corporation for a taxation year an amount equal to 7% of the lesser of

(a) the amount, if any, by which the corporation's Canadian manufacturing and processing profits exceed, where the corporation was a Canadian-controlled private corporation throughout the year, the least of the amounts determined under paragraph 125(1)(a) to (c) in respect of the corporation for the year and

(3)(a) "Canadian manufacturing and processing profits" of a corporation for a taxation year means such portion of the aggregate of all mounts each of which is the income of the corporation for the year from an active business carried on in Canada as is determined under the rules prescribed for that purpose by regulation made on the recommendation for the Minister of Finance to be applicable to the manufacturing or processing in Canada of goods for sale or lease;

(b) "manufacturing or processing" does not include

(x) any manufacturing or processing of goods for sale or lease, if for any taxation year of a corporation in respect of which the expression is being applied, less than 10% of its gross revenue from all active businesses carried on in Canada was from

(A) the selling or leasing of goods manufactured in Canada by it, and

(B) the manufacturing or processing in Canada of goods for sale or lease, other than goods for sale or lease by it.

(4) For the purposes of subparagraph (3)(b)(x), where a corporation was a member of a partnership at any time in a taxation year,

(a) there shall be included in the gross revenue of the corporation for the year from all active businesses carried on in Canada, that proportion of the gross revenue from each such business carried on in Canada by means of the partnership coinciding with or ending in that year, that the corporation's share of the income of the partnership from that business for that fiscal period is of the income of the partnership from that business for that fiscal period;

Regulation 5202:

"qualified activity" means

(a) any of the following activities, when they are performed in Canada in connection with manufacturing or processing (not including activities listed in subparagraphs 125.1(3)(b)(i) to (ix) of the Act) in Canada of goods for sale or lease:

     During the years in question the elevator did not file a separate tax return but maintained separate books. A portion of the income from the elevator, that which was attributable to Range Grain through the joint venture, was included in the appellant's income in the years in question and the manufacturing and processing deduction under section 125.1 attributed to the income of Range Grain company. In calculating the manufacturing and processing profits for the year the appellant included as qualifying activities the laker revenue (all costs associated with transferring the grain into the elevator), conditioning costs (ventilating, fumigating and cleaning), and half the revenues for port charges, stevedoring and storage. The appellant submits that any activities associated with manufacturing and processing are qualified activities. Furthermore, the appellant submits that the storage of raw material used in processing is an activity connected with manufacturing and processing and, therefore, eligible for the manufacturing and processing deduction.

     During the taxation years in question the Minister treated the revenues from the grain elevator as revenue from a partnership. Pursuant to paragraph 125.1(4)(a) the Minister compared the net income from the grain elevator against the gross revenues of Range Grain (including the sale price of wheat and the commission) and determined that the grain elevator did not account for 10% of the company's revenues. The appellant contends that the grain elevator is not a partnership, but rather a joint venture and, therefore, the gross revenues from the elevator should be compared against the gross revenues of Range Grain. The respondent argues that even if that is correct, only those revenues that are legitimately manufacturing and processing should be included in the manufacturing and processing revenues from the elevator and that the taxpayer is claiming activities that do not qualify.

     Ultimately, the issue is which activities carried out by the elevator, if any, qualify as manufacturing or processing. If the respondent is correct and the activities carried out by the elevator are not manufacturing and processing goods for lease or sale within the meaning of the Act, then the appellant is not entitled to the deduction regardless of the percentages. Regulation 5202 makes it clear that qualified activities only include manufacturing and processing of goods for sale or lease in Canada.

     The manufacturing and processing deduction is designed, in part, to facilitate a reduction in the amount of tax payable on income earned in the manufacturing industry. The Federal Court of Appeal has described the purpose of section 127 of the Act, which was included in the same package of amendments as section 125.1, in The Queen v. Coopers & Lybrand Limited (1994), 94 D.T.C. 6541 at page 6548, as follows:

First, it is clear from the total context of the legislation, including the passages from the House of Commons Debates to which I have referred, that Parliament`s objective in enacting the legislation was encouragement of increased production of manufactured and processed goods to be placed on the domestic and international markets in competition with foreign manufacturers. That that is the activity which Parliament sought to encourage is, to my mind, plain from the debates. It is equally plain that Parliament intended to benefit manufacturers and processors who engaged in those activities. In other words, the relevant statutory provisions were designed to give Canadian manufacturers and processors an advantage over their competitors in the domestic and foreign markets. It is also clear that Parliament had in mind specific target groups and specific target activities. The legislation was not intended to benefit every manufacturing activity or every manufacturer.

As indicated previously, ultimately section 125.1 requires, that goods are manufactured or processed in Canada and that the goods be for sale or lease in Canada.

     A number of general principles as to the meaning of manufacturing or processing have evolved. Manufacturing and processing contemplates some change in the appearance or the nature of the good: Démolition A.M. de l`est du Québec v. M.N.R., [1993] 2 C.T.C. 2447 (T.C.C.); Harvey C. Smith Drugs Ltd. v. The Queen, [1995] 1 C.T.C. 143 (F.C.A.); Federal Farms Limited v. Minister of National Revenue (1966), 66 D.T.C. 5068 (Ex.Ct.). Processing should make the product more marketable: Démolition A.M. de l`est du Québec v. M.N.R., supra. This principle reflects the statutory requirement that the goods be for sale or lease. By way of example, materials recovered from demolished buildings and improved for sale qualified as goods which were manufactured or processed for sale in Canada: Démolition A.M. de l`est du Québec v. M.N.R., supra.

     The manufacturing or processing of a good contemplates that the process be considered as a whole and not divided into separate components. In this regard, the regulations specify that activities associated with manufacturing and processing such as receiving and storing raw materials, inspecting and packaging final goods, pollution control and support activities are qualified activities for which the deduction may be claimed (Reg 5202). In The Queen v. Veritas Seismic (1987) Ltd. (1994), 94 D.T.C. 6123, however, the Federal Court of Appeal found that goods produced incidentally to a system of analyzing raw data were not manufactured or processed goods for sale or lease. In that case it was held that the court must consider the overall integrated operation and not look at particular parts of an operation in isolation in order to determine the activity from which the business earns its income: Veritas, supra, at page 6124.

     The second requirement of section 125.1 is that the goods processed or manufactured be for sale or lease in Canada. Two lines of cases have evolved regarding this issue and were described by the Federal Court of Appeal in The Queen v. Coopers & Lybrand Limited, supra, at page 6547, as follows:

In Crown Tire, Strayer was required to construe the phrase as it is used in paragraph 125.1(3)(a) of the Act. He approached construction on the basis that by using the phrase "goods for sale" without defining it, Parliament must have intended that its meaning should be derived from the general law of contract and sale. In that case he applied the common law distinction between contracts for sale and contracts for work and materials and reached a conclusion based upon it. In Nowsco and Halliburton, Urie J.A., for the Court adopted a passage from the reasons of Reed J. in Halliburton in which she rejected the meaning based upon the common law distinction, opting instead for one based upon a literal construction of the word "sale", such that any transfer of property manufactured by a taxpayer to a customer for a consideration, regardless of the nature of the contract between them, would amount to a sale within the meaning of the legislation.

It is important to note that in Halliburton, above, the taxpayer's business involved the cementing of wells for oil and gas companies. In that case, the taxpayer custom-made the cement for each cementing operation. The Court considered this process to involve the production of a good prior to its use in the provision of a service. Regarding these two interpretations, the Federal Court of Appeal determined in Coopers and Lybrand, supra, that the Crown Tire approach was preferable and that these sections should be interpreted according to the general law of lease and sale (at page 6548).

     Finally, in considering whether a contract is for sale or for services, considerable emphasis has been given to the ownership of the product by the courts. In the case of retreaded tires, the court held that the fact that the owner maintained title to the product throughout mitigated against the contract being considered a contract of sale: Crown Tire Service Ltd. v. The Queen (1983), 83 D.T.C. (F.C.T.D). Similarly, where the taxpayer was involved in the repair of airplane engines and the engines remained the property of the customer throughout it was found that no goods were for sale or lease in Canada: Rolls Royce (Canada) v. The Queen (1993), 93 D.T.C. 5031.

     In the case at bar, the respondent does not dispute that some manufacturing or processing may have occurred at the grain elevator. While there is some dispute as to which activities may qualify under that head, both parties agree that some processing did occur. The respondent submits, however, that these activities do not amount to the processing of goods for sale or lease. In the submission of the respondent, the appellant operated a transportation service and any processing which occurred was simply incidental to that service, as in Veritas, supra.

     The appellant argues that the grain industry in Canada is unique and that the entire system must be taken as an integrated system for producing a good for sale. The appellant argues that grain is a live good which requires special treatment. Furthermore, the appellant argues that the entire grain industry, comprised largely of an integrated grain elevator system, is designed to ensure that the product arrives in good condition on the boats for export. The transfer elevator is argued to be but one portion of that entire processing system. In essence, the appellant submits that the process of getting the grain from the field to the tanker is a manufacturing and processing system which must be considered in its entirety and not as discrete components: Midland Transport, supra.

     Obviously, to maintain its international status as a leading provider of grain to world-wide markets, Canadian grain must be prevented from deteriorating throughout the transfer process. I cannot agree with the appellant, however, that the entire grain system in Canada involves manufacturing and processing within the meaning of section 125.1. In my opinion, the grain elevator in question was used primarily for transportation purposes. The grain elevator was utilized by the Canadian Wheat Board to ensure that the grain reached ocean going vessels for export, and not to further refine or process the wheat. The appellant was paid for a transportation service, not processing services.

     It is obvious that some processing did occur during the transportation process; however, not every type of processing will qualify under section 125.1. I am satisfied that the processing, in this case, was for the strict purpose of maintaining the product, not improving or changing it. When the appellant's elevator received the grain it had already been processed for sale. The appellant simply ensured that the wheat did not become any less marketable and did not make the product more marketable within the meaning of the jurisprudence. Maintaining the quality of a good is incidental to any transportation of goods and is not the type of activity contemplated by parliament in permitting the deduction under section 125.1 of the Act.

     Moreover, the appellant did not own the grain and carried out a contract for service, namely transportation, and not for manufacturing and processing: Coopers and Lybrand, supra. While ownership is certainly not determinative of the question of processing a good for sale, it reinforces my view that the appellant was performing a service and not involved in the production of goods for sale within the meaning of section 125.1 of the Act.

    

     Given my findings above, it is not necessary to consider the percentage of activities at the elevator which qualify as processing or manufacturing under the Act. Only those activities which are processing or manufacturing of goods for sale or lease in Canada qualify for this deduction. Since the appellant does not meet this requirement, the section does not apply.

     Accordingly, for the reasons set out above, the appellant's appeal shall be dismissed. Costs shall be in the cause.

                         "H. WETSTON"

                    

                         J.F.C.C.

Toronto, Ontario

March 7, 1997

     FEDERAL COURT OF CANADA

     Names of Counsel and Solicitors of Record

COURT NO:                  T-411-88

STYLE OF CAUSE:              RANGE GRAIN COMPANY LIMITED

                    

                     - and -

                     HER MAJESTY THE QUEEN

DATE OF HEARING:          DECEMBER 18, 1996

PLACE OF HEARING:          WINNIPEG, MANITOBA

REASONS FOR ORDER BY:      WETSTON, J.

DATED:                  MARCH 7, 1997

APPEARANCES:

                     Mr. Richard Pound, Q.C.

                         For the Appellant

                     Mr. Donald Gibson

                         For the Respondent

SOLICITORS OF RECORD:

                     Stikeman, Elliott

                     Barristers & Solicitors

                     Suite 3900

                     1155 Boulevard René-Lévesque Ouest

                     Montréal, Québec

                     H3B 3V2

                                 Tel. (514) 397-3037

                         For the Appellant

                      Department of Justice

                     Justice Building

                     239 Wellington Street

                     Ottawa, Ontario

                     K1A 0H8

                                 Tel. (613) 957-4883

                     George Thomson

                     Deputy Attorney General

                     of Canada

                         For the Respondent

                     FEDERAL COURT OF CANADA

                     Court No.:      T-411-88

                     Between:

                     RANGE GRAIN COMPANY LIMITED

     Appellant

                         - and -

                     HER MAJESTY THE QUEEN

     Respondent

                     REASONS FOR DECISION