Her Majesty the Queen v. Veritas Seismic (1987) Limited, [1994] 1 CTC 241

Pratte, J.A. (Létourneau, McDonald, JJ.A., concurring):— This is an appeal from a judgment of the Canadian Tax Court allowing the respondent's appeal from its income tax assessment for the 1988 taxation year on the basis that, contrary to what had been assumed in making that assessment, the respondent was entitled to the deduction provided for in subsection 1251(1) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") since more than 90 per cent of its profit for that year had been derived from the manufacturing or processing in Canada of goods for sale in Canada.

The only issue on this appeal is whether the Tax Court correctly held that the bulk of the respondent's income for 1988 was derived from the "manufacturing and processing ... of goods for sale. . . ."

The respondent recruits its customers in the oil and gas industry. It is involved in the making, following the "seismic method", of images of sections of the earth in given areas. These images are displayed on plastic sheets called "seismic sections” and their study allows geophysicists to detect the presence of oil or gas.

At the hearing, counsel for the respondent expressed his agreement with the description of the respondent's activities found in the appellant’s factum. I will just summarize that description.

The seismic method involves three steps: the recording of the seismic data in the field, the processing of those data and, finally, the interpretation of the seismic data. The respondent is involved only in the second stage, the processing of the data.

In the first stage, the respondent's customer collects certain data in the area to be explored. A charge of dynamite is exploded in the area and the effect of that explosion, which sets off energy that goes down in the earth and comes back to the surface after being reflected by various geological formations, is recorded on tapes by sensitive listening devices. These tapes, together with other information on the area to be explored as well as on the effects of the explosion, are provided to the respondent by its customer.

At the beginning of the second stage, the information on the field tapes is transferred by the respondent to tapes of a different format compatible with its computers. The field tapes are then returned to the customer. (The other information received from the customer is retained until the completion of the project.) The seismic material appearing on the tapes is thereafter subjected to 23 operations which are primarily applications of computer programs in which the respondent's employees determine and apply various mathematical parameters to the information. At the conclusion of these complex computerized operations, the respondent has extracted from the raw data and information received from its client new information enabling it to create an image of the section of the surface of the earth in the area to be explored. That image is displayed on a sheet of plastic, the “seismic section". From that section, the respondent produces an output tape containing the same information as the section. Both the section and the tape are delivered to the customer who must then submit them to a geophysicist for interpretation.

It is important to note that, as the respondent does not own the information received from its customers, it cannot dispose of the further information extracted from that raw information but must deliver it to its customers who, however, may choose to sell the seismic sections and tapes to third parties rather than use them for their own purposes.

Finally, it is common ground that once the new information has been extracted from the raw information provided by the customers, the costs of printing that new information on the seismic sections and the output tapes is minimal.

On that evidence, the Tax Court held that the seismic sections and output tapes produced by the respondent were goods, that those goods were manufactured or processed by the respondent and that title to those goods passed from the respondent to its customers in the course of the respondent's earning activities. It concluded that the respondent was engaged in the manufacturing or processing of goods for sale in Canada and had derived more than 90 per cent of its 1988 profit from that activity.

This decision, in my view, cannot stand. It is based on the erroneous assumption that if an income earning activity culminates in the production of tangible property having a market Value, the earnings resulting from that activity are necessarily derived from the manufacturing or processing of goods.

In order to determine whether a taxpayer is engaged in the manufacturing or processing of goods, one must consider realistically the whole of the taxpayer's activity; it is not sufficient to have regard to one aspect only of that activity.

The summary that I made of the respondent's business shows, in my view, that the respondent was providing services to its customers by processing the raw information received from them, and derived its income from that activity rather than from the manufacturing or processing of goods. Indeed, the only part of the respondent's activities that might perhaps be characterized as manufacturing or processing was the actual physical preparation of the seismic sections and the output tapes. However, those two simple operations, which were necessary in order to convey the result of the respondent's work to its customers, were not, in themselves, the source of its income. The real source of that income was the processing of information which cannot be equated to the processing or manufacturing of goods.

Both counsel referred in their argument to the decisions of this Court in Nowsco Well Service Ltd. v. Canada, [1990] 1 C.T.C. 416, 90 D.T.C. 6312, and Halliburton Services Ltd. v. Canada, [1990] 1 C.T.C. 427, 90 D.T.C. 6320, two judgments which, in my view, have little relevance to the issue raised by this appeal. In both those cases, it was common ground that a substantial part of the taxpayer's income came from the disposition, in favour of its customers, of goods that it manufactured or processed; the only question, which the Court answered in the affirmative, was whether those goods could be said to be manufactured or processed "for sale" within the meaning of paragraph 125.1 (3)(b) of the Income Tax Act even though the contracts whereby the taxpayer disposed of them in favour of its customers were contracts for work and material rather than for the sale of goods.

I would allow the appeal with costs, set aside the decision of the Tax Court allowing the respondent's appeal and, rendering the judgment that ought to have been given by that Court, I would dismiss with costs the respondent's appeal from its 1988 income tax assessment.

Appeal allowed.