Brulé, T.C.C.J.:—Each of these appellants was reassessed for their 1985, 1986 and 1987 taxation years on the basis that their claims for manufacturing and processing deductions were denied. Each appellant appeals from the decision of the Minister.
At the outset of the hearing it was agreed that the appeals be heard on common evidence.
By way of background a brief description of the appellants is useful.
The first appellant, Industrial Forestry Service Ltd. ("I.F.S.") is a company incorporated on January 5, 1954, under the British Columbia Company Act. I.F.S. carries on the business of providing forestry and engineering services to companies involved in the forest industry. I.F.S. also carries on a map-drafting function in connection with these activities.
In 1978, I.F.S. purchased a precision stereoplotter instrument in order to produce maps for companies engaged in the forest industry and other interested purchasers. In 1984, the company established a digital mapping system. The revenue from this activity accounts for approximately 12 per cent of total revenue for the 1985, 1986 and 1987 taxation years.
In filing its income tax returns for its 1985, 1986 and 1987 taxation years, I.F.S. took the position that the map-making part of its business was distinct from the map-drafting part and that it should qualify for the manufacturing and processing deduction in subsection 125.1(3) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").
The second appellant, Douglas Photogrammetric Inc. ("D.P.I.") is a company incorporated on August 20, 1980, under the British Columbia Company Act and has been a wholly owned subsidiary of the first appellant, I.F.S., since 1982. D.P.I. was incorporated to carry out aerial triangulation work for I.F.S. and other map-producing companies.
In 1982, D.P.I. developed a new business consisting of marketing aerial photographs and maps and is an authorized retailer of maps for Maps B.C.
During the 1985, 1986, and 1987 taxation years, D.P.I.'s revenue from aerial triangulation accounted for 77 per cent, 79 per cent, and 69 per cent respectively, of its total revenue, with aerial photographs and mapsales accounting for the remainder.
In filing its income tax returns for the 1985, 1986 and 1987 taxation years, D.P.I. claimed manufacturing and processing deductions. By notices of reassessment issued on January 4, 1990, the respondent reassessed the appellants 1985, 1986 and 1987 taxation years to disallow the manufacturing and processing profits deduction claimed.
Issue
The sole issue is whether the appellants were in the business of manufacturing or processing goods for sale in the areas of their corporate operations for which deductions were claimed.
Facts
While the facts were not in dispute the Minister took the position that each appellant was rendering a service.
Counsel for the appellants set out in evidence their activities in connection with these appeals and a summary follows.
Industrial Forestry Service Ltd.
While this appeal deals only with digital map-making a description of analogue map-making is useful in the appreciation of digital map-making.
(1) Analogue Map-Making
Analogue map-making commences with setting up stereo models (pairs of adjacent photograph diapositives) on a precision stereoplotter photogrammetric instrument using the products of the aerial triangulation process previously described under D.P.I. operations. The stereoplotter operator then draws the map on the base mapsheet framework (also a product of D.P.I. aerial triangulation) as he follows the details of planimetry (roads, watercourses and other identifiable physical features) on the stereo model. If topographic information in the form of contours is required, the position of contours can also be drawn by following a particular elevation on the ground in the stereo model, which appears in exaggerated three dimensions to the stereoplotter operator. When all required detail has been completely drawn on a base mapsheet it may be delivered as is, in manuscript form, to the customer or, more commonly it is carefully redrawn by a draftsperson to improve the appearance, correct minor errors and add textual information. This redrawing may be in the form of ink lines on mylar film or scribed lines on coloured film. Scribing is used if multicolour or other special effects are required when multiple copies are later reproduced.
(2) Digital Map-Making
Digital map-making is similar to analogue map-making except that the data captured by the stereoplotter operator is stored in computer memory rather than being drawn onto a base mapsheet. The digital framework for the data capture is obtained from the computer tape product of D.P.I. aerial triangulation. For digital topographic maps, the elevation data may be captured either as contours in the same manner as analogue mapping or as a Digital Elevation Model ("D.E.M."). A D.E.M. consists of a large number of measured ground elevation points either systematically or randomly distributed over the area of the map.
When topographic information is recorded as a D.E.M., contours can be later drawn by a computer using software specifically written for this purpose. To produce clean digital topographic maps requires that the data collected from each stereo model be joined with that from adjacent models, textual information added and the final mapsheet data-set "clipped" to the boundaries of the mapsheet. This work is accomplished by map editors using the KORK digital mapping system on computer graphics workstations. When a digital map is complete and has passed all quality control checks, the computer file is stored on computer tape and plotted by computer on mylar film. Both the tape and the plotted products are delivered to the customer.
Customers for I.F.S. photogrammetric maps include the departments of provincial and federal governments, municipalities, forest companies, mining companies and railways. The work is always priced not on the amount of hours of labour or use of machinery but on the basis of a quoted lump sum for the project or on a quoted price per unit of area covered by the map.
The final product in reproducible form is always delivered to the customer. I.F.S. is not able to provide copies of maps made for one customer to another customer. Rather than do the work over again when a map for the same area is requested, I.F.S. either has the second customer purchase the maps from the first customer or buys the maps back if some enhancements are required for the second customer.
Douglas Photogrammetric Inc.
Aerial Triangulation Process
Inputs required for aerial triangulation are:
1. Aerial photograph prints and diapositives (positive transparencies). 2. Field survey coordinates for control points.
3. Aerial photographs (usually large scale) showing the location of the survey control points.
4 For some types of mapping coordinates of a large number of points can be obtained from existing maps and a statistical analysis rejecting those that fit poorly can produce an acceptable substitute for the surveyed control. Aerial triangulation is required to produce the base map framework on which subsequent detailed mapping is filled in so that mapping from individual stereo models (two adjacent aerial photographs) can be joined together to produce an accurate map controlled to real earth coordinates. The process is as follows:
1. Control points are transferred from the control point photography to the mapping photography diapositives using a zoom point transfer device. A precise fine hole is actually drilled or melted in the diapositive at the exact point.
2. A network of identifiable points are marked on adjacent photograph diapositives (each point marked on two or more diapositives) in the same way as the control points are marked. This network is carefully designed to connect adjacent photographs in a line of photographs (pass points) and to connect adjacent lines of photography (tie points).
3. All control, pass and tie points are aerial marked on the aerial photograph prints and numbered for identification.
4. Each diapositive is set up on a precise monocomparator with which an operator can measure the photo coordinates of all the control, pass, and tie points. In the appellants system, these coordinates are automatically stored in the memory of a Digital VAX 11/780 computer.
5. The final matrix of photo coordinate measurements, together with ground coordinates data for the control points is then processed through several computer programs to determine the adjustments required to produce an overall best fit to the known control point data. Several computer runs through the programs are often required due to survey data errors, adjusting the weights given to control data with different accuracy specifications, etc.
Products of aerial triangulation consist of the following:
1. A set of aerial photograph prints and diapositives with control and pass points marked and identified to allow stereo models to be set up on photogrammetric mapping instruments.
2. A report detailing the results of the computer adjustment and including specific model set-up instructions for each stereo model.
3. A computer tape, if required, containing all of the results of the computer adjustment including the set-up coordinates for customers who carry out digital mapping.
4. A computer plotted map showing the location of each stereo model, the control survey points used and the location of mapsheet boundaries if required.
5. Computer plotted base mapsheets for analogue mapping (not provided to digital mapping customers) showing geographic and other coordinates, identified control and pass points and all other information necessary to commence filling in the map detail using an analogue photogrammetric instrument (stereoplotter).
D.P.I. has a fixed charge schedule which applies to all customers. Aerial triangulation is charged on a per stereo model basis with an extra charge for each plotted base mapsheet. Invoices indicate that customers are not charged for work done but for the products.
If the result of the computer adjustment fails to measure up to the customer's specifications in any way, it will be returned to D.P.I., at no cost to the customer, for another computer run.
D.P.I. does not hold title to, or even retain copies of the results of aerial triangulation. All products are delivered to the customer at the completion of the work. If any D.P.I. aerial triangulation product was required for a project for a different customer, the company would negotiate with the first customer to obtain the rights to use it.
Analysis
The applicable section of the Act reads as follows:
125.1(3)(a) " Canadian manufacturing and processing profits” of a corporation for a taxation year means such portion of the aggregate of all amounts each of which is the income of the corporation for the year from an active business carried on in Canada as is determined under rules prescribed for that purpose by regulation made on the recommendation of the Minister of Finance to be applicable to the manufacturing or processing in Canada of goods for sale or lease; and . . .
It has been pointed out that when dealing with manufacturing and processing cases, it is important that a common sense, realistic and business-like appreciation of all the facts be taken (see Canada v. Nowsco Well Service Ltd., [1990] 1 C.T.C. 416, 90 D.T.C. 6312, at page 424 (D.T.C. 6318)).
These appeals, probably more so in D.P.I.'s case, closely resemble that in Design One Graphic Production Ltd. v. M.N.R., [1991] 2 C.T.C. 2667,92 D.T.C. 1006. In that case the appellant corporation was involved in producing final art boards to sell to customers who would then use them to create flyers. This was a type of framework for the flyer. Notwithstanding the fact that the product was of no use in itself, it was essential as a product to produce a four colours flyer. Title to the final art board passed to the customer upon delivery, and after printing, the customer retained it. Teskey, J. ruled that the appellant did not enter into a pure service contract but manufactured goods to the customer's specifications which the customer then used to create flyers.
The respondent's position is that the companies are performing a service, and if it is not a service, it is still not manufacturing or processing. The argument is that I.F.S. and D.P.I. are service companies whose activities consist of obtaining, compiling, transferring and analyzing data. Following Nowsco, supra, the focus should be on the profit-generating activity. The end products here, the maps and the frameworks, are the manipulation of this data and not the essence of the profit-making activities. There is no printing, only the production of a prototype, and there is no mass production. The material costs are negligible in relation to the labour and machinery costs.
The appellants argue that both the corporations come within section 125.1 of the Act because they both produce a product: While D.P.I. makes a frame work for maps, I.F.S. produces finished maps. The end result is an item produced by a process, not by manufacturing. Canada v. Halliburton Services Ltd., [1990] 1 C.T.C. 427, 90 D.T.C. 6320 and Nowsco, supra, both say that if the end result is a good, even though a service is being provided, the company is processing. In any event, both companies contend that there are no services provided in connection with the production of maps and frameworks. In the present case if a service is required it is invoiced separately.
In order to qualify for the deduction, a corporation must come within the meaning of the words “ manufacturing or processing in Canada of goods for sale or lease", jurisprudence has dealt extensively with these last words of the section, and I thus propose to detail what was said about each.
Manufacturing or Processing
According to Federal Farms Ltd. v. M.N.R., [1966] C.T.C. 62, 66 D.T.C. 5068, the words "manufacturing" and "processing" must be used in their ordinary unrestricted senses. The reason for this is that if the words were not intended to be used in their ordinary senses, it would be unnecessary to make a specific enumeration of those types of businesses which are excluded under this section, i.e., 40A (since repealed but now enacted as section 125.1 of the Act).
In this Federal Farms case, supra, Cattanach, J. said at page 67 (D.T.C. 5071-72):
While I am aware that dictionaries are not to be taken, in all instances, as authoritative exponents of the meaning of words as used in Acts of Parliament, nevertheless when words are used in their ordinary sense (as I have concluded they are in the section under which the present appeal is made) it is then appropriate that resort be had to recognized dictionaries for it is in these books that the ordinary meaning of a word is ordinarily to be found.
The word "process" is defined in the Shorter Oxford English Dictionary, Third Edition, as "To treat by a special process: e.g. to reproduce (a drawing, etc.) by a mechanical or photographic process."
In Webster Third New International Dictionary published in 1964 the word "process" is defined as follows, “to subject to a particular method, system or technique of preparation, handling or other treatment designed to effect a particular result: put through a special process as (1) to prepare for market, manufacture or other commercial use by subjecting to some process (-ing cattle by slaughtering them) (-ed milk by pasteurizing it) (-ing grain by milling) (-ing cotton by spinning):
In Webster's Second New International Dictionary published in 1959 the following definition of the word ” process" appears, "To subject (especially raw material) to a process of manufacturing, development, preparation for market, etc.; to convert into marketable form as live stock by slaughtering, grain by milling, cotton by spinning, milk by pasteurizing fruits and vegetables by sorting and repacking."
Other standard works consulted define “process” as "to treat, prepare, or handle by some special method.
Although Federal Farms, supra, used the ordinary meaning of the word "processing", Harvey C. Smith Drugs Ltd. v. M.N.R., [1986] 1 C.T.C. 2379, 86 D.T.C. 1243 decided that in the context of a pharmacist dispensing prescription drugs from bulk containers in smaller quantities, the ordinary meaning was too general. In this decision, I gave guidelines for the interpretation of this word, including whether the process changed the product in its form, appearance or other characteristic and whether the process made the product more marketable.
In B.B.G.P. Inc. v. M.N.R., [1987] 1 C.T.C. 2162, 87 D.T.C. 108, the appellant corporation was in the business of designing, developing and implementing computerized accounting systems. It would examine a customer's needs then prepare a program for the customer. The customer had all the necessary information, including sales figures, inventory, costs, and prices, and the company would supply the program structure. Yet the financial statements showed that all the revenue was derived from professional fees. There were no figures for sales, sales costs or other accounting details used by a manufacturer. Rip, J. did not allow the appeal because he did not believe that the process of developing a system was a manufacturing stage. His view was that only once had the system been created could it be transformed into tangible property and its manufacture begun.
In the present appeal, both the ordinary and the qualified meanings of the word "processing" may be used to determine that each appellant comes within the section. D.P.I. goes through a series of operations to produce the framework. In addition, notwithstanding the fact that it is a smaller part of the operation, D.P.I. also changes a product in its form or appearance by drilling holes in and marking points on diapositives and photograph prints.
I.F.S. also goes through a series of operations to produce a map. As well, it takes the digital framework obtained from aerial triangulation and modifies it by adding more information. From this a map is drawn, but the computer tape with the modified aerial triangulation is delivered to the customer. Its form has been changed.
Goods
In order to qualify for the deduction, the company must be manufacturing or processing goods. In Canadian Wirevison Ltd. v. The Queen, [1979] C.T.C. 122, 79 D.T.C. 5101, the Court found that television and radio signals transmitted by the company to subscribers were not "goods" within the meaning of section 125.1 of the Act because they were not tangible, moveable property.
In MDS Health Group Ltd. v. The Queen, [1979] C.T.C. 337, 79 D.T.C. 5279, Gibson, J. did not allow the appeal because reports on the analysis of various specimens were not "goods" for the purposes of the section. These reports were not the end product of the specimens, and the analysis of the specimens ended in nothing that could become the subject of a sale.
In McGraw-Hill Ryerson Ltd. v. The Queen, [1980] C.T.C. 280, 80 D.T.C. 6211, Mahoney, J. decided that the appellant corporation was not only selling information in the books but the books themselves. He said at page 283 (D.T.C. 6214):
The plaintiff does not sell only the information contained in the books it sells any more than an automobile manufacturer sells only the transportation capability of the vehicles it sells. The plaintiff sells the books. Those books are goods. It may be that it is the information content that gives a book its value, as it is the transportation capability that gives a motor vehicle its value, but the subject matter of sale is the book, as it is the vehicle.
I believe that both appellants are processing goods. Exhibits A-5 and A-8 placed in evidence show that I.F.S. is producing tangible, moveable property while Exhibits A-6 and A-7 show the same for D.P.I. In contrast to MDS Health Group, supra, the framework is the end product of the process of aerial triangulation and the maps are the end product of the processing of the framework. The analysis of the data here does end in something that can become the subject of a sale. And in keeping with McGraw-Hill, supra, the appellants are not only selling data or the manipulation of data. They are selling maps and frameworks. Notwithstanding that it is the data content that gives these goods their value, the subject matter of the sales are the maps and the frameworks.
Goods for Sale or Lease
To qualify for the deduction, not only must the taxpayer be manufacturing or processing goods, but these must be goods for sale or lease. Many cases illustrate the application of this requirement. While some cases characterize the test as one distinguishing between contracts for the sale of goods and contracts for work and materials, other cases look to the source of profit or to the substance of the contract. Views as to which test applies differ depending on the facts of each case.
Contracts for work and materials vs. contracts for the sale of goods
In Crown Tire Service Ltd. v. The Queen, [1983] C.T.C. 412, 83 D.T.C. 5426, the company was involved in retreading worn tires for customers. As the customers retained ownership of the tires throughout the process, the company could not have been manufacturing or processing goods for sale. Strayer, J. cited Benjamin's Sale of Goods, (London, 1974) to explain the general principle applicable to the situation at page 414 (D.T.C. 5428):
Where work is to be done on the land of the employer or on a chattel belonging to him, which involves the use of affixing of materials belonging to the person employed, the contract will ordinarily be one for work and materials, the property in the latter passing to the employer by accession and not under any contract of sale.
In Cabana, Seguin Inc. v. M.N.R., [1982] C.T.C. 2363, 82 D.T.C. 1360, the appellant corporation was in the advertising business. Customers would commission the company to deliver a brochure or catalogue, yet the clients were free to have the brochure or catalogue printed elsewhere. The evidence showed that the orders placed by the customers called for more in the way of expertise on the part of the appellant than of equipment, machinery, and labour. The appeal was dismissed when the Tax Review Board decided that the company was much more involved in the provision of a service than in the sale of a finished product. R. St. Onge, Member, cited from“ Definition of Contract of Sale” in his decision at page 2367 (D.T.C. 1364):
Contracts for the provision of services may include within their scope the transfer of goods from one person to another, where the service involved is the making of something.
There has been some variation in the views expressed in English and Canadian courts. Whereas in Clay v. Yates, the view was adopted that the test was whether the work or the material was the essence of the contract, Lee v. Griffen, Blackburn J. said that the true test was the value of work as contrasted with the value of the materials. In Robinson v. Graves the Court of Appeal in England, deciding that a contract to paint a portrait was contract for work and materials not one of sale of goods, did not entirely approve of the language of Blackburn J. in Lee v. Griffen, but adopted his idea that the substance of the contract must be regarded and a decision made in accordance with the way a reasonable man would describe the transaction.
In other words, if the primary object of the contract is the transference of property in something which was not originally the property of the "buyer", the contract will be one of sale of goods: but if the primary purpose of the parties is the performance of certain work, or the provision of services, incidentally to which property in goods is to pass from one party to the other, the contract will not be one of sale of goods.
Cabana, supra, is distinguishable from Design One Creative Graphic Production Ltd., supra, on the facts. In Design One, the customer had the option of relying upon the company's expertise for the format or instructing the company as to the format. As well, the company did all the printing, photographing, and drawing itself, whereas in Cabana, supra, this work was assigned to a subcontractor.
Source of profit
In Canada v. Halliburton Services Ltd., supra, the company was hired not only to provide specialized cement but also to place that cement in the well hole around the casing pipe. The evidence revealed that the customer was billed for both the services and the material.
In a decision confirming that of the Federal Court-Trial Division, in Halliburton, supra, Urie, J.A. at pages 428-29 (D.T.C. 5338) cited with approval the words of Reed, J. In her decision to allow the appeal, she had not accepted the distinction between contracts for the sale of goods and contracts for work, labour and materials. She found first that the distinction was developed for purposes of the sale of goods legislation and not with respect to paragraph 125.1(3)(b) of the Act. Secondly, she was of the view that the source of profit was important, not the nature of the taxpayer's contract with the customers. And finally, she thought that the distinction would create an illogical result. If a manufacturer of a product merely sold the product, he would be entitled to the deduction, but if he also provided a service in connection with this product, he would be denied the deduction.
In Canada v. Nowsco Well Service Ltd., supra, the Federal Court of Appeal allowed the deduction, the view being that the company processed goods to the customer's specifications which it then used to perform the specialized services required. The Court, agreeing with Reed, J. in Halliburton, supra, refused to apply the test established in Crown Tire, supra, because it was inappropriate in this context to attempt to distinguish between a contract for the sale of goods and one for the sale of services.
Substance of the contract
In Dixie X-Ray Associates Ltd. v. The Queen, [1988] 1 C.T.C. 69, 88 D.T.C. 6076, the appellant corporation was in the business of processing and developing x-ray films of patients for diagnostic purposes. McNair, J. found that the substance of the contract with the patient was the provision of services in which the passing of property in x-ray films was merely ancillary or incidental thereto. He said at page 74 (D.T.C. 6079):
The test for determining whether a contract is one for the sale of goods or for the supply of services is to ask the question: What is the substance of the contract? If the substance of the contract is the production of something to be sold and the transference of property therein to a buyer then the contract is a sale of goods. But if the real substance of the contract is the skill and labour of the supplier in the performance of work for another then that is a contract for work and labour, notwithstanding that property in some materials may pass under the contract as accessory thereto.
A similar case is Reg Rad Tech Ltd. v. Canada, [1990] 2 C.T.C. 77, 90 D.T.C. 6350 where the appellant corporation was formed by a partnership of medical doctors. The company purchased raw film, took x-rays or ultrasound thereon, developed the film, and sold it to the partnership whose members then used it to make diagnoses. The deduction was not allowed in this case, Collier, J. viewing the substance of the business as providing services to the patients and the partnership, and the sale of the developed film as but a minor step in this process. He distinguished Halliburton and Nowsco (both supra) by reason that the appellants in those cases were engaged, as one of their primary purposes, in the processing of goods for sale. Here, the appellant company was primarily providing services to the patients and the radiologists. (This decision was upheld by the F.C.A on September 4, 1991.)
In my opinion, all three of the tests favour the appellants positions. With respect to the distinction between contracts for the sale of services and contracts for the sale of goods, it can be said that the primary object of contracts between the appellants and their customers is the transference of property in something. The appellants receive requests to make maps or frameworks, they process their materials, and they deliver the end product to the customer. They are paid for their products, not on the basis of labour involved. The customer then has full ownership of the product. There is no payment for the provision of services.
With respect to the source of profit test, the result leads me to the same conclusion. Halliburton and Nowsco (both supra) both dealt with companies that provided both services and goods at the same time. The source of profit was examined to determine whether or not the goods made a profit. In the present appeal, there are no services being provided with the goods. The goods are made and delivered to the customer. The invoices, produced for the Court, indicate clearly that the map or the framework is the source of profit.
With respect to the substance of the contract, Dixie X-Ray, supra, states that it is necessary to ask whether the contract calls primarily for work and labour for another or for the production of something to be sold. Clearly the contracts call for something to be sold. Of course skill, labour and machinery are absolute essentials for the production of these products, yet this can be said about nearly every item that is produced. The appellants are not hired to work for their customers but are commissioned to supply their customers with specific products.
Conclusion
The respondent maintains that the appellants are providing services. The evidence shows however, that the appellants are being asked to supply maps and framework for maps, not to work for the customers.
The respondent also maintains that the appellants are not manufacturing or processing. Based on the actual activities involved, it is my opinion that the appellants are processing goods for sale.
I believe that with a common sense, realistic and business-like appreciation of all the facts, it can be said that both appellant corporations are in the business of manufacturing or processing in Canada goods for sale or lease.
The appeals are allowed with costs, and are referred back to the Minister for reconsideration and reassessments.
Appeals allowed.
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