Funtronix Amusements Ltd. v. Minister of National Revenue, [1989] 2 CTC 2296

Garon, T.C.J.: —In this case the appellant appeals reassessments made by the respondent for the 1982 and 1983 taxation years. These appeals have to do with the proper classification, for capital cost allowance purposes, of electronic video game equipment purchased by the appellant during these two years.

In computing its taxable income for its 1982 and 1983 taxation years the appellant deducted the amounts of $151,729 and $174,193 with respect to the capital cost to it of electronic video game equipment on the basis that such property fell within Class 10 in Schedule II of the Income Tax Regulations, being, “general-purpose electronic data processing equipment and systems software therefor, including ancillary data processing equipment, acquired after May 25, 1976. . .". The maximum rate of deduction for capital cost allowance purposes for property of Class 10 is 30 per cent.

The Minister reassessed the appellant for its 1982 and 1983 taxation years and added to the appellant’s income $50,577 in its 1982 taxation year and $47,423 in its 1983 taxation year by disallowing a portion of the capital cost allowances claimed on the basis that the equipment in question should be properly falling in Class 8 of Schedule II of the Income Tax Regulations. That class is the catch-all category for tangible capital property. The applicable maximum rate, for capital cost allowance purposes, for property of that Class is 20 per cent.

In a nutshell, the issue in this case is whether the video equipment referred to in the pleadings is "general-purpose electronic data processing equipment" as defined in subsection 1104(2) of the Income Tax Regulations. This subsection reads as follows:

(2) In this Part and in Schedule II,

''general-purpose electronic data processing equipment" means electronic equipment that, in its operation, requires an internally stored computer program that

(a) is executed by the equipment,

(b) can be altered by the user of the equipment,

(c) instructs the equipment to read and select, alter or store data from an external medium such as a card, disk or tape, and

(d) depends upon the characteristics of the data being processed to determine the sequence of its execution.

The appellant is a body corporate incorporated pursuant to the Alberta Companies Act in 1980 and continued under the Alberta Business Corporations Act in 1983. At all times material hereto, the appellant was a resident of Canada for purposes of the Income Tax Act and was engaged in the business, inter alia, of acquiring from manufacturers, installing and operating portable electronic equipment at several locations in the City of Calgary, together with all activities ancillary thereto, with a view to profit. In the course of carrying on its business, the appellant acquired computerized electronic equipment whose configuration and accessories permitted the appellant to install and operate such equipment as coin-operated electronic games. These electronic games were placed at establishments such as military bases, universities, technical institutes and amusement arcades.

It is common ground that the video equipment with which we are concerned here is “an electronic equipment that, in its operation, requires an internally stored computer program that is executed by the equipment". Accordingly, the first requirement of the definition of "general-purpose electronic data processing equipment" is applicable to the video games with which we are concerned here.

The second requirement of that definition is that the internally-stored computer program “can be altered by the user of the equipment". There was much discussion about this aspect of the definition and it can be considered to be the central point of the respondent's argument. However, it was made clear by counsel for the respondent that it was his submission that the other two requirements of the definition set out in paragraphs (c) and (d) of subsection 1104(2) were not met in the case of the property at issue.

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

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

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

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

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

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

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

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

The matter could also be looked at from another angle. In effect, the evidence clearly showed that the appellant was the user of the property in the sense that it had access to such equipment at all times and could alter the computer programs stored in such equipment. In fact, it has been established that these video games depreciate very quickly and in order to earn revenue from such games, there was a requirement for the appellant to change or alter the computer programs from time to time. It is not disputed that the appellant could alter the computer programs by simply changing what is referred to as the EPROM unit (the acronym EPROM stands for erasable programmable read only memory). This was certainly in my view, an important use of the equipment by its owner.

I therefore conclude that the appellant was within the purview of paragraph (b) of the definition of "general-purpose electronic data processing equipment" set out in subsection 1104(2) of the Income Tax Regulations a "user" of the subject equipment.

I shall now advert to the third requirement laid down in paragraph (c) of the definition of "general-purpose electronic data processing equipment" in subsection 1104(2) to the effect that the internally-stored computer program must instruct the equipment to read, select, alter or store data from an external medium such as a card, disk or tape. The evidence is clear that the equipment has a program that instructs it to read and select data from a medium. The question that remains to be determined is whether the medium is an "external" medium.

Counsel for the respondent suggested that this paragraph refers to a storage medium that is external to the machine, that is, one that can be removed and placed on a shelf or mailed or used in another machine such as a card, disk or tape. Reference is made to the latter examples in paragraph (c) of the definition of "general-purpose electronic data processing equipment" in subsection 1104(2) of the Regulations. He then argued that the medium in the case of the present equipment did not satisfy this requirement. On the other hand, an expert witness by the name of Bruce Alan Johnston, who was qualified as a professional engineer specialized in computer programming, testified on behalf of the appellant to the effect that while these medium were bolted into place inside the machine they could be removed, stored or used in another machine, should the need arise. It would appear that the main purpose for the fixing of these medium into the machines is that these machines reuse the same data on the same medium over an extended period of time.

Mr. Johnston stated that the person who owns the computer can order by mail from the manufacturer a different set of ROM (these letters stand for "read only memory") which can be plugged into the computer. This expert witness suggested that the ROM is an external medium in the sense that that medium comes from the outside, retains data that can be put into the computer and is removable. According to Mr. Johnston, that procedure of an owner receiving through the mail a ROM and putting a new program into the machine is something contemplated by the manufacturers. In other words, the persons who bought these types of computers are able to replace the ROMs in them whenever they wish to do so. The procedure of replacing the ROMs is at most a five-minute operation and is fairly simple. This witness was emphatic that ROM devices can be used as external storage mediums. After having indicated that the phrase "external medium" is not known in the industry, Mr. Johnston pointed out that he drew the definition of what an external medium is from his knowledge of computer systems. Incidentally the expression "external medium" is not found either in the Glossary of Computer Terminology by Prentice-Hall, one of the better known technical publishers and their books are widely used as texts in universities and colleges throughout the world. I accept that definition and interpretation placed by Mr. Johnston on the phrase "external medium" in the context of the definition of the expression "general-purpose electronic data processing equipment" in paragraph 1104(2) of the Income Tax Regulations. His evidence was not shaken in cross-examination. As well, his testimony was not contradicted as the respondent chose not to produce any expert witness.

On balance, I am inclined to the view that, notwithstanding the fact that these medium are affixed to the machine, they are “external medium" because they come from the manufacturers, retain data that can be put into the computer and are removable through a simple procedure taking only a few minutes.

Finally, the last requirement of the definition of "general-purpose electronic data processing equipment” is that the program "depends upon the characteristics of the data being processed to determine the sequence of its execution.” There was very little evidence led with respect to this particular requirement. Counsel for the respondent admitted that the element of the definition referred to in paragraph (d) of the definition of "general-purpose electronic processing equipment" in subsection 1104(2) is tied in with the requirement found in paragraph (c) of the latter definition. It is therefore not necessary for me to discuss the fourth element in more detail. Since I have found that the equipment in question satisfies the requirement referred to in paragraph (c) of the definition of the expression "general-purpose electronic data processing equipment" in subsection 1104(2) of the Income Tax Regulations, I am of the view that the fourth condition is equally met. The existence of this requirement was not seriously challenged by the respondent if the other two elements of (b) and (c) of that definition were satisfied.

For these reasons, the appeals are allowed, with costs, and the matter is referred back to the respondent for reconsideration and reassessment on the basis that the electronic games in question are "general-purpose electronic data processing equipment" described in subsection 1104(2) of the Income Tax Regulations and in paragraph (f) of Class 10 in Schedule II to these Regulations.

Appeal allowed.