British Columbia Telephone Company v. Minister of National Revenue, [1986] 1 CTC 2410, 86 DTC 1286

Rip, T.C.J.:—The appellant, British Columbia Telephone Company, appeals its income tax reassessment for 1977 issued by the respondent, the Minister of National Revenue, who added the amount of $27,469 to the appellant’s income for the year on the basis that a portion of the appellant’s inventory did not qualify for the allowance under paragraph 20(1 )(gg) of the Income Tax Act (“Act”).

British Columbia Telephone Company (“B.C. Telephone”) was incorporated by a Special Act of the Parliament of Canada and has its head office in the District of Burnaby, British Columbia. B.C. Telephone carries on the business of telecommunications, in particular, telephone service. In 1977 it provided a telephone service and leased telephone equipment to its customers who paid a monthly fee for the service which included the equipment.

In computing its income for tax purposes for 1977 B.C. Telephone claimed an allowance under paragraph 20(1)(gg) of the Act in respect of certain properties it considered inventory used in its business. The inventory included repair shop supplies, directory paper, non-capitalized outside plant material and property sold to subsidiary and non-related corporations.* [1]

Repair shop supplies include such items as small wires and switches and dials. These are items required for the repair of the telephone equipment leased to customers. It also included what is called “pole line hardware,” which includes material such as bolts and clamps, required to repair pole lines used to transmit the telephone signals.

Directory paper is paper used in the production of directories of telephone subscribers in particular localities where the appellant carries on business and which are distributed to the appellant’s subscribers in the particular locality.

Non-capitalized outside plant material includes replacement parts to equipment outside the appellant’s own facilities which are not large enough to be capitalized. These items include clamps, small wiring and pole lines; for example, these include parts used in the hook up of the telephone service from the pole to which the wires are attached to the home of the customer. This is basically maintenance and repair equipment used in the telephone service to the public.

The last group of items consists of the property sold by B.C. Telephone primarily to its subsidiary, Okanagan Telephone Company Ltd. (“Okanagan Telephone”),! [2] as well as to other corporations who were in need of this type of property; these corporations included Alaska Telephone, Alberta Government Telephones, Prince Rupert Telephone Company Ltd., Pacific Hydro, British Columbia Hydro and Canadian Telephone and Supply Ltd. B.C. Telephone sold this property providing for a mark-up only for overhead and handling; there was no provision for profit.

Mr. Robert McCargar testified on behalf of B.C. Telephone. Mr. McCar- gar is employed by B.C. Telephone as a materials control supervisor. In 1976 and 1977 he was a buyer for B.C. Telephone and purchased the inventory in question for the corporation. He stated that B.C. Telephone would determine usage and requirement of materials for a twelve-month period; the determination of materials would be not only for itself but for its subsidiary, Okanagan Telephone, and the other corporations. He would be in constant communication with these corporations to determine their requirements. Orders for the materials would be made by B.C. Telephone in order to benefit from volume discounts. Monthly stock statement reports would reflect the volume of material on hand and, if necessary, material in short supply would be ordered. No significant change was made to this procedure when the assets of Okanagan Telephone were wound up into B.C. Telephone in 1978.

Also testifying for the appellant was Mr. Martin McKinley, C.A., Income and Sales Tax Manager for B.C. Telephone. Corporate tax returns were prepared by Mr. McKinley and accordingly he made himself familiar with the inventory purchases. In 1977 Mr. McKinley was a Tax Specialist, Research and Planning, with B.C. Telephone. Mr. McKinley stated that in 1977, 83.3 per cent of what he described as major inventory was capitalized; this constituted large heavy equipment for the telephone plant, namely, poles, conduits and cable switchboards, as well as radio broadcasting equipment. Material released from stock which was not capitalized was used for maintenance and repairs and sold to other corporations.

Mr. McKinley testified that repair shop supplies were used in the repair shop operations to repair telephone sets. This was material used to service customers paying for the service and included property it sold to other corporations.

Mr. McKinley added that in applying for rate increases to the Canadian Radio-Television and Telecommunications Commission, B.C. Telephone projects income and expenses, which include the costs of the material in question in this appeal, and requests a particular rate of return on its assets.

In cross-examination, Mr. McKinley acknowledged that B.C. Telephone sells its customers a telephone service; it carries on no other business. The bulk of contracts B.C. Telephone has are with its customers. I assume it has other contracts with suppliers. He also informed the Court that during its 1977 fiscal year B.C. Telephone did not sell telephones as it does today; it owned the telephone sets and treated them as capital assets. He also testified that the appellant sold materials to other corporations without profit since it was a “good corporate citizen”; similarly when it was in need of material it would purchase such property from these corporations on a similar basis.

Paragraph 20(1)(gg) reads as follows:

20(1) Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer’s income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:

(gg) an amount in respect of any business carried on by the taxpayer in the year, equal to that portion of 3% of the cost amount to the taxpayer, at the commencement of the year, of the tangible property (other than real property or an interest therein) that was

(i) described in the taxpayer’s inventory in respect of the business, and

(ii) held by him for sale or for the purposes of being processed, fabricated, manufactured, incorporated into, attached to, or otherwise converted into or used in the packaging of, property for sale in the ordinary course of the business

that the number of days in the year is of 365:

In the view of counsel for B.C. Telephone the property in issue was tangible property that was held by the appellant for sale or for the purposes of being incorporated into property for sale in the ordinary course of business, and is therefore entitled to the inventory allowance allowed by para- graph 20(1)(gg).

Counsel argues that certain property was in fact sold to other corporations; this consisted of property purchased by B.C. Telephone for its own purposes and for those of the other corporations. The levels of this property are determined on the basis of past demand of both the appellant and the other corporations. That no profit was built into the selling price should not affect the fact that the properties were purchased and held for sale. There was a reciprocal arrangement between the companies in the industry that one would assist the other when required and that such sales were in the ordinary course of the appellant’s business.

The other items — the repair shop supplies, directory paper ¢ [3] and outside plant material used in the provision of services to the public — were part of the service supplied by B.C. Telephone to its customers; these items are sold to the public, he stated, because the monthly telephone fee for the telephone service is dependent on the costs of these items and the costs of such property are deducted by B.C. Telephone in computing its income.

Counsel submitted that the directory paper, repair shop and outside plant materials used by B.C. Telephone in the provision of services to its customers is an indirect sale of such property to the customer. It is no different, he suggests, than the indirect sales of asphalt in the paving, repairing or resurfacing of roads: vide Nova Construction Company Ltd. v. M.N.R., [1979] C.T.C. 2048 at 2049-50; 79 D.T.C. 77 at 79; [1983] C.T.C. 58; 83 D.T.C. 5105 (F.C.T.D.). See also Halliburton Services Ltd. v. The Queen, [1985] 2 C.T.C. 52 at 55-59; 85 D.T.C. 5336 at 5338-41.

Counsel for the Minister argued that in 1977 B.C. Telephone did not sell any tangible property; it sold a telephone service. When B.C. Telephone made repairs to telephone sets, transmission equipment, wires, circuits and poles it was repairing its own equipment. No sale took place. Counsel referred the Court to the decision of the Federal Court — Trial Division in Crown Tire Service Ltd. v. The Queen, [1983] C.T.C. 412; 83 D.T.C. 5426. In that case the taxpayer corporation was engaged in a tire retreading busi- ness. Much of the taxpayer's business involved receiving worn tires from customers for retreading. The old tread would be stripped off, leaving a "casing/' a new tread would be applied and secured and the tire would be returned to the customer. In some cases the taxpayer itself owned the casings and, after retreading, the tire would be sold to random purchasers. The taxpayer was unable to say how much of its business was the former and how much was the latter. The taxpayer treated all of its income as profits from the “manufacturing or processing in Canada of goods for sale or lease" and claimed the relevant deduction in accordance with subsection 125.1 of the Act. The Minister disallowed the deduction on the ground that the taxpayer was merely providing services with respect to the retreading of tires owned by customers and assumed that this constituted at least 90 per cent of the taxpayer's business. Strayer, J., of the Federal Court, found, with respect to the retreading of tires owned by customers, that the manufacturing or processing in which the taxpayer was engaged was not with respect to "goods for sale or lease." The contracts involved with such tires were for work and materials and not for the sale of goods.

In his reasons for judgment,* [4] Strayer, J., relied on the decision of the Manitoba Court of Appeal in Sterling Engine Works v. Red Deer Lumber Co. (1920), 51 D.L.R. 509 where the Court held that where two steel plates were attached by the plaintiff to the defendant's locomotive to repair the fire box the title in the plates passed to the defendant not by sale but by accession. Mr. Justice Strayer states that in reaching this conclusion Dennis- toun, J.A., noted "there was no evidence to suggest the plaintiff was a vendor of, or dealer in, steel plates and that they merely used steel plates in the course of repairing the locomotive."

In the case at bar the evidence indicates the sole business of B.C. Telephone in 1977 was the sale of telephone service and that the repair shop supplies and other material used in providing services to the public were attached to, or incorporated into, property owned by B.C. Telephone itself. I cannot even contemplate a sale, either direct or indirect, taking place when one repairs or maintains one's own property, even if some of the property is used by one's customers. B.C. Telephone provided service and equipment to its customers to enable the latter to transmit messages through B.C. Telephone's telephone system, but this property is not sold as a consequence thereof. Accordingly property used in repairing or maintaining the system remains the property of B.C. Telephone.

The evidence at trial was that the cost of the directory paper is a factor used in support of B.C. Telephone's application for any telephone rate increase and that this cost is considered when a rate increase is granted. Also the cost of the directory paper is deducted by B.C Telephone in computing income.

The main thrust of the appellant’s argument was that the distribution of a new directory to customers each year is a sale of the directory; this position, he states, is supported by the fact that the customer may throw away the previous year’s directory and so consumes the directory. No party produced either a directory or a copy of the general tariff of B.C. Telephone in evidence. The contents of the telephone directory and the general tariff may only be noticed by the Court with proof thereof. While the Court may take judicial notice of a telephone directory and the existence of a tariff I do not believe the contents of the directory or the tariff are indisputable. The Canada Evidence Act does not permit me to take judicial notice of the general tariff of B.C. Telephone. Since counsel for the respondent did not challenge this evidence I must conclude that he agrees that the customer consumes the directory. However in my view the directories are distributed to the customers of B.C. Telephone as a service; no sale transpires. While there is evidence the cost of the directory is included in the rate charged to customers for the service B.C. Telephone provides, there is no evidence the customer knows what this cost is, or more important, that the customer is a party to a contract of sale of a directory. Based on the evidence there is no sale. The telephone directory is part and parcel of the telephone service B.C. Telephone supplies to its customers. The directory assists the customers to use the service; the directory paper is a good that is consumed in the rendering of the service.

The repair shop supplies the other material used in providing services to the public and the directory paper was not held by B.C. Telephone for sale or for the purpose of being incorporated into or attached to property for sale since no sales took place.

There is no doubt that sales of property took place when B.C. Telephone disposed of equipment to Okanagan Telephone and the other corporations notwithstanding no profit was earned on such sales. When B.C. Telephone ordered equipment which it both used and sold in its 1977 fiscal year, the volume of equipment was dependent on its use by B.C. Telephone in prior years and on sales made by B.C. Telephone in previous years; B.C. Telephone considered both its needs and those of the other corporations. The sales cannot be said to be sales of equipment surplus to its needs, since the equipment was purchased expressly for resale. B.C. Telephone's counsel states this property was tangible property described in B.C. Telephone's inventory in respect of the business. The “business" of B.C. Telephone was described by Mr. McKinley as the sale of a telephone service and, he added, no other business was carried on by B.C. Telephone. The question I must decide, therefore, is whether the sales of property by B.C. Telephone to Okanagan Telephone and the other corporations were in the ordinary course of B.C. Telephone's business.

Although the Courts have considered the term “ordinary course of business" on many occasions,! [5] only very few cases are of assistance in this appeal. In Nourse v. Canadian Canners Ltd., [1935] O.R. 361; [1935] 3 D.L.R. 168 per Middleton, J.A., the Ontario Court of Appeal relied on the ordinary course of a trade in a particular community. The term used in subsection 20(1 )(gg) is not “ordinary course of business,’ but “ordinary course of the business," that is, the ordinary course of the business carried on by the taxpayer. Thus I must consider the business of B.C. Telephone to determine whether the property sold by it to Okanagan Telephone and other corporations was in the ordinary course of its business.

The property in question was not property acquired by B.C. Telephone for its needs and subsequently found surplus to these needs. B.C. Telephone purchased the property knowing from experience it would sell it to specific purchasers. By purchasing large quantities of material and equipment B.C. Telephone obtained volume discounts from its suppliers. At the same time B.C. Telephone had access to the purchasers in the event it required certain property for its business. Because of the volume discounts and the relationship with the other companies, B.C. Telephone acquired property at relatively lower prices; its costs were reduced. There were practical business reasons to enter into such relationships.

In a bankruptcy matter before the High Court of Australia, Rich, J. wrote that for transactions to be considered in the ordinary course of business supposes “‘that according to the ordinary and common flow of transactions in affairs of business there is a course, an ordinary course. It means that the transaction must fall into place as part of the undistinguished common flow of business done; that it should form part of the ordinary business as carried on, calling for no remark and arising out of no special or particular situation”: Downs Distributing Co. Pty., Ltd. v. Associated Blue Star Stores Pty., Ltd. (In Liquidation) (1948), 76 C.L.R. 463 at 477. Street, J., of the Supreme Court of New South Wales stated that “the transaction must be one of the ordinary day-to-day business activities, having no unusual or special features, and being such as a manager of a business might reasonably be expected to be permitted to carry out on his own inititiative without making prior reference back or subsequent report to his superior authorities, such as, for example, to his board of directors.”: Re Bradford Roofing Industries Pty., Ltd., (1966) 84 W.N. (Pt. 1) (N.S.W.) 276 at 285; Street, J., borrowed with minor adaptations the words of Rich, J.: "the requirement is that the transaction must fall into place as part of the undistinguished common flow of the company’s business, that it should form part of the ordinary course of the company’s business as carried on, calling for no remark and arising out of no special or particular situation.” See also Re Pacific Mobile Corporation; American Biltrite (Canada) Ltée v. Robitaille, 44 C.B.R. 190 at 201-5.

In the case at bar the evidence is that at least one employee of B.C. Telephone was in charge of the acquisition and sale of the property and that he was in regular touch with the other corporations to determine their needs for the property. This was part of his regular duties for his employer. The sales of the property were not isolated; they were carried on in the ordinary course of that business. What we are dealing with, it should be remembered, is not a normal type of business; B.C. Telephone's business is a monopoly and the sales it makes are to other corporations with a similar monopoly and which do not threaten B.C. Telephone's business. Accordingly I do not find it unusual that corporations having a similar business assist each other when practical, and such assistance is made in the ordinary course of that business.

The appeal will be allowed with costs and referred back to the respondent for reconsideration and reassessment to permit the appellant the inventory allowance described in paragraph 20(1 )(gg) of the Act in respect of the property held by B.C. Telephone for sale to Okanagan Telephone and the other corporations to which property was sold.

Appeal allowed in part.