Igtc LTD v. Minister of National Revenue, [1982] CTC 2570

D E Taylor:—This is an appeal heard in Montreal, Quebec, on May 5, 1982 against an income tax assessment for the year 1979 in which the Minister of National Revenue disallowed an amount claimed by the appellant pursuant to the provisions of section 125.1 of the Income Tax Act, SC 1970-71-72, c. 63, as amended. The relevant notice of appeal portrays in some detail the position taken by the taxpayer:

Issue

1. The Taxpayer is incorporated pursuant to the laws of Canada. It carries on business as a manufacturer of ladies jackets and coats and has carried on the said manufacturing business since 1974.

2. The Taxpayer carries on its business and did during the 1979 taxation year carry on its business, at 7101 Park Avenue, Suite 110, which is situated in the garment manufacturing district of Montreal.

3. The Taxpayer employs and, during all periods pertinent to this appeal, did employ approximately 6 persons.

4. During peak operating periods, it has been the custom of the Taxpayer to hire additional temporary staff.

5. The Taxpayer carries out the following functions in its manufacturing process:

(a) the ordering of all raw materials, including fabrics, trimmings (zippers, buttons

and snaps), linings, interlinings, fusibles and other accessories;

(b) planning the line which involves an analysis of the available fabrics, colours and current styling;

(c) design of the line:

(d) preparation of patterns;

(e) production of samples;

(f) cutting of fabric;

(g) sewing; and

(h) touch up, when necessary.

6. The Taxpayer carries out all of the above functions except for cutting the fabric and sewing.

7. Cutting of the fabric and sewing is carried out through the use of outside contractors. Such contractors are paid on a weekly basis.

8. The Taxpayer controls all details of the manufacturing process including those pertaining to cutting the fabric and sewing.

9. The Taxpayer establishes its own production schedules and instructs the contractors accordingly. No production scheduling may be done by the contractors.

9. (Sic) The Taxpayer verifies all production as to quality both on the various contractors’ premises and at its own premises. The work done by the contractors is purely mechanical. The Taxpayer retains complete control over the material, styling, trim and physical qualities of all garments produced. The Taxpayer provides continuous supervision and control over all aspects of the production and the manufacturing process.

10. The Taxpayer sells its products to retail users and is responsible to them for the said products. Any problems which a retail user has or a return which it wishes to make of merchandise is referred to the Taxpayer and to no other entity. All the business risks associated with the manufacture of the Taxpayer’s product is borne by the Taxpayer.

In an amended reply to notice of appeal which was agreed to by counsel for the appellant, the Minister contended:

The Appellant was not a manufacturer or processor of goods for lease during its 1979 taxation year;

The Appellant, which claims to be a manufacturer or processor of goods, had only one sewing machine during its 1979 taxation year;

The Appellant’s activities did not amount to the manufacturing or processing of goods, but consisted essentially in the designing of ladies’ garments.

The original amount claimed as a credit by the appellant had been $2,970 but at the commencement of the hearing, the parties agreed to a revision of this amount, to leave only the sum of $1,056 in issue. A calculation to support this second amount was also agreed to and submitted by the parties.

Evidence

Limited evidence and testimony were provided by both the president of the corporation and by the employee largely responsible for design and supervision. Their testimony was directed to emphasizing the critical importance to the entire operation of the various roles enacted directly by employees of IGTC Ltd and the relevance of the role of supervision and examination also performed by them over the cutting and sewing functions. In summary, the garments could not be “manufactured” simply by virtue of the cutting and sewing process — the complete operation conducted by the appellant had to be examined and taken into account by the Board.

Findings

The functions of “cutting and sewing” which are subcontracted are a major element in the entire operation of IGTC Ltd and they dwarf those functions such as designing, pattern making, selection of fabrics, storing, selling and shipping which were described in greater detail and given higher emphasis by the appellant in the notice of appeal. The appellant also supervises in all its aspects the cutting and sewing work, and performs the inspection and grading necessary on the work done by the subcontractors. There are relatively few direct employees of IGTC and little in the way of machinery since the direct physical impact on the fabric and other material is performed by the subcontractors. There can hardly be any room for debate that the fabric purchased is eventually manufactured into garments which are sold by the appellant. Right from the time of receipt of the unfinished goods through the various processes which it undergoes, up to and including the selling of the garment, the fabric and other materials which compose the finished product are the property of the appellant, and totally under its direct control. In the final analysis, the appellant is solely responsible for the quantity and quality of the garment, and required to provide the garment to the satisfaction of its own customers. The Minister’s position, therefore, comes down to an assertion that since the “hands of the appellant” are not directly involved in the mechanical process of cutting and sewing, the appellant’s activities including such cutting and sewing cannot be described as “manufacturing or processing”. Or perhaps another way to view the Minister’s position is that the real “manufacturing and processing” is done by the cutters and sewers, and that the appellant’s actual physical functions fall more appropriately into a category which should be excluded from the benefit sought by virtue of Revenue Canada Interpretation Bulletin IT-145R dated June 19, 1981 —

A corporation which merely sells goods manufactured or processed by another party or that supervises the manufacturing or processing of goods where the actual manufacturing or processing is carried on by another party will not qualify for the deduction.

I would agree that there might be a set of circumstances in which any or all of the direct functions performed by a taxpayer, such as those referenced in this appeal (design, pattern making, supervision, selling, etc) Could be performed by a corporation which had no overall responsibility for the product, had no property rights in it at one or more stages of the operation, and had no responsibility for the satisfaction of customers or users. In that kind of situation the words in the Interpretation Bulletin might have some bearing on the outcome. However, that is not the situation here. The fact is that the cutting and sewing processes are an integral part of the entire operation, all of which is conducted by this appellant. Those operations (cutting and sewing in particular) are not part of the calculation base upon which the appellant can make its claim for the relevant deduction — and indeed the appellant is not claiming that they should be. (See Canadian Clyde Tube Forgings Limited v The Queen, [1982] CTC 21; 82 DTC 6041; and Levi Strauss of Canada, Inc v The Queen, [1982] CTC 65; 82 DTC 6070.) But that exclusion from the calculations relevant to the deduction claimed cannot be equated to exclusion of the same functions from the manufacturing or processing for which this appellant is directly and solely responsible.

I note with some interest that the words “manufacturer” or “processor” as such do not seem to appear in the relevant sections of the Act, nor in the Regulations. Equally, the critical term used is not “engaged in”, “involved in”, “participated in”, or something similar which it might be argued would further restrict the role of a taxpayer corporation seeking the deduction (although it was not so argued at this hearing). The closest description of the need for the appellant to have “his hands on the goods” appears to arise in Regulation 5202 under “qualified activities” as . . in connection with manufacturing or processing .. I do not view the term “in connection with” as requiring the direct contact asserted by the Minister in this matter.

Counsel for the appellant cited the recent judgment of the Federal Court of Appeal which upheld the judgment of the Federal Court, Trial Division in McGraw-Hill Ryerson Limited v The Queen, [1980] CTC 280; 80 DTC 6211. Counsel for the respondent, in turn, put forward certain impressions upon which that case might be distinguished by the Board from the instant appeal. I fail to see that any distinction of merit can be sustained. The appellant corporation’s “activities . . . are performed . . . in connection with manufacturing and processing ..and that “manufacturing and processing” include the subcontract work for purposes of qualifying for the deduction claimed. The McGraw-Hill judgment would appear in my view to clarify any question regarding the spectrum covering “manufacturing and processing” and under the circumstances of this case, any refraction into its component elements by means of calculations does not adversely affect the integrity of the whole.

The activities which comprise the labour cost of the calculation — the $1,056 at issue — were within the meaning and definition of “qualified activities” as outlined in Regulation 5202.

Decision

The appeal is allowed and the matter referred back for the respondent for reconsideration and reassessment in accordance with the above reasons for decision.

Appeal allowed.