Burger King Restaurants of Canada Inc. v. Her Majesty the Queen, [1997] 1 CTC 2058, 97 DTC 841

Bonner J.T.C.C.: — The appellant appeals from assessments of income tax for the 1985, 1986 and 1987 taxation years. It claims that it is entitled to investment tax credits in respect of buildings acquired during those three taxation years and prior years as well. The buildings were intended for use as Burger King fast-food restaurants. The assessments in issue denied the investment tax credits on the basis that the buildings did not fall within the definition of “qualified property” in subsection 127(9) of the Income Tax Act (“Act”).

The relevant statutory provisions include subsection 127(5) of the Act which permits the deduction from tax otherwise payable of amounts related to the taxpayer’s investment tax credit at the end of the year in respect of property acquired. They include as well subsection 127(9) of the Act which defines “investment tax credit” utilizing a formula which incorporates in the computation of the credit a specified percentage of the capital cost to the taxpayer of “qualified property”, a term also defined in subsection 127(9). That definition reads in part:

“qualified property” of a taxpayer means property (other than an approved project property or a certified property) that is

(a) a prescribed building to the extent that it is acquired by the taxpayer after June 23, 1975,

that has not been used, or acquired for use or lease, for any purpose whatever before it was acquired by the taxpayer and that is

(c) to be used by him in Canada primarily for the purpose of

(i) manufacturing or processing goods for sale or lease,

The definition is restricted somewhat by subsection by 127(11). It reads:

(11) For the purposes of the definition of “qualified property” in subsection (9),

(b) for greater certainty, the purposes referred to in paragraph (c) of the definition “qualified property” in subsection (9) do not include

(i) ... selling ... finished goods

(vi) providing facilities for employees, including cafeterias, clinics and recreational facilities.

The Minister of National Revenue (“Minister”) made the assessments in issue on the basis that not more than 40 per cent of the building area in Burger King restaurants was used for the preparation of food for immediate consumption, an activity which the assessor considered to constitute the processing of goods for sale. On the basis of a comparison of the area of the buildings used for food preparation with the area used for other purposes, the assessor found that the buildings were not acquired by the appellant to be used “primarily” for the processing of goods for sale. Counsel for the respondent argued as well that the preparation of food for immediate sale as a finished product does not constitute manufacturing or processing goods for sale within the meaning of section 127 of the Act.

At this point it may be useful to briefly examine the state of the law and of administrative practice relating to whether and to what extent restaurant operations constitute processing within the meaning of section 127. The assessor’s view is consistent with an Interpretation Bulletin, IT-145R, published by the Department of National Revenue and dated June 19, 1981. Paragraph 45 of that Bulletin reads as follows:

Restaurants and “Take-Out Stores”

45. Generally, the primary activities of a restaurant are those of providing service to its patrons. Such services include the waiting upon tables, clearing, washing and drying of cutlery and dishes, cashier services and in some cases the provision of entertainment. However, the activities of preparing meals for consumption constitute processing and thus some part of a restaurant’s income may be eligible for the reduced rate of corporate tax. The mixing of a number of ingredients of a drink is considered processing but the mere pouring of liquor or beer into a glass and the dispensing of draft beer are not considered processing.

In the case of “take-out” establishments, the primary activities may be the preparation of meals and thus all of the business income of the corporation may qualify for the reduced rate of tax under the small manufacturers’ rule.

[Emphasis added.]

It is noteworthy that the Department persists in the view expressed in paragraph 45 of the Bulletin despite the 1985 decision of the Federal Court Trial Division in Mother’s Pizza Parlour (London) Ltd. v. R., (sub nom. Mother’s Pizza Parlour (London) Ltd. et al. v. The Queen) [1985] 1 C.T.C. 361, 85 D.T.C. 5271. In that case the Court found that the preparation of food for immediate consumption and sale is not processing within the meaning of the statute. The Department issued a special release on February 28, 1986 noting the inconsistency between its administrative practice and the law as stated by the Federal Court Trial Division. It noted further that the decision had been appealed to the Federal Court of Appeal and stated:

A review of the reasons for judgment given by the Court indicates that the Department’s position as stated in paragraph 45 may have been ill-founded. However, it has been decided for assessing purposes to continue to follow the view expressed in that paragraph pending further consideration and the deci- sion of the Federal Court of Appeal.

The Federal Court of Appeal dismissed the appeal by judgment dated July 25, 1988. The reasons for judgment are published at [1988] 2 C.T.C. 197, 88 D.T.C. 6397. The court refrained from expressing any opinion on the finding of the Trial Division. It disposed of the appeal on another basis. At page 200 (D.T.C. 6399) Pratte J., speaking for the Court stated:

When, as in the present case, different parts of a same building are permanently used for what is considered to be two different purposes, the most important factor in determining the purpose for which the building is primarily used is the amount of space in the building that is used for each one of those two purposes. In the case at bar, the part of the building that was used for the sale and consumption of food was, by far, larger than the part used for the preparation of food. For that reason, I cannot escape the conclusion that the building was not primarily used for the preparation of food.

It was argued, however, that the kitchen area in the building had been more expensive to build and to equip than the rest of the building. This may be true, but that difference in costs is not, in my view, sufficient to outweigh the factor that I have just considered. It was also said that the space in the kitchen was more efficiently used than in the rest of the building and that the kitchen area was the scene of more intense activity than the dining rooms. Those facts are, in my view, irrelevant.

The assessment in this case appears to suggest that the administrative practices of the Department of National Revenue continued unchanged following the decision of the Court of Appeal which did not suggest that the Trial Division had erred.

I propose to approach this case on the assumption, and I emphasize that it is an assumption only, that the preparation of food for immediate consumption constitutes processing goods for sale within the meaning of section 127. On that basis the threshold issue is whether the part of the appellant’s buildings used for the preparation of food is greater than the part used for other purposes.

There are 68 buildings in issue all of which are fast-food restaurants in which raw materials are received, stored briefly pending use, then prepared, wrapped, sold and handed to customers. The evidence indicated that 98.6 per cent of the dollar value of the appellant’s total sales are derived from products which result from preparation in the form of cooking and/or combining raw ingredients to create such menu items as hamburgers and other hot sandwiches, french fries, salads and beverages, both carbonated and otherwise. The use of space for storing and reselling food items, such as cartons of milk which are resold in the same state as when they were received, is minimal and therefore of no significance.

The 68 buildings in issue have much in common. Each was constructed in accordance with one of 20 rather similar layouts or plans. Broadly speaking, each contains two areas:

a) an area intended for use by restaurant staff in which raw ingredients and other goods such as wrapping material are received and stored and in which the preparation of the appellant’s wares takes place (“the rear area”); and

b) an area intended for use by the public including space adjacent to a sales counter, a dining room and public washrooms (“the public area”).

The sales counter lies at the boundary between the rear area and the public area. The appellant’s position is that all or almost all of the rear area including the sales counter is used for a qualifying purpose.

Approximately 50 per cent of the appellant’s sales are made to customers who consume their food in the dining room. This room, which is fitted with tables and seats, operates on a self-serve basis. There are no waiters or waitresses. Cutlery is of the disposable plastic variety. Employees of the appellant keep the room clean but do not otherwise serve the customers who choose to dine there. Approximately 40 per cent of the appellant’s sales are made to customers who remain in their cars both to place their orders and to eat their meals. Their orders are taken and food is delivered to them by employees stationed at drive-by windows. Ten per cent of sales are made to customers who walk in, place their orders and take their food away for consumption elsewhere.

The rear area contains rooms or areas described in evidence as walk-in boxes [1] , kitchen, drive-through, pick-up/expediting, storage, staff area, utility and, in most cases, staff washrooms. Frozen raw materials such as hamburger patties, chicken and fish are received and stored in a walk-in freezer. Other raw materials such as buns, produce, syrup for soft drinks and supplies such as napkins and wrapping materials are stored as appropriate, either in the unrefrigerated storage area or the walk-in cooler. Raw materials are removed as required from storage areas just mentioned to the kitchen where patties are broiled, buns are toasted, ketchup and other condiments are added and hamburgers or other sandwiches are assembled. Other products prepared in the kitchen include salads made there from raw materials by slicing and mixing produce and other ingredients. The finished products are wrapped and placed in convenient holding areas.

The pick-up/expediting area is located between the kitchen and the sales counter at which orders are taken, food is delivered to customers and payment is received. That area is used in part for gathering together the various finished products which constitute the meal ordered by the customer. Chutes between the kitchen and this area aid in the delivery of some of the components of the meal. Equipment for cooking and packaging french fries is located in or adjacent to this area. In most of the restaurants carbonated drinks and shakes are dispensed in this area using a drink station which mixes components such as carbonated water and syrup. The components are piped in from tanks located in the storage area. In other cases self-serve drink stations are located adjacent to the dining room. The assembled meal is then handed to the customer at the sales counter located between the pick-up/expediting area and public area. The drive-through area is located close to the pick- up/expediting area. It is equipped with a drink station and coffee maker. It appears to serve much the same function in the assembly and delivery of meals to drive-through customers as the pick-up/expediting area and sales counter serve in relation to other customers.

The utility area contains the electrical service panel required to supply power in the restaurant and a hot water tank and storage for mops, buckets and other equipment used to maintain a clean restaurant.

Each of the restaurants in issue is built in accordance with one of a group of 20 layouts. The evidence adduced by the appellant includes four schedules which set out the square footage of the various rooms or areas of many of the plans used in building the restaurants in issue. Each schedule is prepared on a different premise as to which rooms are used for processing and which are used for another purpose. The first schedule is prepared on the premise that the areas used for processing include the utility area, storage area, pick-up/expediting, drive-through, kitchen, walk-in boxes, a self-serve drink bar [2] (where present) and staff washrooms. On that basis the area devoted to processing exceeded 50 per cent in only two of the 20 designs listed on the schedule and then only by margins of 2.38 per cent and .06 per cent.

The calculations on the second schedule were based on the premise that the area used for processing included all of those on the first schedule plus the staff area, a room located in the rear of the building. Staff areas contain staff lockers and, in some cases at least, equipment including a video cassette recorder and television set used to train staff in the methods which the appellant insists be employed in all of its restaurants to ensure uniformity of product throughout the Burger King chain. When the area devoted to processing is calculated on that basis it exceeds 50 per cent in five of the 20 restaurant designs for which area breakdowns were provided. The excess however is relatively small, in no case greater than 6.5 per cent. On the other 15 designs the area so devoted drops as low as 35.77 per cent.

The calculation on the third schedule excludes vestibules from the total area of the building on the basis that they perform an energy conservation function only. This calculation need not be considered further. I can see no reason why any part of the building should be excluded from consideration.

A fourth calculation was made. It is said to vary from the third by the inclusion in the processing area of 225 square feet for a self-serve salad bar in the dining area. It is of no assistance. It is not apparent how the action of a customer in serving his or her own salad can constitute processing.

Evidence was given by Narine Harry-Persad, the assessor who performed the audit giving rise to the assessment in issue. He obtained blue prints of restaurants said by his “contact” at Burger King to be representative of those in issue. He visited the restaurants, made estimates from blue prints of the areas devoted to various uses and observed the activities of employees in those areas. When a second official of the appellant suggested that the restaurants selected for the first visit were not truly representative, Mr. Harry-Persad visited other restaurants said by that official to be representative, took measurements and again observed the uses made of various ares. Mr. Harry-Persad’s work led him to conclude that more than 50 per cent of the area of the restaurant buildings which he viewed was used for purposes which in his opinion did not constitute processing. In arriving at that conclusion he excluded from areas used for processing the dining area, the sales counter, portions of the storage area not devoted to the storage of food and supplies such as napkins, the manager’s office, the staff area, staff washrooms and the utility area. Mr. Harry-Persad did not see either a television set or a video cassette recorder in any staff room. He did not observe staff training in progress during any of his visits. Mr. Harry-Persad was, in my view, an honest witness who had done his work with diligence. However he excluded from areas he regarded as used for processing some portions of the restaurant which, if meal preparation does constitute processing, are properly included, 1.e., the staff area, the staff washrooms and utility area.

Still assuming that the preparation of food for immediate consumption constitutes processing, I have concluded that the appellant has not succeeded in establishing on the balance of probabilities that its buildings were to be used “primarily” for the purpose of processing goods for sale. As previously indicated, the appellant’s third and fourth schedules of area calculations rest on an unsound basis and are therefore unacceptable. I accept the premise on which the second calculation is based that a room used for staff lockers and for the training of staff in procedures essential to the success of the processing operation is used for purposes of processing. The staff area cannot therefore be regarded as “facilities for employees” within the meaning of subparagraph 127(1 l)(b)(vi). The evidence suggests that it is more accurate to identify the staff area as a facility for the employer. The inclusion in the appellant’s second schedule of the staff area in the computation of the area used for processing is therefore appropriate.

On the other hand the inclusion in the second schedule of the area of the sales counter is inappropriate. A distinction exists between the processing of goods for sale and the selling of goods already processed. It is the latter activity which takes place at the sales counter. Furthermore the evidence is less than clear that the pick-up/expediting area and the drive-through area are used primarily for the purpose of processing. The two areas appear to be used in part for the purpose of processing such as the blending operation carried out at the drink station and in part for the purpose of filling customers’ orders by the assembly of meals comprised of menu items already fully processed. I can discover no basis on which it can be found that these two dual purpose areas can be said to be used primarily for processing. The utility area containing cleaning equipment and an electrical panel both of which serve the entire building is also a dual purpose area. Neither purpose appears to predominate. Thus the appellant’s second calculation overstates the area used for processing. Furthermore the second calculation, even with the inclusion of the two dual purpose areas, does not support the appellant’s position. Some of the designs which, according to Exhibit A- 2 Tab 1, were most frequently used in building the restaurants in issue are listed below together with the processing area as a percentage of total building area computed in accordance with the second calculation.

Neither counsel suggested that success be divided on the basis that the processing portion of the floor area of some buildings is greater than 50 per cent and of others is less. Even if they had done so the evidence in this case does not lend itself to any such disposition of the appeals. It is not clear to what extent the calculations on the appellant’s second schedule will change if the area of the sales counter, the pick- up/expediting zone, the drive- through and the utility area are excluded. My impression from a review of the layout plans entered in evidence is that in the event of such exclusion the processing area in all layouts will be less than 50 per cent.

It may well be that, from the standpoint of the appellant’s overall business, the activities which take place in the kitchen and in areas of the building used in direct support of the kitchen activities are of very great importance. There can be no doubt on the evidence that maintenance of consistent levels of product quality is of overriding importance to the success of the appellant’s business. Nevertheless the statutory test looks to primary use of a building. Where the building accommodates more than one use, the focus must be on the area devoted to each of the uses which must be weighed.

For the foregoing reasons, the appeals will be dismissed with costs.

Appeal dismissed.