Allarcom Pay Television Limited v. Her Majesty the Queen, [1996] 3 CTC 2608, 97 DTC 1558

Sarchuk J.T.C.C.: - The appeal of Allarcom Pay Television Limited (Allarcom) is from assessments of tax with respect to its 1985 and 1988 taxation years. During those years Allarcom carried on a pay television business in the Province of Alberta. In taxation year 1985 Allarcom classified certain of its assets as manufacturing and processing assets and placed them in Class 29. In reporting its income and tax for that year it characterized its income as manufacturing and processing profits. Allarcom claimed no deduction in respect thereof as it reported nil taxable income and nil tax but it did claim a refundable investment tax credit in the amount of $322.

In reassessing Allarcom for its 1985 taxation year, the Minister assessed nil tax, determined that the amount deemed to have been paid by Allarcom under subsection 127.1(1) on account of its tax was nil and not $322, and claimed repayment of the said refund with interest. The Minister also recorded that Allarcom’s balance of unused investment tax credits be reduced from $24,176 to nil.

In reporting income and tax for the 1988 taxation year, Allarcom claimed the amount of $24,176 being the unused investment tax credit carried forward from the 1985 taxation year. The Minister disallowed this claim.

The issue is whether the property in respect of which Allarcom claimed the refundable investment tax credit and the investment tax credits was qualified property within the meaning of subparagraph 127(9)(c)(i) of the Income Tax Act (the Act) and section 4600 of the Regulations. If it is demonstrated that the property in issue was acquired by Allarcom to be used by it in Canada primarily for the purpose of manufacturing or processing goods for sale or lease, then certain capital assets may be properly included in Class 29 pursuant to the Regulations and Schedule II of the Act and it will be entitled to the manufacturing and processing profits deduction pursuant to section 125.1 of the Act.

Evidence

One witness testified on behalf of Allarcom, Mr. Thomas E. Eggertson (Eggertson). He holds a Bachelor of Commerce degree from the University of Alberta and is a chartered accountant. He joined Alberta Independent Pay Television (a predecessor to Allarcom) in 1983 and worked with Allarcom and its parent company for five years. Eggertson is presently the director of financial affairs for Calgary Television, a company related to Allarcom.

Allarcom has been licensed by the CRTC as a pay television company since 1983 and operates in Alberta, British Columbia, Saskatchewan, Manitoba and the Northwest Territories under the trade name “Superchannel”. It purchases its product (movies) from major production studios in the United States and major Canadian production houses. [1] It also acquires ‘shorts’ from the National Film Board and other programming from small independent producers, both Canadian and American.

According to Eggertson, Allarcom takes the “raw material” acquired from the major studios and others and “processes or manufactures” it into a “continuous entertainment package” that is designed “to be sold wholesale to the retailer ... a cable company, and the cable company ultimately sells the product to its customers”. For this, each cable company pays Allarcom based on the number of subscribers it has on a monthly basis. Concurrently, Allarcom pays for the majority of its “raw material” based on the number of subscribers or customers the cable companies have.

The movies acquired from a studio are received on a tape that Allarcom is entitled to utilize during the period authorized by their agreement. Upon receipt of the tape, it is inspected for quality and is indexed for its filing system. The contents of the tape received from the movie studio are retaped on a blank tape together with an introduction that states SPECIAL FEATURE, SPECIAL PRESENTATION, or FEATURE PRESENTATION, depending on the categorization of the product. Incorporated into the new tape are such items as the rating of the movie, warnings regarding content if necessary, closed captioning and time codes which facilitate the management of the tape within Allarcom’s equipment, followed by the movie itself. At the conclusion of the movie, Allarcom adds a “closing” to fill up the tape in order that it is of a consistent length for scheduling purposes. Some of the material added was described by Eggertson as interstitial programs that, for example, tell the viewer in a 31-second spot what is coming up in the entertainment package either immediately following the movie or later in the day or in his words: “it could be a collection of little bits that run for a total of one minute ... promoting or discussing ... some feature”. This re-taping is performed completely on equipment owned by Allarcom at its premises by its own employees.

Allarcom stores its “product” on the new tape electromagnetically. Equipment owned by Allarcom converts the information on the tape into a signal that is projected to a satellite. At each cable company’s location, Allarcom has another piece of equipment, the Wagner Demodulator, which converts the signal and puts the audio and the video back together. According to Eggertson in this fashion, Allarcom “delivers” a signal to the cable company that it can distribute through its cable system to its subscribers. In Eggertson’s view, a distinction can be drawn between the activities of Allarcom and that of Cable TV. He contends that Cable TV is merely a distributor of other people’s programs, whereas Allarcom produces and sells a product to Cable TV which he described as “‘a discrete product that is unique to ourselves, it’s copyrighted. We have the right to restrict, and we do restrict through our affiliation agreements, how the cable company can sell, market and distribute that product”. [2]

Appellant’s Position

Allarcom manufactures and processes goods for sale or lease. Raw materials such as feature films are acquired from motion picture producers, are edited for quality and are surrounded by promotional fillers and interstitial material with the result that what is created from the raw material is a new tape which contains Allarcom’s “program”. The Appellant contends that this tape is a new product, “a new good which it processed”. This “good” is then sold to the cable companies in monthly units. While obviously it has some similarity to the original raw material, it is, according to Allarcom, a very different product. Regarding delivery, while the new tapes could be delivered to the cable companies physically, Allarcom, utilizing current technological means “delivers” them by means of electronic signals to the cable companies who then distribute these signals to their customers. That nonetheless, constitutes delivery. Furthermore, there is payment by the cable company for the delivery of this product at a prescribed rate.

In the alternative, it is contended that the activities of Allarcom constitute manufacturing or processing a good for lease. The transaction between Allarcom and a cable company is in the nature of a lease as the cable company is entitled to exclusive possession and use of the program in its defined territory for a defined period of time and such use may not be revoked by Allarcom at will. [3]

Counsel for Allarcom contended that three decisions in which the Courts held that television and radio signals received by antennas that the respective Appellants transmitted by actual cables to their subscribers’ receiver sets were not “goods” and that those Appellants never sold signals to their subscribers were not applicable in the present appeal. [4] Counsel argued that:

... In all three of those cases the Courts determined that there was no manufacturing or processing of goods for sale or lease. In our view, that was a correct decision because all that a cablevision company is doing is to act as a conduit. It takes a signal, in this case from the Appellant or Superchannel, and transmits it on to the subscriber. So we think those cases are rightly decided. There is no intervention, there is no good, there is no manufacturing. But we put them aside, we don’t think they’re applicable to the present facts.

and contended that these activities were clearly distinguishable from those carried on by Allarcom.

Counsel for the Appellant urged the Court in determining the issue in the present appeal, to interpret and apply the relevant legislative provisions in line with current technology and if necessary, to update the wording to allow for changes occurring since the Statute was initially framed. [5] In this context, Counsel made reference to the decision in St. Catharines Standard Ltd. v. Æ. [6] In that case, it was held that various activities involved in producing a newspaper constituted the business of manufacturing or processing goods for sale. Counsel argued that as newspapers can now be received on the Internet, if St. Catharine's were to be considered by the Court in light of this technology, it would be “somewhat bizarre” if the method of delivery changed the outcome. Counsel argued that in the present appeal, the relevant statutory provisions were first brought into the Income Tax Act in the early 1970s at which time, pay television did not exist and did not become a reality until the first licences were issued in 1982. Accordingly, he urged the Court to consider the application of section 125.1 and other relevant sections not on the basis of what was intended by the legislators at that time, but in light of “new 20th century technology”.

Respondent’s Position

It is the Respondent’s position that the “qualified property” clause in subsection 127(9) of the Act does not apply to Allarcom. Pursuant to subsection 127(9) prescribed machinery and equipment must be acquired and used by a taxpayer primarily for the purpose of manufacturing or processing goods for sale or lease. This is not the case with Allarcom.

The Respondent bases her position on three grounds. First, she contends that the operations of Allarcom were not manufacturing or processing since it is not manufacturing or processing a new product when it is simply compiling a series of programs for exhibition on a continuous basis. The program material which is essentially the full length feature films, are a finished product, and are saleable as such. According to the Respondent the Appellant is simply in the business of providing a new means of exhibition for the viewers. In this context, reference was made by Counsel to Tenneco Canada Inc. v. R.’ [7] In that case, Linden J.A. found that assembly does not necessarily amount to “manufacturing” and defined “processing” as occurring “when raw or natural materials are transformed into saleable items. Such raw or natural materials are unsaleable, or would sell for a lesser price, in their unprocessed state”. Although acknowledging that the Appellant may have produced some interstitial material, the Respondent states this formed a relatively minor part of Allarcom’s activities and does not constitute manufacturing or processing within the meaning of the relevant sections.

Second, there were no goods being processed or manufactured by Allarcom and that there were no goods sold or leased by it. The Respondent relies on Canadian Wirevision Ltd. v. /?. [8] for the proposition that the word “goods” in section 125.1 “is used in the common parlance of merchandise or wares, or, to put it in legal jargon, tangible, movable ... property”. It is the Respondent’s position that the entertainment package which is described by Allarcom as the good which is sold is not a tangible property if it is property at all. The Respondent further contends that information is not “goods” within the meaning of section 125( 1 ). [9]

Third, there was no sale of property by Allarcom, whether goods or otherwise, since in essence, its business and source of profit was the provision of services. The evidence adduced establishes that Allarcom did not enter into contracts of sale with its customers but rather that it entered into contracts for the supply of services. Counsel for the Respondent made reference to certain CRTC contracts and argues that they clearly support the Respondent’s position since those documents consistently refer to Allarcom’s activities as a service, both in the various licences and in its discussions regarding pay television.

Conclusion

I am of the view that Allarcom’s contracts with the cable companies were not for the sale of goods but were for the supply and provision of services. Although the factual basis for the decision of the Federal Court of Appeal in Canadian Wirevision is distinguishable, I am nonetheless satisfied that the comments of Pratte J.A. are applicable. In that case, the taxpayer cablevision company received television and radio signals (which it alleged became its property when received), were processed by the use of sophisticated equipment which cleaned, filtered and amplified, and were sold to subscribers by way of coaxial cable. The Minister of National Revenue alleged that the taxpayer did not process goods for sale.

The issue in Canadian Wirevision was clearly set out by Pratte J.A. as “whether the signals are goods within the meaning of section 125.1 and whether the Appellant did, in fact, enter into contracts of sale with its customers”. Both those questions were answered in the negative. First, the Federal Court of Appeal found that the signals were not goods within the meaning of the relevant provision of the Income Tax Act since they were not tangible, movable property. Second, as to whether the taxpayer entered into contracts of sale, Pratte J.A. noted: [10]

... The Appellant is in the communication business; it is not in the business of selling goods. The text of the form of contract used by the Appellant in its relations with its subscribers supports that conclusion and makes clear that this is the view that the Appellant takes of its role. This form does not refer to the sale of any commodity, but to the supply of services.

These words equally apply to Allarcom. In this context, it is of some import that each of Superchannel’s Affiliation Agreements [11] refer to the fact that Allarcom has been licensed by the CRTC “to operate a pay television network to provide a discretionary pay television service” and that Allarcom “has created a pay television service to be provided to network affiliates under the name Superchannel”. While I agree with Counsel for the Appellant that the language used by CRTC in its licences is not determinative of the issue before me, nonetheless, it is some evidence of that fact. The conclusion that Allarcom was in the business of providing services is consistent not only with the licence granted to it by CRTC [12] , but is also consistent with Allarcom’s relationship with its customers, the cable companies, and its suppliers, the movie studios.

The Minister’s position that Allarcom’s cable company customers were acquiring “information” which in this case was essentially the feature movies for further retransmission to their subscribers is also sound. Such information is an intangible property and not a “good” within the meaning of section 125.1 of the Income Tax Act. In Canadian Wirevision, Pratte J.A. stated: [13]

I agree with the trial judge that the word “goods” in section 125.1 “is used in the common parlance of merchandise or wares, or, to put in legal jargon, tangible, moveable (sic) property. ... By contrast, radio and television signals, while electrical currents, are never referred to as goods. The television or radio broadcaster is never thought of as the producer of commodities or goods. And the owner of a television set which receives a signal, be it with or without the help of a C.A.T.V. system, is never said to acquire or consume any goods.

In this context, useful reference can be made to R. v. Veritas Seismic (1987) Ltd. [14] where Pratte J.A. speaking for the Court said at page 243 (D.T.C. 6124-25):

In order to determine whether a taxpayer is engaged in the manufacturing or processing of goods, one must consider realistically the whole of the taxpayer’s activity; it is not sufficient to have regard to one aspect only of that activity.

The summary that I made of the respondent’s business shows, in my view, that the respondent was providing services to its customers by processing the raw information received from them, and derived its income from that activity rather than from the manufacturing or processing of goods. Indeed, the only part of the respondent’s activities that might perhaps be characterized as manufacturing or processing was the actual physical preparation of the seismic sections and the output tapes. However, those two simple operations, which were necessary in order to convey the result of the respondent's work to its customers, were not, in themselves, the source of its income. The real source of that income was the processing of information which cannot be equated to the processing or manufacturing of goods.

[Emphasis added.]

A similar conclusion was reached in the International Petrodata Inc. v. Æ. [15] In that case the taxpayer was engaged in the gathering, editing and interpreting of technical data for wells drilled for oil and gas in Canada and placed it on computer tapes or microfiches. These were then provided to the taxpayer’s customers for a fee. The Minister disallowed the manufac- turing and processing profits deduction claimed by the taxpayer under section 125 of the Act. The taxpayer’s appeal to the Tax Court of Canada was allowed on the ground that the taxpayer’s activities constituted the “manufacturing or processing in Canada of goods for sale or lease” within the meaning of paragraph 125.1(3)(a) of the Act. Upon appeal the Federal Court of Appeal disagreed, holding that the case was indistinguishable from the decision in R. v. Veritas Seismic (1987) Ltd. (sub nom. Canada v. Veritas Seismic (1987) Ltd.), Hugessen, J.A., for the Court stated, at page 14 (D.T.C. 5336):

The fact that, contrary to the situation in Veritas, the taxpayer here itself collected the data from various public sources does nothing to aid the respondent’s case. It is clear that the essence of its business is gathering, processing and providing information. /t is conceded that information is not “goods” within the meaning of Section 125.1 of the Income Tax Act. See Canadian Wirevision Limited, 79 D.T.C. 5101. The only goods involved here are the tapes and microfiches which serve simply as the medium on which the information is copied. Assuming that they are in fact sold or leased by the respondent, such sale or lease is not the real source of its income.

[Emphasis added.]

In my view, as was the case in Veritas, there was no tangible property transferred to the cable company by Allarcom and the tapes were merely a medium on which the real product, the information, was carried. It may be noted as well that in Petrodata, tangible items, the tapes themselves, were transferred to the customer but this did not convince the Court that they constituted “goods” for the purposes of section 125.1 of the Act. The transferring of the movies and shorts to a new tape and the addition of interstitial material such as trailers and other promotional material was not the primary source of Allarcom’s income in the taxation years in issue. On the evidence, I do not believe that any substantive distinction can be drawn between the activities of Allarcom and those of Veritas and International Petrodata. The substance of Allarcom’s business is the provision of a service.

As to the submission by Counsel for Allarcom that it is necessary to update the interpretation of statutes to be consistent with current technology, I note the following. In St. Catharine’s'®, [16] it was conceded that the publication of a newspaper is a manufacturing or processing business and that the newspaper itself constitutes a good for sale. The sole issue to be determined was what portion of certain salaries and wages paid to employees in the editorial reporting, etc. departments came within the definition of “qualified activities” found in Regulation 5202. I hasten to add that Counsel for the Appellant did not argue that the decision in St. Catharine's was on points of fact relevant to the appeal before this Court, but rather argued that if newspapers were not printed but were merely transmitted by way of an electrical signal on the Internet, there still would have been the sale and delivery of a good and that the method of delivery would not have changed the outcome. He also submitted that: [17]

It is presumed that Parliament intended the Court to apply to an ongoing Act a construction that continuously updates its wording to allow for changes since the Act was initially framed.

and that such interpretative presumption would have required the Federal Court-Trial Division:

...to take account of changes in technology and to treat the statutory language as modified accordingly when this is needed to implement the legislative intention.

I am not at all convinced that would have been the result. To do so would have required reading into the relevant provisions of Regulation 5202 a meaning clearly not intended by the legislators. I agree with the comments of Counsel for the Respondent that “there is no basis for assuming that Parliament intended to abolish the distinction between goods and other property, or that services should be included or read into the meaning of the phrase ’’goods for sale or lease”.

In view of my conclusion, it is not necessary to consider whether the activities of Allarcom constituted manufacturing or processing of a good for lease. The appeal is dismissed, costs to the Respondent.

Appeal dismissed.