O’Connor J.T.C.C. : — This appeal was heard at Ottawa, Ontario, on August 6, 1996 pursuant to the General Procedure of this Court.
Testimony on behalf of the Appellant (“Dew”) was given by Brian Smith, its vice-president engineering, James Pickard, a Program Manager and Engineer and Kevin Stewart, a representative of Public Works Canada who, in 1992, was a senior contract officer with the Department of Supply and Services.
Issue
The issue is whether, in the 1992 taxation year, Dew was entitled to deduct as a research and development expenditure an amount of $45,683, being the cost to Dew of constructing a laboratory, plus a related capitalized salary expense of $9,370. If so, Dew will also be entitled to certain investment tax credits in 1992 and 1993. The outcome will depend upon whether the laboratory is a “building” within the meaning of the relevant provisions of the Income Tax Act (“Act”).
Law
Paragraphs 37(1 )(a), 37(1 )(b) and 37(7)(f) of the Act provide, subject to certain conditions and limitations, that a taxpayer may deduct research and development expenditures of a current nature and of a capital nature, but not capital expenditures made in respect of the acquisition of land or of a building. The total expenditures are reduced by certain deductions but those deductions are not relevant in this appeal. Paragraph 37(7)(f) was renumbered 37(8)(d) in the revised Income Tax Act (Fifth Supplement) effective after November 1991. So far as material these provisions read as follows:
37(1) Where a taxpayer carried on a business in Canada in a taxation year and...there may be deducted in computing his income from the business for the year...the aggregate of
(a) the aggregate of all amounts each of which is an expenditure of a current nature made by the taxpayer in the year or in a preceding taxation year ending after 1973
(i) on scientific research and experimental development carried on in Canada, directly undertaken by or on behalf of the taxpayer, and related to a business of the taxpayer,
(b) the lesser of
(i) the aggregate of all amounts each of which is an expenditure of a capital nature made by the taxpayer (in respect of property acquired that would be depreciable property of the taxpayer if this section were not applicable in respect of the property, other than land or a leasehold interest in land) in the year or in a preceding taxation year ending after 1958 on scientific research and experimental development carried on in Canada, directly undertaken by or on behalf of the taxpayer, and related to a business of the taxpayer, and
(ii) the undepreciated capital cost to the taxpayer of the property so acquired as of the end of the taxation year (before making any deduction under this paragraph in computing the income of the taxpayer for the taxation year).
37(7)(f) ... references to expenditures on or in respect of scientific research and experimental development shall not include
(i) any capital expenditure made in respect of the acquisition of a building
Facts
In 1992 Dew spent $45,683 to construct a laboratory (“lab”) and incurred the related capitalized salary expense of $9,370.
The lab was constructed and located on Dew’s premises at 3429 Hawthorne Road, Ottawa. It 1s composed of five modules connected to one another by bolts and at the points of connection exterior moulding and flashing are in place. The modules are almost identical to the components of the walkways at the Ottawa International Airport which allow passengers to connect to and from their flights with the main terminal building. Each module is made of steel and contains a floor, roof and walls. The lab was adjacent to Dew’s plant and was connected to the plant by bolts. An opening in the wall of the plant gave access to and from the lab. It was approximately 80 feet long by 10 feet wide with a total area of 800 square feet. The roof, floor and walls are all insulated, the roof and floor slightly more so than the walls. The interior is finished. In appearance the lab resembles a long mobile home.
The lab has fitted triangular shaped footings which sit on steel plates which in turn sit upon the ground. The footings can be raised or lowered to achieve a level position. There are two walls also made of steel at the extremities of the connected five modules.
The lab has its own power distribution system connected to the system in the plant. It also has its own heating, ventilating and air conditioning system which is fuelled by natural gas supplied by a tributary of the main pipeline serving the plant.
The lab can be disconnected from the plant and prepared in approximately one day for shipment to a new location. It was initially constructed to assist the University of Ottawa Heart Institute to develop a totally implantable vascular assist device (artificial heart). Research was carried on in the lab by Dew’s employees or contractors with the expectant hope of ultimately developing and marketing artificial heart components to be made by Dew. It was designed to be portable to enable it to be initially moved from the company’s premises to the Ottawa Civic Hospital and connected thereto. Further, its portability feature enabled it to be disconnected and moved to another medical facility. Its design permitted its quick and easy dismantling and relocation to another site. The contemplated mode of transporting the lab was a flat bed truck upon which it would be loaded by means of an installation crane. Similarly installation at a new site would be achieved by an installation crane removing the lab from the flat bed truck, lowering it into position and setting it down on the ground. The footings would be adjusted and the lab levelled. Another mode of transportation would involve separating the modules and disconnecting the component sections of each module, i.e. the roofs, walls and floors and placing them on a truck.
The lab was never actually moved from Dew’s premises to another site. However on two occasions it was moved away from the plant to allow for plant renovations. A video was shown to demonstrate how these minor moves were accomplished. They involved the use of a lift truck, some other small vehicles and a few men to move the lab approximately 100 feet away from the plant. After completion of the plant renovations, the lab would be moved back and connected at another opening in the plant’s wall.
The lab was constructed by Dew as opposed to a fixed building addition because of the flexibility provided by its mobility and the contemplated need therefor. For cleanliness reasons the lab was separate from the plant.
Submissions of Appellant
Counsel for the Appellant submits that the lab 1s not a structure and therefore cannot be a building. He refers to definitions of “building” and “structure” in Black's Law Dictionary and to IT-79R3. IT-79R3 provides:
Meaning of “Building ” and “Structure ”
1. “Building” is a term of wide range covering any structure with walls and a roof affording protection and shelter. The word “structure” includes anything of substantial size that is built up from component parts and intended to remain permanently on a permanent foundation. This definition of “structure” was considered by the Supreme Court of Canada in British Columbia Forest Products Ltd v. Minister of National Revenue, [1971] C.T.C. 270, 71 D.T.C. 5178, which also concluded that the word “structure” when used in the context of “building or other structure” does not mean only a structure in the nature of a building. Bridges or hydro- electric transmission towers, for example, while clearly not buildings, are structures.
2. Portable shelters such as housing, office and other service units are regarded as buildings if they are installed and intended to remain in a particular location. Such things as tents, canvas marquees and air-supported fabric domes that are not part of a rigid structure are not considered to be buildings or structures.
Counsel concludes that for something to be a structure it is necessary, in accordance with the case law and IT-79R3 for the construction to remain permanently in place on a permanent foundation. Since the lab does not rest on a permanent foundation it is therefore not a structure and therefore not a building.
The alternative position of counsel for the Appellant is that even if the lab is found to be a structure, it was not the intention of the Appellant that it remain permanently on a permanent foundation.
Submission of the Respondent
Counsel’s verbal submissions were principally as follows:
... as to whether the portability issue really carried the day. The notion and the very word itself may well have been mentioned in the older cases, when the developments in the field of construction and technological know-how were not as they are today. But... that when one looks at what has been constructed here we look at a structure,... with four walls, a ceiling and a floor. We look at a structure that provides shelter and protection, it provides warmth and acclimatization. It provides security and it enables those who are within it to keep dry, protect themselves from the elements. And it seems to me that when one wants to use a shorthand for all of those attributes that I have just mentioned, the word that easily comes to mind is a ‘building’.
.. although one can have all the comparisons one wishes with modules that provide walkways at the airport and a structure which is only locateable at least once a year, but depends on the decision of the airport authority, it just seems to me that we’re talking about that mobile lab whether it’s stand alone at the Hawthorne Street yards of Dew Engineering or affixed by way of being bolted to the building and the opening protected by flashing and caulking, or whether a hole is made in the side wall of the heart institute or the Civic Hospital and bricks removed and some finishing maneuvers implemented and that structure placed there on, again, ... that we’re talking about a building.
The clear issue that is before us is as to whether this mobile laboratory is a building or not. I of course say that it is and my friend would have it that it is not. It can be a structure, it cannot be a structure, I don’t think that that’s all that important in the context of this debate.
My submission to the court is to the extent that our mobile laboratory is intended to be transportable that that in no way takes away from the essential building features that it possesses. That is merely an added virtue which it possesses because its designers and builders built it in, but that it in no way takes away from its structural soundness or indeed its permanency once installed, that is just as sound as a building built on a foundation, it provides the same degree of security, warmth, et cetera. Now that’s because the focus to a certain extent has been on the intention, the intention of Dew Engineering in designing and in constructing. I think that quite clear, in fact these structures are not moved very often. They are made to be moved but I think we all appreciate that the reality of it is that they are not in fact moved very often and when they are it is, once again, on an intelligent, logical balance of the costs involved in moving that which is movable because it was made movable, or that of acquiring another type of, either erecting or bringing on site another type of structure. It’s a decision that is I suggest financially based, financially motivated. In the same sense that a bungalow, a frame house, covered in aluminum or brick, is transportable. It may not have been the original intention of its builder but given technological advances, given enough money, given imaginative workmen, it is something that can be accomplished. That transportability feature of a family residence in no way takes away from the fact that we are talking about a residence and a building and a house and to be hopefully a home once it’s reinstalled in its new location. ...
[Counsel quoted certain excerpts from the British Columbia Forest Products decision and concluded as follows]:
And so it is my submission, Your Honour, that this mobile lab, a neutral term before the court, has been designed to either stand alone but to function as a mobile lab, a part of a mobile lab, a part of a larger institution, either in a hospital setting, a heart institute setting, a university setting, or to be structurally affixed to that larger building, and in my submission in either sense, given its function and use, it constitutes a building within the terms of the Income Tax Act and as we have seen the word used in the case law.
Analysis and Decision
At one point in time the Act permitted, as a research and development expenditure, the cost of the acquisition of a building. It was only in 1987 that a building was excluded. I agree with Counsel for Respondent that the only issue is whether the lab is a building and that whether or not it is a structure is not important, notwithstanding some of the definitions of structure submitted by the Appellant and the Appellant’s argument that if it is not a structure it cannot be a building. In any event, I am of the opinion that the lab must be a structure of some sort. The question remains whether it was a building.
The proper approach to the interpretation of the Act was adopted by the Supreme Court of Canada in Québec (Communauté urbaine) v. Corp. Notre-Dame de Bon-Secours, [1994] 3 S.C.R. 3, (sub nom. Notre-Dame de Bon-Secours (Corp.) v. Québec (Communauté urbaine) [1995] 1 C.T.C. 241, (sub nom. Corp. Notre-Dame de Bon-Secours v. Québec (Communauté urbaine), 95 D.T.C. 5017. There the issue was whether a non-profit corporation providing low rental housing to low-income seniors qualified for an exemption from municipal tax by reason of being a ‘reception centre’ under provincial health and services legislation.
Under the applicable municipal property tax legislation, properties which were ‘reception centres’ as defined in provincial health and social services legislation were exempt from tax. The plaintiff operated a facility consisting of apartments occupying 89 per cent of the total area of the property, and a shelter and community services area on the remaining 11 per cent of the property. In 1982, a tax assessor permitted the real estate tax exemption for only 11 per cent of the plaintiff’s property on the basis that only the activities carried on in that portion of the property qualified for the exemption. This conclusion was reversed by an administrative board and by the Quebec Provincial Court. However the Quebec Court of Appeal, in part due to its restrictive interpretation of an exemption in tax legislation, held that the exemption applied only to the 11 per cent of the property clearly used as a reception centre. The taxpayer appealed to the Supreme Court of Canada.
The Supreme Court reviewed a number of rules for interpreting tax legislation, first dispensing with the ‘traditional rule’ of strict construction of tax legislation. Under that rule, since tax legislation had been regarded as penal, ‘in cases of doubt a presumption existed in the taxpayer’s favour in taxing situations but against the taxpayer in exception situations.
The Supreme Court reviewed and commented on the various interpretative devices relied on in previous cases, then set out the following summary of how tax legislation should be interpreted, at page 20 (C.T.C. 252, D.T.C. 5023):
- The interpretation of tax legislation should follow the ordinary rules of interpretation;
- A legislative provision should be given a strict or liberal interpretation depending on the purpose underlying it, and that purpose must be identified in light of the context of the statute, its objective and the legislative intent: this is the teleological approach;
- The teleological approach will favour the taxpayer or the tax department depending solely on the legislative provision in question, and not on the existence of predetermined presumptions;
- Substance should be given precedence over form to the extent that this is consistent with the wording and objective of the statute;
- Only a reasonable doubt, not resolved by the ordinary rules of interpretation, will be settled by recourse to the residual presumption in favour of the taxpayer.
Applying these principles, the Supreme Court gave a broad interpretation to the meaning of “reception centre” and found the entire property qualified within the meaning of the relevant health and social services legislation, exempting it from real estate taxes altogether.
In an effort to ascertain the intention of the legislature in removing buildings but not other structures and capital assets from qualifying expenditures, I refer to the Technical Notes of the Department of Finance, 4th Edition, Consolidated to 1992. It states as follows:
1987 TR- It is proposed to exclude expenditures on buildings from tax incentives for scientific research and experimental development (R&D)
— the 20 per cent investment tax credit and the 100 per cent write-off. The incentives for other capital equipment such as machinery and equipment and structures (such as a wind tunnel or an experimental wind or hydro energy prototype) used for R&D will be retained....
Currently, taxpayers are allowed to deduct qualifying R&D expenditures of a current or capital nature. Capital R&D expenditures include the cost of buildings, structures, and machinery and equipment. Current and capital R&D expenditures also qualify for the 20 per cent R&D tax credit while a 30 per cent rate applies for R&D expenditures made in the Atlantic provinces and the Gasp. A 35 per cent rate applies to the first $2 million of current and capital R&D expenditures made in a taxation year by small corporations and the 20 and 30 per cent rates apply to R&D expenditures in excess of this amount. The 35 per cent tax credit for current R&D expenditures is fully refundable if the corporation cannot use it in the year it is earned.
Denying these tax incentives for the cost of R&D buildings will bring the tax treatment of R&D buildings in Canada more into line with that in other industrialized countries. Notwithstanding these changes, however, Canada will continue to offer one of the most favourable packages of R&D tax incentives among the major industrialized countries...
[Emphasis added.]
I refer also to a paper given by James Hutchison entitled Canadian Tax Incentives for Specific Research and Experimental Development published in the report of proceedings of the 40th Tax Conference of the Canadian Tax Foundation of November 1988. The following 1s stated at 26:10 and following:
One significant tax reform addition to subsection 37(7) is paragraph (f), which specifically excludes costs incurred in the acquisition or leasing of a building ... The elimination of a deduction for buildings was based on the perception that many SR & ED buildings are normal office-type structures that can be used for other purposes in the future.
During tax reform consultations many observers argued that this approach was draconian and unjustified. It was said that occupancy costs are valid SR & ED expenditures, and should therefore be deductible under subsection 37(1). The SR & ED community acknowledged that immediate deductibility of building costs was generous, and recommendations were made to spread the deduction over several years, provided that the building continued to be used for SR & ED. The view of the Department of Finance prevailed, however, with the result that legitimate SR & ED building and rental costs are no longer deductible under section 37. This raises the question whether, in certain circumstances, SR & ED building or rental costs are deductible at all by the business. There is an argument to be made that section 37 is required to allow SR & ED costs to be deducted. It is based on the premise that those expenditures are not necessarily ‘amounts laid out in order to earn income;’ therefore, for an expenditure to be deductible, it must be specifically allowed by section 37. If this premise is correct, because section 37 now specifically denies a deduction for buildings and rent, Revenue Canada might deny any deduction for building or rental costs, especially if these costs are incurred on a dedicated SR & ED worksite. Although verbal assurances have been given that this is certainly not the intent of the legislation, a technical amendment may be desirable to provide for the deductibility of these costs.
[Emphasis added. ]
The object and purpose of the beneficial treatment provided by the Act for R&D expenditures is to encourage research and development in Canada. In that context one should not hastily disqualify an expenditure for a facility specifically designed and constructed to carry out research and development.
“Building” can have many different meanings in different contexts and its meaning has been considered in numerous decisions. In some contexts very small things such as barns, silos, sheds and even phone booths might be buildings while in another context huge structures such as the Olympic Stadium in Montreal, the Corel Centre in Ottawa and the Sky Dome in Toronto and similar arenas might not be considered buildings for some reason, such as the temporary nature or non- existence of a roof or its retractability or the fact that these structures are not continually used.
Moreover, a structure might be considered a “building” for real estate tax purposes, but not for GST and PST purposes.
Notwithstanding these observations, it 1s clear however that if something is clearly a building within the meaning and context of provisions in question, the expenditure for it is not a deductible R&D expenditure.
Applying the teleological approach of the Supreme Court to the meaning of “building” in paragraph 37(7)(f) and the related provisions of the Act, the purpose of which is to encourage R & D in Canada, I find the following factors important.
1. The lab has no foundation and is not affixed to the ground.
2. It sits on the ground like some mobile homes.
3. It is designed to be and is in fact portable.
4. It can be easily disassembled and reconstructed.
5 . When in place, its energy needs are met by connecting to facilities of the structure to which it is appended.
6. Its cost was minimal in the general context of building costs; and
7. Its life expectancy was only 20 years.
Although IT-79R3 is not law, if it were applied to this appeal, the lab, in my opinion, would not be considered a “building” because of paragraph 2 of the Bulletin which states that portable shelters are regarded as buildings if they are installed and intended to remain in a particular location. The lab is portable but was not installed and intended to remain in a particular location.
Consequently I find that the lab is not a building. Therefore, the appeal is allowed with costs and the matter is referred back to the Minister for reconsideration and reassessment for both 1992 and 1993 in accordance with the foregoing reasons.
Appeal allowed.
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