Canadian Clyde Tube Forgings Limited v. Minister of National Revenue, [1977] CTC 2451, 77 DTC 304

Roland St-Onge (orally: June 20, 1977):—The appeal of Canadian Clyde Tube Forgings Limited came before me on June 14, 1977 at the City of Toronto, Ontario and it is with respect to its 1973 taxation year. In that year the appellant sought to deduct from its tax otherwise payable a manufacturing and processing tax credit in the amount of $34,940. In his reply to the notice of appeal the respondent admits the following, the appellant’s allegation of facts:

1. The issue in the present case relates to the method of calculating manufacturing and processing profits under Section 125.1 of the Income Tax Act.

2. The appellant is a wholly-owned subsidiary of Emco Limited and is engaged in certain processing of welding fittings and flanges which form part of its inventory.

3. A certain portion of the processing work is done through a contracting and agency arrangement with a company called Weram Limited (Weram).

6. Weram does not purchase any inventory from the Appellant and it receives its compensation simply by way of processing charges for the servicing and processing operations which it performs.

7. Weram acts as a contractor or agent for the application of factory labour to the processing operations which it performs.

8. In the assessment, the Department has eliminated all of Weram’s charges and therefore all of the employment activities of Weram as part of the cost of labour forming part of the calculation in the determination of the manufacturing and the processing profits.

9. Under Section 5202 of the Income Tax Regulations, the cost of labour includes the aggregate of the salaries and wages paid or payable during the year to all the employees of the corporation for services performed during the year as well as to all other amounts each of which is an’ amount paid or payable during the year for the performance during the year, by any person other than an employee of the corporation, of functions relating to a service or function that would normally be performed by an employee of the corporation.

At the hearing two witnesses were heard on behalf of the appellant: (1) Mr John Adams, vice-president of Emco Limited and treasurer and director of the appellant company, and (2) Mr Walter John Wynn, Assistant General Manager of the appellant company. According to these witnesses, the appellant company owns in Mimico, Ontario a plant of some 60,000 square feet and employs some 45 men, 3 of whom are being engaged in the manufacturing operation.

Some 5,000 to 6,000 square feet are occupied by the Weram Company Limited where its 12 employees, all machinists, manufacture and process the raw material purchased from Japan by the appellant company. Every Thursday Weram Limited was paid for its services at a negotiated rate which has changed only two or three times. 7

The appellant company also has branches in Montreal, Vancouver, Edmonton and Toronto. The Weram company was owned by Mr W E Ramsden who passed away and was replaced by his son-in-law, one Mr Doyle. They own 51% of the shares whereas Mr McLeod, the former chairman of the appellant company, owned 49%. Apparently, this was not known by the other directors of the appellant company before 1973 and they are now in the process of suing Mr McLeod for damages.

The evidence did not reveal whether there was a written agreement between Weram Limited and the appellant Company regarding the nature of the processing required by the appellant company, but a written agreement between the appellant company and W E Ramsden Company, the predecessor of Weram Limited was filed as Exhibit A-2 and is reproduced herein:

April 23, 1964. W E Ramsden Company,

23 Buckingham Street,

Mimico, Ontario.

Attention: Mr W E Ramsden.

Gentlemen:

This letter is intended to cover the arrangements made with respect to the machining of welding fittings and flanges for Canadian Clyde Tube Forgings Limited, hereinafter referred to as CCTF, at its premises at 23 Buckingham Street, Mimico, Ontario.

1. The machinery and equipment which is owned by CCTF used for the machining work, consisting of two horizontal milling machines, cannot be disposed of under any circumstances without the permission of W E Ramsden.

2. W E Ramsden must have access to the machines at all times.

3. W E Ramsden will reimburse CCTF for the cost of the equipment. In the event that this arrangement is terminated by CCTF, W E Ramsden will be reimbursed for the cost of the equipment based on a five year amortization from February 4, 1964. Ownership of machinery and equipment can be transferred at any time at a price to be negotiated.

4. Maintenance and repair costs will be absorbed by W E Ramsden, however, all costs for power and lighting to operate the machine will be borne by W E Ramsden.

5. The machinery and equipment referred to in this agreement must be used solely for the machining of material supplied by CCTF.

6. Charges for the machining work will be as agreed in writing by the authorized representatives of both parties. The CCTF representative will be Mr E T McLeod and the representative of the W E Ramsden Company will be W E Ramsden.

Accepted this 24th day of April, 1964.

Witness:

W E Ramsden Company

Per (Signed) W E Ramsden

Canadian Clyde Tube Forgings Limited

(Signed)

Vice-President

(Signed)

secretary

The evidence has also shown that each company had its own accounting system, bank accounts, cheques, stationery, payroll, telephone number, except that the charges by Weram Limited were done on a blank sheet of paper. As to the negotiated rate, the value of the space occupied by Weram Limited as well as some hydro charges were taken into consideration. It was also mentioned that all the competitors of the appellant company did the work directly through their own employees with the exception of one company in the United States and that the appellant company chose Weram Limited to do this kind of processing business because Weram Limited had all the machinery to do the services and by the same token, it was the most efficient and economical way to perform the work.

Counsel for appellant argued that section 125.1 of the Act was an incentive legislation to encourage the employers to employ more employees and that the appellant should not be penalized because it chose the most efficient and economical way to earn its profits. Then he referred to sections 5200 and 5202 of the Regulations to say that these two sections apply to all labour and that manufacturing and processing was among the qualified activities to receive the tax credits.

Counsel for appellant also argued it was not because Weram employees were not the appellant company’s employees that the cost of labour thereof should not be taken into account by the appellant for the purpose of getting the tax credit. According to him, there were two elements in the cost of labour: (1) salaries and wages, and

(2) all other amounts paid for the performance by any person other than an employee of the corporation of functions relating to a service that would normally be performed by an employee of the corporation.

He went on to say that because the appellant company did not perform the function itself but was aided by another company, it does not mean that it was not normally done by it because “normal” does not mean “only”. It was normal for the appellant company to perform the said functions in the most efficient and economical way, that it was common sense nowadays for a taxpayer to organize his business through a chain of corporations and that even if the appellant’s position was unique in this country, it did not mean that it was not normal for it to perform as it did.

Counsel for respondent argued that although section 125.1 of the Act and sections 5200 and 5202 of the Regulations were incentive legislation to encourage employment, the taxpayer did not receive carte blanche but must follow certain rules which are well spelled out in the said sections.

Both companies are separate corporations and what was done by Weram Limited was never done by the appellant. Maybe it was the most efficient and economical way to do it, but what was done by Weram Limited cannot be credited to the appellant company. The appellant made its choice in proceeding as it did and it must bear the consequence of its actions.

Referring to the relevant sections, he also said the [definition of “cost of labour” in] Regulation 5202 at subparagraph (b)(iii) mentioned the corporation which means that the function must be performed “by an employee of the corporation” or other employees that the same corporation would hire for that function.

As to the word “normal” he said because the appellant company never performed such a function with its own employees, it cannot be said that the said function was in relation to a service that would normally be performed by an employee of the appellant company.

The Board realizes that section 125.1 was enacted as an incentive to encourage the employers to hire more employees, but the evidence reveals that the manufacturing and processing was done by the employees of Weram Limited and not by those of the appellant company. The appellant company was not a manufacturing and processing corporation since only 3 of its 45 employees were manufacturing and processing and most of its profits were derived from the sale of goods of which some were manufactured and processed by Weram Limited, another corporation. As may be seen, the appellant company was not normally engaged in the manufacturing and processing of goods.

It is clear that section 125.1 was enacted for a manufacturing and processing corporation. According to the evidence adduced, it cannot be said that the appellant derived its profits from manufacturing and processing and consequently it cannot benefit from the tax credit of the manufacturing and processing profits of Weram Limited.

For these reasons, the appeal is dismissed.

Appeal dismissed.