Dorothy Dean (Canada) Limited v. Minister of National Revenue, [1978] CTC 3057, [1978] DTC 1764

The Chairman:—This is the appeal of Dorothy Dean (Canada) Limited from an income tax assessment in respect of the 1973 taxation year by which the Minister of National Revenue disallowed the manufacturing and processing profit deductions.

Simply stated the issue to be determined in this appeal is whether or not the appellant company was, in the pertinent taxation year, a manufacturer or a processor within the meaning of the Income Tax Act.

Summary of Facts

A company known as Plastic Fabrics Ltd which existed prior to the incorporation of the appellant company was the manufacturer, among other things, of plastic shower curtains and tablecloths. In 1971, Plastic Fabrics Ltd learned that Glen Mfg Inc, a company incorporated and situated in the United States was producing bathroom rugs, tankettes and waste baskets made of Orlon pile or Borg and known as Dorothy Dean products. A partnership was set up between Glen Mfg Inc and Plastic Fabrics Ltd and a company known as Dorothy Dean (Canada) Limited, the appellant company, was incorporated in which the shares were divided on a 50/50 basis for the production in Canada of the Dorothy Dean bathroom rugs etc. (Exhibit R-1).

It is my understanding that a Mrs Coltin and a Mr Crestohl were significantly involved in both Plastic Fabrics Ltd and Dorothy Dean (Canada) Limited, the appellant. A third company known as Collrich Investment Corp described as being a management or administrative company only was also headed by Mrs Coltin as ^President and Mr Crestohl as Vice-President. Collrich Investment Corp in 1973 rendered administrative services to Plastic Fabrics Ltd, Dorothy Dean (Canada) Limited and other companies not germane to the issue. It would appear that Collrich Investment Corp was operated by one person and its own income about covered its expenses with little profit left over, if any.

Mr Arthur Levine, secretary-treasurer and controller of Dorothy Dean and Collrich Investment Corp testified that the principal service rendered by Collrich was that of a clearing house for Plastic Fabrics Ltd and the appellant company. The witness alleged that one of the principal services rendered by Collrich was the payment of salaries of employees of Plastic Fabrics Ltd and Dorothy Dean (Canada) Limited after the usual statutory deductions had been made.

Plastic Fabrics Ltd, the appellant company and Collrich. shared the same premises which was leased by and paid for by Plastic Fabrics. It was also alleged that the appellant company had some twenty employees engaged either part time or full time in producing Dorothy Dean products. However, depending on the workload some of the appellant’s employees also did work for Plastic Fabrics Ltd.

A payroll card for each employee indicated how many hours the employee worked full time for the appellant company and how many hours some of the employees also worked for Plastic Fabrics Ltd.

The payment of all salaries was made by Collrich to Plastic Fabrics ltd. The direct labour and factory overhead expenses were then charged by Plastic Fabrics to the appellant company on. a unit basis and appear on the appellant’s books as contracting charges. The appellant’s balance sheet as at December 26, 1973, under the supporting schedules (included in the appellants 1973 tax return on file) under item “Costs of Goods Manufactured” the contracting charges (Labour and Factory Overhead) indicates a figure of $218,117. Plastic Fabrics’ balance sheet under supporting schedules indicate that its sales from contracting out was in the amount of $218,167 for the year ended December 26, 1973, (Exhibit R-2).

The evidence is that Plastic Fabrics Ltd owned all the equipment used by the appellant company; paid for the maintenance and, energy cost.for their use and took the capital cost allowance on its machinery. It was also admitted that Plastic Fabrics had taken the manufacturing and processing profit deduction.

Mr Victor Gallant, the co-ordinator for the production of Dorothy Dean products and those of Plastic Fabrics, testified that he worked for both companies but was paid by Collrich. In giving evidence he corroborated Mr Levine’s testimony on the allocation of the employees’ work for either or both the appellant company and Plastic Fabrics. He stated that when the production of the appellant’s products commenced some 10 years ago a specific area of the shared premises was set aside for the storing, cutting, sewing, finishing, folding and bagging of Dorothy Dean products, which subsequently had to be enlarged. He stated that there was a specific area in the premises shared with Plastic Fabrics in which the Dorothy Dean products were made and there were employees, cutters, sewers specifically employed to do Dorothy Dean’s work but who would, on occasion in slack periods, also help out in producing Plastic Fabrics products. The witness also stated that the appellant company hired its own employees and was empowered to fire them.

The third witness called was Mr Leonard Wolman a chartered accountant who had prepared the appellant company’s 1973 return. Mr Wolman explained that the purpose of making Collrich an administrative company for the appellant company, Plastic Fabrics was to facilitate the bookkeeping entries. Since the appellant’s employees at some time during the year had also worked for Plastic Fabrics, it would have been necessary to issue two T4 slips to each employee after calculating the statutory deductions for each employee and for each employer. This would have entailed double bookkeeping systems, double payrolls, double computer programming and an increase in the issuance of cheques for deductions at the source. Since the beneficial shareholders of both the appellant company and Plastic Fabrics were the same they decided to simplify the administrative procedure by using the services of Collrich Investment Corp as an administrative company.

Dealing with the preparation of the appellant’s 1973 return, Mr Wolman explained that although he lumped together the direct labour and the overhead costs as a charge from Plastic Fabrics he could easily have broken them down into their precise components but did not do so because it was irrelevant for accounting purposes. The witness stated that in filling out Form T2S(27) (Exhibit R-3), in respect of the manufacturing and processing tax credit, he could have and would have broken down the figures into the various components as required by sections 5200 and 5201 of the Income Tax Regulations had he known at the time the importance of doing so. The witness

that in his working papers the equipment used by the appellant was identified as Dorothy Dean equipment but was in fact purchased for the appellant by Plastic Fabrics Ltd.. The payment of a rental cost for the equipment is allegedly included in the bookkeeping charges which could have been determined and broken down in direct labour, total labour, direct cost of manufacturing, separate and total cost for purposes of the manufacturing and processing formula. Mr Wolman added that this bookkeeping procedure had never been done because of the relationship between the two companies.

Finding of Facts

In support of his contention that the appellant company was a manufacturer or a processor within the meaning of the Act, counsel for the appellant submitted that the appellant company had its own employees and that it occupied a specific area in the premises shared by Plastic Fabrics. It was also contended that the appellant’s use of Collrich for administrative purposes only was for the sake of convenience and efficiency.

I have no difficulty, under the circumstances, in seeing the advantages of centralizing the bookkeeping of the appellant company. Plastic Fabrics Ltd and other companies owned by the principals of Plastic Fabrics Ltd, however, it does very little in establishing that the appellant company was itself a manufacturer and processor of goods.

Although the onus of establishing itself as a manufacturer in 1973, rests on the appellant company, the allegations to the effect that the appellant had its own employees and its own specific areas of work are not conclusive in establishing that the appellant was a manufacturer or a processor.

On the other hand, the evidence. is clear that the appellant company and Plastic Fabrics, though separate legal .entities, were not dealing at arm’s length. It is also clear that all the employees worked on the production of both companies, and were all paid by Collrich through the intermediary of Plastic Fabrics. The employees’ work cards differentiating the amount of time each employee worked on shower curtains and the hours worked on Dorothy Dean products may be essential for bookkeeping purposes but it does not establish that the appellant company had its own employees and was itself engaged in the manufacturing or processing of goods. The fact that Dorothy Dean products were processed in a specific area of the premises is normal, since the product is different from the shower curtains also produced on the same premises, however, neither does this prove that it is the appellant company which actually manufactures the Dorothy Dean products. .

In my opinion, on the basis of the evidence adduced, the appellant company did not establish to the satisfaction of the Board that it was a manufacturer or processor. Moreover, if as suggested by counsel for the respondent, we examine the agreement signed by Glen Mfg Inc and Plastic Fabrics Ltd for establishing the appellant company, it appears clear that Plastic Fabrics was to manufacture, store and sell the appellant’s products at a fixed price per unit at a fixed profit.

Paragraphs 11 and 12 of the agreement (Exhibit R-1) read:

11. THAT the Venture shall contract with the Second Party, or another designated by it, for the manufacturing, warehousing and internal shipping of the products of the Venture at a set price per unit including trim, such as for example elastic threads, fasteners, etc. Under such contract the Venture shall pay for the costs of raw materials and packaging as well as selling commissions on sales to customers in addition to the contract price. Duty, exchange, brokerage, excise taxes and in-transit insurance and inward freight shall be considered as part of raw materials costs and local delivery cartage, costs shall be considered as part of the direct costs payable by the Venture. The contract price shall be reviewable semi-annually in the light of changes in the costs included in the contract price. The contract price shall include a reasonable profit for the Second Party;

12. THAT the Venture shall also pay all direct costs of its office operations, including postage, stationery, printing and other items of a similar nature but shall not include inside clerical help. The costs of such help as well as the balance of the costs of the office of the Second Party (except executive costs) will be allocated on the basis of the ratio which the number of sales invoices of the Venture bears to the total number of sales invoices handled by the office of the Second Party. The various allocations shall be on a monthly basis but shall be adjusted at the end of each fiscal year. In any event the total annual office expenses of the Venture shall not exceed 8V2 % of the total value of its sales invoices less any amount charged as sales taxes:

The evidence indicates that these two clauses of the agreement were carried out which, in my view, greatly weakens the appellant’s contention that it manufactured or processed Dorothy Dean products. The nature of the agreement between Glen Mfg Inc and Plastic Fabrics Ltd is reflected in both the appellant’s notice of objection and notice of appeal. The appellant’s notice of objection (on file) reads:

The manufacturing and processing deduction should be allowed in full for the following reasons:

1) Company purchases raw materials, box, supplies, etc from various suppliers.

2) The company has a Federal sales tax license for manufacturers and applies the tax on its selling price of all sales made to retailers. If it was not a manufacturer, sales tax would apply on cost and the tax department would lose tne tax on the gross profit.

3) The company carries a large inventory of raw materials and manufactured finished products.

4) The company uses a contractor to sew the products of its own design. This is a common practice in the needle trade.

5) The company buys goods in rolls up to 60 yards in length and cuts, combines, sews and forms and changes the nature of the original product.

6) Refer to IT No 145, February 5, 1974 for reasons why company must use a contractor to manufacture product.

The pertinent paragraphs of the appellant’s notice of appeal are:

b) Whereas the company purchases in bulk raw materials, boxes, supplies and all manufacturing components from various suppliers in Canada and USA.

d) Whereas the company carries a large inventory of raw materials and finished goods which they are either preparing for a manufacturing process or Nave been prepared and are ready for marketing.

g) Whereas a corporation shares a plant with this company and for “accounting purposes and incentive purposes only’’ all the labour is on one payroll, all records are kept in one office and all other administrative, purchasing and sales functions are combined and integrated entirely; and this corporation who has the employees, equipment etc on its books charges Dorothy Dean (Canada) Ltd for the actual costs of labour and overhead on a formula arrived at in 1970 to eliminate duplicate bookkeeping functions and problems in controlling costs etc; and whereas this company is at all time under the management supervision of the management of Dorothy Dean and performs all manufacturing acts as if it were one corporation with no other objective other than to keep the labour and overhead per unit manufactured to a minimum.

A letter written by the appellant’s accountants to the Receiver General of Canada dated December 8, 1975, and produced as Exhibit R-4 reads in part:

December 8, 1975

Receiver General of Canada,

305 Dorchester Blvd West,

Montreal, PQ

Attention: Miss Francine St Onge,

Section 34, 8th Floor

Re: Dorothy Dean Canada Ltd

Dear Miss St Onge:

This is further to your audit of the records of the above mentioned company for the 1973 taxation year, and our. discussions relative thereto. In particular, you asked for explanations with regard to (1) the accrual of the advertising allowance, and (2) our reasons for the 5% manufacturing allowance.

(2) 5% MANUFACTURING ALLOWANCE

d) The charge from the contractor is determined by its relationship to the suggested selling prices of the finished product and its calculated as follows:

1)	For actual direct production labour for
	cutting and sewing, etc	11.5%
2)	For its share of the factory overhead including
	rent, taxes, insurance, equipment, rental and
	depreciation, lights, power and direct labour, etc	6.1
3)	Sundry trimmings (thread, binding, etc
	supplied by the contractor)	0.5
4)	Share of distribution costs	6.0
		24.1
5)	Profit allowance	3.4
Total contracting charge		27.5%

Yours very truly,

(signed) Mithcell M. Richler

RICHLER, LERNER, WOLMAN & CO, Chartered Accountants

MMR:rk

These documents taken singly or together indicate to me that the actual manufacturing of Dorothy Dean products was contracted out by the appellant company and manufactured or processed by Plastic Fabrics.

Notwithstanding Mr Wolman’s statements that he did not realize the importance of properly filling out Form T2S(27); that under the circumstances the method utilized in keeping the appellant’s records was adequate for accounting purposes, and that the use of the word “contracting” in the Financial Statement was made in error; the preponderance of the evidence, in my opinion, leans heavily toward the conclusion that the appellant company contracted out the manufacturing of Dorothy Dean products and the appellant company did not succeed in establishing that it manufactured or processed any part of the finished product on its own.

The case law in point is rightly consistent in holding that the manufacturers’ and’ processors’ profit deductions can only be allowed if the taxpayer himself manufactures or processes at least some part of the finished product. The evidence in this appeal, in my opinion, indicates that all of the processing and manufacturing of Dorothy Dean products was contracted out and no part of the finished product was either manufactured or processed by the appellant company so that no manufacturing or processing profit could have been realized by the appellant in the 1973 taxation year.

For these reasons the appeal is dismissed.

Appeal dismissed.