11 June 1990 Ruling 74563 F - Investment Tax Credit on Logging Assets

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

SUBJECT:  ITC on Logging Assets Subparagraph 127(11)(b)(i) and Regulation 4600(2)(f)

We have been called upon by Industry Studies to resolve an issue which has for several years plagued the application of investment tax credits to certain capital assets used in the logging industry.

So that we may resolve this complication in the most equitable manner, we request Finance's observations and input regarding it's resolution.

THE LAW

Subsection 127(5) of the Act provides, inter alia, that a taxpayer may deduct from his tax otherwise payable under Part I his investment tax credit (ITC).

ITC is defined at subsection 127(9) of the Act to mean, inter alia, the specified percentage of the capital cost to the taxpayer of a qualified property.

That same subsection goes on to define a qualified property as being, inter alia, prescribed machinery and equipment used primarily for the purpose of logging.

Paragraph 4600(2)(f) of the Regulations define prescribed machinery and equipment, inter alia, as a loading truck to be used in the activity of logging.

The commencement of our difficulty with regards to granting ITC's in the logging industry was with logging trucks and whether they receive ITC's.  Amongst other uses in the industry, these trucks are used to haul logs from the cutting site to a sorting facility after which the logs are forwarded to a mill either by water or logging trucks.

Prior to the decision in Lor-Wes Contracting Ltd. v. The Queen 85 DTC 5310, logging trucks were considered to be in the business of transportation and as such did not earn ITC's upon their acquisition since transportation was not a purpose referred to in the definition of "qualified property" at subsection 127(9) as was the activity of logging.

However, the Honourable Justice MacGuigan who delivered the unanimous decision of the Federal Appeal Court in the Lor-Wes contracting Ltd. case, found that a contract logging road builders "work is dedicated, and their equipment is used by them, primarily for the purpose of logging."

Given this interpretation, the then Minister of National Revenue communicated with         19(1)  in October 1985,stating that the same rationale would be applied to contract log hollers, stating "that operating a truck solely to transport logs will be logging", i.e. the trucks used by the operators would qualify as assets eligible to earn ITC's.

The difficulty with this reasoning involves a conflict between the legislation and the regulations promulgated in support of the legislation.  A general rule in applying the ITC legislation is found at subparagraph 127(11)(b)(i), which restricts the definition of "qualified property" in subsection 127(9) as not including the storing, shipping, selling or leasing of finished goods.  Prior to the October 1985 letter, this Department had taken the long standing view that logs were the finished goods of logging.  However given the existence of the said letter by the Minister in October 1985 and the amendment to paragraph 4600(2)(f) of the Regulations which included logging trucks to the definition of "prescribed machinery and equipment", the Department's position that logs are the finished goods of that industry could no longer be advanced.

In addition to the above, could it be advanced that for purposes of the Act a finished good does not exist in the logging industry?  Paragraph 127(11)(a) of the Act states that manufacturing or processing does not include any of the activities referred to in subparagraph 125.1(3)(b)(i) to (x). Subparagraph 125.1(3)(b)(ii) states that logging is not a manufacturing or processing activity. Upon first analysis of the term "finished good", it would appear necessary that a product must be manufactured or at least undergo a process in order to fit the interpretation of the phrase. Items which are harvested, such as farm crops or logs would therefore seem to be automatically excluded.  However, upon closer examination of the Act and in particular subparagraph 127(11)(b)(i), the legislation carved out of storing finished-goods, the storing of grain.  Thus it appears that the legislature intended to include harvested vegetation in finished goods at subparagraph 127(11)(b)(i).  The problem with this conclusion is that storing grain is included as a purpose test in the definition of qualified property at subsection 127(9).

Nature of the Problem

Given the Departmental position that logs are not the finished goods of logging, Audit is required to treat all the assets at a dryland sort, commencing from the self tripping bunks and onward as assets qualifying to earn ITC's since these assets were not used for the purpose of storing and shipping finished goods and pursuant to subparagraph 127(11)(b)(i) the purpose test for ITC disqualification is not met.

Dryland sorts came into being in the mid 1970's when the industry started to build large centralized "dryland sorts" on the shores where logs would be sorted, graded, remanufactured, and wired together in bundles before being dumped into the water.

24(1)

24(1)

The industry has been taking the position that ITC's are earned upon dryland sort facilities by contending that their finished goods are lumber, pulp, newsprint, etc.  and if that is not accepted, in the alternative the finished goods are graded and sealed logs in the water in a packaged unit (i.e. "bay") and that unbundled individuals logs are not finished goods.

Revenue's industry specialist, as well as Audit, have contended that finished goods in the logging industry occur when logs are "packaged" by being wired together in bundles in the self-tripping bunks, and it is only at that point do they become finished goods. That being the case, all assets used beyond the point of the self-tripping bunks are used for storing and shipping and thus are denied the ability to earn ITC's.

The Rulings Directorate has been obliged to consider the comments of the Minister in his letter of October 1985 in its analysis as to whether a log is the finished good of the logging industry.

21(1)(b)

However, in order to give a certain amount of continuity to the different Branches of the Department, Rulings took the position that the assets used for handling the logs in the water at a dryland sort are not used in the logging activity, under the premise that once the logs are in the water after leaving the skids, the logging activity ends.

This position followed the rationale laid down by the Federal Court of Appeal in Bunge of Canada Ltd. v The Queen 84 DTC 6276 where at page 6277 Pratte J stated:

     "... the equipment required to discharge grain from the appellant's silo was equipment used for 'the storing of  grain' because the discharge of grain from a silo appears to me to be a necessary and integral part of the storing of the grain..."

21(1)(b)

Since we have been requested to present this issue in a presentation at a 24(1)                    attended by Revenue Canada, Taxation representatives from across the country, we would appreciate a response to this request by June 30, 1990, so that we will be able to consider Finance's thoughts prior to formulating our opinion.

Director General    Rulings DirectorateLegislative and Intergovernmental  Affairs Branch