27 January 1994 Ruling 9333591 F - Trucks Hauling Wood Chips - Qualified Property?

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.

Issue Sheet

Background

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The owners of such trucks and trailers (the "Assets") are stated to be independent contractors engaged by pulp and paper companies or logging companies to haul the wood chips to the mill in the following alternative situations:

A. The wood chips are transported from a location in the woods where the landowner or logging contractor has stationed a wood chipper.

B. The wood chips are transported from a sawmill operation where they are a by-product processed from waste material.

Issue

The issue is whether the Assets used to haul wood chips would be "qualified property" as defined in subsection 127(9) of the Act (the "Definition") for ITC purposes. In particular, it was asked if the Assets would be used primarily for the purpose of "logging" or "manufacturing or processing goods for sale or lease" referred to in subparagraphs (c)(ix) and (c)(i), respectively, of the Definition.

Position

No. In both of the above situations, it is our view that the Assets would be utilized in transportation occurring after the cessation of "logging" with such transportation not constituting "manufacturing or processing". Depending upon the facts of a particular situation, such transportation might also constitute the "shipping...of finished goods" and therefore, pursuant to the provisions of paragraph 127(11)(b) of the Act, be precluded from the purposes specified in paragraph (c) of the Definition in any case.

Discussion

In order to satisfy the "prescribed machinery and equipment" requirement contained in paragraph (b) of the Definition, a property included in paragraph (a) of Class 10 to Schedule II of the Regulations which is a truck designed for use on highways or streets, would, pursuant to paragraph 4600(2)(f) of the Regulations, have to be "a logging truck acquired after March 31, 1977 to be used in the activity of logging and having a weight...in excess of 16,000 pounds". In addition, as noted above, paragraph (c) of the Definition also requires that all of the property in question be acquired to be used by the owner in Canada primarily for the purpose of the activities listed in subparagraphs (c)(i) through (c)(xiii) thereof. The provisions of subsection 127(11) of the Act are also relevant to the Definition with paragraph 127(11)(b) thereof expressly excluding, from the purposes referred to in paragraph (c) of the Definition, "shipping...of finished goods".

The determination as to whether or not these requirements are satisfied in a particular situation involve questions of fact which can only be resolved with reference to the facts and circumstances of that situation. However, in considering the purpose test contained in the Definition with respect to "logging", the Federal Court of Appeal (the "FCA") in its decision in the Lor-Wes Contracting Ltd. case, 85 DTC 5310 at 5313, indicated that:

...it is the use of the equipment that has to be by the taxpayer claiming the benefit, not that the purpose of logging has to be uniquely his. It suffices if the ultimate purpose, as defined by the overall contractor, is that of logging.

In reaching its conclusion that such test was satisfied, the FCA determined at the same page that the equipment in question in that case was "used to carry out an integral part of logging".

In its decision in The James MacLaren Company Limited case, 52 DTC 1030 at 1031, the Exchequer Court of Canada (the "Ex. Ct.") indicated, with reference to its decision in the Spruce Falls Power and Paper Company Limited case, 52 DTC 1023, that income from logging operations arose "up to the point where the logs were taken into the mill for processing". It was also decided in The James MacLaren Company Limited case, at pages 1032 and 1033, that the cost of "barking" the logs was to be excluded from the cost of logging operations, with the Court indicating "barking" was to be "considered as part of manufacturing or processing".

In our opinion, the Court decisions referred to in the previous paragraph support the view that "logging" ends upon delivery of the logs to the site where "processing" of the logs first occurs. This view is also consistent with the comments contained in the first sentence of paragraph 12 of Interpretation Bulletin IT-145R as well as those contained in paragraph 2 of Interpretation Bulletin IT-501 as reflected in the Special Release thereto dated December 30, 1987.

In the decision rendered in the Tenneco Canada Inc. case, 91 DTC 5207 at page 5209, while considering the word "processing", as utilized in the provisions of section 125.1 of the Act, the FCA indicated (with reference to the decision of the Ex. Ct. in the Federal Farms Limited case 66 DTC 5068, affirmed by the Supreme Court 67 DTC 5311) that:

The two tests for determining whether a taxpayer processes goods are (i) whether there is a change in the form, appearance or other characteristics of the goods subject to the operation, and (ii) whether the product becomes more marketable.

The FCA went on to say, at the same page, that "(p)rocessing occurs when raw or natural materials are transformed into saleable items."

In our view, based upon the above factors, the Assets would be used, in both of situations A and B described above, in transportation occurring after the completion of logging operations. Therefore, in our opinion, the Assets could not be "used... primarily for the purpose of...logging" for the purposes of subparagraph (c)(ix) of the Definition.

In addition and as noted above, prior to considering the purpose test contained in paragraph (c) of the Definition, in order to satisfy the "prescribed machinery and equipment" requirement contained in paragraph (b) of the Definition, a property included in paragraph (a) of Class 10 to Schedule II of the Regulations which is a truck designed for use on highways or streets, would have to satisfy the requirements contained in paragraph 4600(2)(f) of the Regulations, which include being "a logging truck acquired...to be used in the activity of logging".

Since, as discussed above, in our view the transportation involved in both of situations A and B occurs after the cessation of logging operations, this requirement could not be satisfied in either of those situations with respect to such a truck included in the Assets.

The wood chips described in situations A and B above may, depending upon the facts of a particular situation, represent "finished goods" for the purposes of paragraph 127(11)(b) of the Act. For example, where they are being sold by a landowner, sawmill owner or independent contractor to the pulp and paper company rather than forming "goods in process" in the integrated operations of such a company. In the latter situation the independent contractor would, basically, be transporting this material to the next stage in such operations which may not yield a saleable product or "finished good" until the end of such integrated operations. In the former situation, the shipping of the wood chips would be excluded from the purposes referred to in paragraph (c) of the Definition pursuant to the provisions of paragraph 127(11)(b) of the Act, as indicated above, without having to rely on the above analysis concerning "logging". (For a detailed discussion of "finished goods" in the resource sector, see document #E7456306 dated March 25, 1991.)

It is also our view that the transportation of goods in process which may arise in situations A and B above does not constitute manufacturing and processing for the purposes of the Definition. This conclusion is consistent with the above discussion of the meaning of the term "processing" and with the comments concerning the phrase "manufacturing or processing" contained in paragraph 5 of Interpretation Bulletin IT- 145R. It should also be noted that the Department's view with regard to the reference to the "handling of goods in process", in subparagraph (a)(iii) of the definition of "qualified activities" contained in section 5202 of the Regulations, relevant in determining a taxpayer's "Canadian manufacturing and processing profits" was stated in the document #E55151 dated January 7, 1988 as follows:

Where a taxpayer's goods in process are transported by the taxpayer or a subcontractor from one plant to another for further processing, it is our general view that this activity would not constitute the "handling of goods in process". We regard this phrase as generally referring to handling that occurs as manufacturing or processing steps are being carried out.

In our view, the fact that the legislators chose to include in "qualified activities", for purposes of the "manufacturing and processing profits" calculations, the "handling" of goods in process rather than the "transportation" or "shipping" of same (the latter term having being utilized by them in paragraph 127(11)(b) as noted above) supports the restrictive nature of the interpretation quoted above.

Additional Considerations

1.     Document #E72960 written in response to a memorandum dated June 20, 1988, contained an opinion that, in the facts of the situation under consideration, a woodchipper was being used primarily in a logging activity. The company owning the woodchipper was described in that document as deriving the majority of its revenues from "many different activities related to the logging industry including owning cutting or limit rights, cutting or felling its trees in the forest and contracting out its services of cutting pulpwood." The woodchipper was stated as being used to chop "small trees, branches and debris from the areas of the forest that have been cut" and that "this process was required in order to clear and prepare the land for reforestation." With reference to the decision in the Lor-Wes Contracting Ltd. case noted above, it was determined that the clearing of the land after cutting of the pulpwood was an integral part of logging (in certain jurisdictions such clearing being a legal requirement).

Based upon the facts of that situation, it was decided that the primary use of the woodchipper was to clear the land (the woodchips produced being a secondary byproduct) and therefore it was concluded that the woodchipper was used primarily in a logging activity. It was, however, also noted that "the activity of turning small trees, branches, etc. into wood chips would still constitute a processing activity".

In our view, while the opinion expressed in the above document decision reflects the "question of fact" nature of the determination of whether or not a particular asset is used primarily in logging it also supports the view that the transportation of woodchips occurs after logging has ceased. It should also be noted that, although tractor-trailer trucks owned by a related company were also considered in that document, based upon the facts presented, it would appear that they were used primarily to transport pulpwood or logs rather than wood chips.

2.     The decisions made by the Courts in a number of recent cases indicate that a truck originally "designed for use on highways or streets" will not necessarily be precluded from being "prescribed machinery and equipment" within paragraph 4600(2)(e), or potentially paragraph 4600(2)(c), of the Regulations.

In the Nowsco Well Service Ltd. case, 90 DTC 6312, (the "Nowsco case") the FCA indicated at pages 9319 and 6320, with reference to assets of the taxpayer described as "cement trucks, frac pumpers and similar automotive equipment", that:

While perhaps initially the vehicles used by the Respondent were "designed for use on highways or streets" their design was so modified for purposes of their utilization, that the limited design purpose was of minimal importance. Their primary purpose was to become parts of an integrated process for the cementing and/or stimulation of oil or gas wells.

After stating its agreement with the views of the Trial Judge, that none of the equipment in question ought to be included in class 10(a), and prior to stating its conclusion that the property in question fell within paragraph 4600(2)(c) of the Regulations, the FCA indicated at page 6320 that:

...on the particular and somewhat unusual facts of this case, since the Respondent's property is not described in any other class in Schedule B, it is property which falls into the residual Class 8(i)...

The FCA also used the same reasoning in the Halliburton Services Ltd. case, 90 DTC 6320, which had similar facts.

In the Terroco Industries Ltd. case, #1-93 in the Current Cases volume of the CCH looseleaf service, (the "Terroco case") the Tax Court of Canada decided that the truck upon which a "hot oil unit" was mounted was an "integral part" of such unit as 90% of the truck engine's operating time was in a stationary position providing power to that unit. Accordingly, and considering the modifications made by the taxpayer, the truck could not be considered to have been "designed for use on highways or streets" within such phrase in paragraph 4600(2)(e) of the Regulations.

The Court also decided that the "hot oil unit's" function of enhancing the recovery of oil from a producing well was an integral part of operating the well such that the purpose test contained in subparagraph (c)(ii) of the Definition was satisfied.

The Judge did go on to state, however, at page 6 and 7, that he may not have reached the conclusion that the truck and chassis, apart from the "hot oil unit", were "qualified property" under the Definition "if the truck's engine had not powered the hot oil unit."

In the Cumberland Ready Mix Ltd. case recently decided by the Federal Court-Trial Division, discussed in CCH Tax Topics report #1141 dated January 20, 1994, the Court decided that cement trucks, i.e., a truck cab and chassis on which a concrete mixer was mounted, are "qualified property" for ITC purposes. The Court apparently agreed that the vehicles were not "designed for use on streets and highways" based upon the "primary purpose test" found in the Nowsco case and the Terroco case; the "primary purpose" of such vehicles being to process and deliver concrete to the taxpayer's customers.

In our view, these decisions from the Courts support the view that the determination of whether or not a particular property is a "qualified property" for ITC purposes is a question of fact. In addition, it would appear that these decisions can be differentiated from the situation at hand in that they appear to be involve trucks generally extensively modified for a specific purpose which were used directly in, or formed an integral part of, the performance of processing activities. In the situation presently under consideration, although the trailers are said to be "designed specifically" to haul wood chips there is no indication that modifications of the trucks has been undertaken or that the primary use of the Assets will be other than to transport the wood chips by highway to a mill, i.e., the taxpayer is not undertaking any processing operation as was the situation in the cases referred to above.