13 February 1996 External T.I. 9528555 - MANUFACTURING AND PROCESSING DEDUCTION

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

Manufacturing and Processing Deduction

Position:

Gave general position stated at round table and in the IT bulletin

Reasons:

		5-952855
XXXXXXXXXX	M.P. Baldwin

Attention: XXXXXXXXXX

February 13, 1996

Dear Sirs:

Re: Manufacturing and Processing Deduction

This is in reply to your letter of October 25, 1995 in which request a technical interpretation with respect to whether or not a particular corporation will qualify for the manufacturing and processing deduction under subsection 125.1(1) of the Income Tax Act (the "Act").

The situation given in your letter appears to be an actual fact situation and as noted in Information Circular 70-6R2, we do not express opinions on specific proposed transactions other than as a reply to an advance income tax ruling request. As a consequence thereof, we may only offer the following general comments.

A situation similar to the one described in your letter was addressed at the 1995 Association de Planification Fiscale et Financière conference in which the Department stated in response to question 15 the following;

Question 15

Tax credit for manufacturing and processing profits

Company B manufactures goods for Company A, which sells them to retailers. Company A exercises a degree of control over the goods manufactured for it, but Company A does not own the goods while they are being manufactured by Company B. Company A reserves the right to refuse possession of the goods manufactured for it by Company B. However, Company A selects the fabrics from third-party suppliers and requires that these fabrics be delivered to the facilities of Company B. Company A is responsible for payment in the event of a dispute between a third-party supplier and Company B.

Does Company A qualify for the tax credit for manufacturing and processing profits, even if it does not own the goods during the manufacturing process?

Answer by the Department of Revenue

The Department's position with respect to the eligibility of a company for the tax credit for manufacturing and processing profits when goods are manufactured or processed by another party is set out in paragraph 4 of Interpretation Bulletin IT-145R, which reads as follows:

"The reduced rate of corporate tax is applicable only to a corporation which carries on manufacturing or processing activities in Canada of goods for sale or lease. The manufacturer or processor of the goods need not necessarily be the vendor of the goods. However, the reduced rate is not applicable to income arising from service or repair activities carried out on goods which are not for sale or lease. A corporation which merely sells goods manufactured or processed by another party or that supervises the manufacturing or processing of goods where the actual manufacturing or processing is carried on by another party will not qualify for the deduction. However, where the goods are being manufactured or processed by another party on behalf of the corporation and the corporation exercises extensive involvement and control over the content, design, and physical qualities of the goods from inception to completion, the corporation will qualify for the deduction."

The last sentence in paragraph 4 of Interpretation Bulletin IT-145R was added in a Special Release dated February 23, 1986 following the decision in McGraw-Hill Ryerson Limited v. Her Majesty the Queen (82 DTC 6142 confirming 80 DTC 6211). To summarize, the issue in this case was to determine whether the taxpayer qualified for the tax credit for manufacturing and processing profits even though certain steps in the manufacture of the goods that it sold were carried out by another party. The Federal Court of Appeal determined that the taxpayer qualified for the tax credit for manufacturing and processing profits because it exercised extensive control over the production of the goods, from inception to completion.

Since this judgment, the Department has allowed a corporation to claim the tax credit for manufacturing and processing profits,primarily when the goods that it sells are manufactured or processed by another party on its behalf, provided the corporation exercises extensive control over the content, design, and physical qualities of the goods from inception to completion. Determining whether a taxpayer exercises extensive control over the content, design and physical qualities of goods designed for sale is an issue that must be resolved on the basis of all relevant facts in a given situation. Further, the Department is of the opinion that the fact that a third party actually supervises the manufacture or processing of manufactured or processed goods is not sufficient in itself to allow the tax credit for manufacturing and processing profits.

We trust our comments will be of assistance to you.

Yours truly,

for Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch