Date:
20020705
Docket:
2000-2630-IT-G
BETWEEN:
SCIERIE
ST-ELZÉAR INC.,
Appellant,
and
HER MAJESTY
THE QUEEN,
Respondent.
Reasons
for Judgment
Tardif,
J.T.C.C.
[1]
This is an appeal from reassessments dated May 3, 1999 for the
1998 taxation year.
[2]
The issue is to what class of property in Schedule II to the
Income Tax Regulations ("the
Regulations") do a fire protection system and a steam
heating system belong for capital cost allowance
purposes?
[3]
The appellant argued that this property belongs in Class 43.
The respondent, on the other hand, maintained that it must be
included in Class 1.
[4]
According to the respondent, the property at issue was not used
directly or indirectly primarily in the manufacturing or
processing of goods for sale by the appellant.
Facts
[5]
The appellant, which operates a sawmill at St-Elzéar
in the Gaspé region, is a co-operative corporation
employing nearly 200 persons. The business has annual sales of
approximately $15 million.
[6]
Alain Tremblay testified in his capacity as general manager of
the business. He explained that he began working there as an
advisor specializing in business turnaround at a time when the
company was experiencing some difficulties.
[7]
Mr. Tremblay continued to be employed by the co-operative
following a reorganization. He explained that the business had
been obliged to reinvest to a considerable degree because of the
remoteness of the location, certain market constraints, and the
species of trees growing in the region. As part of the
reorganization, the business had also had to take precautions
against possible fire, all of which required a significant
investment.
[8]
Mr. Tremblay described and justified the outlays for the
lumber drying operations. He explained that, because of the
mill's remoteness from its markets, the sawed lumber had to
be dried before being hauled. In order to dry the lumber, the
business was obliged to invest in a system that used steam
produced by burning the bark from the sawn or processed
logs.
[9]
Drying the lumber was a prerequisite for the business's
competitiveness. Mr. Tremblay described the lumber drying
process in detail, explaining why drying was an essential
condition for the business's viability.
[10]
Mr. Tremblay stated that the drying operations produced a
large quantity of unutilized energy. To recover part of that
energy, they set up a facility that allowed the energy to be
transformed into a source of heating, at a cost much lower than
that of traditional heating sources.
[11] Mr.
Tremblay noted that this use was marginal both from a
quantitative standpoint and in terms of frequency of use. Heat
was recovered only during periods of very intense winter
cold.
[12] He
estimated that between 3 and 5 per cent of the heating
requirement was met in this manner, adding that during the summer
the steam was used only to dry the lumber. The heating provided
by the steam was used only in the mill; the administrative
offices did not make use of this form of energy since they were
not connected to the mill. The first issue will involve
determining to what class of property the equipment purchased and
used to produce the heating energy inside the mill
belongs.
[13] With
regard to the second aspect of the appeal, that is, the
characterization of the fire protection system, Mr. Tremblay
first explained why this system existed.
[14] Thus,
he explained that, in the area where the mill was being operated,
there was no access to a flow of water adequate to deal with fire
hazards. He described how the business had approached the
municipality in order to obtain access to the municipal water
reserves. This was essential since the business's insurers
demanded quick and easy access to an adequate supply of water in
case of fire, failing which they refused to insure the
business's fixed assets.
[15]
Mr. Tremblay began by noting that the limestone soil of the
region where the mill was located had unique characteristics; the
only small watercourses that might be sources of water supply
were mostly underground. These watercourses, to which access was
very difficult, could not meet the mill's needs in case of a
major fire.
[16] Because
the sawmill had experienced two fires, the insurers were
unwilling to issue an appropriate insurance policy without sound
guarantees of access at all times to a satisfactory flow of
water.
[17] The
approaches the business made to the municipality proved
unproductive, because the municipality itself had a great deal of
difficulty meeting its own needs with respect to protecting
residences from fire.
[18] In
order to protect its investment and its operations and obtain
appropriate insurance coverage, the appellant was obliged to
install its own fire protection facility. It had a reservoir
excavated, which measured approximately 100 by 100 by 15
feet deep and would hold 500,000 gallons of water and to which
was connected piping for a sprinkler system. The entire project
necessitated an outlay of $459,214.
[19]
Mr. Tremblay also placed great emphasis on the extreme
danger of fire in this type of business. The ambient dust
produced by the sawing operations, he said, was a veritable
combustible capable of instantaneously igniting huge areas; it
represented a real and omnipresent danger for both property and
persons.
[20] On the
basis of these facts, the appellant argued that the two assets in
question, that is, the fire protection system, including a
sprinkler system, installed at a cost of $459,214, and the
$75,000 steam heating system, belonged in Class 43 of
Schedule II to the Regulations, which would give
entitlement to accelerated depreciation on them.
[21] The
appellant also argued that the reservoir and all the piping
connected thereto constituted property that was essential to its
lumber manufacturing and processing activities.
[22] The
respondent, for her part, argued that, while these assets were
certainly useful and their existence was possibly justified, they
were not used directly in the processing activities or in the
primary mission of the business. The respondent thus asserted
that the lumber sawing and processing operations could be
performed independently of the two assets at issue. In other
words, according to the respondent, these assets were not
essential to the lumber manufacturing and processing
operations.
[23] The
issues in this appeal are the following:
(1)
To what class of property in
Schedule II to the Regulations does a fire protection system belong for capital cost
allowance purposes?
(2)
To what class of property in
Schedule II to the Regulations does a steam heating system belong for capital cost
allowance purposes?
RELEVANT
STATUTORY AND REGULATORY PROVISIONS
[24] The
relevant provision of the Income Tax Act is the
following:
20(1) Deductions
permitted in computing income from business or property -
Notwithstanding paragraphs 18(1)(a), (b) and
(h), in computing a taxpayer's income for a taxation
year from a business or property, there may be deducted such of
the following amounts as are wholly applicable to that source or
such part of the following amounts as may reasonably be regarded
as applicable thereto:
(a)
Capital cost of property - such part of the capital cost
to the taxpayer of property, or such amount in respect of the
capital cost to the taxpayer of property, if any, as is allowed
by regulation;
. . .
The relevant provisions of the Regulations read in part as
follows:
DEDUCTIONS
ALLOWED
1100(1) For the
purposes of paragraphs 8(1)(j) and (p) and
20(1)(a) of the Act, the following deductions are allowed
in computing a taxpayer's income for each taxation
year:
Rates
(a)
subject to subsection (2), such amount as he may claim in respect
of property of each of the following classes in Schedule II not
exceeding in respect of property
(i)
of Class 1, 4 per cent,
. . .
(xxix) of Class 43,
30 per cent . . . .
SCHEDULE
II
CAPITAL COST
ALLOWANCES
CLASS 1
(4 per
cent)
Property not included
in any other class that is
. . .
(j)
a subway or tunnel, acquired after May 25, 1976;
. . .
(l)
a pipeline, other than gas or oil well equipment, unless, in the
case of a pipeline for oil or natural gas, the Minister, in
consultation with the Minister of Energy, Mines and Resources, is
or has been satisfied that the main source of supply for the
pipeline is or was likely to be exhausted within 15 years
after the date on which operation of the pipeline
commenced;
. . .
(q)
a building or other structure, or part thereof, including
component parts such as electric wiring, plumbing,
sprinkler systems, air-conditioning equipment,
heating equipment, lighting fixtures, elevators and
escalators.
CLASS 8
(20 per
cent)
Property not included
in Class 1, 2, 7, 9, 11 or 30 that is
(a)
a structure that is manufacturing or processing machinery or
equipment;
(b)
tangible property attached to a building and acquired solely for
the purpose of
(i)
servicing, supporting or providing access to or egress from,
machinery or equipment,
(ii)
manufacturing or processing, or
(iii)
any combination of the functions described in subparagraphs (i)
and (ii);
(c)
a building that is a kiln, tank or vat, acquired for the purpose
of manufacturing or processing;
. . .
CLASS 29
[50 per cent]
Property that would
otherwise be included in another class in this
Schedule
(a)
that is property manufactured by the taxpayer, the manufacture of
which was completed by him after May 8, 1972, or
other property acquired by the taxpayer after May 8,
1972,
(i)
to be used directly or indirectly by him in Canada primarily in
the manufacturing or processing of goods for sale or lease . .
.
(b)
that is
(i)
property that, but for this class, would be included in Class 8 .
. . .
CLASS 43
[30 per cent]
Property acquired
after February 25, 1992 that
(a)
is not included in Class 29, but that would otherwise be included
in that Class if that Class were read without reference to
subparagraphs (b)(iii) and (v) and paragraph (c)
thereof . . . .
[25] What is
involved is carrying out an analysis and assessing whether the
two assets in question, namely the fire protection system and the
steam heating system, were used directly or indirectly primarily
in the lumber production and processing activities. The evidence
has established that these two assets were acquired solely and
exclusively in order to ensure to the greatest extent possible
the continuation of the lumber production and processing
operations. Without the property at issue, the business's
basic activities could have been or would have had to have been
interrupted in the event of fire or of a period of Siberian
cold.
[26] In
other words, neither the heating system nor the fire protection
system benefited other activities or other businesses, nor did
they serve purposes other than those for which they were
acquired, that is, providing protection against fire, and heating
the premises in which the business's activities took
place.
[27] The
assets in question were used only as required, that is, in case
of fire or during periods of intense cold. Until one of these two
situations occurred, they were there, ready and
waiting.
[28] Was the
fact that the assets were not in continual use sufficient reason
to conclude that they were property not used directly or
indirectly primarily in the lumber manufacturing and processing
activities? I think not.
[29] In
either of the situations referred to above, the purpose of the
property in question was to ensure the maintenance of operations
and activities in specific circumstances. Lack of availability of
or access to the two assets at issue could result in temporary,
perhaps even lengthy, stoppage of the lumber manufacturing and
processing activities. Thus, they were not superfluous property
acquired on a whim. On the contrary, they were essential assets
whose appropriateness has been explained and amply
justified.
[30] In
support of her claims, the respondent stated that before 1998 the
mill was operated with no fire protection system, and that since
1998 the system had been used only three times; on the basis of
those facts, the respondent concluded that the business could be
operated without the property at issue.
[31]
Determining whether property is used directly or indirectly as an
integral and essential part of manufacturing and industrial
activities is a difficult exercise in which there are no
objective criteria or mathematical formulas to rely on; as well,
certain equipment may be required because of specific
characteristics such as climate, location, the quality of the
labour force, productivity, and the state of the facilities,
whether outdated or modern.
[32]
Normally, buildings and other structures or parts thereof,
including sprinkler systems and heating equipment, acquired
after 1987 are included in
subparagraph (q) of Class 1 for capital cost
allowance purposes.
[33] Among
the exceptions to this general rule are structures and buildings expressly included in the other
classes, in particular structures that are manufacturing or
processing machinery or equipment (Class 8).
[36] It is
quite clear that the fire protection system and the steam heating
system are property included in or covered by one of the
paragraphs of Class 8. Given that the sawmill is a lumber
manufacturing and processing operation located in Canada, I must
essentially determine whether the two assets at issue were used
directly or indirectly primarily in the manufacturing or
processing of goods for sale.
[37] The
expression "used directly or indirectly" is not defined
in the Act; thus it is appropriate to refer to the case
law. In Nowsco Well
Service v. The Queen,
88 DTC 6300, at page 6313, Cullen J. of the Federal
Court-Trial Division accepted the plaintiff company's claim
that:
for the purposes of
Class 29, one includes all equipment that is both necessary
and ancillary to the processing operation.
The term to be
used . . . directly or indirectly . . . refers to
property acquired by the taxpayer for the purpose of being an
integral and essential part of the taxpayer's . . .
manufacturing or processing activities, as well as any
ancillary equipment such as furniture and fixtures,
repair and maintenance equipment and fire extinguishing
equipment, which is acquired for use in those
activities. [Emphasis added.]
[39]
Paragraph 9 of that Interpretation
Bulletin states as well:
Although such
equipment is generally located in the manufacturing or processing
plant, it may also qualify if located
elsewhere. [Emphasis
added.]
[40] The
fire protection system sprinklers and piping incorporated with
the appellant's mill are immovables either by their nature
or, alternatively, by virtue of their being attached or joined to
an immovable (Civil Code of
Québec, article 903 ff.).
[41] As
such, the sprinklers and the piping form part of a structure
that includes manufacturing or
processing machinery or equipment and that is used directly or
indirectly in Canada primarily in the manufacturing or processing
of goods for sale.
[42] The
same is true for the water heaters and the piping of the heating
system that are incorporated with the mill. However, in the case
of the fire protection system in particular, a large part of the
system, namely the water reservoir and the pumping station, is
located outside the mill and is connected to it by
piping.
[43] In the
case at bar, the fire protection system and the steam heating
system were acquired by the appellant as integral and essential,
albeit ancillary, parts of its manufacturing and processing
activities.
[44]
Evidence was adduced that the permanent presence of flammable
wood dust in the appellant's mill constituted a real fire
hazard. A fire protection system was therefore necessary and
indeed essential to provide for the safety of the appellant's
employees, to ensure the continuing
operation of its business, and to enable it to obtain fire
insurance coverage. For a business of this type, such coverage is
neither superfluous nor secondary, but is an essential form of
protection that any responsible, well-informed owner must include
in operating costs.
[45] A steam
heating system was also required in the operation of the
appellant's mill in order to provide a suitable work
environment for its employees during the winter
months.
[46] I
believe that the evaluation or assessment of the factors
essential to the smooth operation of a manufacturing business
today must take into account certain property that is not
absolutely essential at first glance, but becomes essential in a
context where the environment, workers' quality of life,
productivity, and production quality are increasingly
indispensable to a business's survival. I therefore do
not think that an asset or set of assets used in a business of
which the purpose is manufacturing and processing should be
assessed outside its context or essentially on the basis of the
importance of an active, ongoing contribution to the
business.
[47] If
property is or may be put to use on an occasional basis as needed
and thereby makes a contribution that is positive and useful, or
indeed indispensable in certain circumstances, I am of the
opinion that it must be characterized as being directly involved
in production.
[48] I
therefore conclude that the fire protection system and the steam
heating system belong in Class 43
of Schedule II to the Regulations.
[49] The
appeal is accordingly allowed with costs, and the case shall be
reconsidered on the basis that the
property at issue, that is, the fire protection system and the
steam heating system, belongs in Class 43.
Signed at
Ottawa, Canada, this 5th day of July 2002.
J.T.C.C.
Translation certified
true on this 22nd day of October 2002.
Erich Klein,
Revisor
[OFFICIAL
ENGLISH TRANSLATION]
2000-2630(IT)G
BETWEEN:
SCIERIE
ST-ELZÉAR INC.,
Appellant,
and
HER MAJESTY
THE QUEEN,
Respondent.
Appeal heard
on November 6, 2001, at Québec, Quebec, by
the
Honourable Judge Alain Tardif
Appearances
Counsel
for the
Appellant:
André Lévesque
Counsel
for the
Respondent:
Alain Gareau
JUDGMENT
The appeal from the assessment made under the Income Tax
Act for the 1998 taxation year is allowed with costs and the
assessment is referred back to the Minister of National Revenue
for reconsideration and reassessment on the basis that the
property at issue, that is, the fire protection system and the
steam heating system, belongs in Class 43, the whole in
accordance with the attached Reasons for Judgment.
Signed at
Ottawa, Canada, this 5th day of July 2002.
J.T.C.C.
Translation
certified true on this 22nd day of October 2002.
Erich Klein,
Revisor
[OFFICIAL
ENGLISH TRANSLATION]
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