Signalisation De Montréal Inc. v. Her Majesty the Queen (Informal Procedure), [1993] 1 CTC 2246

Couture, C.T.C.C.J.:—This appeal was heard under the rules concerning the informal procedure.

The appeal concerns an assessment for the 1988 taxation year. In its income tax return for the taxation year in question, the appellant claimed a reduction of its income tax payable computed on its manufacturing and processing profits in accordance with the provisions of section 125.1 of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act").

To determine this deduction, the appellant argued that it qualified under the provisions of Regulation 5201 of the Act, which apply, inter alia, to businesses whose adjusted income is less than $200,000 for the year. It therefore claimed the amount of $11,178 as a deduction from its income tax.

Subsection 125.1(1) reads:

125.1 Deduction re manufacturing and processing profits.—

(1) There may be deducted from the tax otherwise payable under this Part by a corporation for a taxation year an amount equal to five per cent of the lesser of

(a) the amount, if any, by which the corporation's Canadian manufacturing and processing profits for the year exceed, where the corporation was a Canadian-controlled private corporation throughout the year, the least of the amounts determined under paragraphs 125(1)(a) to (c) in respect of the corporation for the year, and

(b) the amount, if any, by which the corporation's taxable income for the year exceeds the aggregate of

(i) where the corporation was a Canadian-controlled private corporation throughout the year, the least of the amounts determined under paragraphs 125(1)(a) to (c) in respect of the corporation for the year,

(ii) 10/4 of the aggregate of amounts deducted under subsection 126(2) from the tax for the year otherwise payable under this Part by the corporation, and

(iii) where the corporation was a Canadian-controlled private corporation throughout the year, the amount determined under clause 129(3)(a)(i)(B) in respect of the corporation for the year.

The definition of "Canadian manufacturing and processing profits” appears in paragraph 125.1(3)(a), which reads:

125.1(3)(a) "Canadian manufacturing and processing profits".—"Canadian manufacturing and processing profits” of a corporation for a taxation year means such portion of the aggregate of all amounts each of which is the income of the corporation for the year from an active business carried on in Canada as is determined under rules prescribed for that purpose by regulation made on the recommendation of the Minister of Finance to be applicable to the manufacturing or processing in Canada of goods for sale or lease; and

Regulation 5201 reads as follows:

5201. For the purposes of paragraph 125.1(3)(a) of the Act, "Canadian manufacturing and processing profits” of a corporation for a taxation year are hereby prescribed to be equal to the corporation's adjusted business income for the year where

(a) the activities of the corporation during the year were primarily manufacturing Or processing in Canada of goods for sale or lease;

(b) the aggregate of

(i) the aggregate of all amounts each of which is the income of the corporation for the year from an active business minus the aggregate of all amounts each of which is the loss of the corporation for the year from an active business, and

(ii) if the corporation is associated in the year with a Canadian corporation, the aggregate of all amounts each of which is the income of the latter corporation from an active business for its taxation year coinciding with or ending in the year,

did not exceed $200,000;

(c) the corporation was not engaged in any of the activities listed in subparagraphs

125.1 (3)b)(i) to (ix) of the Act at any time during the year; and

(d) the corporation did not carry on any active business outside Canada at any time during the year.

In assessing the appellant, the respondent disallowed the tax deduction in question up to an amount of $3,586 on the ground that it was not eligible for the calculation provided in Regulation 5201, and, consequently, it had to compute its tax deduction according to the formula provided in Regulation 5200, which reads:

5200. Subject to section 5201, for the purposes of paragraph 125.1(3)(a) of the Act, "Canadian manufacturing and processing profits" of a corporation for a taxation year are hereby prescribed to be that proportion of the corporation's adjusted business income for the year that

(a) the aggregate of its cost of manufacturing and processing capital for the year and its cost of manufacturing and processing labour for the year,

is of

(b) the aggregate of its cost of capital for the year and its cost of labour for the year.

Mr. Michel Beaudry, an auditor in the service of Revenue Canada, testified for the respondent and very clearly explained the reasons which led the respondent to reduce the tax deduction claimed by the appellant.

He mentioned that Regulation 5201, which concerns small manufacturers, is applicable to a corporation to the extent that the latter meets the following conditions:

(a) its activities are primarily manufacturing or processing in Canada of goods for sale or lease;

(b) its income and that of any other corporation with which it may be associated do not exceed $200,000;

(c) it is not engaged in any of the activities of farming, fishing, logging, construction or specified resource activities;

(d) it is not engaged in a foreign active business.

[Translation.]

According to him, the appellant did not meet the first condition, that its activities be primarily manufacturing or processing in Canada.

To reach this conclusion, he relied on the Department's administrative policy as stated in its Interpretation Bulletin IT-145R, paragraph 16, providing that, since the activities of a corporation are generally carried on by its employees, one must look at the said activities to determine whether they are principally or chiefly manufacturing or processing.

He further stated that all wages paid to employees for manufacturing activities for the taxation year amounted to 14.79 per cent of the payroll.

He also mentioned that, as provided in paragraph 16 of IT-145R, where, in certain circumstances, the use of labour does not accurately reflect the principal activities of the corporation, the Department may consider the use of the company's assets in manufacturing and processing activities.

In the appellant's case, he emphasized that, according to its financial statements filed in evidence, its capital assets were valuated at $1,101,443, and that its analysis of the capital cost of its assets assigned to manufacturing amounted only to $76,083, a nominal proportion relative to the total cost of the corporation's capital assets.

Mr. Sylvain Dunn testified for the appellant. He had been employed by the corporation as a comptroller since June 1991 only and admitted that he was not familiar with its operations for the 1988 taxation year. Furthermore, the appellant had merged with another corporation in September 1991, so that the operations of the new corporation were not entirely the same as those run by the appellant in 1988.

Since the witness had not been employed by the appellant and, by his own admission, had no knowledge of the operations of the 1988 taxation year, no probative value may be assigned to his testimony.

It is fundamental to the success of an appeal before this Court that it is up to the appellant to demolish the basis on which the respondent has relied in order to issue her assessment (Johnston v. M.N.R., [1948] S.C.R. 486, [1948] C.T.C. 195, 3 D.T.C. 1182). It is up to him to prove that the facts on which the respondent relied in the formulation of the assessment are not consistent with reality and to submit evidence of those which, in his view, must be considered in order to determine the validity of his claims.

No such evidence was filed by the appellant to show that his activities were primarily manufacturing or processing in Canada during the taxation year under appeal.

Notwithstanding this lack of evidence, the agent for the appellant submitted an argument based on the documentary evidence filed at the hearing.

Relying on the comments in Bulletin IT-145R concerning the situation in which the Department may consider the use of the company's assets in manufacturing and processing activities where the use of labour does not accurately reflect the activities of a corporation in certain industries, he maintained that a labour use percentage of 14.79 per cent was not representative of the appellant's operations. He therefore submitted that the respondent should have considered the use of assets in order to determine whether the appellant's activities were primarily manufacturing or processing.

I must say, first, that the respondent's explanation contained in her Bulletin IT-145R as to how she normally determines whether a taxpayer's activities are primarily manufacturing or processing by considering the use of labour is perfectly acceptable and, in my view, meets the requirements of the legislation. The alternative method described in this bulletin concerning the use of the corporation's assets in certain situations is also acceptable. Whatever the method chosen by the respondent to compute an assessment, it is up to the appellant to show that it does not reflect the exact situation with regard to its activities.

Counsel for the appellant relied on a document, which was filed in evidence, prepared by the witness Beaudry in order to maintain that the respondent should have considered the use of capital assets in order to issue her assessment. That document shows:

Signalisation de Montréal Inc. 7400, rue Vérité

St-Laurent (Québec) H4S 1C5

Revised Manufacturing and Processing Profit — 1988

Gross capital cost as declared	$1,101,443
10% of capital cost	$110,144
Rental cost as declared	17,676
Capital cost (CC)	$127,820
Capital cost of manufacturing and processing
— Equipment	50,633
— Rent ($17,676 X 70.15%)	12,400
— Leasehold improvements ($26,100 x 50%)	13,050
100/85 of capital cost of manufacturing and
processing	$76,083
Cost of manufacturing and processing capital
(CMPC)	$ 89,509
	[Translation.]

In the light of these figures, he submitted that, since the capital cost of the assets used in manufacturing was $76,083, compared to the capital cost of $127,820, or 60 per cent of that figure, it was clear that the respondent, according to Bulletin IT-145R, should have applied this method in order to compute the assessment. The flagrant error in the reasoning of the agent for the appellant was to consider, in support of his thesis, only the capital cost of $127,820 and not the cost of all the appellant's capital assets, which was $1,101,443, as shown in its financial statements.

The figure of $127,820 is composed of an amount of $110,144, which represents only ten per cent of the capital cost of the appellant's assets, as provided in Regulation 5202 for the purposes of the equation which determines a corporation's profit from manufacturing and processing in Canada. The balance, that is the amount of $17,676, represents part of the rental cost of the appellant's assets used in manufacturing or processing.

If the cost of the taxpayer's capital assets better reflects the true nature of its activities than the cost of labour, such a determination must be based on all assets, including the portion used in production or processing, not on a nominal percentage of the cost of those assets, as the agent for the appellant submitted. The formula which the latter invoked in support of its claims is completely false in its foundation and cannot be accepted.

For these reasons, the appeal is dismissed.

Appeal dismissed.