Woods Harbour Lobster Company Limited v. Minister of National Revenue, [1989] 2 CTC 2032, 89 DTC 303

Kempo, T.C.J.:— This appeal concerns the appellant's 1981, 1982, 1983 and 1984 taxation years. The essential issue raised was whether the appellant's operations represented “processing” within the meaning of sections 125.1 and 127 of the Income Tax Act so that it would be entitled to claim, for each year, a manufacturing and processing deduction under section 125.1, an investment tax credit under section 127 and accelerated capital cost allowance on machinery and equipment as assets included in Class 29 of Schedule II of the Income Tax Regulations.

Counsel have submitted a concisely stated Agreed Statement of Facts as follows:

Agreed Statement of Facts

The parties hereto, by their respective solicitors, admit the following facts provided that the admission is made for the purpose of this proceeding only and may not be used against either party on any occasion and provided further that the parties may adduce further and other evidence relevant to the issues and not inconsistent with this agreement.

1. The Appellant is a body corporate, organized and existing under the laws of Nova Scotia.

2. At all relevant times the Appellant owned and operated a lobster pound in or about Woods Harbour in the Province of Nova Scotia.

3. At all relevant times the Appellant's principal business consisted of the purchase and resale of live lobsters to wholesale purchasers.

4. The Appellant purchased lobsters primarily from subbuyers but also from local fishermen either at dockside or delivered by the fishermen to the Appellant's premises.

5. Upon delivery of lobsters to its premises the Appellant inspects them to remove any diseased and/or weak ones and puts the remainder in large, outdoor ponds for storage or in crates in a reservoir to be held for immediate shipment.

6. The lobsters are held in the outdoor holding ponds until they are crated for shipment and sale, at which time they are moved to an indoor holding tank facility.

7. The outdoor holding ponds are fed by untreated seawater and the indoor holding tanks are fed by seawater aerated to increase the oxygen content of the water.

8. The environmental conditions in both the outdoor ponds and the indoor tanks function to meet the biological needs of lobsters for survival. The conditions do not duplicate the lobsters' natural environment and they do not promote growth of the lobsters.

9. The lobsters are crated by the Appellant either in response to specific orders from customers or to fill anticipated sales.

Oral testimony was given by Mr. Richard Malone who was President and a 50 per cent shareholder of the appellant corporation. He ran all of its business matters and has had a lifetime hands-on experience in the lobster trade.

Mr. Malone explained that market and customer needs and demands had markedly changed during the 1970s and the 1980s wherein the simple purchase and resale of lobster boat-runs were no longer in demand and that the wholesale buyers in Boston, U.S.A., who essentially dictated what was required of the appellant, were wanting living and healthy specified grades or selections —be it "chicks" or one-pounders, "quarters" or one and one- half pounders, jumbos being larger ones, or "culls" which had either one or no claws. These different types were individually selected, graded, classified and crated at the appellant's plant prior to delivery to its purchasers as the appellant found it was more profitable for them to do it rather than simply trading in boat-runs. Therefore the business operation was much more than simply the buying, holding and resale of lobsters as a middleman or broker may do.

Upon purchase of the lobsters which had been delivered to its premises in 100-pound crates or units, they were put into a salt-water holding tank in crates for seasoning during which they purged themselves of old bait and other contaminants. The next business day they were then removed and examined individually. The undersized and the female seeded lobsters were illegal and had to be returned to the ocean, the dead, shell-diseased and badly damaged ones were discarded, the weak and soft-shelled ones were redirected for fast cooking purposes and those having one or no claws were sorted-out and sized for sale in that category. There were electronic weighing machines at hand but not every lobster had to be weighed because of the experienced hands of the employees who often knew the weight of a lobster through feel and its visual size. Firm immobilization of the lobster's claws was imperative and frequently had to be redone by the appellant's employees to ensure that the stock, while being held in the ponds by the appellant or while in transit to its buyers, would not be damaged or depleted.

During the years under appeal the incisor claw of each lobster had to be either pegged with a wood peg or the muscle had to be cut, and it was later that the appellant changed to heavy-duty rubber banding. The disabling of the claws was essential, not only to preserve the appellant's lobster stock but also, and more importantly, to render it marketable as its customers would not purchase stock that was dead, harmed or dismembered on arrival occasioned by the savageness of one that had not been properly banded or pegged. It was admitted that the crowding of the lobsters had, whether by crate purchase, pond-holding or crate resale, contributed to their ferocity to each other.

Mr. Malone's experience was that he could not rely on his suppliers to have properly disabled the claws or to have culled out the illegal ones. The same pertains to the ones which were weak, diseased or dead.

On receipt the lobster were always put in the appellant's salt-water pond. The indoor salt-water tank could hold many more lobsters than the outside ocean-fed pond because it was temperature controlled and oxygenated with rapid water changes. The indoor tank use was essentially for up to 48-hour holding purposes, both when the lobsters first came in and then just prior to departure to market. In between these two stages the cleaning and culling activities happened at least twice and those lobsters that were not immediately recrated for sale from the indoor pond were put over into the outside fenced salt-water pond.

Mr. Malone testifed that in many respects, and for many reasons, the business was seasonal: this included the volume and condition of lobster delivered to the premises, their size and state of health, as well as the market demand for volume, kind, size and condition. Extra holding ponds had been utilized to hold over some lobster stock in order to be able to market aggressively and competitively during peak demands or during times of low- supply and high demand, and thereby enhance bulk-sales profitability. These lobsters had been subjected to the appellant’s meticulous individual examination and cull process before being put over for such holding.

The appellant had approximately 14 regular wholesale buyers in the Boston, U.S.A. area. Not only had the appellant been responding to what that market wanted from time to time, but also Mr. Malone had been actively reaching out to them to advise and sell those categories of lobster that he knew he had on hand. Business was active during the November to June season with only approximately ten per cent of the boat-run purchases having been immediately turned over and resold to wholesalers without the appellant's usual meticulous sorting and culling.

Once it has been appreciated that the business of the appellant was that of bulk sales of lobsters which had been culled and categorized as aforesaid in response to known or anticipated wholesale customer needs, the fact simply that it was live lobsters that were being bought and sold is, standing by itself, without much meaning. Indeed, when taken out of context, it distorts the whole situation. This appellant was not operating lobster holding tanks from which buyers were expected to come to pick out and carry some away for their own purposes. The evidence heard supports the conclusion that what the appellant bought, that is what came into the plant in 100-pound crates, was markedly different from that which went out in 100- pound crates, and that that very essential difference was as a direct result of the described activities which, to my mind, attract the appellation of "processing" in its commercial sense.

I do not agree with counsel for the Minister that this appellant's business can be equated with brokerage-type activities. The appellant bought the lobster and took all the operational risks associated with having had that inventory on hand and then having to be able to sell it in a marketable state, at a profit, after it had been converted to bulk-wholesale marketable form. There is no evidence present to support a finding that the appellant was simply a broker in its ordinary commercial sense.

Mr. Malone's testimony that the afore-described culling activity was for the primary purpose of increasing price was unshaken. He said that the appellant could not have operated its business without that kind of plant activity which was a material part of its business notwithstanding that its greatest expense was for lobster purchases. He explained that wage and employee benefit expenses were low due to he and his uncle (the other 50 per cent shareholder) not having taken any remuneration during these startup years and that all the lobster handlers were experienced and were able to perform knowledgeably and quickly. Four experienced men were able to cull 6,000 to 7,000 pounds of lobster in about six hours.

Mr. Malone acknowledged that an obvious consequence of culling was to minimize inventory loss, but he adamantly maintained the primary purpose and benefit was that of being able to respond to market demands and to increase unit or bulk price. Even those held back were for unit-price- increase purposes because they were to be on hand when future short supply and high-demand was predictable. Thus their "shelf-life", so to speak, had been preserved and maintained through the described operational efforts of the appellant.

Both counsel have referred to the same jurisprudence and have extrapolated therefrom certain aspects that were felt favourable to their respective positions.

Counsel for the Minister has submitted that the product was a live creature, that it was essentially a husbandry-type of operation and that the lobster was bought and sold that way in a brokerage sense. He submitted that all that was essentially happening in between the buying, husbanding and re-selling of the live lobsters was the preservation of that inventory pending sale to a market that was already there.

If the thrust of the first part of the submission was that live creatures could never be the subject of processing for fiscal purposes, that, in my view, would not only be begging the question itself but also is an undue and unsupportable narrow approach to the whole matter. If Parliament had intended to exempt out living creatures in all respects it could have done so rather easily. A perusal of the actual words employed in the relevant statutory parameters show that they had been directed to the activity performed on a product and not the product per se. The case law has looked to whether the product had been changed as a result of the activity and/or whether it has been rendered more marketable thereby.

The distinguishing feature in this case, upon which I concur with counsel for the appellant, was that what had been coming-in in bulk boat-runs was so essentially different from and less marketable to that which was going out in enhanced marketable culled or sorted units commanding a higher price. The whole point of the appellant's activities was to add value to the inventory to be sold in bulk form which differed so markedly from the bulk form in which it had been received. The difference between the two was precisely that which made the possibility and actuality of the appellant's business being profitable. It was the plant activity which had created this result within the meaning and purpose of the fiscal provisions; and the nature and extent of the market demand for the end product undoubtedly drove and impacted on the reason for these activities to have occurred in the first place. The appellant’s situation was not at all like a druggist who "processed" prescription pills only after the sale to the customer had been consummated, and only then had simply counted out a finished product into the prescribed lotsize; viz, Harvey C. Smith Drugs Ltd. v. M.N.R., [1986] 1 C.T.C. 2339; 86 D.T.C. 1243 (T.C.C.) at 1249.

I would adopt and apply the analysis of Judge Brulé of this Court, in the Harvey C. Smith Drugs Ltd. case commencing at page 1248 to the case at hand. The facts of this appellant's situation fall within the interpretative guidelines explored by Judge Brulé on page 1249 and the authorities referred to therein, especially that of Federal Farms Limited v. M.N.R., [1966] C.T.C. 62; 66 D.T.C. 5068 (Ex. Ct.) affirmed as to conclusion and interpretative approach by the Supreme Court of Canada reported at 67 D.T.C. 5311.

In conclusion, then, the appeals are to be allowed, with costs, and the matters referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the appellant, for each of its 1981 to 1984 inclusive taxation years, is entitled to the claimed manufacturing and processing tax deduction under section 125.1 of the Act, the claimed investment tax credit under section 127 of the Act and the claimed capital cost allowance on its equipment and machinery as being included in Class 29 of Schedule II of the Regulations.

Appeals allowed.