Dragon Construction Ltd. v. Minister of National Revenue, [1989] 2 CTC 2265, 89 DTC 464

Rip, T.C.J. [Translation]:—These appeals are by Dragon Construction Limitée ("Dragon"), the appellant, from assessments for the 1982, 1983 and 1984 taxation years made by the Minister of National Revenue, the respondent, by which the latter denied the appellant investment tax credits ("tax credits’) pursuant to subsection 127(5) [1] of the Income Tax Act ("the Act") amounting to $21,910 for 1983 and $34,450 for 1984. The case also concerns an appeal from an assessment for the 1982 taxation year, denying a carryover in 1982 of a tax credit balance of $3,160 for the 1983 taxation year, not claimed in 1983.

The Minister said that the appellant is not entitled to the tax credits claimed in 1983 and 1984 because the property in question was not "prescribed equipment" within the meaning of paragraph 127(10.1)(f) of the Act, mainly because if was not used principally for the purpose of construction in Canada.

For the purposes of this appeal paragraph 127(10.1)(f) read as follows:

“qualified construction equipment” of a taxpayer means prescribed equipment acquired by him after April 19, 1983 that has not been used, or acquired for use or lease, for any purpose whatever before its acquisition by him and that is

(i) to be used by the taxpayer principally for the purpose of construction in

Canada in the course of carrying on a business other than a business

(A) the income from which is exempt from income tax by virtue of any provision of this Act, or

(B) the income from which is not included in his income or, in the case of a

non-resident person, in his taxable income earned in Canada, or

(ii) to be leased by the taxpayer, if

(A) the equipment is leased by the taxpayer in the ordinary course of carrying on in Canada a business the income from which is other than income referred to in clause (i)(A) or (B), to a lesee who can reasonably be expected to use the equipment principally for the purpose referred to in subparagraph (i), and

(B) the taxpayer is a corporation whose principal business is a business described in any of clauses 127(10(d)(i)(A) to (E) or in any combination thereof, or is a taxpayer whose principal business is a construction business. [2]

(c) an amount not exceeding the lesser of

(i) his investment tax credit at the end of the year in respect of property acquired, or an expenditure made, in a subsequent taxation year and after April 19, 1983, to the extent that the investment tax credit was not deductible under this subsection in the taxation year in which the property was acquired, or the expenditure was made, as the case may be, and

(ii) the amount, if any, by which the tax otherwise payable by him under this Part for the year exceeds the aggregate of the amounts, if any, determined under paragraphs (a) and (b).

Section 127(5) was amended by 1983-84, c. 1, s. 72(2), in effect from the date of royal assent on January 19, 1984. Section 127(5) previously read as follows:

There may be deducted from the tax otherwise payable by a taxpayer under this Part for a taxation year an amount not exceeding the lesser of

(a) his investment tax credit at the end of the year, and

(b) the aggregate of

(i) $15,000, and

(ii) /2 the amount, if any, by which the tax otherwise payable by him under this Part for the year exceeds $15,000.

Subsection 127(9) defines "investment tax credit". For the appellant it was an amount equal to five per cent of the aggregate of all amounts each of which is the capital cost to him of qualified construction equipment acquired by him in the year, calculated without regard to subsection 13(7.1).

Before and during the years at issue, Dragon bought construction equipment to lease it primarily to a lessee who would use it for the purpose of construction in Canada. Naturally, the possibility existed that items of equipment would be leased to other lessees, since the equipment had to be used as often as possible in order to cover the heavy purchase price. Prior to the years at issue the construction equipment was generally used for the purpose of construction in Canada, chiefly by the principal lessee.

The principal lessee was a subsidiary of Dragon, Société Les Excavations Hel-Ren Ltée ("Hel-Ren"). Hel-Ren performed subcontracts for various contractors, supplying machinery and an operator. The cost of performing this work was charged at an hourly rate. If other companies were interested in leasing equipment without using the services of an operator, Dragon leased the equipment to those customers. If the customers from time to time asked that work be done with the services of an operator, they were referred to Hel-Ren.

Mr. Yves Gauthier is one of the directors and a shareholder of Dragon, which is a family company. He explained that the contracts with customers were short-term and varied: two days, a week, ten days and so on.

On December 28, 1983 Dragon purchased a new excavator, a CAT 235 ("Property A”), to meet the needs of Hel-Ren, at a cost of $313,000 from Hewitt Equipment Ltée (“Hewitt”) of Montréal. The first registration of this equipment was dated February 3, 1984, but Dragon rented Property A to Hel- Ren in January; in January and February Property A was rented by Hel-Ren to the contractor Meloche for work on a site on Ile-Perrot. Mr. Gauthier said this equipment could be used before being registered.

Mr. Gauthier testified that one day in mid-February 1984 he received a telephone call from Lavalin International Inc. ("Lavalin"), the subsidiary of a well-known corporation. Lavalin wanted to rent a used excavator, of the

(d) to be leased by the taxpayer, to a lessee (other than a person exempt from tax under section 149) who can reasonably be expected to use the property in Canada primarily for any of the purposes referred to in subparagraphs (c)(i) to (x), but this paragraph does not apply in respect of property that is a prescribed property for the purposes of paragraph (b), unless

(i) the property is leased by the taxpayer in the ordnary course of carrying on a business in Canada and the taxpayer is a corporation whose principal business is

(A) leasing property,

(B) manufacturing property that it sells or leases,

(C) the lending of money,

(D) the purchasing of conditional sales contracts, accounts receivable, bills of sale, chattel mortgages, bills of exchange or other obligations representing part or all of the sale price of merchandise or services, or

(E) selling or servicing a type of property that it also leases,

or any combination thereof and . . .

same type as Property A, in good condition for work in Algeria. Mr. Gauthier testified that the lease was to be for three months: one month for shipping it to Algeria, one month's operation in Algeria and one month to bring it back. Dragon had eight other excavators of the same type as Property A. Lavalin might be an eventual customer: it was the first time Lavalin had contacted Dragon and Mr. Gauthier clearly wanted to do business with Lavalin. Accordingly, Dragon agreed to Lavalin’s request and rented Property A on February 29, 1984. The lease was in fact renewed monthly until February 1985, when Property A was returned to Canada. On Property A's return to Canada Dragon repaired it to rentable condition. Property A was sold in 1986.

Dragon bought two other excavators, CAT 225 ("Properties B and C"), which it rented to Lavalin. Dragon and Lavalin began negotiations to rent these properties in February 1984. Mr. Gauthier testified that Dragon, which had three CAT 225s, was considering buying two others in any way it could. The company bought two excavators from Hewitt on March 15, 1984 and rented them the same day. Mr. Gauthier said that the rentals were for three months and were extended monthly until 1985. He admitted that he knew Lavalin wanted to use these excavators in Algeria, and this was in fact the case.

These two excavators were returned to Canada with Property A and after repairing them Dragon rented them to Hel-Ren, until they were sold in March 1986.

Mr. Gauthier stated that Dragon rented Properties B and C (CAT 225) to Lavalin for good business reasons, though the latter had only requested used equipment.

The appellant said that the use of the three excavators in Algeria was very limited and marginal compared to the Canadian use to which they had been almost exclusively devoted, the use in Algeria was justified on sound business principles, and therefore such use should not disqualify the tax credit claims.

The respondent contended that the appellant was not entitled to the tax credits because the three excavators were not prescribed equipment under paragraph 127(10.1)(f), mainly because they were not principally used for the purpose of construction in Canada.

Under subparagraph 127(10.1)(f)(ii), the phrase "qualified construction equipment" of a taxpayer means in particular new prescribed equipment, purchased by him for rental in the ordinary course of the operation of his business in Canada to a lessee who "can reasonably be expected" to use it "principally" for the purpose of construction in Canada. In short, the equipment must be acquired by the taxpayer to be leased to a lessee who can reasonably be expected to use it principally for the purpose of construction in Canada.

The appellant must determine at the time the equipment is acquired whether it can reasonably expect that its present lessees, or the lessees to whom the equipment will be leased, will use it principally for the purpose of construction in Canada. The question of whether it can reasonably be expected that the equipment will be used in this way is a conclusion as to the future which must be made at the time the equipment is acquired. In its Capacity as owner of the equipment, the appellant may determine when and how the equipment leased will be used. It must consider the way in which its past and present lessees have used and are now using the leased equipment, as well as the use of the equipment by any other person to whom it can reasonably expect to lease it during its anticipated active life. Evidence relating to the possible use of the equipment by lessees during tis anticipated active life may be helpful to a court in determining the use that a possible lessee is likely to make of the equipment at the time it is acquired. This would also depend in part on established leasing practices.

In subparagraph 127(10.1)(f)(ii), the equipment must be used principally by the lessee, not the appellant, for the purpose of construction in Canada. The adverb "principally" modifies use of the equipment by the lessee, not the appellant.

Dragon's business before 1984 consisted of leasing construction equipment to various firms who operated a construction business in Canada, and to Hel-Ren the employees of which used the equipment principally for the purpose of construction in Canada. The deposition by Mr. Gauthier that he had never had any contact with Lavalin before mid-February 1984 was not seriously challenged during the cross-examination, and I accept it.

Dragon acquired Property A in the ordinary course of its equipment purchases for the purpose of leasing to its customers. Property A was first leased to Hel-Ren, which leased it to a contractor in Québec. Lavalin’s telephone call regarding the leasing to Property A was fortuitous and could not reasonably have been anticipated at the time the equipment was acquired on December 29, 1983. On that day Dragon expected to do business with its ordinary customers, who could reasonably be expected to use Property A principally for the purpose of construction in Canada. It is thus clear that Property A is qualified construction equipment within the meaning given to that phrase by paragraph 127(10.1)(f).

In March 1984 Lavalin was a customer of Dragon. Mr. Gauthier explained that Dragon could have leased Lavalin two of the excavators which it already owned, but Mr. Gauthier decided to lease Lavalin two new excavators. Properties B and C were acquired and leased by Dragon the same day, as negotiations for their lease had begun in February 1984. At the time the two excavators which are Properties B and C were acquired, Dragon had agreed to lease them to Lavalin for the purpose of construction in Algeria.

Counsel for the appellant argued that each of the leases made with Lavalin for the three excavators ran for three months. He therefore concluded that at the time Properties B and C were acquired, Dragon reasonably expected three-month leases only with Lavalin, and that the subsequent leasing of the equipment, once the three-month period was over, was to ordinary customers who used the equipment for the purpose of construction in Canada.

The three leases for Properties A, B and C were entered in evidence. As I interpret these leases, they were not solely for a three-month period as Mr. Gauthier seemed to think. Twice in each of the page-long contracts it states that the minimum lease period is three months; on the printed form there is a heading “MINIMUM LEASE PERIOD”, the words "three months" are typed below and the words "minimum lease period: three months" with the monthly rental are typed in the body of the lease. I therefore conclude that each of the contracts was for an unspecified period, probably until the equipment was no longer required for the project in Algeria, not just for three months. I believe that this was the real meaning of the agreement between Dragon and Lavalin. On the facts, it is clear that properties B and C were acquired for Lavalin, which could not reasonably be expected to use the equipment principally for the purpose of construction in Canada.

It would appear from the explanation regarding the changes made to the reassessment by the 1982 taxation year that the 1983 investment tax credit of $3,160 already applied in 1982 was disallowed in its entirety. There was no other explanation submitted to the Court as to why the 1982 taxation year was at issue. The appeal for the 1982 taxation year is accordingly dismissed.

The appeals for the 1983 and 1984 taxation years are allowed with costs, and the assessments referred back to the respondent for reconsideration and reassessment on the basis that the appellant is entitled to an investment tax credit for Property A only.

Appeals allowed in part.