Canvil LTD v. Minister of National Revenue, [1985] 2 CTC 2451, 85 DTC 699

Tremblay, TCJ:—This case was heard on December 13, 1984 in the City of Toronto, Ontario.

1. The Point at Issue

The main point is whether the appellant company is correct in claiming an investment tax credit on a building expansion which cost of $271,533.

The respondent disallowed the said investment tax credit on the grounds that the building addition was used as a finished goods warehouse area and not used “primarily for the purpose of manufacturing or processing goods for sale or lease” as provided in provision 127(10) of the Income Tax Act. This provision states that qualified property for an investment tax credit must meet that requirement. The appellant rebuts this in saying that in expanding presently the manufacturing area into the addition and having the warehouse area in the original building, this would have been extremely inefficient. He contends that the investment tax credit was designed to encourage new investment and not to encourage inefficiency in the manufacturing industry.

2. Settlement and Withdrawal

The reassessment in respect of the 1980 taxation year issued by the repondent mainly concerns four points from which it was appealed. They are well described in paragraph 4 of the reply to notice of appeal.

4. The respondent, in a reassessment of tax to the appellant for the 1980 taxation year:

(i) disallowed, inter alia, an investment tax credit with respect to a building addition constructed by the appellant at a cost $271,533;

(ii) calculated the capital cost allowance to which the appellant was entitled in its 1980 taxation year on the basis of the amount of investment tax credit to which the appellant was entitled in the 1980 taxation year rather than upon the amount it claimed in that year;

(iii) applied a non-capital loss in the amount of $362,524 from the taxation year ending October 3, 1980 against income of the appellant in the taxation year ending September 30, 1980; and

(iv) reduced the amount of the appellant’s refundable dividend tax on hand and dividend refund from $3,984 as claimed by the appellant in its return of income to $493.

At the beginning of the trial, counsel for the parties filed minutes of settlement allowing the appeal concerning the two points described in 4(ii) and 4(iii) above.

Counsel for the appellant informed that he withdrew the point described in 4(iv). Therefore the only point in dispute is the one described in 4(i).

3. The Burden of Proof

3.01 The burden is on the appellant to show that the respondent's assessment is incorrect. This burden of proof results particularly from several judicial decisions, including the judgment delivered by the Supreme Court of Canada in Johnston v MNR, [1948] CTC 195; 3 DTC 1182.

3.02 In the same judgment, the Court decided that the assumed facts on which the respondent based his assessment or reassessment are also deemed to be correct. In the present case, the assumed facts are described in the reply to notice of appeal as follows:

6. The respondent, in so reassessing tax to the appellant for its 1980 taxation year, made the following assumptions and findings of fact:

(a) the appellant was, at all material times, a manufacturer of pipe fittings and valves;

(b) the appellant constructed a building addition in the 1980 taxation year which addition, at all material times, was used as a finished goods warehouse area;

(c) the appellant incurred foreign exchange losses on capital items of $21,577 in the 1980 taxation year reducing its Canadian investment income in the 1980 taxation year to nil.

4. The Facts

4.01 Mr David William Muir, professional engineer and engineering manager of the appellant company testified that:

(a) Canvil is a manufacturer of high pressure steel pipe fittings, forged steel valves and oil well couplings.

(b) An advertising brochure issued by Canvil was filed as Exhibit A-1. One can read it was established in 1953. Presently it has manufacturing areas at Simcoe (Ontario), Edmonton (Alberta), Acton Vale (Quebec) and Hamilton (Ontario). It has 400 employees in all locations, and 250 only in Simcoe. The annual sales in 1981 was $36,000,000.

(c) The plant facility is located in Simcoe. The first building was opened in 1950.

(d) A photostated copy of a drawing (Exhibit A-2) shows the seven main bays of the building and the years in which they were constructed. Construction was completed from 1954 for the first segment through 1980; 1954, 1957, 1962, 1969, 1974 and 1980.

(e) The bays are structural steel basic constructions with sheet metal walls and insulation. It is all one continuous space except for the junction between the 1980 and 1974 bay where the exterior wall was left sitting on the floor.

(f) Heavy machinery is located in the plant. It weighs from 20,000 tons to 50,000 tons: machine forgings, coupling stocks and pipes. The floor must be a rigid structure to avoid vibration through the base of the machine into the tooling. Alignment and accuracy of the machining is important in the product.

(g) The finished goods are stored in the plant. In fact they are presently stored in the segment built in 1980. A binder containing schematic diagrams and five photos was filed as Exhibit A-3. Eighty-five per cent of the plant is used for manufacturing and 15 per cent for storage.

(h) The bay built in 1980, even if it was in immediate view for storage, the floor was built six inches thick, heavy wire mesh reinforced. In fact on a long-term basis the intention is that it shall be used for manufacturing area. “A floor strictly for warehouse could be thinner, less concrete, would have a lighter wire mesh in it, would probably be a floating floor, not tied to the foundation wall because it would be simply dead weight, no vibration problem”. TS 10, 11

(i) The warehouse is presently in the 1980 bay because the addition had to be built in the west of the building. “We would get the production space as close as possible to our ideal location”.

(j) The new 1980 addition was required because of new machinery and “that put a lot of pressure on for additional space”. TS p 14 A two-page list of machinery purchases was filed as Exhibit A-4. From 1978 to 1980, 29 machines were purchased, 15 of which in 1980 and three in 1981. In 1980, “we increased our manufacturing area by the size of our previous finished goods warehouse”. TS p 15

(k) “Storage is a necessary part of a manufacturing process. Ideally, our customers would carry all our stock, but, of course, they won’t do that and so we have to maintain, in addition to raw material and work in process, we have to maintain the stock of finished goods”. TS 17

4.02 In cross-examination, Mr Muir testified that:

(a) storage is necessary to building inventory (TS p 17);

(b) the old storage (before the 1980 addition) was 16,200 sf; the present storage space is 17,400 sf;

(c) only one new machine was located in the former storage area because a part of the former storage is now used for the office. Also some of the machines were sold, some moved into other areas of the plant (Edmonton, etc);

(d) in 1980, the primary purpose of the new addition “was to use it to produce more manufacturing space in the rest of the building”. (TS p 21) There are some small grinding operations that are done in that area (the 1980 addition) but it is not a major piece of production;

(e) with the 1980 addition, Canvil did not have any specific storage space with the appropriate storage floor; “We don't because we anticipate using all of that floor eventually as production space. I suppose if we got to the end of the property, our last bay, we could build a warehouse with a thin floor”. (TS p 22);

4.03 Mr Allan Harvey Hays, accountant and vice-president of finance of the appellant testified that:

(a) the final decision to build the last addition was taken in spring 1979. The planning had gone on for many months prior to that. (TS p 23)

(b) “The main reason (of the addition) was that for the years beginning in 1978, our business grew rather dramatically. We acquired a great deal of additional machinery and were required to carry the additional load of work in process inventory as a result of increased volume. We simply ran out of manufacturing space in our Simcoe plant". (TS p 23)

(c) “Storage is an integral part of the business almost as far as that is concerned. In order to service our customers and get the business that is generating by our manufacturing efforts, we must ship from stock and in order to ship from stock we must carry finished goods, inventory". (TS p 24)

4.04 In cross-examination, Mr Hays testified that:

(a) All the floors in the factory are all manufacturing strength floors. (TS P 25)

(b) “We have never specifically built storage space on the assumption that whatever space we build, on account of the location of the plant on our land, that that storage will eventually become manufacturing space. So in that sense, sir, we have not ever built only warehousing space". (TS

p 25)

(c) In 1953, the appellant acquired four acres of land. In the late 50s it acquired another seven acres to the west. The only land left to the appellant is to the west. “. . . there would be foolhardy to build warehousing space in the midst of what will in all likelihood become manufacturing area. So, in that sense, sir, we will probably never even build warehouse space except for that one at the westerly end of our property". (TS p 26)

5. Law — Cases at law — Analysis

5.01 Law

The main provisions of the Income Tax Act involved in the instant case are 127(5), 127(9) introduction, 127(10) introduction, 127(11 )(b)(i).

Section 127(5)

(5) Investment Tax Credit — There may be deducted from the tax otherwise payable by a taxpayer under this Part for a taxation year an amount equal to the aggregate of

(a) 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, before April 20, 1983, and

(ii) the aggregate of

(A) $15,000, and

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

(b) 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, after April 19, 1983, and before the end of the year, and

(ii) the amount, if any, by which the tax otherwise payable by him under this Part for the year exceeds the amount, if any, determined under paragraph (a); and

(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 paragraph (a) and (b).

Section 127(9) introduction

(9) “Investment tax credit” defined. For the purposes of subsections (5) to (8) and subject to subsection (11.1), “investment tax credit” of a taxpayer at the end of a taxation year means the amount.

Section 127(10) introduction

(10) “Qualified property”. For the purposes of subsection (9), a “qualified property” of a taxpayer means a property (other than a certified property).

Section 127(11 )(b)(i)

(11) Interpretation. For the purposes of subsection (10),

(b) for the greater certainty, the purposes referred to in subparagraphs (10)(c)(i) to (x) do not include

(i) storing (other than the storing of grain), shipping, selling and leasing of finished goods.

5.02. Cases at Law

Counsel for the parties referred the Court to the following cases at law:

1. Bunge of Canada Ltd v The Queen, [1982] CTC 313; 82 DTC 6273, FCTD; [1984] CTC 284; 84 DTC 6276 FCA;

2. Lor-Wes Contracting Ltd v The Queen, [1982] CTC 415; 83 DTC 5016;

3. G GA Nowegijick v The Queen, [1983] CTC 20; 83 DTC 5041;

4. Lapointe Drainage Limited v MNR, [1983] CTC 2497; 83 DTC 440;

5. Clarence Daigle & Fils Ltd v MNR, [1981] CTC 2770; 81 DTC 663.

5.03. Analysis

5.03.1 It is obvious from the evidence that the 1980 bay was primarily built to be used for the purpose of manufacturing or processing of goods for sale. Indeed the nature of equipment used to build the floor and the way it was fixed show that it was to be used for manufacturing area of the building: 4.01(h), 4.02(e), 4.04(b)(c).

It was only on a temporary basis that 1980 bay was used for storage. The Court shares the appellant's opinion that the building, as a whole (1954 bay to 1980 bay see par 4.01(d), Exhibit A-2) is used primarily for manufacturing and processing of goods. However the 1954 bay to 1974 bay are not qualified buildings because they were not built after June 23,1975 as provided in 127(10)(a). Therefore only 1980 can be a qualified building if it meets the requirements of the legal provisions.

The Court also shares counsel for the appellant’s opinion that generally speaking the storage space is a necessary and integral part of its manufacturing business and that the appellant is not a warehouser. However provision 127(11)(b)(i) does not include “storing” in “manufacturing”.

5.03.2 In view of construing the legal provisions involved, the crux of the matter is whether the actual use of the building must be considered or the primary use that the appellant had in mind in acquiring the 1980 bay.

5.03.3 Basis in the cases at law

In the Bunge of Canada case (5.02.1)), the Federal Court of Appeal decided that the discharge of grain from a silo was an integral and necessary part of the storing of grain which is a qualified property pursuant to 127(10)(c)(ix). Therefore the Court in the said case had to consider the actual use and the nature of storing the grain.

In the Lor-Wes case (5.02(2)), Dubé, J of the Federal Court—Trial Division decided that a heavy equipment acquired by a road building firm and not by a logging operator was not considered as a qualified property for logging, despite the fact that the road building firm was engaged only by logging operators on the timber limits to build logging roads. Therefore the Judge did not look at the actual and immediate use of the equipment but at the user. If a logging operator, indeed, has acquired the same equipment then it would have been considered as qualified property. The Federal Court of Appeal however reversed this decision last July ([1985] 2 CTC 79; 85 DTC 5310). I quote the summary [DTC]:

HELD: The taxpayer's appeal was allowed. The Court found that when the relevant statutory provision was interpreted with a “words-in-total-context” approach with a view to determining its object and spirit, no distinction could be made between the logging company itself and a subcontractor such as the taxpayer. Furthermore, it was clear from the budget statement which led to this provision that the evil sought to be remedied was “any slowdown in investment”. Such an evil would be removed by appropriate activity regardless of its source, and would be achieved by encouraging the logging industry in its integral totality.

The same basis as the one of the Federal Court—Trial Division in the Lor-Wes case was used by St-Onge, TCJ then member of the Tax Review Board on the Clarence Daigle case (5.02(5)). He decided indeed that a tractor equipped for tilling soil and used by a road gravel contractor was not primarily used for the purpose of farming (127(10)(c)(viii) ), the road gravel contractor not being in the business of farming. The decision in the Lapointe Drainage case is similar to the former case.

5.03.4 In the instant case the user criterion does [not] help the Court despite the fact that the appellant was an appropriate user. The problem indeed is not at that level but at the level pointed out in para 5.03.2. At first glance it seems that the actual use in the year involved rather than the final use provided in the construction of the building must be considered. The income tax indeed is based on the annual income. Provision 127(5) provides the investment tax credit may be deducted in a taxation year. Provision 127(9), in giving the definition of “Investment Tax Credit” of a taxpayer, says it is at “the end of a taxation year”.

The definition of “qualified property”, in subsection 127(10), is for the purpose of subsection 127(9). Also the definition of investment tax credit, in subsection 127(9), is for the purpose of subsection 127(5). Therefore the Court thinks that when the legislator in 127(10)(c) says that the property is “to be used by him in Canada primarily for the purpose of . . .” one must understand, “in a taxation year”.

Therefore, now the point is whether in 1980, the 1980 bay was primarily used for the purpose of manufacturing. The evidence is to the contrary. It was used for the storage and “manufacturing” does not include “storing”.

The Court does not see another basis to construe these exemption provisions which must be strictly construed especially when “storing” is excluded from “manufacturing” and despite a “words-in-total-context” approach.

6. Conclusion

The appeal is allowed in part and the matter referred back to the respondent for reassessment in accordance with the above reasons for judgment.

Appeal allowed in part.