9 August 1990 Ministerial Correspondence 74794 F - Manufacturing and Processing Deductions - Qualified Activities

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

SUBJECT:  24(1)

We are writing in reply to the memorandum from Gary Baker dated March 8, 1990, wherein.he requested our comments on whether certain equipment of the above noted taxpayer would be considered "qualified property" used primarily for the purpose of manufacturing or processing goods for sale.  We apologize for the delay in responding to your memo.

Facts

Our understanding of the facts of the situation as outlined in the memo and discussed with G. Baker is as follows:

24(1)

24(1)

Taxpayer's Opinion

The taxpayer's representative is of the opinion  24(1)  He is taking support for his position from paragraphs 40 and 44 of IT-149R which state, inter alia, that:

     The sale of or lease of computer software is considered to be the sale of information and as a result the costs of developing the software would not qualify as manufacturing and processing of goods.  Where software is transmitted by way of tangible property, such as computer cards, tapes or discs, those activities that relate to the manufacture or process of this property, such as a clean compilation and testing the program, would be considered qualified activities.

     The activities of a printing or publishing firm that qualify as manufacturing or processing include the activities such as typesetting, printing, collating, folding and bundling. Reporting of news, preparation of copy of advertisements, photographs and art work, and editing are also considered qualified activities provided that the physical activities of manufacturing a newspaper are carried out by the taxpayer.

Your Opinion

It is your opinion that  (24)(1)

Our Comments

A)     Court cases

     In determining whether a particular activity of a taxpayer can be considered manufacturing or processing of goods for sale or lease in Canada, it is our view that a distinction must be made between the manufacturing of goods for sale and the provision of a service.  Our position is supported by the following court cases.

1)     The case Crown Tire Service Ltd. v. The Queen, 83 DTC 5425 at page 5429, indicates that in interpreting the words "goods for sale or lease" contained in section 125.1 of the Act, reference should he given to the general law of sale or lease in order to give greater precision to the phrase.

2)     The judge in the case Dixie X-Ray Associates Limited v. The Queen, 88 DTC 6076, states that the courts would look to the substance of the contract in order to determine whether the contract is for the sale of goods or for the supply of services to which the transfer of title to goods is incidental. More specifically on page 6079, McNair, J. says "But if the substance of the contract is the production of something to be sold and the transference of property therein to a buyer then the contract is a sale of goods. But if the real substance of the contract is the skill and labour of the supplier in the performance of work for another then that is a contract for work and labour, notwithstanding that property in some material may pass under the contract as accessory thereto."

3)     In the case Cabana, Seguin Inc. v. M.N.R., 82 DTC 1360, the taxpayer was in the advertising business and its activities included "all the phases necessary to the appearance of the finished product, from the design to the preparation of the layout, text and final layout, to the typography, pasting-up, photo engraving and printing".  The judge examined the issue of whether or not the taxpayer was in the business of manufacturing or processing of goods for sale and thus entitled to the manufacturing and processing profits deduction.  The decision arrived at that the taxpayer was not in the business of manufacturing and processing of goods for sale was based on the following:

i)     The majority of the taxpayer's operation called for the professional skill and judgement rather than use of equipment, machinery and labour.

ii)      As the supply of materials of and goods was incidental to the service provided, the delivery of the finished brochure was not considered to be the sale of a tangible good so as to qualify the taxpayer's profits for manufacturing and processing.

iii)     The taxpayer's operation did not process a product from raw materials but rather provided a service.

iv)     Even though the contract called for the delivery of a tangible good, it was clearly shown that the operation was much more involved in the provision of a service than in the sale of a finished product.  What the agency provided was considerably more valuable in terms of services          rendered than in raw materials manufactured to a final       product.

4)     In the case B.B.G.P. Inc. v. M.N.R., 87 DTC 108, the taxpayer was in the business of designing, developing and implementing computerized accounting systems on a custom basis.  The taxpayer submitted that it manufactured computer systems for customers and that after a particular system had been manufactured, it was sold to the customer.  Although the taxpayer relied on the last sentence in paragraph 40 of IT-145R, the court decided that the process of designing and developing a system is not a manufacturing stage.  Once the system is developed, its manufacture can begin and it can be received by way of tangible property; computer cards, tapes or disks.  In other words, only once the product has been created, can it be transformed into a tangible property and its manufacture begin.

5)     In the case Reg Rad Tech Ltd. v. The Queen, 90 DTC 6350, the taxpayer purchased raw film, took X-Rays or ultra sound films of patients, developed the films and sold them to the requesting physicians.  Upon the court reviewing the outcome of the decisions in the cases of Nowsco and Halliburton (indicated below), it held that those two cases were distinguishable from the facts of this case.  The decision reached was that the taxpayer "was not engaged, as its primary purpose, in the processing as goods for sale.  It was, in my opinion, from a common sense, realistic and business like appreciation of the evidence, providing services to the patients and the diagnosing radiologists of the partnership."

     Two court cases which do not support our position and were heard together at the Federal Court of Appeal on April 10, 1990 are.The Queen v. Nowsco Well Service Ltd. and The Queen v. Halliburton Services Ltd.  However, the outcome and rationale for the decisions made in these cases is considered by the Department to have restricted application to similar businesses in the oil well service industry.

B)     IT-145R

     The activities being referred to in the last sentence in paragraph 40 of IT-145R are those that take place subsequent to the developing of the software and relate to any additional preparation required to enter information onto a tangible medium (such as a blank computer disk or tape) or to verifying that information.  This position is decision in the court case B.B.G.P. Inc. outlined above.  In order for the computer tapes or disks with information transferred to them to be considered goods for sale, they would either have to sold as finished products to the general public or sold to a purchaser who entered into a contract for the sale of a good rather than a contract for the supply of a service (labour, skill and materials).

     The basis for the position in paragraph 44 of IT-145R allowing most of the activities performed in connection with publication of a newspaper to be considered qualifying activities arose as a result of the Department losing the   court case The St. Catharines Standard Limited, 78 DTC 6168, (F.C.T.D.).  In reaching its decision, the underlying premises held by the court were that 1) the publication of newspapers is a manufacturing and processing business, 2) the raw materials required to produce the newspaper are the editorials, feature articles, and news stories written and 3) the sale of newspapers produced constitutes goods for sale.  The comments in paragraph 44 will only apply to a taxpayer who manufactures or processes newspapers or books for sale to the general public or who enters into a contract with a purchaser for the sale of a good, e.g., a book.

C)     Fact situation

     Based on the meaning and examples of manufacturing or processing outlined in paragraphs 5, 40, 42 and 44 of IT-145R, it is our opinion, 24(1) Unfortunately, the concept of goods for sale is not discussed or emphasized in the bulletin and the determination of whether there are goods for sale can be difficult to make in some fact situations.  It requires a judgement call to be made after considering all of the relevant facts of the situation including the review of the contracts entered into by the taxpayer. However, pursuant to your request, but without having reviewed the contracts entered into we have stated our opinion based on the information provided.

     In some situations

     24(1)

D)     Used primarily

     Paragraph 16 of IT-331R provides comments on a piece of equipment used in carrying out both a designated and non-designated purpose or activity.  If the equipment is used more than 50% of the time in a designated activity, i.e. manufacturing or processing of goods for sale then the entire cost of the equipment will meet the requirement of the definition of qualified property of being used primarily for that designated purpose.  In order to measure the percentage, that paragraph suggests in the case of property that is capable of action and are highly automated, use can be gauged exclusively by the length of time activated for a particular purpose.

     24(1)

We trust these comments will be of assistance, but if you require a more definitive response it will be necessary for us to review some sample contracts entered into by  24(1)

ChiefMerchandising, Manufacturing and Construction SectionRulings DirectorateLegislative and IntergovernmentalAffairs Branch