Farmparts Distributing LTD v. Her Majesty the Queen, [1979] CTC 263, 79 DTC 5193

Gibson, J:—Farmparts Distributing Ltd of Saskatchewan, Canada by notices of assessment for income tax dated November 26, 1976 and April 29, 1976 was levied tax equivalent to 15% of two amounts paid by it to Wonder International Limited of New Jersey, USA, on the premise that such should have been withheld and paid as income tax.

This is a hearing on common evidence of the appeals from both these assessments.

Farmparts entered into two agreements with Wonder International dated respectively March 1, 1976 (Exhibit 1) and May 25, 1976 (Exhibit 2); and Farmparts paid Wonder International $115,000 US in respect to the agreement Exhibit 1 and $75,000 US in respect to the agreement Exhibit 2.

What Farmparts obtained from Wonder International pursuant to the agreement Exhibit 1 and Exhibit 2 was:

1. the exclusive right to purchase from Wonder International its “Wonder Matic” pipe bending machine (to bend stock or universal exhaust pipes for replacement of exhaust systems for American automobiles) for resale to others by Farmparts in Manitoba, Saskatchewan, Alberta, BC, Northwest Territories, Yukon and Alaska;

2. the concept or technique of merchandising these replacement muffler systems using this “Wonder Matic” machine; and

3. certain use of the “Wonder Muffler” trade name and logos of Wonder International.

The payments made pursuant to Exhibits 1 and 2 did not entitle Farmparts to receive without charge any “Wonder Matic” machines. Instead Farmparts had to buy each machine from Wonder International and pay for each. These machines in turn Farmparts re-sold to its sub-distributors. Farmparts, however, did not purchase anything else from Wonder International except the machines and was not required to do so.

Farmparts in re-selling to its sub-distributors sold them not only a machine but also a so-called “package” it devised on its own and for which these sub-distributors paid $17,950. These sub-distributors obtained with their “package”:

1. one “Wonder Matic” pipe bending machine with all the dies etc., to enable them to make universal exhaust pipes fit the exhaust systems of all American cars, together with a card deck showing the various degrees of bend required to enable the exhaust pipes to be bent to fit these cars;

2. an opening advertising programme (prepared by the advertising agency of Farmparts);

3. an inventory of certain business forms;

4. “Wonder” decals of its logo;

5. a sign; and

6. an opening inventory of exhaust pipes, shackles and other parts necessary to complete the installation replacement muffler systems in cars.

Of all the parts of this “package”, only the exhaust pipe bending “Wonder Matic” machine came from Wonder International.

These sub-distributors who were sold the so-called “package” by Farmparts were permitted to use the trade mark “Wonder Muffler” and logos of Wonder International apparently without objection by Wonder International. No effective control of such use was required by Wonder International. But according to Clause 17 in each of the agreements, Exhibits 1 and 2, which are entitled “Procedures Upon Termination” (of the agreements), the only matter or thing that is mentioned is the trade name “Wonder Muffler” and logo and labels relating to Wonder International. This clause in each of the agreements requires Farmparts to cease to use the trade name and to return to Wonder International any forms of advertising matter or manuals and bulletins. (It is not necessary for the purpose of these appeals to express any opinion as to what would be “left” to “return” to Wonder International in so far as the trade mark “Wonder Muffler” is concerned in view of the use made of the trade mark by Farmparts and its subdistributors apparently with the tacit consent of Wonder International).

The issue in each of the appeals is whether or not the respective payments of $115,000 US and $75,000 US made by Farmparts to Wonder International are subject to the 15% tax imposed by paragraph 212(1 )(d) of the Income Tax Act in the taxation year 1976.

Paragraph 212(1 )(d) of the Income Tax Act reads as follows:

(1) Every non-resident person shall pay an income tax of 25% (15% for the purpose of these appeals) on every amount that a person resident in Canada pays or credits, or is deemed by Part I to pay or credit, to him as, on account of or in lieu of payment of, or in satisfaction of,

(d) Rents, royalties, etc—rent, royalty or a similar payment, including, but not so as to restrict the generality of the foregoing, any payment

(i) for the use of or for the right to use in Canada any property, invention, trade name, patent, trade mark, design or model, plan, secret formula, process of other thing whatever,

(ii) for the information concerning industrial, commercial or scientific experience where the total amount payable as consideration for such information is dependent in whole or in part upon

(A) the use to be made thereof or the benefit to be derived therefrom,

(B) production or sales of goods or services, or

(C) profits,

(iii) for services of an industrial, commercial or sceintific character performed by anon-resident person where the total amount payable as consideration for such services is dependent in whole or in part upon

(A) the use to be made thereof or the benefit to be derived therefrom,

(B) production or sales of goods or services, or

(C) profits,

but not including a payment made for services performed in connection with the sale of property or the negotiation of a contract,

(iv) made pursuant to an agreement between a person resident in Canada and a non-resident person under which the non-resident person agrees not to use or not to permit any other person to use any thing referred to in subparagraph (i) or any information referred to in subparagraph (il), or

(v) that was dependent upon the use of or production from property in Canada whether or not it was an instalment on the sale price of the property, but not including an instalement on the sale price of agricultural land,

but not including

(vi) a royalty or similar payment on or in respect of a copyright,

(vii) a payment in respect of the use by a railway company of a property that is railway rolling stock as defined in the definition “rolling stock” in section 2 of the Railway Act

(A) if the payment is made for the use of that property for a period or periods not expected to exceed in the aggregate 90 days in any 12 month period, or

(B) in any other case, if the payment is made pursuant to an agreement in writing entered into before November 19, 1974;

(viii) a payment made under a bona fide cost-sharing arrangement under which the person making the payment shares on a reasonable basis with one or more non-resident persons research and development expenses in exchange for an interest in any or all property or other things of value that may result therefrom,

(ix) a rental payment for the use of or the right to use outside Canada any corporeal property, or

(x) any payment made to a person with whom the payer is dealing at arm’s length, to the extent that the amount thereof is deductible in computing the income of the payer under Part I from a business carried on by him in a country other than Canada;

The words “rent” or “royalty” are not defined in paragraph 212(1 )(d) of the Income Tax Act or elsewhere in the Act.

Subsection 212(1) of the Act is a charging provision. If these amounts are payments within the meaning of paragraph 212(1 )(d), these appeals fail and countrarywise.

Farmparts was incorporated under the laws of the Province of Saskatchewan, Canada, on December 9, 1974. Its business includes the sale and distribution of farm machinery and farm and automatic parts. In its distribution business it made contract arangements with 31 sub-distributors who bought its so-called “package” above referred to, and after that replacement parts inventory.

Wonder International is a Delaware corporation of New Jersey, USA. It manufactured and sold the machine called “Wonder Matic” which was an exhaust pipe bending machine which enabled an operator of it to make universal exhaust pipes fit the exhaust systems of any American automobile.

This concept of merchandising replacement muffler systems for automobiles is relatively new.

Before that and for many years parts for replacement muffler systems for American automobiles were supplied by the various franchised dealers of the various automobile manufacturers. The replacement systems were installed by authorized dealers of these automobile manufacturers or by private repair shops or service stations which latter would obtain the muffler parts for replacement from such authorized automobile dealers.

In recent years however, at least two companies and now more, established and operate in many cities and towns a specialized muffler replacement business. Two of the prominent ones are Midas Muffler and Speedy Muffler. They obtain their inventory from certain plants in Canada. Midas and Speedy at each of their locations stock a considerable inventory of muffler pipes, mufflers, shackles, etc.

The subject merchandising concept for replacement muffler systems was different from either of the two concepts of merchandising referred to above.

Wonder International manufactured this machine which enabled an operator to bend universal exhaust pipes to the required angle so that they fitted the exhaust systems of any American automobile thereby eliminating the necessity of a vendor and installer of replacement muffler systems carrying and having a large inventory of muffler exhaust pipe. Small service stations, small garages and any other establishments by buying and using this machine could establish and operate an “added on’’ division of their businesses without the necessity of being required to have and using large amounts of working capital for inventories of exhaust pipes and other necessary parts to carry on such a business. That was the big feature of this machine and the merchandising concept.

During all material times, no exhaust pipe bending machine was manufactured in Canada. Consequently, this Wonder International machine came into Canada duty free. That, however, is not the situation today. According to the evidence there are at least two manufacturers of exhaust pipe bending machines in Canada, and so the advantage (whatever it may have been, or thought to have been) of buying this Wonder International machine no longer exists.

Pursuant to Exhibits 1 and 2 and not in issue in these appeals, Farmparts also had to pay Wonder International pursuant to Clause 8 in each of the agreements a royalty (within the meaning of “royalty” in paragraph 212(1 )(d) of the Income Tax Act in “the sum of 5% of . . . (its) gross receipts”. Farmparts paid Wonder International royalty payments under these provisions and deducted and paid the requisite income tax for a year or two but has ceased now, according to the evidence, because Wonder International apparently is no longer in business.

The pleadings, especially the assumptions in the Defence on which issue was joined, require specially a determination of whether or not each of the payments made by Farmparts to Wonder International in respect to the Agreements, Exhibits 1 and 2, was or was not “rent, royalty or similar payment” within the meaning of paragraph 212(1)(d) of the Income Tax Act.

That subsection also employs the following words in an attempt to better categorize such payments, namely: “including but not so as to restrict the generality of the foregoing any payment (i) for the use of or for the right to use in Canada any property, invention, trade name, patent, trade mark, design or model, plan secret formula, process or other thing whatever”.

Counsel for the defendant submits that each of these payments by Farmparts to Wonder International a non-resident person were within the meaning of one or more of the following things in that subsection, namely: “for the use of or for the right to use in Canada ... property... trade name, . . . or other thing whatever”.

Counsel for the plaintiff, among other things, submits that the ejusdem generis rule should be employed in considering all the words used in the subsection of the Act to assist in determining whether each of these payments should be considered as payment falling within the meaning of “rent, royalty or other similar payment”; and that in so employing this rule one should find that they are outside such meaning because that subsection refers to and charges only payments made on income account not on capital account. (cf Murray (Inspector of Taxes) v Imperial Chemical Industries, Ltd, [1967] 2 All ER 980 at 981.

The words “rent, royalty or other similar payment” used in paragraph 212(1)(d) of the Income Tax Act require a determination categorizing the payments made in every case. This is so because the basic scheme and concept of the present Income Tax Act is that all categories of specific factual situations are provided for in its charging provisions. In other words, everything is considered to be covered.

This is a fundamental change from the basic scheme and concept of the previous Act which employed general language in its charging provisions. It dealt with principles and standards. It left for judical decision whether a particular factual situation fell within or without such general language in the charging provisions.

Therefore, in considering the categorization of the payments made in this case, it appears that in all of the subsections of paragraph 212(1)(d) of the Income Tax Act (except subparagraph 212(1 )(d)(v)) what is contemplated is payments on income account. It appears also that subparagraph 212(1 )(d)(i) only may be applicable in these appeals. It appears also that the subject payments were lump sum payments, made once and for all, but that feature in the subject cases is not of material assistance in determining the categorization of such payments.

As is commented upon in such texts as Whiteman and Wheatcroft on Income Tax, Second Edition, and as was said in Harry Ferguson (Motors) Ltd v IRC (1951), 33 TC 15 by Lord MacDermott, LCJ, at p 42, the problem of deciding what features or characteristics distinguish “an income receipt from a capital receipt” is a difficult question of fact:

During the debate many cases were cited in which a decision was reached as to whether particular payments were capital or income . . . There is so far as we are aware no single infallible test for settling the vexed question where a receipt is of an income or a capital nature. Each case must depend upon its particular facts and what may have weight in one set of circumstances may have little weight in another. Thus the use of the words ‘’income” and “capital” is not necessarily conclusive; what is paid out of profits may not always be income; and what is paid as consideration for a capital asset may on occasion be received as income. One has to look to all the relevant circumstances and reach a conclusion according to their general tenor and combined effect.

But this does not hold true of payments, although the problem of deciding whether a payment is on income account or on capital account is also a question of fact. In the case of payments the difficulty experienced in the case of receipts of “no single infallible test’’ to determine whether a receipt is capital or income frequently does not exist where often in respect to payments there are tests available in the context of particular facts and statutory provisions so that a payment may be more easily designated as either of an income or capital nature.

Accordingly in considering the facts disclosed in the evidence on these appeals and applying the meaning as indicated of this subsection to such evidence, it appears that the only things that Farmparts obtained from Wonder International for these payments which fits within the concept of this subsection, namely, payments on income account (and therefore within the charging provisions and as a consequence subject to income tax) was the right to use the trade name “Wonder Muffler” and logo together with whatever “other thing” Farmparts obtained arising out of the apparent failure of Wonder International to prohibit Farmparts from telling its sub-distributors that they also could use such.

What part these payments should be allocated as being payments for such “things” on income account is impossible to determine on the evidence. The other part of these payments however, should be allocated as payments for “things” on capital account, and therefore not within the charging provisions of this subsection. Again, what part should be so allocated is impossible to determine.

In the result, the plaintiff in evidence has established that the assumptions for the assessments are not correct in part. The plaintiff is therefore entitled to relief. (See MNR v Pillsbury Holdings Limited, [1965] 1 Ex CR 676; [1964] CTC 294; 64 DTC 5184.) Further, premised on the particular facts in the case, on the assessments made and on the pleadings, there was an onus of allocation on the Minister to establish what part of the said payments were payments for “things” within the meaning of the charging provisions of subparagraph 212(1 )(d)(i) of the Income Tax Act and so subject to assessment for income tax which was not discharged. The plaintiff therefore is entitled to succeed in full.

Accordingly, the appeals are allowed with costs.