A W Prociuk (orally: October 29, 1975):
1 The appellant, Tsuda Canada Ltd, a company incorporated in August of 1968 under the laws of British Columbia, appeals from the respondent's assessment of its income for the taxation year 1973 by notice of assessment dated February 14, 1974 and confirmed on August 14, 1974, wherein the sum of $2,210 claimed by the appellant as a deduction from the tax payable pursuant to section 125.1 of the Income Tax Act, SC 1970–71–72, c 63, as amended, was disallowed on the ground that the taxpayer had no Canadian manufacturing and processing profits for the year within the meaning of subsection 125.1(3) and Regulations 5200 and 5201 relative thereto. The relevant section and regulations of the Act read as follows:
125.1(1) There may be deducted from the tax otherwise payable under this Part by a corporation for a taxation year an amount equal to the aggregate of- (a) 9% of the lesser of
(i) the amount, if any, by which the corporation's Canadian manufacturing and processing profits for the year exceed the least of the amounts determined under paragraphs 125(1)(a) to (d) in respect of the corporation for the year, and
- (ii) the amount, if any, by which the corporation's taxable income for the year exceeds the aggregate of
(A) where the year ends after 1976, the lesser of the amounts determined under paragraphs 124(2)(a) and (b) in respect of the corporation for the year,
(B) the least of the amounts determined under paragraphs 125(1)(a) to (d) in respect of the corporation for the year,
(C) 2 times the aggregate of amounts deducted under subsection 126(2) from the tax for the year otherwise payable under this Part by the corporation, and
(D) the amount, if any, by which the aggregate of the corporation's Canadian investment income for the year and its foreign investment income for the year (within the meanings assigned by subsection 129(4) exceeds the amount, if any, deductible under paragraph 111(1)(b) from the corporation's income for the year; and
- (b) 5% of the lesser of
(i) the corporation's Canadian manufacturing and processing profits for the year, and
(ii) the least of the amounts determined under paragraphs 125(1)(a) to (d) in respect of the corporation for the year;
except that in applying this section for a taxation year after the 1973 taxation year, the reference in paragraph (a) to “9%” shall be read as a reference to “8%” for the 1974 taxation year, “7%” for the 1975 taxation year, and “6%” for the 1976 and subsequent taxation years.
125.1(3) In this section,5200. Subject to section 5201, for the purpose of paragraph 125.1(3)(a) of the Act, “Canadian manufacturing and processing profits” of a corporation for a taxation year are hereby prescribed to be that proportion of the corporation's adjusted business income for the year that(a) the aggregate of its cost of manufacturing and processing capital for the year and its cost of manufacturing and processing labour for the year
(b) the aggregate of its cost of capital for the year and its cost of labour for the year.
5201. For the purpose of paragraph 125.1(3)(a) of the Act, “Canadian manufacturing and processing profits” of a corporation for a taxation year are hereby prescribed to be equal to the corporation's adjusted business income for the year where(a) the activities of the corporation during the year were primarily manufacturing or processing in Canada of goods for sale or lease,
- (b) the aggregate of
(i) the aggregate of all amounts each of which is the income of the corporation for the year from an active business minus the aggregate of all amounts each of which is the loss of the corporation for the year from an active business, and
(ii) if the corporation is associated in the year with a Canadian corporation, the aggregate of all amounts each of which is the income of the latter corporation from an active business for its taxation year coinciding with or ending in the year
(c) the corporation was not engaged in any of the activities listed in subparagraphs 125.1(3)(b)(i) to (ix) of the Act at any time during the year, and
(d) the corporation did not carry on any active business outside Canada at any time during the year.
2 At the hearing of this appeal it was agreed that Regulation 5201 entitled “Small Manufacturers' Rule” was applicable in this case if the appellant were entitled to a deduction. The quantum of the deduction is not in dispute.
3 The issue to be determined is, firstly, whether the activities of the appellant company were primarily the manufacturing or processing in Canada of goods for resale or lease. Mr Yuichi Tsuda, managing director and secretary- treasurer of the appellant company, testified on its behalf. At all relevant times, he and his assistant were the only employees of the company. The appellant had an office in the City of Vancouver as well as office equipment and two automobiles.
4 Prior to 1973 the appellant purchased logs in the open market, chiefly in the Vancouver area, and sold them to its parent company in Japan. I gather by inference from the evidence that the appellant company was a wholly-owned subsidiary of the Japanese parent company in Japan.
5 In 1973 it ceased this type of activity and commenced selling dimension lumber to its parent company rather than raw logs. Mr Tsuda stated that, after consultation with the parent company as to the latter's lumber requirements and the price it would pay, he would proceed to purchase a sufficient quantity of suitable logs in the open market in the Vancouver area from Goodwin, Johnson Ltd which, I take it, was a logging broker. He would then arrange with a towing company for storage of the said logs until he found a sawmill that would contract with the appellant, for a fee, to saw the logs into lumber in accordance with the required specifications of the parent company.
6 In 1973 Pine Lake Sawmill Co Ltd did this work for the appellant. There were three contracts entered into by the appellant with the said Pine Lake Sawmill Co. Ltd.
7 In paragraph 3 of its Notice of Appeal, the appellant pleads as follows:
3. The Appellant was at all times until resale of the lumber the owner of the logs and lumber in question, and the manufacturing and processing operations conducted by Pine Lake Lumber Co Ltd for and on behalf of the Appellant were carried out according to the specifications and directions of the Appellant and under the supervision and control of the Appellant's officers and employees.
The evidence, however, establishes, in my opinion, that there was no master-servant relationship and no agency, nor was the sawmill in any way associated with the appellant.8 Learned counsel for the appellant stated, in his summation, that the sawmill company was an independent contractor and performed its services in accordance with the terms and specifications stipulated in the contract.
9 Mr Tsuda further stated that he or his assistant would go to the sawmill “to supervise if they were cutting according to specifications”. There is no evidence to indicate the extent of the supervision or what actually was done by Mr Tsuda when he attended at the site of the sawmill. It appears that after the lumber was cut, Mr Tsuda would hire a trucking firm to transport the lumber from the sawmill to the docks for shipment to Japan.
10 In 1973 sales to the parent company amounted to $461,372. The appellant company sold to no one else. The cost of the sales was $349,314 and included the cost of logs, storage, towing, fees paid to Pine Lake Sawmill Co Ltd, freight and trucking.
11 Learned counsel for the appellant contended that in order to qualify for the deduction claimed, it was not necessary for the appellant to have its own sawmill equipment and employ the necessary labour to operate it. In his opinion, it was not at all necessary for the appellant to do the manufacturing or processing itself with its own equipment and labour.
12 With deference to this contention, it seems to me that, if this is the proper interpretation of the relevant sections and regulations of the Act, then the field is open to anyone acting in the capacity of a middleman, so to speak, to incorporate a company in Canada and qualify for the deduction as a manufacturer or a processor.
13 There can be no doubt that the deduction under section 125.1 is a tax incentive. It is, I suggest, for the purpose of inducing actual manufacturers and processors to expand and improve their operations and thus provide more jobs for the Canadian labour force. If I am correct in holding this view, I fail to see how the appellant fits into this category.
14 Furthermore, paragraphs 125.1(3)(a) and (b), referred to by counsel for the respondent in her summation, deal with definitions and exclusions and, in my humble opinion, state quite clearly that the manufacturing or processing for sale or lease be performed by the corporation seeking the deduction.
15 I noted the contention of counsel for the appellant that paragraph (c) of section 5201 of the Income Tax Regulations does not list all the exclusions contained in paragraph 125.1(3)(b) of the Act but only mentions subparagraphs (i) to (ix). However, on checking the said paragraph again, I find that subparagraph (ix) ends with the word “or” and is immediately followed by paragraph (x) which reads:
(x) any manufacturing or processing of goods for sale or lease if, for any taxation year of a corporation, in respect of which the expression is being applied, less than 10% of its gross revenue from all active businesses carried on in Canada was from(A) the selling or leasing of goods manufactured or processed in Canada by it,[FN1: <p>The italics are mine.</p>] and
(B) the manufacturing or processing in Canada of goods for sale or lease, other than goods for sale or lease by it.[FN2: <p>The italics are mine.</p>]
16 It seems clear to me that subparagraph (x) is to be referred to if subparagraphs (i) to (ix) are inapplicable, as they obviously are in this case.
17 My interpretation of the meaning of subparagraph (x) is that, if less than 10% of the gross revenue of a taxpayer is “from the selling or leasing of goods manufactured or processed in Canada by it” its profits do not fall within the definition of “Canadian manufacturing and processing profits” and therefore, by analogy, in order for its profits to come within that definition, more than 10% of its gross revenue must come from goods “manufactured or processed in Canada by it”. Consequently, it would indeed be necessary for a qualifying company to do the manufacturing or processing with its own equipment and labour.
18 Again with deference to the contention by learned counsel for the appellant, I would also hold that the Board is entitled to look at the entire paragraph 125.1(3)(b) and, indeed at any other sections it considers relevant in the determination of the issue. For example, the formula for calculating the amount of manufacturing and processing profits, as set out in Regulation 5200, refers to the cost of manufacturing and processing capital and manufacturing and processing labour, neither of which is part of the appellant's structure.
19 In the textbook entitled “The Income Tax Law of Canada”, by Arthur R A Scace, 2nd Edition, I refer to pages 256 and 257, from the general heading of “Reduced rate of tax on income from manufacturing and processing operations” which appears on page 256 to the last paragraph on page 257 under “Manufacturing income by formula”. In that paragraph, the learned author states as follows:
Once it is established that a manufacturing or a processing operation is carried on by a corporation[FN3: <p>The Italics are mine.</p>] it would then be necessary to determine the proportion of the company's profit from such operation.
He then goes on to discuss the establishment of the formula enunciated by the then Minister of Finance of Canada in November of 1972.20 In my view, the appellant, in the taxation year under appeal, was not a manufacturer or processor within the meaning of the Income Tax Act and, accordingly, had no manufacturing or processing profits.
21 The appeal is dismissed.
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