A-40-80
Canadian Clyde Tube Forgings Limited (Appel-
lant)
v.
The Queen (Respondent)
Court of Appeal, Urie and Le Dain JJ. and Kelly
D.J.—Toronto, December 1 and 3, 1981.
Income tax — Income calculation — Manufacturing or
processing tax credit — Appeal from a judgment of the Trial
Division dismissing an appeal from a reassessment for income
tax in respect of the 1973 taxation year — Appellant included
labour costs paid to an independent contractor in computing s.
125.1 deduction — Semi-finished items delivered to contrac
tor for machining — Contractor supplied own machinery and
work force — Contractor's operation carried on entirely in
appellant's plant with no artificial barriers between areas of
plant occupied by appellant and contractor — Trial Judge
held that the function carried on by the contractor was not a
function normally performed by the appellant's employees
pursuant to the definition of "cost of labour" — Whether the
payments to the contractor fall within the definition of "cost of
labour" under s. 5202 of the Income Tax Regulations —
Appeal is dismissed — Income Tax Act, R.S.C. 1952, c. 148 as
amended by S.C. 1970-71-72, c. 63 and S.C. 1973-74, c. 29,
s. 125.1 — Income Tax Regulations, SOR/73-495, ss. 5200,
5202.
APPEAL.
COUNSEL:
Philip F. Vineberg, Q.C. for appellant.
Wilfred Lefebvre and Ian S. MacGregor for
respondent.
SOLICITORS:
Phillips & Vineberg, Montreal, for appellant.
Deputy Attorney General of Canada for
respondent.
The following are the reasons for judgment
rendered in English by
URIE J.: This is an appeal from a judgment of
the Trial Division [[1980] 2 F.C. 15] dismissing
the appellant's appeal from a reassessment for
income tax made by the Minister of National
Revenue in respect of the appellant's 1973 taxa-
tion year. The appellant's appeal to the Tax
Review Board had also been dismissed.
It is common ground that the sole issue in the
appeal is the proper method of calculation of the
manufacturing and processing tax deduction to
which the appellant may be entitled by virtue of
section 125.1 of the Income Tax Act, R.S.C. 1952,
c. 148 as amended by S.C. 1970-71-72, c. 63,
section 1 ("the Act") and S.C. 1973-74, c. 29. The
appellant computed the deduction at $34,940. The
reassessment reduced it to $5,497. Which calcula
tion is correct must be determined by deciding
whether payments made by the appellant to an
independent contractor, Weram Limited, fall
within the definition of "cost of labour" under
section 5202 of the Income Tax Regulations,
SOR/73-495 ("the Regulations").
The learned Trial Judge accurately described
the appellant's operations in the following fashion
[at page 16]:
The plaintiff is engaged in the manufacture and processing of
special pipes and fittings for the refining industry. The entire
operation is carried out in the plaintiffs plant into which it
receives semi-finished fittings and flanges. The semi-finished
items are delivered by the plaintiff to the contractor for
machining. They are then returned to the plaintiff for finishing,
such as painting, and are stocked there and shipped from there
to customers. The contractor supplies the necessary machines
and tools, employs the machinists and is paid at agreed piece
rates. The machinery is all located in the plaintiffs plant and
the contractor's employees do all their work there. To any
observer, the entire operation, from receiving to shipping,
would appear to be a single, integrated process. There are no
artificial physical barriers between the areas of the plant
occupied by the plaintiff and the contractor nor superfluous
segregation of the employees of one from those of the other.
This modus operandi was adopted when the plant was estab
lished in 1960 and continues today.
The relevant part of section 125.1(1) of the Act
reds 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 Canadi-
an manufacturing and processing profits for the year
exceed the least of the amounts determined under para
graphs 125(1)(a) to (d) in respect of the corporation for
the year, ...
Section 5200 and the relevant definitions in
section 5202 of the Regulations read as follows:
Basic Formula
5200. Subject to section 5201, for the purpose of paragraph
125.1(3)(a) of the Act, "Canadian manufacturing and process
ing 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
is of
(b) the aggregate of its cost of capital for the year and its
cost of labour for the year.
Definitions
5202. In this Part, except as otherwise provided in section
5203 or 5204,
"cost of labour" of a corporation for a taxation year means an
amount equal to the aggregate of
(a) the salaries and wages paid or payable during the year to
all employees of the corporation for services performed
during the year, and
(b) all other amounts each of which is an amount paid or
payable during the year for the performance during the year,
by any person other than an employee of the corporation, of
functions relating to
(i) the management or administration of the corporation,
(ii) scientific research as defined in section 2900, or
(iii) a service or function that would normally be per
formed by an employee of the corporation,
but for the purposes of this definition, the salaries and wages
referred to in paragraph (a) or other amounts referred to in
paragraph (b) do not include that portion of those amounts that
(c) was included in the gross cost to the corporation of a
property (other than a property that was manufactured by
the corporation and leased during the year by the corporation
to another person) that was included in computing the cost of
capital of the corporation for the year, or
(d) was related to an active business carried on outside
Canada by the corporation;
"cost of manufacturing and processing labour" of a corporation
for a taxation year means 100/75 of that portion of the cost
of labour of the corporation for that year that reflects the
extent to which
(a) the salaries and wages included in the calculation thereof
were paid or payable to persons for the portion of their time
that they were directly engaged in qualified activities of the
corporation during the year, and
(b) the other amounts included in the calculation thereof
were paid or payable to persons for the performance of
functions that would be directly related to qualified activities
of the corporation during the year if those persons were
employees of the corporation,
but the amount so calculated shall not exceed the cost of labour
of the corporation for the year;
It will be seen that section 125.1 of the Act is a
provision which permits a taxpayer to deduct from
its tax otherwise payable an amount which would
not otherwise be permitted as a deduction. The
"Canadian manufacturing and processing profits"
are computed by the application of a formula
ascertained by means of section 5200 of the Regu
lations. The parties agree that the formula is:
MP = MC + ML x Adjusted business income
C+L
for this purpose, the initials mean:
MP: Canadian Manufacturing and Processing Profits
ML: Cost of Manufacturing and Processing Labour
L: Cost of Labour
C: Cost of Capital
The parties agree on the amounts of all items to
be used in the formula for purposes of this case
except the "Cost of Labour" and "Cost of Manu
facturing and Processing Labour". The appellant
computed the section 125.1 deduction for its 1973
tax return by including the labour costs paid to
Weram Limited both in the numerator and the
denominator of the formula while the Minister in
his reassessment excluded that item from each.
The exclusion was founded on his contention that
the machining functions were not "normally" (that
is to say as a "regular occurrence") performed by
employees of the appellant. The sole question is,
then, which of the two computations, on applying
the relevant definitions to the facts of this case, is
the correct one?
The learned Trial Judge expressed his view on
the question in a succinct fashion [at page 17], as
follows:
It is normal for a corporation carrying on such an operation to
carry it on in its entirety and the service or function performed
by the contractor for the plaintiff is a service or function
normally performed by employees of such corporation. It is not,
however, a service or function normally performed by the
plaintiff's employees. The plaintiff normally engages the con
tractor, rather than its own employees, to perform that service
or function. Indeed, its own employees have never, before,
during or since its 1973 taxation year, performed that service or
function.
Nothing in the related provisions of the Act or Regulations
leads me to conclude that the pertinent words of the definition
of the "cost of labour" are to be interpreted otherwise than in
their plain English sense. The adverb "normally" appears clear
ly to relate to the modus operandi of the manufacturer and
processor claiming inclusion of the particular outlay in its cost
of labour. [Emphasis added.]
Despite the able and persuasive argument of
counsel for the appellant expressing a contrary
view, I agree with the conclusion of the learned
Trial Judge and with his reasons for reaching that
conclusion. Subparagraph (b)(iii) of the definition
of "cost of labour" does not refer to a service or
function that would normally be performed by an
employee of a (i.e. any) corporation. It uses the
definite article "the" before the word "corpora-
tion" thus pointing clearly to the corporation
claiming the deduction from the tax otherwise
payable as the relevant entity, namely, in this case,
the appellant. Since normally it engages Weram
Limited to do its machining, rather than using its
own employees, it does not meet the requirements
of the subparagraph. It cannot, therefore, unfortu
nately for it, include the payment it makes to
Weram Limited for its services as a cost of labour
in the denominator of the fraction used in the
calculation of its adjusted business income.
It follows, then, that since the definition of "cost
of manufacturing and processing labour" in sec
tion 5202 of the Regulations refers to "that por
tion of the cost of labour of the corporation" as the
latter term is defined in the same Regulation, it
cannot include the payment to Weram Limited as
part of the cost of manufacturing and processing
labour in the numerator of the formula for the
calculation under section 5200.
The appeal should, accordingly, be dismissed
with costs.
* * *
LE DAIN J.: I agree.
* * *
KELLY D.J.: I concur.
You are being directed to the most recent version of the statute which may not be the version considered at the time of the judgment.