T-2940-83
Dixie X-Ray Associates Limited (Plaintiff)
v.
The Queen (Defendant)
INDEXED AS: DIXIE X-RAY ASSOCIATES LTD. Y. CANADA
Trial Division, McNair J.—Toronto, November
17; Ottawa, December 23, 1987.
Income tax — Income calculation — Deductions — Tax
payer incorporated by radiologists to process and develop
X-ray films in diagnosis of patients referred to radiologists —
Minister disallowing deduction in respect of manufacturing
and processing profits — Whether company in business of
processing goods or of rendering services — Substance of
contract provision of services (radiologists' reports based on
interpretation of X-ray films).
This is an appeal from the Minister's decision to disallow the
taxpayer's claim for a deduction in respect of manufacturing
and processing profits for its 1978 taxation year.
In 1977, three radiologists incorporated the plaintiff com
pany for processing and developing X-ray films of patients
referred to them for diagnostic purposes. The radiologists inter
pret the X-ray films and prepare written reports which are sent
to the patient's referring physician. The X-ray films are not
given to the patient or the referring physician but will be
surrendered on request on the understanding that they are to be
returned. At the end of the storage periods, the discarded X-ray
films are sold by the plaintiff to another firm for silver recov
ery. Dixie X-Ray performs all the technical functions and
leaves the diagnostic professional work to the radiologists. The
company charges them for the use of their office space. The
professional component of all billings is paid to the radiologists
who report it in their income tax returns.
The issue is whether the business carried on by the taxpayer
in 1978 constituted the "manufacturing or processing in
Canada of goods for sale or lease" within the meaning of
section 125.1 of the Act and Part LII of the Regulations so as
to entitle the taxpayer to the deduction claimed from its
manufacturing and processing profits.
Held, the action by way of appeal should be dismissed.
The test for determining whether a contract is one for the
sale of goods or for the supply of services is to ask the question:
What is the substance of the contract? If, as in this case, the
real substance of the contract is the skill and labour of the
supplier in the performance of work for another, then the
contract is one for work and labour, notwithstanding that
property in some materials may incidentally pass under the
contract as accessory thereto. The technological processing of
X-ray films by the plaintiff is but part of its overall function of
providing services. Moreover, it is not without significance that
the definition of "qualified activities" in Regulation 5202(b)
makes specific reference to activities performed in Canada
"directly in connection with manufacturing or processing ... in
Canada of goods for sale or lease."
If the case of Halliburton Services Ltd. v. The Queen is
meant to stand for a general proposition that the words "manu-
facturing or processing in Canada of goods for sale or lease"
employed in paragraphs 125.1(3)(a) and (b) of the Act and in
Regulation 5202 preclude the drawing of any distinction in
every case between contracts for the sale of goods and contracts
for work and materials or the supply of services, then that case
must be disagreed with. The words "goods for sale or lease"
were clearly intended by Parliament to have meaning and
function in terms of common mercantile or legal usage for the
purpose of giving greater exactitude to the particular phraseolo
gy employed, which may in many cases necessitate making a
distinction between a contract for the sale of goods and a
contract for the supply of services.
STATUTES AND REGULATIONS JUDICIALLY
CONSIDERED
Income Tax Act, S.C. 1970-71-72, c. 63, s.
125.1(3)(a),(b) (as added by S.C. 1973-74, c. 29, s. 1;
1977-78, c. 1, s. 60).
Income Tax Regulations, C.R.C., c. 945, ss. 5200, 5202,
5204.
CASES JUDICIALLY CONSIDERED
APPLIED:
Crown Tire Service Ltd. v. The Queen, [1984] 2 F.C.
219; (1983), 83 DTC 5426 (T.D.); affg. (1981), 81 DTC
931 (T.R.B.).
NOT FOLLOWED:
Halliburton Services Ltd. v. The Queen (1985), 85 DTC
5336 (F.C.T.D.).
CONSIDERED:
MDS Health Group Ltd. v. R., [1980] 1 F.C. 511;
(1979), 79 DTC 5279 (T.D.); Canadian Wirevision Ltd.
v. R., [1979] 2 F.C. 164; 79 DTC 5101 (C.A.); aft'
[1978] 2 F.C. 577; 78 DTC 6113 (T.D.); Tenneco
Canada Inc. v. Canada, [1988] 2 F.C. 3 (T.D.).
REFERRED TO:
Robinson v. Graves, [1935] 1 K.B. 579 (C.A.); Sterling
Engine Works v. Red Deer Lumber Co. (1920), 51
D.L.R. 519 (Man. C.A.).
AUTHORS CITED
Atiyah, P. S. The Sale of Goods, 7th ed. London: Pitman
Publishing Limited, 1986.
Benjamin, Judah Philip. Benjamin's Sale of Goods,
London: Sweet & Maxwell, 1974.
Fridman, G. H. L. Sale of Goods in Canada, 3rd ed.
Toronto-Calgary-Vancouver: Carswell, 1986.
COUNSEL:
Brian R. Carr and Colin Campbell for
plaintiff.
J. C. B. Dans and Alexandra Brown for
defendant.
SOLICITORS:
Davies, Ward & Beck, Toronto, for plaintiff.
Deputy Attorney General of Canada for
defendant.
The following are the reasons for judgment
rendered in English by
MCNAIR J.: This action and T-2941-83 are
appeals by the plaintiff from reassessments of its
income for the 1978 and 1979 taxation years
which, by agreement, are to be heard and tried on
common evidence.
The issue for determination on this appeal is
whether the taxpayer's business during its 1978
taxation year was that of developing and process
ing medical X-ray films for sale, thereby making
such business a manufacturing and processing of
goods for sale or lease within the meaning of
paragraph 125.1(3)(b) of the Income Tax Act
[R.S.C. 1952, c. 148 (as am. by S.C. 1970-71-72,
c. 63, s. 1; 1973-74, c. 29, s. 1; 1977-78, c. 1, s.
60)] and Part LII of the Income Tax Regulations
[C.R.C., c. 945].
In computing its income tax for the 1978 taxa
tion year, the claimant claimed a deduction of
$5,644 in respect of its Canadian manufacturing
and processing profits pursuant to the relevant
statutory provisions. By notice of reassessment
dated August 31, 1981, the Minister disallowed
the deduction.
The basis of disallowance was simply that the
plaintiff was not selling or leasing goods but rather
was engaged in the business of rendering a service
to the medical profession and their patients. The
Minister assumed as a fact that the production of
a tangible piece of property, that is, the X-ray film
was merely incidental to the providing of the ser
vice and that the primary purpose of having the
X-rays taken, and indeed the end result of the
whole exercise, was the radiologist's diagnostic
report based on his interpretation of the particular
X-ray film or radiograph in question. The final
assumption was that the radiograph remained the
property of the X-ray laboratory and did not
become the property of the patient or the
radiologist.
Dr. James E. Mergelas and two other radiologist
associates incorporated Dixie X-Ray Associates
Limited as an Ontario corporation on June 27,
1977. The corporation has business premises in
Mississauga, Etobicoke and Downsview and by its
fiscal year end of June 30, 1978 had the equipment
and staff necessary for processing and developing
X-ray films or radiographs of patients for diagnos
tic purposes. The actual X-ray films were taken
and developed in most cases by properly qualified
technicians employed by the plaintiff corporation.
The doctor radiologists only comes into the picture
at the professional and diagnostic stage of inter
pretation of the X-ray film. He prepares a written
report which is sent in most cases to the patient's
referring physician. The fees for these professional
and technical services are billed to OHIP in ninety
per cent of the cases. The remaining ten per cent
represent billings to chiropractors, insurance com
panies, U.S. citizens and other persons not covered
by OHIP. This small category is billed by the
plaintiff directly. In contrast, the OHIP billings go
out on a computer card under the name of one of
the radiologists. Both billings contain a column for
a breakdown between the technical and profession
al components of the particular bill. The actual,
average breakdown of fees is calculated by OHIP
at 73% technical and 27% professional. On receipt
of the OHIP billings, the radiologists retain the
professional fees and pay over to the corporation
the technical component portion. The situation is
just the reverse with the corporate billings, the
plaintiff keeps the technical fee and pays the
professional fee component to the doctor entitled.
The radiographs or X-ray films are placed in a
large manila envelope, marked with the patient's
name and other identifying data, and are stored by
the plaintiff corporation. They are not given to the
patient or the referring physician but will be sur
rendered on request on the understanding that
they are to be returned to the plaintiff. The period
of storage varies, depending on the type of X-ray.
X-ray films of the chest and those showing abnor
mal conditions are stored for five years. All others
are stored for one year. At the end of the storage
periods, the discarded X-ray films are sold by the
plaintiff to another firm or corporation for silver
recovery, followed by their total destruction, and
the plaintiff is paid a monetary amount for the
value of the recovered silver.
In the plaintiffs invoices for X-rays not covered
by OHIP the billing terminology employed is "For
Services Rendered". On the other hand, in the
computer card billings to OHIP under the name
and number of a radiologist the word "Fee" is
employed. In the financial statements of the plain
tiff the statement of income makes no reference to
sales revenue or the expenditure costs thereof.
Instead, the income is shown as fees, which is the
largest item, followed by management fees, rentals
and sundry or silver recovery. As to the business
arrangement between the plaintiff corporation and
the three radiologist partners, Dixie X-Ray does
everything concerning the X-rays except the inter
pretation of the radiographs. This function is per
formed by the radiologists. The corporation
charges them for the use of their office space. The
professional component of all billings is paid to the
medical partners who report it in their income tax
returns. The corporation performs all the technical
functions and leaves the diagnostic professional
work to the radiologists. The fees are allocated
accordingly on the 73% to 27% ratio basis.
The crux of the case, as I see it, is whether the
business carried on by the plaintiff during its 1978
taxation year constituted the "manufacturing or
processing in Canada of goods for sale or lease"
within the meaning of section 125.1 of the Income
Tax Act and Part LII of the Income Tax Regula
tions so as to entitle the plaintiff to the deduction
claimed from its manufacturing and processing
profits. It is common ground that the amount of
the deduction, if allowable, is $5,644. The defen
dant has admitted that the developing of X-ray
film is "processing" and that the end product
resulting from the processing, namely, the X-ray
film or radiograph is "a good". That being so, the
real issue from the defendant's standpoint is
whether the plaintiff's business activity amounts to
the processing in Canada of goods for sale. There
is no question of any leasing of goods.
Section 125.1 of the Act makes provision for a
tax reduction on Canadian manufacturing and
processing profits for the 1973 and subsequent
taxation years and the statutory scheme contained
therein may provide a tax credit. The calculation
of Canadian manufacturing and processing profits
is determined under a formula prescribed by
Regulations 5200 to 5204 (Part LII).
Paragraph 125.1(3)(b) of the Act provides that
"manufacturing or processing" does not include
those business activities specifically described and
enumerated in subparagraphs (i) to (x) thereof.
Regulation 5202 defines "qualified activities" to
mean and include a number of business activities
performed in Canada in connection with manufac
turing or processing in Canada of goods for sale or
lease (not including activities listed in subpara-
graphs 125.1(3)(b)(i) to (ix) of the Act) and as
not including certain others specified in para
graphs (d) to (i) of the definition of "qualified
activities" in Regulation 5202. Paragraph (b) of
Regulation 5202 reads as follows:
5202....
"qualified activities" .
(b) all other activities that are performed in Canada directly
in connection with manufacturing or processing (not includ
ing the activities listed in subparagraphs 125.1(3)(b)(i) to
(ix) of the Act) in Canada of goods for sale or lease, ...
The gist of the plaintiff's contention is simply
this: given the admissions by the defendant that
the developing of X-ray film is a processing and
that the film itself is a good, the transaction is one
involving a sale of goods whereby the property in
the radiographs passes to the patient as the person
paying for them. It is argued that the real function
of Dixie X-Ray is the production of the radio-
graphs and nothing more by reason that the plain
tiff is precluded by statutory enactment from prac
tising medicine. The diagnostic function of
interpreting the X-ray films or radiographs is
necessarily left to the radiologist doctors. The
plaintiff's practice of retaining the X-ray films for
a time and not handing them over to the patients
does not derogate from the fact that the property
in them has passed to the patients. As to the
ultimate disposition of the X-ray films and mone
tary compensation to the plaintiff for the residual
silver recovery, the contention is that any property
in them at that time must be taken to have been
abandoned by the patients. In summary, it is the
plaintiff's submission that it was carrying on at the
material time an active business involving the
processing of goods for sale with the result that it
is entitled to the deduction claimed pursuant to
section 125.1 of the Act and the relevant regula
tions thereunder. Counsel for the plaintiff relies
strongly on the recent case of Halliburton Services
Ltd. v. The Queen (1985), 85 DTC 5336
(F.C.T.D.).
The Minister's basic factual assumptions have
already been touched on. Essentially, the defen
dant's position is that there was no substratum of
agreement or consensus ad idem between Dixie
X-Ray and the patient for the sale of the X-ray
film as a good or chattel. The point is pressed that
there is no evidence of any contract between the
plaintiff and the individual patient with respect to
the passing of title in the X-ray film itself. The
alternative submission is made that even if it
should be found that the title in the X-ray film
passes from the plaintiff to the patient or someone
else then the contract is one for the supply of
services to which the passing of property in the
radiograph, if any, is merely ancillary or inciden
tal. It is argued that the weight of evidence leads
irresistibly to the conclusion that the relationship
between the plaintiff and a patient connotes a
contract for services in which the key feature from
the patient's standpoint is the radiological diagno
sis.
As for the Halliburton Services case, it is the
defendant's position that the case must be confined
to its particular facts and should not be taken as
authority for the general proposition that there is
no need to draw any distinction between contracts
for the sale of goods and contracts for services,
labour and material in determining the applicabili
ty of section 125.1 of the Income Tax Act with
respect to deductions for Canadian manufacturing
and processing profits.
A brief review of the relevant authorities would
be in order.
Crown Tire Service Ltd. v. The Queen, [1984] 2
F.C. 219; (1983), 83 DTC 5426 (T.D.); affg.
(1981), 81 DTC 931 (T.R.B.), held that the
retreading of customers' tires by a taxpayer corpo
ration engaged in the tire retreading business did
not constitute manufacturing or processing for sale
or lease within the meaning of section 125.1. In
alluding to the distinction between the situation of
work being done to a tire casing owned by the
customer throughout and those cases where the
customer had never previously owned any part of
the end product, Mr. Justice Strayer made this
statement at pages 225 F.C.; 5429 DTC:
... one must assume that Parliament in speaking of "goods for
sale or lease" had reference to the general law of sale or lease
to give greater precision to this phrase in particular cases.
The learned Judge applied a general principle of
Benjamin's Sale of Goods to reach his conclusion
that the contracts with respect to the retreaded
tires were contracts for work and materials and
not contracts for the sale of goods.
MDS Health Group Ltd. v. R., [1980] 1 F.C.
511; (1979), 79 DTC 5279 (T.D.) held that
reports produced by medical laboratories of the
taxpayer engaged in the analysis of specimens of
human tissue and secretions, upon request by
medical doctors, did not constitute the manufac
turing or processing in Canada of goods for sale or
lease within the meaning of section 125.1 of the
Income Tax Act so as to qualify for any deduction
thereunder.
Gibson J., stated the rationale at pages 516-517
F.C.; 5282 DTC:
In this case, the quality of the contents of the report pro
duced by the plaintiff's various laboratories is the only thing of
value. It is not an end product of the specimens after analysis in
the sense required by the Act and Regulations, namely, goods
as contemplated and within the meaning of section 125.1 of the
Income Tax Act and Regulation 5200. The analysis of the
specimens ends in nothing that can become the subject of a
sale. Although after the analysis reports are prepared and such
reports contain valuable information, such reports are not
"goods" contemplated and meant in the context of the words
"manufacturing or processing in Canada of goods for sale" in
section 125.1 of the Act.
Canadian Wirevision Ltd. v. R., [1979] 2 F.C.
164; 79 DTC 5101 (C.A.); affg. [1978] 2 F.C.
577; 78 DTC 6113 (T.D.), held that the reception
and distribution of radio and television signals by a
cablevision company to its customers did not con
stitute the manufacturing or processing of goods
for sale within the meaning of section 125.1 on the
ground that the signals were not "goods" within
the common parlance usage of merchandise or
wares or tangible movable property. Even if that
conclusion were wrong, the Court was still of the
view that the taxpayer could not succeed because
it did not sell signals to its subscribers. Moreover,
the text of the contract with subscribers referred
not to the sale of goods but to the supply of
services.
In Tenneco Canada Inc. v. Canada, [1988] 2
F.C. 3 (T.D.), Dubé J. held that the replacement
or repair of customers' exhaust components by
Speedy Muffler was not a manufacturing or proc
essing of goods for sale within the meaning of
section 125.1 of the Act but rather was essentially
a contract for services whereby the ownership of
any muffler components passed to the customers
by accession.
In Halliburton Services Ltd. v. The Queen
(1985), 85 DTC 5336 (F.C.T.D.), the taxpayer
claimed a deduction under paragraph 125.1(3)(b)
in respect of the profits arising from the manufac
turing or processing of goods for sale. In addition
to providing services related to the drilling of oil
and gas wells, the taxpayer also provided a related
specialized product for its customers. The Court
held that the profits received from the processing
of the specialized product could be treated as
manufacturing or processing profit within the
meaning of paragraph 125.1(3)(b) on the ground
that the specialized product in question was sold to
customers. The Court could not find on the par
ticular facts of the case that the service aspect of
the taxpayer's business activity was more impor
tant than the production of the specialized product
required in connection therewith.
Madam Justice Reed made this statement at
page 5338:
... I do not find that the wording [s. 125.1(3)(b)] clearly
requires a distinction to be made between profits arising out of
a sale of goods and profits arising out of the sale of a good
when that good is part of a larger contract including services
and labour as well.
If that statement is meant to stand for a general
proposition that the words "manufacturing or
processing in Canada of goods for sale or lease"
employed in paragraphs 125.1(3)(a) and
125.1(3)(b) of the Act and Regulation 5202 pre
clude the drawing of any distinction in every case
between contracts for the sale of goods and con
tracts for work and materials or the supply of
services then I must, with respect, disagree.
Rather, it is my opinion that the words "goods for
sale or lease" were clearly intended by Parliament
to have meaning and function in terms of common
mercantile or legal usage for the purpose of giving
greater exactitude to the particular phraseology
employed, which may in many cases necessitate
making a distinction between a contract for the
sale of goods and a contract for the supply of
services. Essentially, this is the same view
expressed by Strayer J., in Crown Tire Service
Ltd. v. The Queen, supra.
The test for determining whether a contract is
one for the sale of goods or for the supply of
services is to ask the question: What is the sub
stance of the contract? 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 ma
terials may pass under the contract as accessory
thereto. See Atiyah, The Sale of Goods, 7th ed.,
pages 23-24; Robinson v. Graves, [1935] 1 K.B.
579 (C.A.) per Greer L.J., at page 587; and
Sterling Engine Works v. Red Deer Lumber Co.
(1920), 51 D.L.R. 519 (Man. C.A.).
G. H. L. Fridman, Sale of Goods in Canada,
(3rd ed.), agreeing that the better Canadian view
was consonant with what the English Court of
Appeal decided in Robinson v. Graves, states at
page 22 as follows:
... if the primary object of the contract is the transference of
property in something which was not originally the property of
the "buyer", the contract will be one of sale of goods, but if the
primary purpose of the parties is the performance of certain
work, or the provision of services, incidentally to which prop
erty in goods is to pass from one party to the other, the contract
will not be one of sale of goods.
Dr. James E. Mergelas was the plaintiff's princi
pal witness. He testified that the relationship be-
tween the radiologist partners and Dixie X-Ray
was a business relationship. The corporation
charges the medical partners for the use of office
space and they in turn charge the corporation for
the use of the X-ray equipment. He went on to
outline the plaintiff's normal procedure on patient
referrals.
On arrival at the plaintiff's premises, the
referred patient is interviewed by the receptionist,
who records the relevant patient information,
including the OHIP number. The patient is taken
to a changing room and required to disrobe to the
extent necessary for taking the X-ray. The patient
is then brought into the X-ray room where a
qualified technologist takes the appropriate X-ray
film and has the patient wait while the film is
developed in a processor. The developed radio-
graph is then marked and identified and put into a
manila envelope to await the interpretation and
report of the radiologist, which is required in the
vast majority of cases. The evidence of Dr. Mer-
gelas is quite explicit that the plaintiff at no time
volunteers to the patient that the property in the
radiograph is his for the taking and that it is only
if the patient asks on his own initiative that he is
told he may have it. The evidence is also clear that
the billing terminology employed in all invoices of
the plaintiff is that of "fees for services rendered".
Counsel for the plaintiff fairly and frankly
admitted during the course of his argument that
the patient is referred by his or her attending
physician to Dr. Mergelas or one of his medical
partners for a diagnostic report of the radiograph
based on the attending physician's belief in the
professional skill and competence of the radiolo
gists rather than on the capability of Dixie X-Ray
to properly process the X-ray film. Conceding the
importance of the diagnostic report itself, he sug
gests that this is indicative of the fact that the
referral is to the medical partners and that it is
they who sub-contract the technical processing and
development of the X-ray films to the plaintiff. I
quite agree and indeed find that the evidence in its
entirety points to no other logical conclusion than
that all patient referrals in the first instance are to
the medical partners by reason of their profession
al reputation in providing X-ray films of good
quality and their skill and expertise in radiological
diagnosis. This is what forms the basis of any
contractual relationship vis-à-vis the patients and
what happens thereafter as to the passing of any
property in the radiograph itself is, in my view, of
relatively secondary importance. In short, it is my
opinion that the substance of the contract is the
provision of services in which the passing of any
property in the X-ray films is merely ancillary or
incidental thereto, and that the contract is not one
for the sale of goods per se. I am further of the
opinion that the technological processing of the
X-ray films by the plaintiff is but part of its
overall function of providing service to the medical
profession and their patients from which it follows
that no essential differentiation can be made be
tween the vast majority of cases where a diagnostic
report is the end result of the whole process and
those ten per cent of cases where the radiographs
are delivered to others without any written report
by a radiologist. Moreover, it is not without sig
nificance, in my view, that the definition of "quali-
fied activities" in paragraph (b) of Regulation
5202 makes specific reference to activities per
formed in Canada "directly in connection with
manufacturing or processing ... in Canada of
goods for sale or lease". (My underlining.)
I find therefore that the plaintiff has failed to
demolish the factual assumptions forming the
basis of the Minister's assessment with respect to
the plaintiff's 1978 taxation year. In my opinion
the plaintiff has not proven on the balance of
probability that its business constitutes the pro
cessing of goods for sale within the meaning of
section 125.1 of the Income Tax Act and Regula
tions 5200 and 5202. It goes without saying that
the selfsame reasoning and result pertains to the
other case tried herewith (T-2941-83).
For these reasons, the plaintiff's action by way
of appeal is dismissed with costs.
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.