Date: 20020705
Docket: 2000-2630-IT-G
BETWEEN:
SCIERIE ST-ELZÉAR INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Tardif, J.T.C.C.
[1] This is an appeal from reassessments dated May 3, 1999 for the 1998 taxation year.
[2] The issue is to what class of property in Schedule II to the Income Tax Regulations ("the Regulations") do a fire protection system and a steam heating system belong for capital cost allowance purposes?
[3] The appellant argued that this property belongs in Class 43. The respondent, on the other hand, maintained that it must be included in Class 1.
[4] According to the respondent, the property at issue was not used directly or indirectly primarily in the manufacturing or processing of goods for sale by the appellant.
Facts
[5] The appellant, which operates a sawmill at St-Elzéar in the Gaspé region, is a co-operative corporation employing nearly 200 persons. The business has annual sales of approximately $15 million.
[6] Alain Tremblay testified in his capacity as general manager of the business. He explained that he began working there as an advisor specializing in business turnaround at a time when the company was experiencing some difficulties.
[7] Mr. Tremblay continued to be employed by the co-operative following a reorganization. He explained that the business had been obliged to reinvest to a considerable degree because of the remoteness of the location, certain market constraints, and the species of trees growing in the region. As part of the reorganization, the business had also had to take precautions against possible fire, all of which required a significant investment.
[8] Mr. Tremblay described and justified the outlays for the lumber drying operations. He explained that, because of the mill's remoteness from its markets, the sawed lumber had to be dried before being hauled. In order to dry the lumber, the business was obliged to invest in a system that used steam produced by burning the bark from the sawn or processed logs.
[9] Drying the lumber was a prerequisite for the business's competitiveness. Mr. Tremblay described the lumber drying process in detail, explaining why drying was an essential condition for the business's viability.
[10] Mr. Tremblay stated that the drying operations produced a large quantity of unutilized energy. To recover part of that energy, they set up a facility that allowed the energy to be transformed into a source of heating, at a cost much lower than that of traditional heating sources.
[11] Mr. Tremblay noted that this use was marginal both from a quantitative standpoint and in terms of frequency of use. Heat was recovered only during periods of very intense winter cold.
[12] He estimated that between 3 and 5 per cent of the heating requirement was met in this manner, adding that during the summer the steam was used only to dry the lumber. The heating provided by the steam was used only in the mill; the administrative offices did not make use of this form of energy since they were not connected to the mill. The first issue will involve determining to what class of property the equipment purchased and used to produce the heating energy inside the mill belongs.
[13] With regard to the second aspect of the appeal, that is, the characterization of the fire protection system, Mr. Tremblay first explained why this system existed.
[14] Thus, he explained that, in the area where the mill was being operated, there was no access to a flow of water adequate to deal with fire hazards. He described how the business had approached the municipality in order to obtain access to the municipal water reserves. This was essential since the business's insurers demanded quick and easy access to an adequate supply of water in case of fire, failing which they refused to insure the business's fixed assets.
[15] Mr. Tremblay began by noting that the limestone soil of the region where the mill was located had unique characteristics; the only small watercourses that might be sources of water supply were mostly underground. These watercourses, to which access was very difficult, could not meet the mill's needs in case of a major fire.
[16] Because the sawmill had experienced two fires, the insurers were unwilling to issue an appropriate insurance policy without sound guarantees of access at all times to a satisfactory flow of water.
[17] The approaches the business made to the municipality proved unproductive, because the municipality itself had a great deal of difficulty meeting its own needs with respect to protecting residences from fire.
[18] In order to protect its investment and its operations and obtain appropriate insurance coverage, the appellant was obliged to install its own fire protection facility. It had a reservoir excavated, which measured approximately 100 by 100 by 15 feet deep and would hold 500,000 gallons of water and to which was connected piping for a sprinkler system. The entire project necessitated an outlay of $459,214.
[19] Mr. Tremblay also placed great emphasis on the extreme danger of fire in this type of business. The ambient dust produced by the sawing operations, he said, was a veritable combustible capable of instantaneously igniting huge areas; it represented a real and omnipresent danger for both property and persons.
[20] On the basis of these facts, the appellant argued that the two assets in question, that is, the fire protection system, including a sprinkler system, installed at a cost of $459,214, and the $75,000 steam heating system, belonged in Class 43 of Schedule II to the Regulations, which would give entitlement to accelerated depreciation on them.
[21] The appellant also argued that the reservoir and all the piping connected thereto constituted property that was essential to its lumber manufacturing and processing activities.
[22] The respondent, for her part, argued that, while these assets were certainly useful and their existence was possibly justified, they were not used directly in the processing activities or in the primary mission of the business. The respondent thus asserted that the lumber sawing and processing operations could be performed independently of the two assets at issue. In other words, according to the respondent, these assets were not essential to the lumber manufacturing and processing operations.
[23] The issues in this appeal are the following:
(1) To what class of property in Schedule II to the Regulations does a fire protection system belong for capital cost allowance purposes?
(2) To what class of property in Schedule II to the Regulations does a steam heating system belong for capital cost allowance purposes?
RELEVANT STATUTORY AND REGULATORY PROVISIONS
[24] The relevant provision of the Income Tax Act is the following:
20(1) Deductions permitted in computing income from business or property - Notwithstanding paragraphs 18(1)(a), (b) and (h), in computing a taxpayer's income for a taxation year from a business or property, there may be deducted such of the following amounts as are wholly applicable to that source or such part of the following amounts as may reasonably be regarded as applicable thereto:
(a) Capital cost of property - such part of the capital cost to the taxpayer of property, or such amount in respect of the capital cost to the taxpayer of property, if any, as is allowed by regulation;
. . .
The relevant provisions of the Regulations read in part as follows:
DEDUCTIONS ALLOWED
1100(1) For the purposes of paragraphs 8(1)(j) and (p) and 20(1)(a) of the Act, the following deductions are allowed in computing a taxpayer's income for each taxation year:
Rates
(a) subject to subsection (2), such amount as he may claim in respect of property of each of the following classes in Schedule II not exceeding in respect of property
(i) of Class 1, 4 per cent,
. . .
(xxix) of Class 43, 30 per cent . . . .
SCHEDULE II
CAPITAL COST ALLOWANCES
CLASS 1
(4 per cent)
Property not included in any other class that is
. . .
(j) a subway or tunnel, acquired after May 25, 1976;
. . .
(l) a pipeline, other than gas or oil well equipment, unless, in the case of a pipeline for oil or natural gas, the Minister, in consultation with the Minister of Energy, Mines and Resources, is or has been satisfied that the main source of supply for the pipeline is or was likely to be exhausted within 15 years after the date on which operation of the pipeline commenced;
. . .
(q) a building or other structure, or part thereof, including component parts such as electric wiring, plumbing, sprinkler systems, air-conditioning equipment, heating equipment, lighting fixtures, elevators and escalators.
CLASS 8
(20 per cent)
Property not included in Class 1, 2, 7, 9, 11 or 30 that is
(a) a structure that is manufacturing or processing machinery or equipment;
(b) tangible property attached to a building and acquired solely for the purpose of
(i) servicing, supporting or providing access to or egress from, machinery or equipment,
(ii) manufacturing or processing, or
(iii) any combination of the functions described in subparagraphs (i) and (ii);
(c) a building that is a kiln, tank or vat, acquired for the purpose of manufacturing or processing;
. . .
CLASS 29
[50 per cent]
Property that would otherwise be included in another class in this Schedule
(a) that is property manufactured by the taxpayer, the manufacture of which was completed by him after May 8, 1972, or other property acquired by the taxpayer after May 8, 1972,
(i) to be used directly or indirectly by him in Canada primarily in the manufacturing or processing of goods for sale or lease . . .
(b) that is
(i) property that, but for this class, would be included in Class 8 . . . .
CLASS 43
[30 per cent]
Property acquired after February 25, 1992 that
(a) is not included in Class 29, but that would otherwise be included in that Class if that Class were read without reference to subparagraphs (b)(iii) and (v) and paragraph (c) thereof . . . .
[25] What is involved is carrying out an analysis and assessing whether the two assets in question, namely the fire protection system and the steam heating system, were used directly or indirectly primarily in the lumber production and processing activities. The evidence has established that these two assets were acquired solely and exclusively in order to ensure to the greatest extent possible the continuation of the lumber production and processing operations. Without the property at issue, the business's basic activities could have been or would have had to have been interrupted in the event of fire or of a period of Siberian cold.
[26] In other words, neither the heating system nor the fire protection system benefited other activities or other businesses, nor did they serve purposes other than those for which they were acquired, that is, providing protection against fire, and heating the premises in which the business's activities took place.
[27] The assets in question were used only as required, that is, in case of fire or during periods of intense cold. Until one of these two situations occurred, they were there, ready and waiting.
[28] Was the fact that the assets were not in continual use sufficient reason to conclude that they were property not used directly or indirectly primarily in the lumber manufacturing and processing activities? I think not.
[29] In either of the situations referred to above, the purpose of the property in question was to ensure the maintenance of operations and activities in specific circumstances. Lack of availability of or access to the two assets at issue could result in temporary, perhaps even lengthy, stoppage of the lumber manufacturing and processing activities. Thus, they were not superfluous property acquired on a whim. On the contrary, they were essential assets whose appropriateness has been explained and amply justified.
[30] In support of her claims, the respondent stated that before 1998 the mill was operated with no fire protection system, and that since 1998 the system had been used only three times; on the basis of those facts, the respondent concluded that the business could be operated without the property at issue.
[31] Determining whether property is used directly or indirectly as an integral and essential part of manufacturing and industrial activities is a difficult exercise in which there are no objective criteria or mathematical formulas to rely on; as well, certain equipment may be required because of specific characteristics such as climate, location, the quality of the labour force, productivity, and the state of the facilities, whether outdated or modern.
[32] Normally, buildings and other structures or parts thereof, including sprinkler systems and heating equipment, acquired after 1987 are included in subparagraph (q) of Class 1 for capital cost allowance purposes.
[33] Among the exceptions to this general rule are structures and buildings expressly included in the other classes, in particular structures that are manufacturing or processing machinery or equipment (Class 8).
[34] Class 43 was added to Schedule II to the Regulations following the 1992 budget; it applies to property acquired after February 25, 1992 that is not included in Class 29 but would otherwise be included in that Class if that Class were read without reference to subparagraphs (b)(iii) and (v) and paragraph (c) thereof (D. N. Finkelstein, ed., Canada Tax Service, loose-leaf pages, vol. 3 (Scarborough, Ont.: Carswell, 2000), at page 20-600).
[35] Class 43 applies to property that is to be used directly or indirectly by the taxpayer in Canada primarily in the manufacturing or processing of goods for sale or lease (Class 29, subparagraph (a)(i)) and that is property that would be included in Class 8.
[36] It is quite clear that the fire protection system and the steam heating system are property included in or covered by one of the paragraphs of Class 8. Given that the sawmill is a lumber manufacturing and processing operation located in Canada, I must essentially determine whether the two assets at issue were used directly or indirectly primarily in the manufacturing or processing of goods for sale.
[37] The expression "used directly or indirectly" is not defined in the Act; thus it is appropriate to refer to the case law. In Nowsco Well Service v. The Queen, 88 DTC 6300, at page 6313, Cullen J. of the Federal Court-Trial Division accepted the plaintiff company's claim that:
for the purposes of Class 29, one includes all equipment that is both necessary and ancillary to the processing operation.
[38] This rule was adopted by Judge Rip in Roy Legumex v. M.N.R., 90 DTC 1858 (T.C.C.), a case in which it was determined that steel containers used to dry legumes were properly included in Class 29. In that case, the Court also referred to an excerpt from Interpretation Bulletin IT-147R3 on ''Capital Cost Allowance - Accelerated Write-Off of Manufacturing and Processing Machinery and Equipment'' (September 14, 1992), paragraph 9 of which reads in part as follows:
The term to be used . . . directly or indirectly . . . refers to property acquired by the taxpayer for the purpose of being an integral and essential part of the taxpayer's . . . manufacturing or processing activities, as well as any ancillary equipment such as furniture and fixtures, repair and maintenance equipment and fire extinguishing equipment, which is acquired for use in those activities. [Emphasis added.]
[39] Paragraph 9 of that Interpretation Bulletin states as well:
Although such equipment is generally located in the manufacturing or processing plant, it may also qualify if located elsewhere. [Emphasis added.]
[40] The fire protection system sprinklers and piping incorporated with the appellant's mill are immovables either by their nature or, alternatively, by virtue of their being attached or joined to an immovable (Civil Code of Québec, article 903 ff.).
[41] As such, the sprinklers and the piping form part of a structure that includes manufacturing or processing machinery or equipment and that is used directly or indirectly in Canada primarily in the manufacturing or processing of goods for sale.
[42] The same is true for the water heaters and the piping of the heating system that are incorporated with the mill. However, in the case of the fire protection system in particular, a large part of the system, namely the water reservoir and the pumping station, is located outside the mill and is connected to it by piping.
[43] In the case at bar, the fire protection system and the steam heating system were acquired by the appellant as integral and essential, albeit ancillary, parts of its manufacturing and processing activities.
[44] Evidence was adduced that the permanent presence of flammable wood dust in the appellant's mill constituted a real fire hazard. A fire protection system was therefore necessary and indeed essential to provide for the safety of the appellant's employees, to ensure the continuing operation of its business, and to enable it to obtain fire insurance coverage. For a business of this type, such coverage is neither superfluous nor secondary, but is an essential form of protection that any responsible, well-informed owner must include in operating costs.
[45] A steam heating system was also required in the operation of the appellant's mill in order to provide a suitable work environment for its employees during the winter months.
[46] I believe that the evaluation or assessment of the factors essential to the smooth operation of a manufacturing business today must take into account certain property that is not absolutely essential at first glance, but becomes essential in a context where the environment, workers' quality of life, productivity, and production quality are increasingly indispensable to a business's survival. I therefore do not think that an asset or set of assets used in a business of which the purpose is manufacturing and processing should be assessed outside its context or essentially on the basis of the importance of an active, ongoing contribution to the business.
[47] If property is or may be put to use on an occasional basis as needed and thereby makes a contribution that is positive and useful, or indeed indispensable in certain circumstances, I am of the opinion that it must be characterized as being directly involved in production.
[48] I therefore conclude that the fire protection system and the steam heating system belong in Class 43 of Schedule II to the Regulations.
[49] The appeal is accordingly allowed with costs, and the case shall be reconsidered on the basis that the property at issue, that is, the fire protection system and the steam heating system, belongs in Class 43.
Signed at Ottawa, Canada, this 5th day of July 2002.
|
''Alain Tardif'' |
J.T.C.C.
Translation certified true on this 22nd day of October 2002.
Erich Klein, Revisor
[OFFICIAL ENGLISH TRANSLATION]
2000-2630(IT)G
BETWEEN:
SCIERIE ST-ELZÉAR INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on November 6, 2001, at Québec, Quebec, by
the Honourable Judge Alain Tardif
Appearances
Counsel for the Appellant: André Lévesque
Counsel for the Respondent: Alain Gareau
JUDGMENT
The appeal from the assessment made under the Income Tax Act for the 1998 taxation year is allowed with costs and the assessment is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the property at issue, that is, the fire protection system and the steam heating system, belongs in Class 43, the whole in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 5th day of July 2002.
|
"Alain Tardif" |
J.T.C.C.
Translation certified true on this 22nd day of October 2002.
Erich Klein, Revisor
[OFFICIAL ENGLISH TRANSLATION]