23 January 1990 External T.I. 74120 F - Capital Cost Allowance for Fixed and Portable Asphalt Plants

SUBJECT:  24(1) Fixed and Portable Asphalt Plants

We are writing in reply to your memorandum of July 11, 1989, wherein you requested our comments 1) on the classification of a portable asphalt plant for capital cost allowance purposes in view of the Nova Construction court case and 2) on whether asphalt produced by a taxpayer is considered to be a good for sale.  We regret the delay in our response.

The facts as we understand them are as follows:

Facts

24(1)

Your Questions

1.     Is the asphalt produced from a fixed plant location considered to be a good sale for the purposes of the manufacturing incentives claimed, in view of the fact that the asphalt is used by the taxpayer in performing its road paving contracts?

2.     In view of the decision in the court case Nova Construction Company Limited, 83 DTC 5105, in which the judge ruled that a portable asphalt plant should be in class 29 as opposed to class 10(h), which capital cost allowance class should a portable asphalt plant be included in?

Our Comments

1.     Goods For Sale

     In determining whether an activity of a taxpayer can be considered manufacturing or processing of a good for sale or lease in Canada, a distinction must be made between a contract entered into by the taxpayer 1) to manufacture or process a good for sale and 2) to supply work and materials.  In making this distinction, several factors must be taken into account.

a)        Affixing Property

     In Benjamins Sale of Goods, (London, 1987), in considering the distinction between a contract of sale of goods and a contract for work and materials, it is stated:

     "Where work is to be done on the land of the employer or on a chattel belonging to him, which involves the use of affixing of materials belonging the person employed, the contract will ordinarily be one for work and materials, the property in the latter passing to the employer by accession and not under any contract of sale.  Sometimes, however, there may instead be a sale of an article with an additional and subsidiary agreement of affix it.  The property then passes before the article is affixed, by virtue of the contract of sale itself or an appropriation made under it.  Obviously, the question whether the intention of the parties is substantially one of improving the land or principal chattel (to which the furnishing of materials is incidental) on the one hand or one of making a sale (to which the agreement to affix is incidental) on the other hand is a matter of degree, which may be difficult to determine in practice; but there is no theoretical difficulty.  In decided cases, the following have been held contracts for work and materials; to supply and install machinery in a building, to renew and alter the' engines and other machinery in a ship, to erect a building, to construct a built-in cocktail cabinet in a house; to fit new brake-linings to a car.  In contrast, a contract to supply black-out curtains and rails and to fit them in premises has been held a sale of goods, and so has a contract to manufacture a bulk food hopper and (for an additional charge) to deliver and erect it."

     This text is quoted on page 5437 of the court case Tenneco Canada Inc. v. the Queen, 87 DTC 5434, in which the court finds that the taxpayer installing mufflers, manufactured elsewhere, on automobiles is providing a service.  On page 5438, the Court states "Furthermore, even if I considered such work to constitute manufacturing or processing, such activities would not be in respect of goods for sale within the meaning of the Act, as in my view the exhaust parts installed under the vehicles of the customers are not sold to the customers, but have become the property of' the customers by accession."

b)       Tests

     In Sale of Goods, by M.G. Bridge, (Toronto, 1988), in considering the distinction between a contract for a sale of goods and a contract for work and materials, it is stated:

     "If a compound transaction must be classified as a contract of work and materials or one of sale of goods, the choice seems to lie among three possible tests.  Either a court can look impressionistically at a transaction and decide whether in substance or essential character it is the one or the other: or, doing much the same thing but more pedantically, the court can quantify the comparative financial value of the labour and the goods; or, it may decide that all transactions involving the conveyance of goods are sale of goods contracts except where the goods aspect is wholly incidental to the transaction.  As the cases currently stand, the first of these tests is uncontroversial and objectionable only to those who oppose vague tests; the second has attracted some support and the third, despite strong 19th century authority in favour of it, has received little support in the present century.  It cannot be stressed too strongly, however, that it is only under section 5 (of the Sale of Goods Act) that the distinction between sale of goods and work and materials is vitally important in the Sale of Goods Act.  The disfavour in which many courts have held the writing requirement has led to a shrinking of the sale of goods category and consequently to a preference for the first and second tests over the third test."

     The decision in the case Dixie X-Ray Associates Limited v. The Queen, 88 DTC 6076, supports the concept that the courts would look to the substance of the contract in order to determine whether the contract is for the sale of goods or for the supply of services to which the transfer of title to goods was merely incidental.  More specifically on page 6079, McNair, J. says "But 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 the property in some materials may pass under the contract as accessory thereto."

     In addition, the case Crown Tire Service Ltd. v. The Queen, 83 DTC 5425 at page 5429, indicated that in interpreting the words "goods for sale or lease" contained in section 125.1 of the Act, reference should be made to the general law of sale or lease in order to give greater precision to the phrase.  This case also supports the concept that a taxpayer can not have a good for sale where the manufacturing or processing is done by the taxpayer to property already owned by the customer.

     Two court cases which did not support our position - Nowsco Well Service Ltd. v. The Queen, 88 DTC 6300, (F.C.T.D.), and Halliburton Services Ltd., 85 DTC 5336, (F.C.T.D.), are currently under appeal by Revenue Canada, Taxation and are to be heard at the Federal Court of Appeal.  Therefore, the reasons adopted in these two court cases have not been taken into account in this reply.

c)        Conclusion

24(1)

2.     Asphalt Plant

     The court case Nova Construction Company dealt with a contractor engaged in the business of highway construction which manufactured asphalt in its portable asphalt plant.  In the appeal of this case heard at the Federal Court - Trial Division, 83 DTC 5105, the judge allowed the portable plant to be included in class 29.  We agree with your observation that the judge appears to have missed the phrase between paragraphs (f.l) and (g) in class 10 - "and property that would otherwise be included in another class in this Schedule that is", that results in a portable asphalt plant being included in class 10(h). 

     The case was subsequently heard at the Federal Court of Appeal, 85 DTC 5594, where the Court found that the taxpayer was not  entitled to a deduction in respect of manufacturing and processing profits, because the production of asphaltic concrete was an integral part of the taxpayer's construction projects.  The reasons indicated at page 5598 of that case that:

     "The blackmobile was used in the 1975 taxation year primarily to produce a product needed by the respondent to carry out various obligations under construction contracts.  It is immaterial that the product happened to be produced some distance from actual construction sites.  Nor, in my view, does it matter that some of the paving work involved repair to existing highways as distinguished from the paving of new ones.  As was well stated by the learned trial judge himself, the production of the product in either case was  "construction" within the meaning of section 125.1(3)(b)(iii) of the Act."

     The Court agreed with the Department that the portable asphalt plant could not be included in class 29 and therefore confirmed our assessment based on its inclusion in class 10.  Although there was an obiter comment that classification of the plant in class 8 may have been possible, the Department has not altered its view that class 10(h) is applicable. 

     In light of the comments and outcome of the above court case, the positions outlined in paragraphs 2, 4, 5 and 7 of Interpretation Bulletin IT-411, which state that the off-site manufacture of asphalt and other products used in the construction of a building or road will not be considered to be construction, have recently been reviewed.  The result of the review is that there will not be a change to those positions outlined in IT-411.  Therefore, as indicated in paragraph 7 of IT-411, where asphalt is manufactured on-site by a portable asphalt plant, this activity is considered to be construction and the plant will qualify as class 10(h) and not as class 29.  Where the asphalt is manufactured at the corporation's fixed plant location, this activity will be considered manufacturing and processing.  As discussed previously, in order for such a corporation to claim the manufacturing and processing incentives, it must still meet the test of having manufactured or processed goods for sale or lease.

We trust these comments will be of assistance.

R.E. THOMPSONChiefMerchandising, Manufacturing andConstruction SectionBusiness and General DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch