T-3514-79
McGraw-Hill Ryerson Limited (Plaintiff)
v.
The Queen (Defendant)
Trial Division, Mahoney J.—Toronto, April 1;
Ottawa, May 1, 1980.
Income tax — Income calculation — Deductions — Plain
tiff publishes and sells books, maintaining complete control
over the content, design and physical qualities of each book —
Plaintiff does not do the typesetting, printing and binding —
Whether the plaintiff was engaged in manufacturing or pro
cessing so as to be entitled to claim the deduction under s.
125.1 of the Income Tax Act — Income Tax Act, R.S.C. 1952,
c. 148, s. 125.1 as added by S.C. 1973-74, c. 29, s. 1.
The plaintiff publishes and sells its own books, of which
about 90% are textbooks. The plaintiff identifies the need for a
new textbook, and locates and contracts with a suitable author.
The plaintiffs employees are responsible for guiding the
manuscript through until it is ready for publication, copy
editing, typographical layout and cover design. However, the
plaintiff contracts with a printer to do the typesetting and
binding. The plaintiff is responsible for errors in the published
books and is responsible, as well, for the warehousing, sale and
distribution of the books. The defendant contends that because
the plaintiff did not do the typesetting, printing and binding,
the plaintiff did not manufacture or process books. The defend
ant further argues that if the plaintiff processes anything, it is
the information contained in the books, and that, since it
retains the copyright to that information, it does not sell what it
has processed. Whether the plaintiff was engaged in manufac
turing or processing books so as to be entitled to claim the
deduction from tax provided in section 125.1 of the Income Tax
Act.
Held, the action is allowed. The plaintiff, in publishing
books, does manufacture or process, in Canada, goods for sale.
The plaintiff maintains complete control over the content,
design and physical qualities of each book it publishes. The
plaintiff does not sell only the information contained in the
books it sells. It sells the books. In the ordinary meaning of the
words "manufacturing" and "processing", the plaintiffs activi
ties with respect to a cover and a manuscript, are integral
elements of physically manufacturing or processing a book. The
plaintiff is entitled to a deduction from tax, pursuant to section
125.1.
ACTION.
COUNSEL:
John M. Roland for plaintiff.
Charles T. A. MacNab for defendant.
SOLICITORS:
Osler, Hoskin & Harcourt, Toronto, for
plaintiff.
Deputy Attorney General of Canada for
defendant.
The following are the reasons for judgment
rendered in English by
MAHONEY J.: The issue in this action, and in
actions Nos. 3515-79 and 3518-79, is whether, in
its 1973, 1974 and 1975 taxation years, the plain
tiff was engaged in manufacturing or processing
books so as to be entitled to claim the deduction
from tax provided in section 125.1 of the Income
Tax Act, R.S.C. 1952, c. 148 as added by S.C.
1973-74, c. 29, s. 1. The three actions were tried
together on common evidence. There is no dispute
that books can be the subject of manufacture or
processing. The defendant says that, because the
plaintiff did not itself do the typesetting, printing
and binding necessary to the metamorphosis of any
of the books it published in Canada from their
conceptual to their tangible states, the plaintiff did
not manufacture or process books. The defendant
says further that, if the plaintiff processes any
thing, it is the information contained in the books,
not the books themselves, and that, since it retains
the copyright to that information, it does not sell
what it has processed. There is no issue as to the
plaintiffs qualified activities if it is found to have
manufactured or processed books at all. Neither,
in that event, is there any issue as to the proper
application of the complicated formulae for calcu
lation of the deduction.
In the circumstances, it is unnecessary to set out
the lengthy provisions of section 125.1 and the
Regulations made under it. Suffice it to say, the
section provides for deduction, from the income
tax otherwise payable by a corporation, of an
amount determined with reference to the corpora
tion's active business income from "the manufac
turing or processing in Canada of goods for sale or
lease". The Act does not define "manufacturing or
processing" although paragraph 125.1(3)(b) does
provide certain exclusions from the term. Of these,
the defendant pleads subparagraph (x).
125.1 (3) ...
(8) "manufacturing or processing" does not include
(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, and
(B) the manufacturing or processing in Canada of
goods for sale or lease, other than goods for sale or
lease by it.
This invocation of subparagraph 125.1(3)(b)(x)
appears a tautology of its basic defence. The
defendant admits in pleading that between 47.48%
and 49.33% of the plaintiff's total sales revenues in
the years in issue came from the sale of books
published by it in Canada. If, in so publishing
them, the plaintiff manufactured or processed the
books at all, it escaped the de minimis exclusion of
the subparagraph.
In addition to publishing and selling its own
books, the plaintiff sells the books of other publish
ers and is agent, in Canada, for foreign publishers.
About 90% of its own publications are textbooks.
The remaining 10% comprise general interest
books including novels, which frequently are pre
sented to the plaintiff as complete manuscripts;
textbooks are different.
Textbooks are published in response to the
market. They become obsolete with curriculum
changes. The plaintiff watches the market careful
ly and, when the need for a new textbook is
foreseen, one of its sixteen sponsoring editors is
assigned to locate a suitable author, usually from
within the academic community. One of the func
tions of the plaintiffs sales staff, which is con
stantly in contact with educational institutions, is
to identify suitable authors. Many sponsoring edi
tors are graduates of the sales force. Others are
former teachers.
Once a prospective author is identified, the
sponsoring editor obtains an outline of his material
and a sample of his writing and, if that is satisfac
tory, a contract is entered into whereby it is agreed
that the manuscript will be delivered by a certain
date, copyright is assigned to the plaintiff and
provision is made for certain payments to the
author. The sponsoring editor continues to work
with the author, setting a schedule to meet the
completion date and reviewing the manuscript as it
becomes available, chapter by chapter, comment
ing on and returning it to the author with sugges
tions. Photographs proposed to be incorporated in
the book are obtained by the author or the spon
soring editor. The amount of guidance afforded
varies with the needs of each author. A manuscript
usually goes through at least two drafts before
acceptance for publication.
When it is considered that a manuscript is ready
to proceed further toward publication, it is handed
over by the sponsoring editor for copy editing and
production. The copy editor, seeing it for the first
time, skims through it for its gist and then reads
the manuscript very carefully, editing it for gram
mar, organization and the like. The copy editor
pulls out sample pages of the manuscript showing
every typographical eventuality and turns these
over to a book designer of typographical design.
The book designer establishes the typographical
layout and a design checklist which is related to
the sample pages by a system of symbols.
The plaintiff has nine copy editors and three
book designers. Those nine copy editors do about
90% of its copy editing. There are two or three
freelancers to whom it turns when the work load
requires. Likewise, its employee designers do its
design work except in cases of heavily illustrated
publications where the number of diagrams and
drawings create an unusual demand on their time.
Typically, there are 50 or 60 books at this stage of
publication at a given time.
The copy editing and book design proceed
simultaneously and, as the design becomes firm, a
printer is selected. A specification is drawn. Text
books fall into a limited number of categories so,
for economy, the plaintiff has a number of stand-
and specifications calling for the same kinds of
paper and binding material. Other requirements,
such as dimensions, quantity, colours and so on,
vary. Quotations are invited from between four
and six printers with whom the plaintiff deals
regularly. The quotations are reviewed and the
printing contract awarded.
The printing contract covers typesetting and
binding. The plaintiff does none of its own typeset
ting, printing or binding. The sample pages and
design checklist are sent to the printer. They are
set and galley proofs of the sample pages are
returned. The typographical design is finally
approved and, when copy editing is complete, the
entire manuscript, design, checklist and sample
galley proofs, with changes indicated, are sent to
the printer. The manuscript is set and full galley
proofs returned. Copies are passed to the author
and copy editor who indicate corrections.
A paste-up is done for an illustrated book and
explicit instructions given as to its layout. The
paste-up is done by the copy editor who cuts up a
galley proof and reassembles it, page by page, with
copies of the illustrations, marking it for spacing
and showing every detail of how each page should
be put together.
Corrections by the copy editor and author are
incorporated in a master galley proof and, with the
paste-up, it is delivered to the printer. The printer
produces a reproduction paste-up using the master
galley proof and following the placing and spacing
instructions on the paste-up. The resulting page
proofs are returned to the plaintiff.
The page proofs should be a properly aligned
version of the paste-up. Again, the copy editor
checks the page proofs and makes any changes
that ought to be made including anything due to
the printer's failure to follow previous instructions.
There ought not, at this stage, to be many changes.
If there are many, the printer may have to produce
another set of page proofs; otherwise, he will take
the reproduction pages of which the page proofs
are copies, arrange them in the right configuration
for folding and photograph them. Methodology
varies with the number of colours to appear in the
final product. From the film, the printer produces
a paper proof, or vandyke.* This is a one colour
proof which shows, by varying shades of that
colour, the placement of the different colours to
appear in the book. This is the publisher's last
chance to make corrections. Again, if they are
numerous, a second vandyke may be required.
Once the plaintiff approves the vandyke, the print
er makes the plates and prints the book. Any
remaining errors are the publisher's, not the print
er's, responsibility.
While the content of the proposed book is being
brought to the vandyke stage, the cover goes
through a parallel process. Initially, one of the
plaintiff's artists does rough cover designs. These
are circulated throughout the Company. A rough
design is approved and refined and eventually the
final art is approved. This is provided to the print
er who produces a proof, or series of proofs as may
be necessary, until, ultimately, the cover too goes
to press. Contents and covers are bound together
and the finished books are then delivered to the
plaintiff for warehousing, sale and distribution.
The entire process, from identification of the
need for a new textbook to its availability in the
market place, consumes several months. In the
case of "Physics", a secondary school text used as
example in evidence, the contract with the four
authors was signed in May, 1977, calling for deliv
ery of the manuscript by October 1, 1977. The
quotation from the successful printer was dated
January 24, 1978. The plaintiff's purchase order
for 7,500 copies issued to the printer March 14
and delivery was required by September 15, 1978.
The work of the printer is entirely mechanical.
The plaintiff maintains complete control over the
* The term "vandyke" derives from the fact that, formerly,
page proofs were produced in shades of brown, a colour combi
nation favoured by the barbate painter of that name. Today,
they are usually shades of blue but the term survives.
content, design and physical qualities of each book
it publishes. Printers' representatives call regularly
on the plaintiff to deliver proofs and receive
instructions respecting work in progress. The
plaintiff's representatives do not visit the printing
plants except, rarely, when an unusual production
problem arises.
The plaintiff does not sell only the information
contained in the books it sells any more then an
automobile manufacturer sells only the transporta
tion capability of the vehicles it sells. The plaintiff
sells the books. Those books are goods. It may be
that it is the information content that gives a book
its value, as it is the transportation capability that
gives a motor vehicle its value, but the subject
matter of sale is the book, as it is the vehicle. The
textbooks the plaintiff publishes itself are goods
manufactured and processed in Canada for sale. In
the ordinary meaning of the words "manufactur-
ing" and "processing", the plaintiff's activities
with respect to a cover and a manuscript, from the
point in time it is turned over, by the sponsoring
editor, to the copy editor to the point in time the
vandyke is returned, approved, to the printer, are
integral elements of physically manufacturing or
processing a book. The plaintiff, in publishing
books, does manufacture or process, in Canada,
goods for sale.
The reassessments of the plaintiff's income tax
returns in respect of its 1973, 1974 and 1975
taxation years will be referred back to the Minister
of National Revenue for reconsideration and reas
sessment on the basis that the plaintiff is entitled
to a deduction from tax in each of those years,
pursuant to section 125.1 of the Income Tax Act
in respect of its manufacturing and processing
profits, of an amount based on the qualified activi
ties carried on by the plaintiff as permitted by
section 5202 of the Income Tax Regulations,
SOR/73-495. The plaintiff will be entitled to its
costs to be taxed. Taxation under Tariff B shall be
on the basis that the three actions were a single
Class III action throughout.
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.