Order UT98-1 - UT94102 - Sales Tax Appeal - Northern Telecom v. Provincial Tax Commissioner (Apr. 21/98)

Docket UT94102
Order UT98-1

IN THE MATTER of an appeal by Northern Telecom Limited against a decision of the Provincial Tax Commissioner, dated May 2, 1994.

BEFORE THE COMMISSION
on Tuesday, the 21st day of April, 1998.

Ginger Breedon, Vice-Chair
Deborah MacLellan, Commissioner
Elizabeth MacDonald, Commissioner

Order

Contents

Appearances & Witnesses

Reasons for Order

1.Introduction

2.Discussion

2.1 Introduction

2.2 Software

2.3 Hardware

3.Disposition
Order

Appearances & Witnesses
1. For Northern Telecom Limited

Counsel:
Ronald J. Keefe

Witnesses:
Philip Acorn
General Manager, Network Services
The Island Telephone Company Limited

Donald F. Farmer
Consultant

Yvon Tremblay
Consultant

Glen S. Pye
Director, Sales and Property Taxes
Northern Telecom Canada Limited

Dennis Graves
Senior Engineer, Canadian Customer Service and Global Support
Northern Telecom Canada Limited

2. For the Provincial Tax Commissioner

Counsel:
Roger B. Langille, Q.C.

Witnesses:
Kevin Dingwell
Manager of Assessment Services
Department of the Provincial Treasury

Donald MacDonald
Senior Tax Auditor
Taxation and Property Records Division
Department of the Provincial Treasury

Miro Forest
Consultant
3. For the Island Regulatory and Appeals Commission

Counsel:
Thomas A. Matheson

Staff:
Donald G. Sutherland
Director, Technical Services

Heather R. Walker
Recording Secretary

Reasons for Order

1. Introduction

On January 27, 1994, Notice of Assessment No. 0732 was issued to Northern Telecom Limited ("Nortel" or "Appellant") by the (then) P.E.I. Department of Finance, Revenue Division. The assessment covered the audit period from January, 1991 to July, 1993 and the assessment amount of $1,626,441.99 was comprised of sales tax not collected on:

retail sales of computer software;

retail sales of computer hardware;

trade-ins;

maintenance agreements; and

tax accumulation shortages.

The assessment relates to a Nortel DMS-100 switch sold by the Appellant to the Island Telephone Company Limited ("Island Tel") and the software used to operate the switch. The switch is located at an Island Tel facility in Charlottetown.

On March 3, 1994, Nortel filed a Notice of Objection with the Provincial Tax Commissioner in relation to Notice of Assessment No. 0732. The objection was filed pursuant to Section 9 of the Revenue Administration Act, R.S.P.E.I. 1988, Cap. R-13.2, as amended, which reads as follows:

9. (1) Where a person considers that he is not liable to taxation under a revenue Act or disputes liability for the amount assessed against him, he may, within sixty days of the date of service or mailing of the notice of assessment serve on the [Provincial Tax] Commissioner a notice of objection setting out the reasons for the objection and all relevant facts.

(2) A notice of objection is sufficiently served if delivered to the office of the Commissioner or sent by registered mail addressed to the Commissioner.

(3) The Commissioner shall, within sixty days of receipt of the notice of objection, reconsider the assessment or estimate and vacate, confirm or vary it, and he shall thereupon notify the objector of his decision by registered mail.

The Appellant's objection to the Provincial Tax Commissioner ("Tax Commissioner" or "Respondent") dealt with the same issues that are the subject of the within appeal, as well as items identified as trade-ins and tax accumulation shortages that are not part of the appeal.

As required under Section 9 above, the Tax Commissioner reconsidered the assessment and notified Nortel of his decision as follows:

May 2, 1994

HAND DELIVERED

Stewart McKelvey Sterling Scales
P.O. Box 2140
Charlottetown, P.E.I.
C1A 8B9

Attention: Ronald J. Keefe

Dear Mr. Keefe,

This is in response to your Notice of Objection dated March 3, 1994 and your Supplementary Brief dated April 3, 1994 regarding our recent Sales Tax Assessment on Northern Telecom Canada Ltd.

I have reviewed the circumstances surrounding your objection and render my decision as follows:

1) Software - Section 1(e) of the Revenue Tax Act states in part:

‘(iii) goods includes: computer software as defined in the Regulations.'

Section 1(g)(i) of the Revenue Tax Act Regulations states:

‘computer software means packaged or prewritten computer programs that are designed for general application, including the right to use those programs, and includes modifications to those programs and modifications of those programs but does not include a computer program that is designed and developed solely to meet the specific requirements of the purchaser. A computer program includes:

(i) a plan for the solution of a problem through the use of a computer;

(ii) instructions to enable or cause a computer to control or perform a function, or to produce a desired result either directly or through the working of other equipment;

(iii) systems programs, application programs and any other computer programs or subdivisions thereof, including assemblers, compilers, routines, generators and utility programs; and

(iv) the design, development, writing, translation or fabrication of a computer program, whether or not provided on storage media.'

By virtue of the above Sections, I uphold the Assessment as raised and regret to advise that no adjustment is warranted.

2) Hardware - Your Objection states that the supply and installation of the Digital Multiplex Switch to Island Tel relates to Real Property. It is the position of this office that the supply and installation of the Digital Multiplex Switch ie. computer hardware relates to personal property and therefore tax should have been charged on the retail selling price. I therefore must uphold the Assessment as raised and regret to advise that no adjustment is warranted.

3) Application

a) Extended Warranty Plans - I will address this area in the same format that you have presented it.

i) Repairs - Since it is the decision of this office that Digital Multiplex Switches relates (sic) to personal property, tax was correctly charged on the GST included selling price.

ii) Software Updates - Since these goods come under the definition of computer software, tax should have been charged and therefore no adjustment is warranted.

iii) Technical Assistance Service - I agree that this is a non-taxable service under our legislation and therefore an adjustment is warranted.

b) Trade-ins/Buyback Allowance - Based on the additional information contained in your letter, it is my decision to remove these amounts from the Assessment.

4) Accumulation - I have reviewed the audit procedures carried out by my staff and support their findings. However, since we are dealing with test checks, sampling and estimates and in the spirit of settling this accumulation area, I render my decision as follows:

1) The 1993 year will be reduced to a taxable percentage of 55%, based on the study compiled by Island Tel. I note that this study is for the period January 1993 to December 1993 while our audit period goes to July 1993.

2) Your Objection states that $5,892.99 is self assessed by Island Tel therefore based on this information, I will reduce the assessment accordingly.

I will pass this decision over to Fred J. Weatherby, Chief Tax Auditor who will contact you under separate cover with the details of your adjustment.

If you require further information, please contact this office.

Very truly yours,

(Sgd) J.B. Ramsay

J.B. RAMSAY
Provincial Tax Commissioner

(Exhibit R-1 - May 2, 1994 Letter)

On May 27, 1994, Nortel appealed the above decision to this Commission. In its Notice of Appeal, the Appellant sets forth the following reasons for the appeal:

1. SOFTWARE

(Assessment: $340,740.11 sales tax, plus penalty, plus interest)

The [Notice of Assessment] assesses non-collection of sales tax on telephone switching software sales invoiced to Island Tel from January 1, 1991 to July 31, 1993. In accordance with the Revenue Tax Act, ‘computer software' as defined in the regulations is considered a good (s. 1(e)(iii)). Regulation 1(g.1) defines computer software as meaning

‘packaged or prewritten computer programs that are designed for general application, including the right to use those programs, and includes modification to those programs and modifications of those programs, but does not include a computer program that is designed and developed solely to meet the specific requirements of the purchaser.'

Northern is of the view that the software supplied to the Island Telephone Company Limited ('Island Tel') which forms the subject matter of the assessment is not ‘computer software' as the same is deemed in the applicable legislation. The ‘application software' component is designed and developed specifically for Island Tel and the ‘installation software' relates to installing the non-taxable application software. The software is not ‘a packaged or prewritten computer program designed for general application'.

The engineering software is a service provided to Island Tel and, through the audit period, is not a good as the same is defined in the Act.

2. HARDWARE

(Assessment: $454,591.55 sales tax, plus penalty, plus interest)

The Province of Prince Edward Island has assessed sales tax on telephone switching hardware contracts invoiced to Island Tel from January 1, 1991 to July 31, 1993. Northern is of the view that material hardware and the installation thereof relates to real property. Northern is a manufacturing contractor and acquires tangible personal property which on installation becomes an integral component of real property being a building, a network or structure. Northern is the consumer and pays tax, as applicable, on the manufactured cost of the tangible personal property.

The Province of Prince Edward Island has incorrectly classified the assets purchased by Island Tel and incorrectly considered Northern as a vendor rather than consumer in this instance.

Engineering services provided to the Company with respect to the material and installation hardware are services and, through the audit period, were not taxable.

3. APPLICATION

Original Assessment: $54,031.69 sales tax, plus penalty, plus interest;

Adjustment to Assessment (per May 5, 1994 letter):

A.    Trade-ins - $40,482.77 sales tax plus interest
B.    Technical Assistance Support - $5,910.92 sales tax plus interest

That part of the Assessment with respect to application under appeal deals with Extended Warranty Plans.

Northern offers its customers an Extended Warranty Plan (EWP) associated with its telephone switches. The EWP contract covers three separate elements, software updates being the only one of which is subject to this appeal.

This element is detailed and priced separately in the EWP contract, and subsequent yearly/quarterly/monthly invoicing itemizes this element.

Northern is of the view that software updates do not meet the definition of ‘computer software' as set out in the Revenue Tax Act and Regulations and, therefore, are not taxable. The updates do not relate to a packaged or prewritten computer program designed for general application.

(Exhibit A-1, pp. 2-3)

The appeal is made pursuant to Section 10 of the Revenue Administration Act, which reads as follows:

10. (1) If the taxpayer or collector is dissatisfied with the decision of the Commissioner under subsection 9(3), he may, within thirty days from the date of mailing of the decision, appeal to the Island Regulatory and Appeals Commission hereafter referred to as the 'Commission'.

(2) Any appeal shall be commenced by serving upon the Commision a notice of appeal in writing setting out the grounds of the appeal and stating briefly the facts relative thereto.

(3) A notice of appeal is sufficiently served if delivered to the office of the Commission or sent by registered mail addressed to the Commission.

(4) On the hearing of the appeal both the appellant and the Commissioner are entitled to be heard and to submit further evidence.

(5) The Commission may, in writing, designate a person to act on its behalf and hear an appeal under this section and any reference in this section…to the Commission includes a person so designated.

(6) Upon any appeal, the Commission may affirm, vary or reverse the decision of the Commissioner and shall give the appellant written notice of its decision by registered mail.

The original Commission panel assigned to hear the case conducted a tour of Island Tel facilities in 1994 to view the equipment at issue in this appeal. The case was thereafter recessed and held in abeyance while attempts were made by the parties to reach a settlement. A settlement was not attained and the case was reactivated in June, 1997 at the request of the parties.

A hearing on preliminary issues was held on December 5, 1997. The hearing of the substantive issues was held on December 15, 16, 17 and 18, 1997. Final briefs were filed in late January, 1998 and reply briefs were filed in late February, 1998.

The Commission acknowledges the contributions of counsel and the witnesses in this proceeding.

2. Discussion
2.1 Introduction

The appeal centers on two principal issues:

1.    Whether the software, including engineering and installation software and extended warranty plan software updates provided by Nortel to Island Tel is computer software as defined in the Revenue Tax Act Regulations; and

2.    Whether sales tax is payable on the manufactured cost of the hardware or the retail selling price of the hardware.
2.2 Software

Section 4 of the Revenue Tax Act, R.S.P.E.I. 1988, Cap. R-14, as amended, reads as follows:

4. Every consumer of goods consumed in the province shall, at the time of taking delivery, pay to the Minister for the raising of revenue for provincial purposes, a tax at the rate of ten percent of the fair value of the goods.

Section 1.(e)(iii) of the Act defines goods as follows:

1(e) ‘goods' includes
…
(iii) computer software as defined in the regulations;

Section 1.(g.1) of the Revenue Tax Act Regulations provides as follows:

1(g.1) ‘computer software' means packaged or pre-written computer programs that are designed for general application, including the right to use those programs, and includes modifications to those programs and modifications of those programs but does not include a computer program that is designed and developed solely to meet the specific requirements of the purchaser. A program includes:

(i) a plan for the solution of a problem through the use of a computer;

(ii) instructions to enable or cause a computer to control or perform a function, or to produce a desired result, either directly or through the working of other equipment;

(iii) system programs, application programs and any other computer programs or subdivisions thereof, including assemblers, compilers, routines, generators and utility programs, and

(iv) the design, development, writing, translation or fabrication of a computer program, whether or not provided on storage media;

The Appellant argues that the software operating the DMS-100 switch is not computer software as defined in the Regulations and therefore not a good subject to tax. The Respondent, on the other hand, argues that the software comes within the definition of software found in the Act and Regulations.

The Commission heard evidence on the nature of the software from two witnesses: Dennis Graves, an electrical engineer employed with the Appellant and Miro Forest, also an electrical engineer, employed with the consulting firm Hoey Associates Telecommunications Consulting Services Inc. While neither witness is a software developer or programmer, both have knowledge of the DMS software and their evidence has been helpful to the Commission in its understanding of the software's characteristics and the degree of customization necessary to meet the requirements of the purchaser.

The evidence discloses that the DMS software was developed by Bell Northern Research ("BNR") to run on Nortel DMS switches. In describing the software, Nortel witness Graves had this to say:

Software developed and supplied by Northern is unique to the telecommunications industry. The software development process uses a computer language developed and usable only by Northern. The software has no application outside the telecommunications industry and requires unique hardware to operate.

Digital multi-plex switches (DMS) is the product Northern offers to the telecommunications industry to switch telephone calls. The DMS switch can be customized to work in most telecommunications environments in Canada. There are three traditional types of switches:

local - the switch that is connected to the end user subscriber and provides the services that are visible to the end user;

toll - the switch which connects local switches together and provides billing and routing features; and

Traffic Operators Position System (TOPS) - the switch that provides operator functions.

Each switch type needs to be further customized to fit local requirements.

The ability to take a single product with multiple processor types and hardware configurations and customize it to fit the many environments in which the hardware is utilized is done through software programming. The programming is developed for each specific type of configuration to meet the requirements of the specific site.

(Exhibit A-13, pp. 1-2)

Mr. Graves testified that the software is written in PROTEL, a high-level programming language developed and used exclusively by BNR for DMS software. In describing the characteristics of each software installation, the witness testified that, following the determination of a customer's feature requirements, relevant software modules are extracted from the BNR software libraries. This is followed by the addition of customer hardware and service translation data into the data store portion of the software modules and then the delivery of the software product on a tape for installation on a specific switch.

Mr. Graves noted that another customer may request a different set of features—known as a feature suite—that would involve a different set of software modules or packages. According to the witness, the module mix would be different for each customer and each of the software load-builds would be unique.

Mr. Graves summarized his evidence this way:

…The point that's very key here I think is that this is a site specific software load and it will only operate for his switch. I cannot take it to any other DMS 100 and make it work. So in terms of the key attributes of the DMS software, I tried to summarize preceding slides as follows, is that the DMS switch software is a telephone industry or telecommunications industry specific software system and it does use computer technology to operate. The software is written in PROTEL and is a proprietary software. It is not available for any other use but telecommunications and therefore is not a general type of application software. Each DMS switch has a—I'm terming your custom configured software unique to that customer and the reas—you know custom configured would be the things we talked about which was the unique software modules, the unique hardware translation information, the parms¹ and the patches.

The fourth point is that once a DMS software load is built for a particular DMS switch, it cannot be used in any other DMS switch and I'm terming—terming that as being non-transportable or not portable would be another term you could use from one DMS switch to another. The typical DMS software load site specific content typically in a DMS such as Fitzroy with 40-50,000 subscribers would probably contain in the order of 50% of the overall content as site specific and I wanted to differentiate—I've seen some of the literature, talked to—shrink-wrap software, a pre-packaged software as it applies to a PC where you can effectively go in and—and purchase it off a shelf, take it home and install it on your computer and use that software on any other computer that you wish. The only restriction you have is the licensing agreement from the software supplier that you don't do that. In our case—our software, we cannot do that. We—we build loads you need for each switch and they will only run on that switch. And that concludes my summary.

(Transcript, Dec. 16, 1997, pp. 188-189)

The evidence of Mr. Forest, on the other hand, suggests that the DMS software is packaged or pre-written software that is customized and designed to perform a function through the working of other equipment. In Mr. Forest's view, the software has been developed to support a set of network features or applications that may include administrative functions for a telephone network and is written prior to receiving an order from a customer.

In his evidence, Mr. Forest noted that the software is comprised of many small and contained functions known as software packages. According to the witness, the software packages are set up to allow Nortel to configure a switch for different customers yet retain the ability to support the software. The witness further noted that the packages are pre-written and are later put together in a configuration to suit the demands of a particular customer.

Mr. Forest is also of the view that the DMS software is designed for general application. According to the witness:

The pre-written software associated with the DMS switch is presently estimated to contain over 20 million lines of software code.

…Northern Telecom has sold over 4,600 of these DMS switches, complete with the associated software required to operate them. This installed base of switches provides services to over 65 million telephone network customers world wide.
…
The DMS switch has found general use directly in the Canadian network, by the Canadian telephone companies, and indirectly by the millions of telephone subscribers in Canada. The use of the DMS switch is ubiquitous in the Canadian network. All of the major telephone companies in Canada (and the USA) own and operate DMS switches. The DMS switch, and thus the software needed to operate the switch, has found general application throughout the telephone industry.

(Exhibit R-5, pp. 6-7)

Finally, Mr. Forest testified that the DMS software is not, in his view, designed and developed solely to meet the specific requirements of the purchaser. Although the witness acknowledges that the software load may be modified via the use of parameters or so-called parms, translation data, and features or patches, the patches and features are provided to every DMS customer who buys them and the translation data and parms for the switch are provided by the customer. According to the witness:

It is neither operationally nor economically viable to write or develop new software for each switch. The data which is used to trigger various functions within the switch may be unique to the particular customer, but the software program into which the data is filled is standard. A distinction must be made between the computer program supplied by Northern Telecom Canada Ltd. and the data that is used in the operation of a specific switch.

(Exhibit R-5, pp. 8-9)

Counsel for the Appellant argues that the Respondent must, but has failed to, show that the software in question falls within the definition set out in the Regulations and that the onus is on the Province to prove that its original assessment was correct. Counsel also argues that the opinion evidence of witness Forest should not be considered, as it does not meet the requirements for opinion evidence. In the alternative, counsel for the Appellant submits that, if Forest's evidence is considered, the Commission should take note of his evidence that the software is only used to operate DMS hardware and, further, that such hardware is only used in the telecommunications industry.

Counsel for the Respondent submits that the onus is on the Appellant to establish that the assessment is wrong. The Respondent argues that, in the early stages of the appeal, Counsel for the Appellant acknowledged that the onus of proof was on the Appellant. According to Counsel, it is incorrect to allow the Appellant to change its previous position and now argue that the onus is on the Respondent to uphold its audit.

The Commission notes that there was little substantive conflict between the parties on the facts at issue in this appeal. The Commission has had no difficulty in assessing the evidence as a whole and with reaching its findings. Therefore, the Commission finds it unnecessary to address the submissions of counsel concerning onus.

Counsel for the Appellant also argues that the Commission must first consider whether the software is of general application and thereafter determine whether it is designed and developed solely to meet the requirements of the purchaser. Counsel contends that the software is not of general application in that it is limited to DMS hardware and is particular to a specific industry. Finally, Counsel for the Appellant submits that the software is designed and developed solely to meet the requirements of Island Tel.

Counsel for the Respondent submits that the words general application found in the Regulations must be read together with the words computer programs designed and developed solely to meet the requirements of the purchaser. The Respondent further submits that, if the program is not designed and developed solely for the purchaser, the program is of general application. In the alternative, the Respondent submits that the program is for general application. Finally, counsel for the Respondent submits that there is wide deployment of DMS switches and they have found general application throughout the telephone industry. Counsel concludes that the software is thereby not designed and developed solely to meet the requirements of Island Tel.

In order to be considered computer software and, hence, a taxable good within the meaning of the Revenue Tax Act, the DMS software:

1.    must be packaged or pre-written and designed for general application; and

2.    cannot be designed and developed solely for the use of the purchaser.

The leading Canadian case dealing with statutory interpretation of tax laws is Stubert Investment Ltd. v. The Queen (1984), 10 D.L.R. (4^th) 1, (S.C.C.), wherein Estey, J., stated (at p. 32):

While not directing his observations exclusively to taxing statutes, the learned author of Construction of Statutes, 2^nd ed. (1983), at p.87, E.A. Dreidger, put the modern rule succinctly:

Today there is only one principle or approach, namely, the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament.

The evidence discloses that the DMS software is marketed and sold as part of the DMS switch itself. It is not a product that Nortel markets on a stand-alone basis, nor is it a product that will operate on equipment manufactured by others. The evidence discloses, as well, that the software—containing in excess of 21 million lines of code—is largely a combination of pre-written modules that, when combined with customer-specific data, form a so-called software load intended for a specific DMS switch. The software load itself will not operate on any other switch.

The Commission is of the view that the DMS software is largely a packaged or pre-written product that requires a level of customization to suit the specific requirements of the purchaser. It is not designed or developed solely for the use of the purchaser. The modular nature of the software—undoubtedly a design feature intended to standardize feature sets as well as program maintenance—suggests to the Commission that the software has not been designed solely for Island Tel's use. Rather, it has been designed for deployment on DMS switches throughout the telecommunications industry. In our view, the fact that the delivered software product is unique to each DMS switch is not, in and of itself, an indicator that the software is designed and developed solely for the use of the purchaser.

Although we believe that the software is packaged or pre-written and not designed and developed solely for the use of the purchaser, we are unable to similarly conclude that the DMS software is designed for general application. In our view, the Executive Branch of Government—through the Revenue Tax Act Regulations—did not intend that highly specialized software purchased as part of a telecommunications switch be subject to tax.

Bearing in mind the scheme, object and context of the Revenue Tax Act and Regulations, the Commission believes that the words designed for general application when read in their grammatical and ordinary sense mean that the software to be taxed must, on its own, be a marketed or marketable product generally available to, and usable by, anyone who might want to purchase it.

In this case, the DMS software is merely a component of—and only available with the acquisition of—something else. It is not a product that one would purchase on its own, nor, in our view, does it have any value on its own. The highly proprietary nature of the software, and the fact that it is part of a particular complex telecommunications switch, set it apart from software designed for general application. In our opinion, this is the very type of software that the Executive Branch, through the wording in the Regulations, intended not to tax. In this respect, we accept the following argument of Mr. Keefe:

The Legislature entrusted to Executive Council the responsibility to define what computer software was to be taxed. If all computer software were to be taxed, the Legislature would have simply stated that computer software is a good…

(Appellant's Closing Argument, January 26, 1998, p.27)

For all of these reasons, the Commission finds and concludes that:

1.    The software operating the DMS-100 switch and updates to that software are not ‘computer software' within the meaning of Section 1.(g.1) of the Revenue Tax Act Regulations.

Based on the foregoing,

2.    The decision of the Provincial Tax Commissioner, dated May 2, 1994, respecting sales tax on software associated with the DMS-100 switch is reversed.

At issue, as well, is the question of whether the engineering software and installation software are subject to tax.

Donald MacDonald, a witness for the Respondent, gave the following reasons for taxing these items:

Installation software refers to a charge for the installation of the software sold by Northern Tel to Island Tel. The Revenue Tax Act defines ‘goods' to include repair and installation labour, which the Revenue Tax Act Regulations state ‘mean the labour expended or used to adjust, apply, clean, install, maintain, remodel, rebuild, repair, recondition and service goods which are taxable under the provisions of the Act…' Since the software is taxable, the associated installation charges are taxable as well.

The definition of ‘Engineering Software' dated October 6, 1993 used and provided to us by the Northern Telecom Bramalea Division, is attached as Document D-1.

(Contents of Attachment D-1)

Engineering Software

Time a systems application engineer spends writing instructions that are understandable by the CPU to permit connectivity to the various pieces of equipment.

i.e. Instructions that tell the CPU where it is in the network, (Identification).

Instructions that identify what the equipment configuration is:…such as the nature of each piece of equipment and it's (sic) identification in the network, where is (sic) and how it may be connected to other pieces of equipment. Its (sic) a highway map of the equipment set up in tables that are understandable by the CPU.

…

I regard these component costs as no different than any other costs of producing the software. This labour was expended and computer costs incurred because they were necessary to complete the sale of the software, and are an integral part of the taxable part of the taxable good, computer software…

(Exhibit R-11, Tab 2, pp.5-6 & Attachment D-1)

Since the premise for tax on these services is apparently based on the taxability of the software, and the Commission having found that the software is not computer software, the tax on these items is wrongly assessed. As a result, we determine that:

3.    The decision of the Provincial Tax Commissioner, dated May 2, 1994, respecting sales tax on engineering and installation software is reversed.
2.3 Hardware

For ease of reference, Section 4 of the Revenue Tax Act is repeated below:

4. Every consumer of goods consumed in the province shall, at the time of taking delivery, pay to the Minister for the raising of revenue for provincial purposes, a tax at the rate of ten percent of the fair value of the goods.

Sections 1.(b), 1.(c)(ii) and 1.(e)(i) and (ii) of the Act read as follows:

1.(b) ‘consumer' means a person who

(i) utilizes or intends to utilize within the province goods for his own consumption, or for the consumption of another person at his expense, or

(ii) utilizes or intends to utilize within the province on behalf of or as agent for a principal who desired or desires to so utilize the goods for consumption by the principal or by any other person at the expense of the principal…

1.(c) ‘consumption' includes

(i) use,

(ii) the incorporation into any structure, building or fixture, of goods including those manufactured by the consumer or further processed or otherwise improved by him,

…

1(e) ‘goods' includes

(i) chattels personal, other than things in action,

(ii) admission charges and, except when used in section 12, telecommunication services, laundry and dry cleaning services, repair and installation labour and accommodation charges, each as defined in the regulations,…

At issue here is the question of whether the DMS-100 switch is incorporated into a building, structure or fixture. If it is, the consumer of the goods relating to the hardware portion of the switch is the Appellant and sales tax is calculated on the manufactured cost of the switch. If it is not, the hardware portion of the switch is a chattel personal and the consumer of the goods is Island Tel. In the latter instance, sales tax is calculated on the retail-selling price. The difference in taxes calculated on the manufactured cost versus the retail selling price is significant.

The Appellant argues that the hardware supplied to Island Tel is incorporated into the structure, building or fixture and is subject to tax at the time of such incorporation. According to the Appellant, Nortel, as the consumer of the materials, pays tax on the materials used in the building of the hardware. The Appellant argues, as well, that the hardware is incorporated into the telephone network—a structure affixed to, and part of, the real property.

The Respondent argues that the hardware is not incorporated into a structure, building or fixture. The Respondent submits that, although an object may be necessary for the proper functioning of a network, the addition of the hardware does not, of itself, incorporate the hardware into the network.

Donald Farmer, a consultant engaged by the Appellant, gave evidence respecting the integrated nature of the telephone network. He expressed the view that the characteristics of the network have not changed with advancements in technology. He submits that the DMS switch serves as a computer only to the extent that previous technologies, including a manual operator, served as computers. He further submits that the switch is permanently attached and fully integrated into the building and telecommunications network.

Yvon Tremblay, another consultant engaged by the Appellant, testified that the DMS switch is part of a fully integrated network that spans the province. The switch is supplied on a turnkey basis and is affixed to the building. According to Mr. Tremblay, it is part of the central office equipment portion of the telephone network and the fact that it uses digital technology does not change its nature. He submits that turnkey installations of central office equipment and the degree of affixation and purpose of annexation meet the defined requirements of real property.

The Commission also heard evidence from Philip Acorn, Island Tel's Vice-President of Operations. The thrust of Mr. Acorn's evidence is that the DMS switch is part of a fully functional telephone network and that the switch has no functional value unless it is part of the network.

Mr. Acorn also gave the following evidence on the issue of whether, in his view, the switch is incorporated into a structure, building of fixture:

Unlike some buildings, our buildings are specifically designed to house and protect the equipment. From the time we purchase the land ‘till the time we start constructing that building, that building is designed from the proper air conditioning, the back-up power plants, the way it's framed and fastened to the walls for one purpose only and that is to house the equipment itself. I am involved in that process especially from an approval process, but also from a detailed process for every one of those estimates pass my desk for approval. Again, this building—when a—when a switch is fastened in, it is also then wired in and is therefore connected electrically and physically to the building through a—a distribution frame. It's also then attached on the—on the other side of that frame to the outside plant cable which is physically connected as well to the building.
…
The network is a—is viewed as a whole. It cannot function without its parts and those parts had to be connected together to make the network work, in other words, and if you remove one of those elements out of that, the network would cease to work and by themselves, they're valueless.

(Transcript, December 15, 1997. pp. 28-29)

Kevin Dingwell, a property appraiser with the Department of the Provincial Treasury, gave evidence on behalf of the Respondent. He testified that the DMS switch is not real property within the meaning of Real Property Assessment Act in that the switch does not add utility to the building it is housed in. In the words of Mr. Dingwell:

If Island Telephone were to sell its Queen—Queen Street—or Queen and Fitzroy Street building, it is highly unlikely that the DMS switching equipment would be sold with it unless Island Tel were selling the—its entire telephone business. If Island Tel were to sell the building without selling the business the equip—the switching equipment would most likely be removed from there to a new location. The utility of the building would not be adversely affected by doing so and to go back to my previous comments, the—the building is assessed as an industrial building. There are other uses that could be put to a building without that equipment being in it.
(Transcript, December 17, 1997, p. 252)

The Commission notes that much of the evidence presented to it on this issue centers on the degree and object of annexation and the associated issue of whether the switch is real property. Indeed, much of argument of counsel centers on these issues as well.

The issue of whether the hardware was consumed by incorporation into real property was an issue raised in the initial stages of this case. The Commission was referred to a significant number of case precedents prior to the commencement of the hearing. These authorities and cases appear to deal primarily with the legal distinction between chattels and fixtures and appear to be summarized in Stack v. T. Eaton Co. et al (1902), 4 O.L.R., 335 (Div. Ct.), wherein the law relating to fixtures is summarized, at p. 338, as follows:

I take it to be settled law:
(1)    That articles not otherwise attached to the land than by their own weight are not to be considered as part of the land, unless the circumstances are such as shew that they were intended to be part of the land.

(2)    That articles affixed to the land even slightly are to be considered part of the land unless the circumstances are such as to shew that they were intended to continue chattels.

(3)    That the circumstances necessary to be shew to alter the prima facie character of the articles are circumstances which shew the degree of annexation and object of such annexation, which are patent to all to see.

(4)    That the intention of the person affixing the article to the soil is material only so far as it can be presumed from the degree and object of the annexation.

(5)    That, even in the case of tenants' fixtures put in for the purpose of trade, they form part of the freehold, with the right, however, to the tenant, as between him and his landlord, to bring them back to the state of chattels again by severing them from the soil, and that they pass by a conveyance of the land as part of it, subject to this right of the tenant.

The issue to be resolved in this case, however, is not whether the hardware in question became a fixture, or real property, but whether it was consumed by the incorporation into any structure, building or fixture. While the concept of classification of property into chattels and fixtures is helpful, we are unable to accept that this is synonymous with the words incorporation into any structure, building or fixture found in subsection 1.(c)(ii) of the Revenue Tax Act.

The Appellant and the Respondent have both referred the Commission to the Supreme Court of Canada case Cairns Construction Ltd. v. The Government of Saskatchewan [1960] S.C.R. 619. That case dealt with the Education and Hospitalization Tax Act of Saskatchewan and, although the wording is not the same as the Revenue Tax Act of Prince Edward Island, the case deals with similar concepts that we find helpful. In that case, at page 629, the following statements are made:

But it also appears to me that a person who purchases personal property and incorporates it into something else, in the process of which it loses its own identity as personal property, is the final user of that personal property so incorporated. The nails which were hammered into the structure, the paint placed on the walls, or shingles on the roof were finally used for the purposes for which they were created when they became part of the building. Equally, the prefabricated parts were finally used when they were incorporated into the house which the appellant constructed. The purchaser of a house would not thereafter use them as component parts. He would make use of the completed house.

Having heard the evidence of both parties and having seen the videotape of the hardware at issue, it is apparent to us that the equipment installed in the Island Tel building is not incorporated in the sense referred to above. The hardware has lost none of its original character and, although it was created for the purpose of incorporation into a telecommunications network, the method of attachment or connection was via bolts and electrical connections. The method of connection is, in our view, very similar to the degree of annexation described in the case Ontario Hydro v. Ministry of Revenue (1996), 4 G.T.C. 6048, wherein the court stated, at p. 6049, as follows:

…I am satisfied that the various component parts which comprise Hydro's microwave telecommunications system at its Pickering facility play an integral role in the business conducted by Hydro—the production and distribution of electricity. The equipment consists, for the most part, of various components that are attached by screws to metal racks, which are bolted to the floor of a small building, and removable modules which are placed on the shelves of the racks.

Finally, the Commission was referred to a number of cases originating in the province of Quebec. These cases appear to deal with similar issues to the case before us and, to a large extent, with similar equipment and a similar degree of annexation. However, as these cases deal with the Quebec Civil Code and its categorization of immoveables, we have placed no great reliance on these cases.

In the Commission's view, there is little doubt that Island Tel's communications network is dependent upon the DMS-100 switch. It is an integral and necessary component of the network. The evidence discloses that the switch is composed of, among other things, electrical and electronic wiring, electronic cards, a frame or enclosure to hold this and related equipment and a central processing unit, or CPU, and associated computing equipment. These elements are connected to the network via cabling and wiring and the framing to hold the switch is bolted to the floor of the Island Tel building. While Nortel's contract to set up a turnkey operation included other facilities, such as a permanent electrical connection, these other facilities are, in our view, distinguishable from the switch itself.

Based upon Cairns, above, the test to be applied in determining whether something is incorporated into a building, a structure, or a fixture is not, in our view, based on dependency, or specialization, or degree or object of annexation. Rather, the test to be applied is whether, on incorporation, the object retains or loses its original character. As noted above, we believe the switch has, by virtue of its installation into Island Tel's building and communications network, lost none of its original character. The switch remains a distinctive entity that could, in our view, be moved and, with reprogramming, re-utilized elsewhere.

If, however, we are incorrect in deciding that the law relating to fixtures should not be used in determining the issue of incorporation within the meaning of subsection 1.(c)(ii) of the Revenue Tax Act, we believe that the reasoning in Ontario Hydro v. Ministry of Revenue to be most persuasive. At pages 6049-50, the Court stated:

I agree with the submission made by counsel for the respondent that the weight of modern authority supports the conclusion that this equipment was not a fixture. Counsel's review of the cases indicated that the courts are more inclined to regard an item as a chattel if it is installed as part of the owner's business, as opposed to items installed to improve the freehold. For example, equipment installed in a factory to operate a business is usually found to be a chattel because it has nothing to do with improving the freehold…

In this case, the microwave equipment did not improve the building in which it was installed. It was installed to enable Hydro to carry out its business of producing and distributing electricity. Therefore, it constitutes a chattel. The retail sales tax was properly paid.

In our view, this equipment is clearly installed as part of the business operation of Island Tel.

Bearing in mind the scheme, object and context of the Revenue Tax Act, and having fully considered all of the evidence adduced, the submissions of counsel and the applicable law, the Commission finds and concludes that:

4.    the DMS-100 switch is not incorporated into any building, structure or fixture within the meaning of subsection 1.(c)(ii) of the Revenue Tax Act.

As a result,

5.    the decision of the Provincial Tax Commissioner, dated May 2, 1994, respecting sales tax on the hardware portion of the DMS-100 switch is affirmed.

3. Disposition

An Order incorporating the above findings will therefore be issued.

Order

UPON the appeal of Northern Telecom Limited against a decision of the Provincial Tax Commission dated May 2, 1994;

AND UPON hearing the evidence adduced as well as what was alleged by counsel at hearings conducted in Charlottetown on December 15, 16, 17 and 18, 1997;

NOW THEREFORE, for the reasons given in the annexed Reasons for Order;

IT IS ORDERED THAT

1.    The software operating the DMS-100 switch and updates to that software are not computer software within the meaning of Section 1.(g.1) of the Revenue Tax Act Regulations;

2.The decision of the Provincial Tax Commissioner, dated May 2, 1994, respecting sales tax on software associated with the DMS-100 switch is reversed;

3.    The decision of the Provincial Tax Commissioner, dated May 2, 1994, respecting sales tax on engineering and installation software is reversed;

4.    The DMS-100 switch is not incorporated into any building, structure or fixture within the meaning of subsection 1.(c)(ii) of the Revenue Tax Act; and

5.    The decision of the Provincial Tax Commissioner, dated May 2, 1994, respecting sales tax on the hardware portion of the DMS-100 switch is affirmed.

DATED at Charlottetown, Prince Edward Island, this 21st day of April, 1998.

BY THE COMMISSION:

Ginger Breedon, Vice-Chair

Deborah MacLellan, Commissioner

Elizabeth MacDonald, Commissioner

NOTICE

Section 12 of the Island Regulatory and Appeals Commission Act reads as follows:
12. The Commission may, in its absolute discretion, review, rescind or vary any order or decision made by it or rehear any application before deciding it.

Parties to this proceeding seeking a review of the Commission's decision or order in this matter may do so by filing with the Commission, at the earliest date, a written Request for Review, which clearly states the reasons for the review and the nature of the relief sought.

Sections 13.(1) and 13(2) of the Act provide as follows:

13.(1) An appeal lies from a decision or order of the Commission to the Appeal Division of the Supreme Court upon a question of law or jurisdiction.

(2) The appeal shall be made by filing a notice of appeal in the Supreme Court within twenty days after the decision or order appealed from and the Civil Procedure Rules respecting appeals apply with the necessary changes.

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