Gordon v. Canada

Gordon v. Canada
Court (s) Database
Federal Court Decisions
Date
2019-06-25
Neutral citation
2019 FC 853
File numbers
T-473-06, T-474-06
Notes
A correction was made on March 5, 2020
Decision Content
Date: 20190625
Dockets: T-473-06
T-474-06
Citation: 2019 FC 853
Ottawa, Ontario, June 25, 2019
PRESENT: The Honourable Mr. Justice Barnes
Docket: T-473-06
BETWEEN:
ALLAN JAY GORDON
Plaintiff
and
HER MAJESTY THE QUEEN
Defendant
Docket: T-474-06
AND BETWEEN:
JAMES A. DEACUR AND ASSOCIATES LTD.
AND JAMES ALLAN DEACUR
Plaintiffs
and
HER MAJESTY THE QUEEN
Defendant
JUDGMENT AND REASONS
Table of Contents
I. Background – The Allegations 3
II. Background – The Trial, the Witnesses and the Evidence 7
III. The Credibility of Ms. Northey 9
IV. Background – The Investigation 12
V. The JAD Methods – Backdating of Client Records 13
VI. Did the CRA Validate JAD’s Methods? 52
VII. JAD’s Methods Were Disclosed 62
VIII. The Allegations of Negligence 74
IX. Standard of Care – Negligence 75
X. The Legal Significance of the TOM II Manual 86
XI. The Failure to Interview Messrs. Deacur and Gordon 88
XII. The Failure to Reassess 93
XIII. The Failure to Transfer the JAD Investigation to the RCMP 94
XIV. Intimidation of Witnesses 95
XV. Mr. Deacur Said to be Volatile 97
XVI. Alleged Mixing of the CRA Audit Function and the Special Investigations 98
XVII. The Theft of Ms. Northey’s Vehicle and Investigative Records 100
XVIII. Failure to Supervise 100
XIX. ITA Section 239 112
XX. Deacur as a “Troublemaker” 114
XXI. The Supposed Failure to Use Form T-134 to Support CRA Audit Referrals to Special Investigations and Borrowed Records 114
XXII. Was Ms. Northey Qualified to Lead the JAD Investigation? 116
XXIII. Mr. Patrick Wong 120
XXIV. Standard of Care – Malicious Prosecution 122
XXV. Did the CRA Initiate the Prosecution? 123
XXVI. Was the Decision to Initiate a Prosecution Against the Plaintiffs Made Without Legal and Probable Cause? 124
XXVII. Was the JAD Investigation Motivated by Malice or With an Unlawful Purpose? 126
XXVIII. The Economic Interference Allegations 127
XXIX. Breach of Charter Allegations 130
XXX. Conclusion 130
I. Background – The Allegations
[1] In these proceedings, Allan Jay Gordon, James A. Deacur and Associates Ltd. [JAD] and James Allan Deacur seek damages from the Government of Canada based on pleaded allegations of tortious conduct arising out of a Canada Revenue Agency [CRA] criminal investigation. That investigation began in late 1995 and culminated in the indictment and prosecution of Messrs. Deacur and Gordon on five counts of fraud, attempted fraud and possession of the proceeds of crime. The charges they faced related to their preparation of 31 scientific research and experimental development [SR&ED] claims submitted on behalf of a number of taxpayer clients seeking to obtain substantial tax credits [1] .
[2] After a lengthy preliminary hearing, that ran intermittently between May 27, 1999 and April 29, 2003, Messrs. Deacur and Gordon were committed to stand trial. Nevertheless, on September 24, 2004 the prosecution ended when Crown counsel entered a stay of proceedings.
[3] Messrs. Deacur and Gordon are aggrieved by the conduct of the CRA employees who conducted the subject investigation [the JAD investigation] and they assert several causes of action including negligent investigation, breach of Charter rights, misfeasance in public office, malicious prosecution and intentional interference with contractual relations. No allegations are made against the CRA for the work performed by its auditors and by virtue of s 152(8) of the Income Tax Act, RSC, 1985, c 1 (5th Supp) [ITA] this Court has no authority to entertain a collateral attack on the correctness of any such assessment even if it is alleged to have arisen through an abuse of process: see Roitman v R, 2006 FCA 266 at paras 19-20 and 25, [2006] FCJ No 1177. The earlier pleadings of malicious prosecution against the Crown Prosecutors, defamation and perjury, were either struck from the Statements of Claim by Order of Case Management Prothonotary Kevin Aalto dated October 26, 2012 or abandoned. Nevertheless, the Plaintiffs argued throughout the trial about the conduct of the Crown prosecutors, particularly with reference to disclosure. I have not taken those assertions into account.
[4] The conduct of this proceeding has been extremely acrimonious both before and during the trial. That acrimony in no small measure stems from the visceral and contemptuous opinions that Messrs. Deacur and Gordon hold of the CRA investigators and of the quality of their work. Those views are strongly expressed in the pleadings. Mr. Deacur’s Statement of Claim includes allegations of arbitrary and oppressive conduct, falsification of records, malicious falsehoods, unlawful seizure of property, wilful blindness and incompetence directed at numerous CRA officials. Mr. Gordon’s Statement of Claim is similar in tone and content. He alleges that CRA investigators knowingly made false accusations and lied about their conduct. In paragraph 66 he asserts that the lead investigator, Patricia Northey, made “false allegations” as part of a “fraudulent scheme…to profit from her dishonest behaviour”. Many other allegations of incompetence and dishonesty are set out throughout Mr. Gordon’s pleading and were frequently repeated by Mr. Gordon throughout the trial. The Plaintiffs’ Post-Trial Brief is similarly replete with allegations of corruption and dishonesty – mainly, but not exclusively, directed at Ms. Northey.
[5] Notwithstanding the Plaintiffs’ broad pejorative characterizations of the CRA investigation, the particulars of the “misconduct” and “negligence” they assert are reasonably discrete. They complain that CRA investigators failed to follow fair procedures including some that were recommended in the CRA TOM II Manual or in the CRA Declaration of Taxpayer Rights [2] . Their complaints include the following:
(a) A failure to invite Messrs. Deacur and Gordon to attend for an interview or to make potentially exculpatory submissions in advance of charges being laid.
(b) A failure to notify Mr. Gordon 30 days in advance of charges that he was a target of the investigation.
(c) A failure to turn the investigation over to the RCMP once it became clear that charges under the Income Tax Act, RSC, 1985, c 1 (5th Supp.) [ITA] were not warranted.
(d) The borrowing of records from some taxpayers in support of the investigation.
(e) The intimidation of certain JAD employees and taxpayer clients as a means of obtaining incriminating information.
(f) The mischaracterization of Mr. Deacur as a potential threat in order to obtain RCMP support for the execution of search warrants.
(g) A failure to use form T-134 as the accepted means of referring suspect files to Special Investigations.
(h) The assignment of the investigation to Ms. Northey whose experience grade was below the rated complexity of the case.
(i) A failure to refer the suspect files for a reassessment before the laying of charges.
(j) An alleged mixing of the CRA audit function with the investigation.
(k) The theft of Ms. Northey’s vehicle containing investigative records.
(l) A supposed failure by the CRA to supervise Ms. Northey in the conduct of the JAD investigation.
(m) The alleged misstatement of evidence given by JAD employee, Patrick Wong, to CRA investigators.
[6] More generally Mr. Gordon’s and Mr. Deacur’s theory of liability is based on allegations that Ms. Northey, her colleagues and her supervisors lacked even a rudimentary understanding of SR&ED rules and practices and therefore fundamentally mischaracterized their methods as unlawful. According to this view, the CRA investigators failed to understand the law insofar as it permitted an SR&ED claim to be made on the strength of an after-the-fact recorded entry of an account payable and/or based on fair market valuations instead of bare wages. This lack of basic knowledge, they say, caused the investigators to focus on matters that fell well within the law and which could not reasonably have raised any legal or compliance concerns. They also assert that their impugned accounting methods were validated by some CRA auditors and were ultimately vindicated by three client SR&ED appeals that were allowed after the criminal proceeding was stayed.
[7] It goes without saying that the onus of proof for every element of the alleged causes of action rests with the Plaintiffs.
II. Background – The Trial, the Witnesses and the Evidence
[8] The trial of these actions took place in Toronto between October 15, 2018 and December 20, 2018. Twenty-three witnesses testified and 461 exhibits were introduced. Oral argument and a few remaining evidentiary matters were concluded during the week of February 4, 2019. Detailed written submissions were subsequently provided by the parties and have been carefully considered. The two actions were tried together and this single set of reasons applies to both proceedings.
[9] These actions have been underway in this Court since March 2006 and, for the most part, concern matters dating back to the early 1990s. After the passage of more than 20 years, the quality of witness testimony left much to be desired. As one would expect, the memories of most witnesses had faded or were, in places, non-existent. Fortunately, the available documentary record is reasonably robust and permits the Court to understand much of what took place even where the witnesses could not fully describe it from memory.
[10] The evidentiary record in this case also includes many statements and statutory declarations taken by CRA investigators from persons who were not called as witnesses. That evidence would be inadmissible as classic hearsay if it were received as proof of the truth of its contents. Considerable care must, therefore, be taken as to the use to which this evidence can be put. It cannot be considered for its truth but only as evidence of what the CRA investigators understood about the merits of the case going forward. The conduct and motivations of the investigators in pursuing the investigation and in recommending the laying of criminal charges can be evaluated on the basis of what they learned and recorded from these sources. Similarly, the fact that some clients had expressed reservations about JAD’s methods only serves to establish that those concerns had been raised with JAD representatives. Whether the concerns were valid is not the issue, but only that Messrs. Deacur and Gordon had been told that some clients and JAD employees were uncomfortable with their approach to the presentation of SR&ED claims.
[11] Mr. Gordon frequently asserted that many witness statements were coerced by the investigators and contain errors, if not falsehoods. However, he led no evidence to support those allegations and he failed to establish any material mistakes in what the investigators recorded. This is not entirely surprising because the witness statements conform closely to the documentary record and to the essential facts that Mr. Deacur and Mr. Gordon somewhat reluctantly acknowledge. It was, of course, open to the Plaintiffs to call any of these witnesses to testify about the accuracy of their recorded statements or to speak to the CRA’s investigative methods but, with the exception of Messrs. Savelli and Durst, no JAD clients testified. And in the case of those witnesses no evidence of intimidation or material inaccuracy was developed. Similarly, the Plaintiffs called only two JAD employees – Ron Worthington and Kyle Bondergaard. Mr. Bondergaard said it was unsettling and unnerving to be read his rights in the course of his interaction with CRA investigators but he did not otherwise take issue with their approach. Mr. Worthington was also given a Charter caution but acknowledged that the approach was not “abusive or anything” [p 1292]. Several former JAD employees who presumably had relevant evidence to offer – notably Patrick Wong – were not called and their statements to CRA investigators were, therefore, left unchallenged.
[12] What the witness evidence consistently indicated to CRA investigators was that JAD frequently employed a strategy involving backdated records to support asserted transactions that did not take place at the relevant time and to thereby maximize the value of SR&ED claims on behalf of some of its clients. By virtue of the use of contingency fee agreements, this approach also had the potential to maximize JAD’s fees. The information also indicated to CRA investigators that JAD’s clients were either mostly unaware of the methods or were reassured by JAD representatives that those methods were acceptable and lawful.
III. The Credibility of Ms. Northey
[13] It is very apparent that Messrs. Deacur and Gordon hold Ms. Northey in profound contempt and largely, if not wholly, responsible for the criminal prosecution. Throughout this proceeding, they accused her of incompetence, malice, dishonesty and corruption. Mr. Gordon’s feelings towards Ms. Northey are particularly visceral. During his cross-examination of her, he frequently accused her of dishonesty and, on one occasion, he told her she was a “crook”. What is particularly disturbing about these allegations is that they are entirely baseless. They are opinions based on personal enmity alone.
[14] Ms. Northey consistently gave a reliable history of relevant events – a history that accords with the documentary record. She was not prone to exaggeration, speculation or hyperbole. She testified in a straightforward manner, explaining her actions and decisions through the investigation. Her evidence was also markedly consistent with that given by the several other CRA witnesses who were also involved in the JAD investigation.
[15] The impression I have of Ms. Northey is one of fairness, competence, diligence and thoroughness. Her investigation was intelligently conducted and carefully recorded. Notwithstanding her AU2 status in 1995, I am satisfied that Ms. Northey was well qualified to lead the JAD investigation and the CRA’s confidence in her abilities was not misguided or misplaced.
[16] I note as well that Ms. Northey’s considerable abilities have not gone unnoticed within the CRA. This is evidenced by her subsequent rapid rise through the employment ranks and by the consistently favourable views of her abilities as related by her many colleagues who testified.
[17] I reject unreservedly the Plaintiffs’ contention that Ms. Northey’s investigation was improperly motivated, dishonest or incompetent. To the contrary, it was proficiently and fairly conducted. Ms. Northey established that she was at all times careful and highly professional. Her memory of relevant events was much better than most of the other witnesses. This is unsurprising given her central role in the JAD investigation, her practise of diligently recording her work and her intervening attendance over a period of several weeks as a witness in the criminal preliminary hearing. Where Ms. Northey’s evidence conflicts with the evidence of any other witness, I accept her testimony. In the end, however, there were few evidentiary conflicts of any significance. What happened at that time is well documented and mostly not seriously disputed by Messrs. Deacur and Gordon. It is the characterization of what took place where the disagreement mostly lies in this case.
[18] I would add that the Plaintiffs’ allegation that Ms. Northey was on a personal mission to falsely and maliciously build a prosecution case by intimidating JAD’s employees and clients is belied by the myriad of investigators who were assigned to conduct witness interviews and by the evidence they acquired. The idea that Ms. Northey was motivated by the receipt of modest acting pay and was able to co-opt her many colleagues into intimidating witnesses is both manifestly implausible and wholly unproven. As described later in these reasons, Ms. Northey’s work was also carried out under active CRA supervision at the highest levels. This belies the Plaintiffs’ assertion that she fabricated an untenable prosecution theory that was patently inconsistent with established accounting and tax principles.
[19] The Plaintiffs’ specific suggestion that Ms. Northey was motivated to prolong her investigation because she was receiving additional income from an acting AU4 assignment has no evidentiary foundation. In fact, the record discloses that the Deacur file was given priority and, despite its breadth, it moved forward with relative dispatch. This can be seen from Exhibit D-53 where the Chief of Special Investigations in Hamilton, Rick Michal, directed an interview “blitz” to keep the investigation moving along. This was accomplished by assigning more investigators who were expected to put some of their other work on hold. It is perhaps in recognition that this financial motivation theory is baseless that it is now alleged in the Plaintiffs’ Post-Trial Brief at paragraph 698 that the malicious object of the investigation was to block legitimate SR&ED claims [3] .
IV. Background – The Investigation
[20] The CRA’s concern about the Deacur approach to SR&ED claims initially arose out of multiple, routine SR&ED audits across several CRA offices in and around the Greater Toronto Area. Those audits revealed a pattern of suspicious conduct that was thought worthy of further examination. The identified audit concerns involved high and unsupported labour valuations and the use of backdated taxpayer records. These early audit concerns were raised well before Ms. Northey became involved in the investigation and they informed the decision taken in consultation with numerous CRA officials in November 1995 to launch the investigation into JAD’s methods. What is also evident is that the full extent of JAD’s backdating of taxpayer records had not, at that point, been uncovered [eg see Exhibit D-383].
[21] In the earliest stages of the investigation, Ms. Northey had no involvement. After she was assigned as lead investigator by Mr. Michal many other investigators and supervisors actively assisted. For many months during the investigation, Ms. Northey was on two maternity leaves and was not involved at all. Furthermore, multi-level reviews and approvals were required at every major decision-point including the decision to launch an investigation, the approval of the Primary Report, the decisions to seek and to issue search warrants (including the required judicial authorization), the approval of the Prosecution Report and the decision, in consultation with the Crown prosecutors, to lay criminal charges. Once charges were brought, the authority to continue the prosecution rested with counsel for the Attorney-General and ultimately with the Judge who committed Messrs. Deacur and Gordon to stand trial.
V. The JAD Methods – Backdating of Client Records
[22] In order to assess the reasonableness and lawfulness of the CRA’s conduct, it is necessary to understand what the Plaintiffs were doing in the presentation of their clients’ SR&ED claims to the CRA and the basis on which they say it was justified. It is only with an appreciation of JAD’s methods that I can determine whether there were reasonable and probable grounds to initiate and continue the JAD investigation to the point of a prosecution.
[23] The evidence indicates that JAD promoted itself as a SR&ED specialist firm. It actively solicited SR&ED work and ultimately was responsible for filing several hundred claims on behalf of many taxpayer clients. Many of these clients had little, if any, knowledge of the SR&ED program and had no reason to document the work they were doing or to isolate its costing.
[24] For most of the cases that ultimately became the subject of the prosecution, Messrs. Deacur and Gordon attempted to overcome the absence of documentation by creating the evidence after-the-fact. For some clients, they set up non-arm’s length companies to create the appearance of a sub-contracting relationship. These arrangements also involved the creation of invoices to support the existence of an ostensible subcontract. In these cases there had never been an actual intention by the client at that time to outsource the R&D work to a third party, nor was there any realistic expectation that the subcontract invoices would ever be paid.
[25] Problems with JAD’s SR&ED methodologies were identified by a number of auditors working independently out of different tax offices. Several of the early audit reports involving JAD clients refer to the use of backdated records including corporate histories all in support of claimed management fees.
[26] Ms. Northey testified that from her review of this initial audit material a pattern emerged involving fictitious records and entries in support of many JAD-prepared SR&ED filings. This is borne out by several 1995 audit reports. A December 1995 memo from a Toronto West auditor to Mr. Michal, listed the following problems:
(a) falsehoods;
(b) backdating of documents;
(c) no payments ever made;
(d) use of associated (possibly shell) corporations to legitimize claims;
(e) inflated expenses; and
(f) no SR&ED performed. [Exhibit D-383 at Tab 69]
[27] References to inflated claims, tax manipulation and backdating can be seen throughout a compendium of early audit materials contained in Exhibit D-383, notably at Tabs 6, 51, 55, 57, 68 and 72. A letter from a client, Tim Curtis, described the claim prepared by JAD in the following way:
It was obvious to all informed parties that the claim was not legitimate and hence I did not pursue it. The expenses declared were not incurred specifically for R&D but rather related to work I had completed in the course of normal business which provided me with much need [sic] information for the development of my ideas.
I believe that in good faith I entrusted Deacur And Associates to act on my behalf. If they have taken advantage of the system to the extent that I would surmise, then I believe I would be remiss if I did not do my part to expose them to the authorities. It gives the accounting profession a bad reputation. [Exhibit D-383, Tab 70]
[28] The JAD method of supplying or using companies and ostensible invoices after-the-fact to support inflated management fees was, according to client interviews, widespread. Exhibit D‑418 contains 88 witness statements taken by CRA investigators. This method was described by many JAD clients as can be seen at Tabs 7, 8, 9, 11, 12, 13, 14, 15, 16, 17, 18, 20, 21, 22, 23, 25, 26, 27, 28, 29, 30, 32, 33, 34, 35, 38, 40, 41, 42, 43, 44, 45, 55, 77, 78, 79, 80, 81 and 82.
[29] Not all of JAD’s clients appear to have been comfortable with what was going on. For instance, the bookkeeper for JAD client, Bale-Eze Inc., told the CRA he was so concerned about the method being used by JAD that he resigned as an officer for the two companies involved [Exhibit D-418 at Tab 19]. A similar concern expressed by the accountant for Martinville Hockey Sticks Inc. is noted at Tab 36.
[30] Several JAD employees also expressed reservations about its methods of documenting SR&ED claims [Exhibit D-418, Tabs 84, 86 and 87]. JAD employee Patrick Wong told CRA investigators that Mr. Deacur had advised him to set up a management company to support inter-corporate management fees and to use shell companies owned by JAD. His statement to the CRA included the following:
…
…
[Exhibit D-328] [Handwritten and initialled]
[31] Several CRA auditors also testified about their observations and concerns about JAD’s methods including Michael Wilson. Mr. Wilson is a long-standing CRA auditor. He testified on behalf of the Defendant. I found him to be a reliable witness albeit with some understandable gaps in his independent recollection of relevant events.
[32] In the mid 1990s, Mr. Wilson was an SR&ED team leader working out of the Belleville office. In that capacity, he had supervisory responsibility for a number of SR&ED claims filed by JAD. Because of the size of many of these claims, they were considered to be high risk warranting close scrutiny. Several of the claims were also based on asserted management fees between two related corporations involving significant amounts somewhat out of step with the scope of the taxpayers’ business activity and with the amount of supporting documentation [p 3933, p 3937 and p 3941].
[33] In some instances the SR&ED claims that were based on management fees were disallowed because of concerns about the reasonableness or legitimacy of the asserted fees. In the case of Bale-Eze Inc., Mr. Wilson denied the management fee claim of $850,375 for the following reasons:
The item is also considered under subsec. 18(1)(e). This subsection disallows expenses that are contingent. If at the time of it’s creation, uncertainties exist in respect of whether the amount can be paid, or the time at which the payment will be made, the liability is in it's nature, contingent upon other events. A conditional obligation has no obligatory force until these conditions are met. The apparent inability to pay the amount, as noted above, supports the contingent nature of the accrual. Therefore, the item is being considered to be a contingent liability and not a deductible expense in the 1993 fiscal year.
During the years in question, the management corporation did not report that it possessed any employees to provide the management services, nor did there appear to be any management organizational structure that would have enabled it to perform the services on behalf of the operating corporation. The management corporation also did not report the earning of the income from performing such activities on the accrual basis for the years 1990 through 1993. [Exhibit D-270]
[34] A management fee claim submitted by JAD on behalf of Bubble Action Pumps Ltd. in the amount of $450,000 was rejected by Mr. Wilson on the same basis [Exhibit D-278].
[35] Mr. Wilson described SR&ED claims filed by JAD on behalf of 687348 Ontario Limited where subcontract expenditures of $450,480, $484,440 and $371,040 were asserted for three taxation years [Exhibits D-280, D-281 and D-282]. Each of these claims was supported by invoices between two numbered companies for “R & D services rendered” [Exhibits D-284, D‑285 and D-286]. In another set of SR&ED claims, asserted management fees between the two numbered companies were reversed for an entirely different set of research projects [Exhibits D‑288, D-289, D-290, D-291, D-292, D-293, D-294]. Mr. Wilson described the accounting situation in the following way:
Q. Can you just explain to us how this worked. So there are two different numbered companies and both filed claims for three years?
A. Yes.
Q. Is that right?
A. Yes.
Q. And the two companies billed each other?
A. Correct.
Q. So which company was supposed to be doing the work and which company was the management company; or do you know?
A. Based on that the science said there was no activity or qualifying activity done, it would be hard to say which corporation was responsible for it.
In that regard, if you have got two closely held companies and you are billing them for hours each way, there's really only Mr. Harcourt was the principal involved in the corporation. By submitting two invoices cross-charging the corporations, he would have spent 7,365 hours in one year working on the R&D, if that was Mr. Harcourt himself, which is why additional information would have been required for a breakdown of these hours and cost on these invoices.
Remember that the standard work week is 2,050 hours, which is what most people look at, a 40-hour work week. If you are doing 60 hours it would again be around 6,000 hours. So to see 7,000 hours in billing for one year is a bit unusual. [pp 3980-3981]
[36] Mr. Wilson was sufficiently concerned about JAD’s approach that he wrote to the Manager of the SR&ED audit program in Ottawa describing his findings [Exhibit D-296].
[37] Bonnie Jarrett testified on behalf of the CRA where she continues to be employed. She holds a Chartered Management Accountant designation. She was a well-spoken witness who gave her evidence in an efficient and business-like manner. She is extremely careful, competent and knowledgeable.
[38] Ms. Jarrett was responsible for the financial audit of a JAD-prepared SR&ED claim for Clare Work Stations Inc./Jakry Industries. When she examined the claim, she identified a problem with the two non-arm’s length corporations submitting SR&ED claims on the strength of offsetting book entries without any actual expenditure of funds [p 3856 and p 3858]. She was sufficiently concerned that she wrote a memo to head office [Exhibit D-248]. Her testimony on the same point was the following:
A. I just meant, with no supporting documentation or contracts or validation of expenditures, journal entries can just be made both ways where you have more than one corporation with receivables and payables offsetting each other, resulting in no taxes payable and large R&D claims that never have a cash outlay, never paid, and that was not the intent of the legislation. We are trying to support people doing R&D who have actually spent money on R&D. So people would be getting ITC -- investment tax credit refunds with -- just based on journal entries. And the journal entries weren't limited in dollar. They could be made for hundreds of thousands of dollars because there was no documentation to prove otherwise.
Q. And so if taxpayers -- or when taxpayers don't always submit complete cost allocations for projects, what would be a fair method to calculate the wages for R&D?
A. Based on the T4.
Q. Okay.
A. But there was no T4 in this case.
Q. And what would be the process of determining what a reasonable dollar amount is when looking at a project where work is done?
A. Look at the number of hours spent on the eligible activities, come up with an hourly rate and times it by the number of hours spent on the activities. Applying reasonableness. [p 3869]
[39] Art Payne was employed for 33 years with the CRA. In the mid-1990’s, he worked as a senior investigator and in that capacity he assisted with the JAD investigation. In particular, he was present during many JAD client interviews and was responsible for the preparation of sworn statements taken from many of those witnesses. Much of his testimony concerned his interactions with witnesses and the information they conveyed about JAD’s methodologies. What he learned disclosed a pattern of backdating of records to create the illusion of inter-corporate transactions all in support of inflated SR&ED valuations. In many instances JAD client representatives confirmed that JAD had provided shell corporations with backdated ownership information and fictitious invoices for supposed management fees.
[40] Mr. Payne was asked under direct examination about his perception of the JAD investigation and, in particular, Ms. Northey’s involvement. He answered that he had no concerns about Ms. Northey’s conduct and based on the interviews he conducted, he believed there was evidence to support the investigation [p 4326]. Under cross-examination, he gave the following answer:
Q. Right, okay. But, I mean, for you as an investigator, I am trying to figure out at what time -- like, let's say you think one calculation method is right, and the tax preparer thinks he could use a different one. At what point do you start trying to verify if you're right or the preparer's right?
A. In my experience, I go on the number of statutory declarations we obtained, the stories that we get from those various witnesses. If it looks suspicious to me, especially as a certified fraud examiner, if I am seeing suspicious invoices, if I see corporations that have been backdated, to me that is indication of fraud. So then I would prepare the search information, based on the seized records, of course it's Patricia Northey's case, but based on what she gets together, if she finds additional evidence in those seized records, this shows that there's been interviews held, that there's notes taken, that additional documentation supplied, then she takes that all into consideration before she does her prosecution report. [p 4346]
[41] In their testimony both Mr. Deacur and Mr. Gordon expressed rather benign views of the methods they and others in the firm had used to document SR&ED claims on behalf of many clients. Under direct and cross-examination, Mr. Deacur explained that as long as the SR&ED work had been done by a client, it was largely “irrelevant” how the claim was represented in accounting terms [pp 2160, 2164 and 2187]. Mr. Gordon similarly expressed the opinion that it was legally permissible to advance a SR&ED claim on the strength of a purported contractual obligation that did not exist when the work was carried out. He, too, said the method of recording the transaction was “irrelevant” [pp 3065 and 3108]. In other words, it was appropriate to overcome a lack of documentation in the hands of a client by creating an accounting history that did not exist at the time the SR&ED work was performed. In many cases this was accomplished by furnishing a client with a second related company to serve as an anchor for a supposed SR&ED transaction. That transaction was then represented by an after-the-fact invoice or journal entry recording an SR&ED valuation – a valuation that was typically higher than a valuation based on the wages paid to those carrying out the work at the time. According to Mr. Deacur, the claim could be advanced on the strength of a recorded “payable” whether or not a legal obligation to pay existed at the time the SR&ED work was performed. This point is evident in the following exchange under cross-examination:
Q. Mr. Deacur, in your testimony on Thursday you said:
“We were using shelf or management companies to facilitate basically a post R&D claim because as long as the work was done and it was payable, and it was, if the science qualified and the fair market value was a fair market value or reasonable, then we would deduct that as an R&D expenditure. Then there would be a second corporation receiving funds and then we would have to deal with the taxes in the corporation.” [As read]
That was page 117, 16 to 25 of the transcript from last week.
Do you dispute that the legal obligation between the two companies had to be payable at the time that the R&D work was done?
A. It had to be payable. I don’t know why you are using the expression “legal obligation”. It had to be payable. [p 2177]
[42] Mr. Deacur gave a similar answer under later cross-examination:
Q. Mr. Deacur, when you say "payable," in your lexicon is that a mere journal entry, an accounting entry that makes something a payable?
A. Well, to be payable a whole set of circumstances would have to occur. There would have to be a genuine attempt at doing an R&D project, right. There would have to be bona fide time spent and it would have to be reasonable. Then there would be the determination of what would be a reasonable amount for -- to allocate for those services for those hours spent, and so it would then have to be accrued, at some point becoming a payable.
Q. So is something more required, such as an obligation or a mechanism to enforce the payment, such as a contract?
A. It has to be real in the sense that what the amount was charged on a reasonable basis and for a reasonable -- on a reasonable project. To then argue -- sorry, the question was?
Q. Is something more required than a mere journal entry to make something payable, i.e., is an obligation or mechanism to enforce the payment, such as a contract, required?
A. I don't see that between corporations, no.
Q. So company A can put in a journal entry in its general ledger stating that it paid company B $100,000 for management fees, but company A never paid the money and had no contract with company B, and company B received nothing of this transaction. Does that $100,000 constitute a payable amount or is it fictitious?
A. Well, you haven't established the basis for the $100,000. Is there a service rendered. Like we are talking here about a real R&D attempt.
Q. There can't have been --
A. We are not talking about some imaginary doing it just to obtain an R&D tax credit. We are talking about a real attempt. And this is what your -- the question doesn't address the issue of what that amount is for.
Q. The secondary company didn't exist at the time; agreed? In the year?
A. Yes. [pp 2348-2349]
[43] The point that Mr. Deacur misses in the above exchanges is that there could never be a valid “payable” without a legal obligation to pay; and a legal obligation to pay could not be created in circumstances where no intention to contract and no contract ever existed.
[44] Mr. Deacur’s explanation for using backdated invoices was similarly unconvincing. In the following exchange, he glossed over the problem in the following way:
Q. So then what you are saying is it was up to the auditor to catch it?
A. To catch what?
Q. To catch what was really going on?
A. It was up to the auditor to catch that there was R&D.
Q. And that the R&D was a current, a current expenditure in the year incurred?
A. It had to be payable in the year that the work was done and accrued in that year. Hours were reasonable, rates were reasonable, science was understandable and thought to be R&D. R&D was not a game played on the basis of invoices. R&D is an actual process.
Q. So why were the invoices prepared at all, then?
A. I wouldn’t have prepared invoices. I am not a – I don’t like – but if the they want invoices to support a – it helps to – it helps.
Q. It helps to make it appear as though those transactions occurred?
A. Well they did because we have got live things. It’s not the paperwork, it’s the what happened, and it was done at fair market value and it was accrued. [p 2188]
[45] When asked about whether an accrual for accounting purposes required the existence of a legal obligation, Mr. Deacur conceded that he was not qualified to answer [p 2350].
[46] Mr. Gordon also acknowledged that the SR&ED claims JAD presented to the CRA involved “a lot of backdated documents” [p 3206]. Like Mr. Deacur, he testified that a notional payable between two parties could support an SR&ED valuation whether or not an actual transaction existed at the time the work was carried out. Mr. Gordon was also aware that JAD was providing companies to some of its clients to support higher SR&ED valuations based on ostensible contractual arrangements [p 3184]. However, when he was pressed to justify these methods, he gave evasive responses including the following:
Q. But a payable, by definition, there has to be a legal obligation to pay in a reasonable time?
A. Well, I am not a legal expert with the legal definition. I know a lot of -- there's been a lot of court cases and that's the argument; though it's set up as a payable but, you haven't agreed to when it's going to be paid.
So, I mean, you you'd have to get into the whole law of payables. I am sure you don't want me to talk about 20 minutes about payables now. So, no, like, your questions, again, you are trying to take one word and assign it a minute definition. That's not the way the law works. I wish the law worked that way that you could come up with something in 2 minutes and have everybody agree to it. I wish you could do that in law, but that's not the way the law seems to work. [p 3167]
[47] Mr. Deacur and Mr. Gordon testified that there are several legitimate tax and estate planning reasons for using more than one corporation. This device is, in some situations, a lawful way to split income or to protect assets. They also referred to a text book that they and others in their office had relied upon in the development of SR&ED strategies [Exhibit P-104] [4] . That text explained in the following way why the use of separate corporations could be useful in the presentation of SR&ED claims: