Beaudry v. The Queen

Beaudry v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2008-01-30
Neutral citation
2008 TCC 17
File numbers
2000-2049(IT)G
Judges and Taxing Officers
François M. Angers
Subjects
Income Tax Act
Decision Content
Docket: 2000-2049(IT)G
BETWEEN:
YVES BEAUDRY,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
____________________________________________________________________
Appeal heard on common evidence with the appeals of
James Bullock (2000-2026(IT)G),
Christopher Herten-Greaven (2000-2039(IT)G),
Raphaël Evanson (2000-2044(IT)G),
Oleg Romar (2000-2045(IT)G),
Martin Tyler (2000-2056(IT)G),
David Elkins (2000-2069(IT)G),
James W. McClintock, Executor of the
Estate of John P. McClintock (2000-1189(IT)G)
on April 3, 4, 5, 6, 7, 10, 11, 12 and 13, 2006,
and September 25, 26, 27, 28 and 29, 2006,
at Montreal, Quebec.
Before: The Honourable Justice François Angers
Appearances:
Counsel for the Appellant:
Yves St-Cyr and
Dominic Belley
Counsel for the Respondent:
Guy Laperrière, Janie Payette
and Susan Shaughnessy
____________________________________________________________________
JUDGMENT
The appeal from the assessments made under the Income Tax Act in respect of the 1985, 1986, 1987, 1988, 1989 and 1990 taxation years is dismissed, with costs, in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 30th day of January 2008.
"François Angers"
Angers J.
Translation certified true
on this 28th day of May 2010.
Erich Klein, Revisor
Docket: 2000-2026(IT)G
BETWEEN:
JAMES BULLOCK,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
____________________________________________________________________
Appeal heard on common evidence with the appeals of
Yves Beaudry (2000-2049(IT)G),
Christopher Herten-Greaven (2000-2039(IT)G),
Raphaël Evanson (2000-2044(IT)G),
Oleg Romar (2000-2045(IT)G),
Martin Tyler (2000-2056(IT)G),
David Elkins (2000-2069(IT)G),
James W. McClintock, Executor of the
Estate of John P. McClintock (2000-1189(IT)G)
on April 3, 4, 5, 6, 7, 10, 11, 12 and 13, 2006,
and September 25, 26, 27, 28 and 29, 2006,
at Montreal, Quebec.
Before: The Honourable Justice François Angers
Appearances:
Counsel for the Appellant:
Yves St-Cyr and
Dominic Belley
Counsel for the Respondent:
Guy Laperrière, Janie Payette
and Susan Shaughnessy
____________________________________________________________________
JUDGMENT
The appeal from the assessments made under the Income Tax Act in respect of the 1985, 1986, 1987, 1988, 1989 and 1990 taxation years is dismissed, with costs, in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 30th day of January 2008.
"François Angers"
Angers J.
Translation certified true
on this 28th day of May 2010.
Erich Klein, Revisor
Docket: 2000-2039(IT)G
BETWEEN:
CHRISTOPHER HERTEN-GREAVEN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
____________________________________________________________________
Appeal heard on common evidence with the appeals of
Yves Beaudry (2000-2049(IT)G),
James Bullock (2000-2026(IT)G),
Raphaël Evanson (2000-2044(IT)G),
Oleg Romar (2000-2045(IT)G),
Martin Tyler (2000-2056(IT)G),
David Elkins (2000-2069(IT)G),
James W. McClintock, Executor of the
Estate of John P. McClintock (2000-1189(IT)G)
on April 3, 4, 5, 6, 7, 10, 11, 12 and 13, 2006,
and September 25, 26, 27, 28 and 29, 2006,
at Montreal, Quebec.
Before: The Honourable Justice François Angers
Appearances:
Counsel for the Appellant:
Yves St-Cyr and
Dominic Belley
Counsel for the Respondent:
Guy Laperrière, Janie Payette
and Susan Shaughnessy
____________________________________________________________________
JUDGMENT
The appeal from the assessments made under the Income Tax Act in respect of the 1985, 1986, 1987, 1988, 1989 and 1990 taxation years is dismissed, with costs, in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 30th day of January 2008.
"François Angers"
Angers J.
Translation certified true
on this 28th day of May 2010.
Erich Klein, Revisor
Docket: 2000-2044(IT)G
BETWEEN:
RAPHAËL EVANSON,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
____________________________________________________________________
Appeal heard on common evidence with the appeals of
Yves Beaudry (2000-2049(IT)G),
James Bullock (2000-2026(IT)G),
Christopher Herten-Greaven (2000-2039(IT)G),
Oleg Romar (2000-2045(IT)G),
Martin Tyler (2000-2056(IT)G),
David Elkins (2000-2069(IT)G),
James W. McClintock, Executor of the
Estate of John P. McClintock (2000-1189(IT)G)
on April 3, 4, 5, 6, 7, 10, 11, 12 and 13, 2006,
and September 25, 26, 27, 28 and 29, 2006,
at Montreal, Quebec.
Before: The Honourable Justice François Angers
Appearances:
Counsel for the Appellant:
Yves St-Cyr and
Dominic Belley
Counsel for the Respondent:
Guy Laperrière, Janie Payette
and Susan Shaughnessy
____________________________________________________________________
JUDGMENT
The appeal from the assessments made under the Income Tax Act in respect of the 1985, 1986, 1987, 1988, 1989 and 1990 taxation years is dismissed, with costs, in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 30th day of January 2008.
"François Angers"
Angers J.
Translation certified true
on this 28th day of May 2010.
Erich Klein, Revisor
Docket: 2000-2045(IT)G
BETWEEN:
OLEG ROMAR,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
____________________________________________________________________
Appeal heard on common evidence with the appeals of
Yves Beaudry (2000-2049(IT)G),
James Bullock (2000-2026(IT)G),
Christopher Herten-Greaven (2000-2039(IT)G),
Raphaël Evanson (2000-2044(IT)G),
Martin Tyler (2000-2056(IT)G),
David Elkins (2000-2069(IT)G),
James W. McClintock, Executor of the
Estate of John P. McClintock (2000-1189(IT)G)
on April 3, 4, 5, 6, 7, 10, 11, 12 and 13, 2006,
and September 25, 26, 27, 28 and 29, 2006,
at Montreal, Quebec.
Before: The Honourable Justice François Angers
Appearances:
Counsel for the Appellant:
Yves St-Cyr and
Dominic Belley
Counsel for the Respondent:
Guy Laperrière, Janie Payette
and Susan Shaughnessy
____________________________________________________________________
JUDGMENT
The appeal from the assessments made under the Income Tax Act in respect of the 1985, 1986, 1987, 1988, 1989 and 1990 taxation years is dismissed, with costs, in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 30th day of January 2008.
"François Angers"
Angers J.
Translation certified true
on this 28th day of May 2010.
Erich Klein, Revisor
Docket: 2000-2056(IT)G
BETWEEN:
MARTIN TYLER,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
____________________________________________________________________
Appeal heard on common evidence with the appeals of
Yves Beaudry (2000-2049(IT)G),
James Bullock (2000-2026(IT)G),
Christopher Herten-Greaven (2000-2039(IT)G),
Raphaël Evanson (2000-2044(IT)G),
Oleg Romar (2000-2045(IT)G),
David Elkins (2000-2069(IT)G),
James W. McClintock, Executor of the
Estate of John P. McClintock (2000-1189(IT)G)
on April 3, 4, 5, 6, 7, 10, 11, 12 and 13, 2006,
and September 25, 26, 27, 28 and 29, 2006,
at Montreal, Quebec.
Before: The Honourable Justice François Angers
Appearances:
Counsel for the Appellant:
Yves St-Cyr and
Dominic Belley
Counsel for the Respondent:
Guy Laperrière, Janie Payette
and Susan Shaughnessy
____________________________________________________________________
JUDGMENT
The appeal from the assessments made under the Income Tax Act in respect of the 1985, 1986, 1987, 1988, 1989 and 1990 taxation years is dismissed, with costs, in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 30th day of January 2008.
"François Angers"
Angers J.
Translation certified true
on this 28th day of May 2010.
Erich Klein, Revisor
Docket: 2000-2069(IT)G
BETWEEN:
DAVID ELKINS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
____________________________________________________________________
Appeal heard on common evidence with the appeals of
Yves Beaudry (2000-2049(IT)G),
James Bullock (2000-2026(IT)G),
Christopher Herten-Greaven (2000-2039(IT)G),
Raphaël Evanson (2000-2044(IT)G),
Oleg Romar (2000-2045(IT)G),
Martin Tyler (2000-2056(IT)G),
James W. McClintock, Executor of the
Estate of John P. McClintock (2000-1189(IT)G)
on April 3, 4, 5, 6, 7, 10, 11, 12 and 13, 2006,
and September 25, 26, 27, 28 and 29, 2006,
at Montreal, Quebec.
Before: The Honourable Justice François Angers
Appearances:
Counsel for the Appellant:
Yves St-Cyr and
Dominic Belley
Counsel for the Respondent:
Guy Laperrière, Janie Payette
and Susan Shaughnessy
____________________________________________________________________
JUDGMENT
The appeal from the assessments made under the Income Tax Act in respect of the 1985, 1986, 1987, 1988, 1989 and 1990 taxation years is dismissed, with costs, in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 30th day of January 2008.
"François Angers"
Angers J.
Translation certified true
on this 28th day of May 2010.
Erich Klein, Revisor
Docket: 2000-1189(IT)G
BETWEEN:
JAMES W. McCLINTOCK, EXECUTOR OF THE
ESTATE OF JOHN P. McCLINTOCK,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
____________________________________________________________________
Appeal heard on common evidence with the appeals of
Yves Beaudry (2000-2049(IT)G),
James Bullock (2000-2026(IT)G),
Christopher Herten-Greaven (2000-2039(IT)G),
Raphaël Evanson (2000-2044(IT)G),
Oleg Romar (2000-2045(IT)G),
Martin Tyler (2000-2056(IT)G),
David Elkins (2000-2069(IT)G)
on April 3, 4, 5, 6, 7, 10, 11, 12 and 13, 2006,
and September 25, 26, 27, 28 and 29, 2006,
at Montreal, Quebec.
Before: The Honourable Justice François Angers
Appearances:
Counsel for the Appellant:
Yves St-Cyr and
Dominic Belley
Counsel for the Respondent:
Guy Laperrière, Janie Payette
and Susan Shaughnessy
____________________________________________________________________
JUDGMENT
The appeal from the assessments made under the Income Tax Act in respect of the 1985, 1986, 1987, 1988, 1989 and 1990 taxation years is dismissed, with costs, in accordance with the attached Reasons for Judgment.
Signed at Ottawa, Canada, this 30th day of January 2008.
"François Angers"
Angers J.
Translation certified true
on this 28th day of May 2010.
Erich Klein, Revisor
Citation: 2008TCC17
Date: 20080130
Dockets: 2000-2049(IT)G, 2000-2026(IT)G,
2000-2039(IT)G, 2000-2044(IT)G, 2000-2045(IT)G,
2000-2056(IT)G, 2000-2069(IT)G, 2000-1189(IT)G
BETWEEN:
YVES BEAUDRY, JAMES BULLOCK,
CHRISTOPHER HERTEN-GREAVEN, RAPHAËL EVANSON,
OLEG ROMAR, MARTIN TYLER, DAVID ELKINS,
JAMES W. McCLINTOCK, EXECUTOR OF THE ESTATE
OF JOHN P. McCLINTOCK,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
REASONS FOR JUDGMENT
Angers J.
[1] These appeals, which were heard on common evidence, are from assessments under the Income Tax Act ("the Act"), whereby the Minister of National Revenue ("the Minister") disallowed business losses which had been claimed by the Appellants in respect of their interests in the CMRA and/or CMRA 2 partnerships, and losses from one or both of those partnerships carried over by certain appellants. The taxation years in issue are those from 1985 to 1990. Some of the Appellants also claimed deductions in respect of carrying charges for one or both of the partnerships (as the case may be), and the Minister disallowed those deductions.
[2] The issues, stated in general terms, are as follows. To what deductions are the Appellants entitled, in computing their income for the 1985 and 1986 taxation years, for losses related to the CMRA and CMRA 2 partnerships? Are those for whom the situation arises entitled, in computing their taxable income for subsequent years, to a deduction with respect to a carry-over of non‑capital losses from one or both partnerships, and to a deduction for carrying charges related to the acquisition of shares in the CMRA and CMRA 2 partnerships?
[3] In the 1985 and 1986 taxation years, two partnerships, Canadian Medical Research Associates (CMRA) and Canadian Medical Research Associates #2 (CMRA 2), were formed under the laws of Ontario for the purpose of engaging, on their own account, in various scientific research activities in the field of monoclonal antibodies.
CMRA
[4] CMRA was formed on July 16, 1985, by Corporation Planagex Ltée (Planagex) and Investmed R.B. Inc. (Investmed). Both of these firms of financial and tax advisors were controlled by CMRA's promoters, namely the Appellants Oleg Romar and Yves Beaudry. The CMRA partnership contract refers to an issue price of $1.00 per partnership share. Under the terms of clause 4.2 of that contract, 24.528% of this price was payable in Canadian funds upon the issuance or acquisition of shares, and 75.472% took the form of a promissory note, payable in four equal annual instalments commencing in the seventh year and ending in the tenth year after the issuance of the shares. The four annual instalments were payable in Brazilian funds, and the amount, payable in cruzeiros, was fixed at the exchange rate in effect on the date of issuance of the partnership shares, that is to say, the rate in effect when the shares were issued in 1985. Simple interest at a rate of 11.5% was payable with each of the four annual instalments.
[5] In the course of its fiscal year which ended December 31, 1985, CMRA received C$18,199,908 in total from its members. It also received from its members promissory notes for a total of 369,199,023,074 Brazilian cruzeiros, payable from the seventh to the tenth year following their issuance and bearing interest at a rate of 11.5%. During the same fiscal year, CMRA paid Investmed C$4,199,750, which is 23.08% of the amount in Canadian funds that CMRA received from its members as subscription, administration and other fees.
CMRA 2
[6] The CMRA 2 partnership was formed on February 25, 1986, also under the laws of Ontario, by the same promoters as those who had formed CMRA. The partnership contract specifies an issue price of $1.00 per share, and, under clause 4.2 of the contract, the price of each share was payable in the same manner as with CMRA, that is: 24.528% in Canadian funds, and the balance, 75.472%, in the form of promissory notes, each of which was payable, in Brazilian funds, in four equal annual instalments commencing in the seventh year and ending in the tenth year following the issuance of the partnership shares, and the amount, payable in cruzeiros, was fixed at the exchange rate in effect on the date of issue of the shares in 1986. Simple interest at a rate of 11% was payable with each of the four annual instalments.
[7] CMRA 2's fiscal year ended on December 31, 1986. In the course of that year, CMRA 2 received a total of $19,050,413 in Canadian funds from its members. It received from them as well 612,358,624 cruzeiros worth of promissory notes payable 7‑10 years later with interest at a rate of 11%. CMRA 2 paid Techmed 23.08% of the Canadian funds received, which amounted to $4,396,010.
[8] During their respective fiscal years, both partnerships entered into scientific research and experimental development (SR&ED) contracts with Coral Sociedade Brasilieira De Pesquisas & Desenvolvimento ("Coral"), a corporation controlled by Texas businessman Allen F. Campbell through a Dutch company that he controlled. The object was to have Coral set up and direct research activities at its laboratory in Cambridge, England, and at another laboratory in Brazil.
[9] Thus, the funds invested in CMRA and CMRA 2 were to be used for Coral's research. CMRA's contract was entered into on July 16, 1985, and CMRA 2's contract was entered into on February 25, 1986.
CMRA's contract
[10] CMRA's contract provided that Coral was to conduct research in the field of monoclonal antibodies that was to result in 57 products, each consisting of a conjugate of a murine monoclonal antibody and an enzyme that combine specifically in either an immunological or immunochemical manner with a designated antigen. Coral was to put forth its best efforts to complete the research work by December 31, 1985. The price per product was 7,990,867,500 cruzeiros, and the total price for the 57 products was 455,479,447,500 cruzeiros. The price, according to Schedule B to the contract, was payable in cruzeiros and was split into two components: 20% in cash, payable in cruzeiros upon completion of the work in 1985, and 80% consisting of four annual instalments payable in cruzeiros commencing seven years after the end of the work, with simple interest at 11.5%. The exchange rate applicable to the payments under the contract was the rate in effect on the date that the contract was signed.
[11] The contract between CMRA and Coral also contained a clause providing for a possible reduction of the number of products that would have to be produced and, in February 1986, the number of products was indeed reduced, from 57 to 40, and the contract price was adjusted accordingly.
[12] In the course of its fiscal year 1985, CMRA paid Coral C$350,000 for each product, that is to say, C$14,000,158 in total, by cheque issued to Coral and transferred to Coral's Canadian bank account. During the same fiscal year, CMRA issued 18 notes to Coral, denominated in Brazilian currency, in connection with the 40 Coral projects. Based on the exchange rates in effect at the time of the transactions between CMRA and Coral in 1985, the Canadian-dollar equivalent of the principal amount of 369,199,023,074 cruzeiros was C$56,000,623, which amounts to C$1,400,000 for each of the 40 projects.
[13] In its financial statements for the period from July 16 to December 31, 1985, CMRA entered an expense of C$70,000,781 with respect to the contract signed with Coral. CMRA relied not only on the C$14,000,158 in cash payments to Coral, but also on the principal amount of the term notes denominated in Brazilian currency and signed by CMRA in favour of Coral, in the amount of 369,199,023,074 cruzeiros, which it converted into C$56,000,623 based on the exchange rate in effect on the date of the transaction with Coral.
[14] There was no inflation adjustment and no monetary or exchange‑rate adjustment with respect to the 18 term notes denominated in Brazilian currency, signed by CMRA in favour of Coral. Investmed specified that, with regard to the amounts that CMRA owed Coral, Coral had agreed to waive joint and several liability, to divide its claims, and to limit its remedy against each partner to the amount that the partner owed the partnership.
[15] On March 7, 1986, trustees Ernst Nigg and Christian Rusck notified CMRA that the 18 notes in Brazilian currency issued to Coral had been assigned to Medical Research Trust (MRT). It should be mentioned that Coral and MRT made no demand for payment on the 18 term notes, and in fact CMRA and its members did not pay anything on those 18 notes.
[16] On the same date that the contract between CMRA and Coral was signed, the parties entered into a hedge agreement intended to protect CMRA and its members in the event that Brazil's currency should appreciate. CMRA paid C$1.00 in consideration therefor. There was no similar contract in place to protect Coral from any depreciation of the currency.
CMRA 2's contract
[17] The contract between CMRA 2 and Coral involved 120 projects that were to be completed by December 31, 1986. The price per product was 13,157,894,737 cruzeiros, for a total of 1,578,947,368,421 cruzeiros. The conditions regarding payment were the same as those set out in the CMRA contract, except for the interest rate, which was 11%.
[18] The initial project, whose object was to obtain monoclonal antibodies that react with human leukocyte antigens and human blood group antigens, was later changed. In early 1987, CMRA 2 decided to abandon the 60 human blood group antigen projects after determining that Coral was unable to carry them out. On March 24, 1987, the parties agreed that the contract would involve 42 projects. As part of this transaction, CMRA 2 accepted the work done by Coral under the contract and obtained the rights, title and interest in and to the 42 human leukocyte antigen projects. The agreement dated March 24, 1987, defines the products obtained by CMRA 2 as follows:
The parties acknowledge and agree that the products in Exhibit 1 are supernatants which reacted at least once with an identified HLS-specificity each of which requires additional work to become a monoclonal antibody with reproducible activity produced by a stable hybridoma, said monoclonal antibody to combine specifically in an immunological manner with an identified HLA-specificity.
[19] On March 15, 1986, CMRA 2 notified Coral that it was aware that Brazil had abolished the cruzeiro, and confirmed that it would be performing its obligations under its contract with Coral on the basis of the new Brazilian currency, namely the cruzado.
[20] Over the course of its fiscal year ended December 31, 1986, CMRA 2 paid Coral C$14,654,404, which amounted to roughly C$350,000 for each of the 42 projects. CMRA also issued notes in Brazilian currency payable to Coral in respect of the 42 projects, the total amount of the notes being 612,358,624 cruzados.
[21] In its financial statements for the period from February 25 to December 31, 1986, CMRA 2 entered a research expense of C$73,272,012 in respect of the service contract entered into with Coral on February 25, 1986. In order to arrive at this amount, CMRA 2 did the same thing as CMRA: it entered the initial amount paid in cash as well as the value of the Brazilian-currency term notes converted into Canadian dollars based on the exchange rate in effect on the date of the transactions entered into with Coral.
[22] Like the CMRA notes, the 13 CMRA 2 term notes contained no inflation adjustment formula, no monetary adjustment formula and no exchange rate adjustment formula. In a Notice of Opportunity dated July 28, 1986, Techmed specified that if CMRA 2 defaulted on the payment of the total fees it owed to Coral under their contract, Coral would have a remedy against the partnership's assets. The notice also specified that, in such an event, Coral's remedy against any given partner would be limited to that partner's debt to the partnership.
[23] Like the CMRA term notes, the CMRA 2 term notes were assigned to MRT, but no demand was made, and CMRA 2 and its members did not pay anything on the 13 term notes. The parties also signed a hedge agreement like the one with CMRA, intended to protect CMRA 2 and its members in the event that the Brazilian currency should appreciate, but there was no contract to protect Coral from a depreciation of the currency. On June 17, 1986, Coral agreed, regarding the hedge agreement, that in view of Brazil's currency reform, the contract was to be read as though it referred to cruzados.
[24] Before CMRA and CMRA 2’s contracts with Coral were signed, the partnerships' promoters did not approach any firms other than Coral in connection with the performance of the work contemplated in the contracts.
[25] In the wake of all these events, a corporation named Les Associés de Recherche Médicale Canadienne Inc. (ARMC Inc.) was incorporated under the Quebec Companies Act. The incorporators were the Appellant Oleg Romar, the Appellant Yves Beaudry, and one other person. An offer of exchange was made to the members of CMRA and CMRA 2, which involved the conversion of their partnership shares into common shares of ARMC Inc. The purpose of ARMC Inc. was to develop products based on research done by Coral.
[26] The ultimate objective of that research was to develop diagnostic test kits. ARMC Inc. sold the cell lines to Laval University for the specific purpose of developing such test kits for commercialization. The research activities were carried out at Coral's Cambridge laboratories; no activities took place at the Brazilian laboratories. In light of the outcome of these activities, CMRA and CMRA 2 claimed SR&ED expenses in excess of C$143,272,793, thereby giving rise to losses in an equal amount for 1985 and 1986.
[27] The Appellants posted non-capital losses (NCLs) and claimed carrying charges associated with their investment, as well as NCL carry-overs to other taxation years.
[28] By notice of assessment dated February 17, 2000, the Canada Revenue Agency disallowed practically all of the amounts deducted by the Appellants and some 600 other partners. Settlements were reached in all cases other than the Appellants'.
[29] Now that we have reviewed the facts of the case, the main issues can be summarized as follows:
1. Do the expenses claimed by the Appellants constitute SR&ED expenses within the meaning of section 37 of the Act and section 2900 of the Income Tax Regulations ("the Regulations")?
2. Do the financial statements of the CMRA and CMRA 2 partnerships reflect the partnerships' actual profits?
(a) Was an expense actually incurred with respect to the term notes negotiated between CMRA and CMRA 2?
(b) Were the SR&ED expenses claimed by the Appellants reasonable within the meaning of section 67 of the Act?
3. If the deductions claimed were allowed, would they have the effect of unduly or artificially reducing the Appellants' income as contemplated by subsection 245(1) as it read at the time?
[30] Here, in very succinct terms, is what the Respondent submits. The shares in the CMRA and CMRA 2 partnerships were sold and presented as tax shelters. The two partnerships had no clear and specific business plan based on commercial and scientific practice. The expenses incurred by the partners are not reasonable expenses within the meaning of section 67 of the Act, as regards the work done by Coral.
[31] The Respondent argues that the promoters and the partners in CMRA and CMRA 2 knew of the reputation of the Brazilian cruzeiro and wanted to profit from the situation by setting up tax shelters, which is why the contracts with Coral contained no monetary adjustment clause, and so the members of the two partnerships did not have to repay the true value of the debt that they had contracted.
[32] The Respondent further submits that the financial statements of the partnerships in question were not prepared in accordance with generally accepted accounting principles (GAAP), that the value of the notes should have been discounted to reflect the depreciation of the Brazilian currency and that the losses claimed were not actually incurred. In the Respondent’s submission, the objective of the members of both partnerships was purely tax-related: to claim losses that were created virtually through the depreciation of the Brazilian currency, and thus subsection 245(1) of the Act applies.
[33] For their part, the Appellants submit that the work done by the Coral laboratory meets the criteria with respect to SR&ED. In the alternative, they submit that their expenses were nonetheless incurred in the operation of their business and are therefore deductible under paragraph 18(1)(a) of the Act. They maintain that, in the circumstances, the expenses were reasonable within the meaning of section 67 of the Act. Lastly, they submit that the former subsection 245(1) of the Act does not apply in the case at bar because the deductions do not unduly or artificially reduce the partnerships' income.
[34] Each of the parties called expert witnesses to testify concerning SR&ED, the Brazilian economy at the time, and the GAAP in relation to the partnerships' financial statements. There were also 16 witnesses who testified regarding the facts.
[35] Do the expenses claimed constitute SR&ED expenses within the meaning of section 37 of the Act and section 2900 of the Regulations?
The provisions applicable to the years 1985-1986 are as follows:
37. Scientific research and experimental development
(1) Where a taxpayer files with his return of income under this Part for a taxation year a prescribed form containing prescribed information, carried on a business in Canada and made expenditures in respect of scientific research and experimental development in the year, there may be deducted in computing his income for the year the amount, if any, by which the aggregate of
(a) such amounts as may be claimed by the taxpayer not exceeding all expenditures of a current nature made in Canada by the taxpayer in the year or in any previous taxation year ending after 1973
(i) on scientific research and experimental development related to the business and directly undertaken by or on behalf of the taxpayer,
(ii) by payments to an approved association that undertakes scientific research and experimental development related to the class of business of the taxpayer,
(iii) by payments to an approved university, college, research institute or other similar institution to be used for scientific research and experimental development related to the class of business of the taxpayer,
(iv) by payments to a corporation resident in Canada and exempt from tax under paragraph 149(1)(j), or
(v) by payments to a corporation resident in Canada for scientific research and experimental development related to the business of the taxpayer;
(b) such amount as may be claimed by the taxpayer not exceeding the lesser of
(i) the expenditures of a capital nature made in Canada (by acquiring property other than land) in the year and any previous year ending after 1958 on scientific research and experimental development relating to the business and directly undertaken by or on behalf of the taxpayer, and
(ii) the undepreciated capital cost to the taxpayer of the property so acquired as of the end of the taxation year (before making any deduction under this paragraph in computing the income of the taxpayer for the taxation year),
(c) . . .
(c.1) all amounts included by virtue of paragraph 12(1)(v) in computing the taxpayer's income for any previous taxation year,
exceeds the aggregate of
(d) all amounts paid to him in the year or in any previous taxation year ending after 1973 under an Appropriation Act and on terms and conditions described in paragraph (c),
(e) that portion of the aggregate of all amounts deducted under subsection 127(5) in computing the tax otherwise payable by the taxpayer under this Part for the year or any previous taxation year that may reasonably be attributed to expenditures of a current nature made in Canada in the year or in any previous taxation year that were qualified expenditures in respect of scientific research and experimental development within the meaning of paragraph 127(10.1)(c),
(f) all amounts deducted by virtue of this subsection and paragraph 20(1)(t) in computing the taxpayer's income for any preceding taxation year, except amounts described in subsection (6), and
(g) the aggregate of all amounts each of which is an amount equal to twice the amount claimed under subparagraph 194(2)(a)(ii) by the taxpayer for the year or any preceding taxation year.
(2) Research outside Canada – There may be deducted in computing the income for a taxation year of a taxpayer who carried on business in Canada and made expenditures in the year in respect of scientific research and experimental development carried on outside Canada, all such expenditures of a current nature made in the year
(a) on scientific research and experimental development related to the business and directly undertaken by or on behalf of the taxpayer, or
(b) by payments to an approved association, university, college, research institute or other similar institution to be used for scientific research and experimental development related to the class of business of the taxpayer.
(3) . . .
(4) Deductions – No deduction may be made under this section in respect of an expenditure made to acquire rights in, or arising out of, scientific research and experimental development.
(5) Idem – Where in respect of an expenditure on scientific research and experimental development made by a taxpayer in a taxation year an amount is deductible under this section and under section 110, no deduction may be made in respect of the expenditure under section 110 in computing the taxable income of the taxpayer for any taxation year.
(6) Expenditures of a capital nature – An amount claimed under paragraph (1)(b) in computing a deduction under that subsection shall, for the purpose of section 13, be deemed to be an amount allowed to the taxpayer in respect of the property acquired by the expenditures under regulations made under paragraph 20(1)(a), and for that purpose the property acquired by the expenditures shall be deemed to be of a separate prescribed class.
(7) Definitions – In this section,
(a) . . .
(b) "Scientific research and experimental development" - "scientific research and experimental development" has the meaning given to that expression by regulation;
(c) [Expenditures on scientific research and experimental development] – references to expenditures on or in respect of scientific research and experimental development
(i) where the references occur in subsection (2), include only
(A) expenditures each of which was an expenditure incurred for and all or substantially all of which was attributable to the prosecution of scientific research and experimental development, and
(B) expenditures of a current nature that were directly attributable, as determined by regulation, to the prosecution of scientific research and experimental development, and
(ii) where the references occur other than in subsection (2), include only
(A) expenditures each of which was an expenditure incurred for and all or substantially all of which was attributable to the prosecution, or to the provision of premises, facilities or equipment for the prosecution, of scientific research and experimental development in Canada, and
(B) expenditures of a current nature that were directly attributable, as determined by regulation, to the prosecution, or to the provision of premises, facilities or equipment for the prosecution, of scientific research and experimental development in Canada; and
(d) [References to scientific research and experimental development] – references to scientific research and experimental development relating to a business or class of business include any scientific research and experimental development that may lead to or facilitate an extension of that business or, as the case may be, business of that class.
[36] Under section 37, expenses incurred to prosecute SR&ED may be deducted in computing a taxpayer’s income from a business carried on actively. The definition of scientific research is contained in section 2900 of the Regulations:
Part XXIX
Scientific Research
Interpretation
2900. For the purposes of this Part and paragraphs 37(7)(b) and 37.1(5)(e) of the Act, "scientific research" means systematic investigation or search carried out in a field of science or technology by means of experiment or analysis, that is to say,
(a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view,
(b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or
(c) development, namely, use of the results of basic or applied research for the purpose of creating new, or improving existing, materials, devices, products or processes,
and, where such activities are undertaken directly in support of activities described in paragraph (a), (b) or (c), includes activities with respect to engineering or design, operations research, mathematical analysis or computer programming and psychological research, but does not include activities with respect to
(d) market research or sales promotion;
(e) quality control or routine testing of materials, devices or products;
(f) research in the social sciences or the humanities;
(g) prospecting, exploring or drilling for or producing minerals, petroleum or natural gas;
(h) the commercial production of a new or improved material, device or product or the commercial use of a new or improved process;
(i) style changes; or
(j) routine data collection.
[37] In addition, a body of case law concerning SR&ED has been developed. In R I S - Christie Ltd. v. Canada, [1996] T.C.J. No. 1056, Judge Sarchuk of this Court considered the concept of SR&ED with respect to the 1982 and 1983 taxation years. The appellant had submitted as follows:
Appellant's Submissions
11 Pursuant to paragraphs 37(7)(b) and 37.1(5)(e) of the Act scientific research has the meaning given to that expression by Regulation 2900. The Appellant relies on the evidence of Dorcich and that of Littlejohn whose expert opinion was that the work conducted by 541185 was scientific research and experimental development. Their testimony and a review of the proposal and the synopsis provide ample support that 541185 followed a formalized, scientific methodology and engaged in "systematic investigation or research carried out in the field of science or technology by means of experiment or analysis". More specifically, it conducted applied research with respect to the electro-heating elements of the panel and the adhesives and other materials to be used therein and engaged in the collection of technical information and literature with respect to marketed concrete forming systems that went beyond routine data collection. It was also engaged in extensive development activities in which it analyzed and reviewed existing materials and products to develop the panel. Thus the work performed by it involved a real technical uncertainty, resulted in a new product and the product was developed by using an organized and systematic approach. Furthermore, the research undertaken by 541185 included activities "with respect to engineering and design" as evidenced by its work with respect to the structural, engineering and electrical design aspects of the panel. This included the building of prototypes, the existence of which was confirmed by the testimony of Dorcich, McCabe and Turner.
12 The Appellant asserts that it has met the Department of National Revenue's technical guidelines as to what constitutes scientific research and development for the purpose of subsection 2900(1) of the Regulations in that it has satisfied the criteria of scientific or technological advancement; scientific or technological uncertainty; and scientific and technical content.
[38] Judge Sarchuk also took account of Information Circular 86-4R3 in analyzing the appellant's activities. The following are the general criteria set out in that circular:
2.9 General criteria
2.10 Essential tests that must be met before any activity can be considered scientific research and experimental development include the criterion of scientific or technological advancement; the criterion of scientific or technological uncertainty; and the criterion of scientific and technical content.
2.10.1 The criterion of scientific or technological advancement is as follows:
· The search carried out in the scientific research and experimental development activity must generate information that advances our understanding of scientific relations or technologies. In a business context, this means that when a new or improved product or process is created, it must embody a scientific or technological advancement in order to be eligible.
2.10.2 The criterion of scientific or technological uncertainty is as follows:
· Whether or not a given result or objective can be achieved, and/or how to achieve it, is not known or determined on the basis of generally available scientific or technological knowledge or experience. This criterion implies that we cannot kn