CAE Inc. v. The King

CAE Inc. v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2021-09-14
Neutral citation
2021 TCC 57
File numbers
2016-4984(IT)G
Judges and Taxing Officers
Sylvain Ouimet
Subjects
Income Tax Act
Decision Content
Docket: 2016-4984(IT)G
BETWEEN:
CAE INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
Appeal heard on June 3 and 4, 2019, and August 24 and 25, 2020, at Montreal, Quebec.
Before: The Honourable Justice Sylvain Ouimet
Appearances:
Counsel for the appellant:
Wilfred Lefebvre
Marc-Olivier Plante
Counsel for the respondent:
Dany Leduc
Antonia Paraherakis
JUDGMENT
The appeal from the assessments made pursuant to the Income Tax Act for the 2012 and 2013 taxation years is dismissed with costs in accordance with the attached reasons for judgment.
Signed at Ottawa, Canada, this 14th day of September 2021.
"Sylvain Ouimet"
Judge Ouimet
Translation certified true
on this 2nd day of October 2023.
François Brunet, Revisor
Citation: 2021 TCC 57
Date: September 13, 2021
Docket: 2016-4984(IT)G
BETWEEN:
CAE INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
AMENDED REASONS FOR JUDGMENT
Judge Ouimet
I. INTRODUCTION
(1) CAE Inc. (CAE) is appealing against two assessments made by the Minister of National Revenue (the Minister) on December 15 and October 26, 2016. These assessments are for the 2012 and 2013 taxation years. According to these assessments, the Minister found that the amounts received by CAE pursuant to an agreement entered into with the Minister of Industry Canada entitled "- SADI Agreement NO. 780-503924 - Strategic Aerospace and Defence Initiative - Project Falcon" (SADI Agreement) constituted "government assistance" within the meaning of subsection 127(9) of the Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.) (ITA). More specifically, the Minister held that the amounts of $57,084,395 and $59,148,888 that CAE received or was entitled to receive under the SADI Agreement during the 2012 and 2013 taxation years respectively, constituted a form of "government assistance."
(2) Having found that the amounts of $57,084,395 and $59,148,888 constituted a form of "government assistance" within the meaning of subsection 127(9) of the ITA, the Minister concluded that the amounts of $41,003,491 and $40,652,951 received by CAE under the SADI Agreement during the 2012 and 2013 taxation years that were used for scientific research and experimental development ("SR&ED") were to be subtracted from the amount of CAE's deductible SR&ED expenditures pursuant to paragraph 37(1)(d) of the ITA for those taxation years.
(3) In addition, pursuant to subsection 127(18) of the ITA, the Minister held that the amounts that CAE received or was entitled to receive under the SADI Agreement during the 2012 and 2013 taxation years, i.e., $57,084,395 and $59,148,888 respectively, were to be subtracted from the amount of SR&ED expenditures eligible for the purposes of CAE's investment tax credit for those taxation years.
(4) Finally, pursuant to subparagraphs 12(1)(x)(iv) and 12(1)(x)(v) of the ITA, the Minister found that the amount of $14,806,939, i.e., the difference between the amount that CAE received during the 2012 taxation year under the SADI Agreement ($55,810,430) and the amount of CAE's SR&ED expenditures during that same year in connection with the Agreement ($41,003,491), was to be included in the computation of CAE's income for the 2012 taxation year.
(5) The following persons testified on behalf of the respondent at the hearing:
-Jean Lemieux, employee of the Strategic Innovation Fund at the Department of Industry Canada.
-Neil de Gray, expert witness.
(6) The following persons testified on behalf of the appellant at the hearing:
-Constantino Malatesta, Vice-President, Finance, CAE.
-Sylvie Brossard, Vice-President, Taxation Department, CAE.
II. ISSUES
(7) The issues are as follows:
1. Was the Minister correct in finding that the amounts of $57,084,395 and $59,148,888 that CAE received or was entitled to receive under the SADI Agreement during the 2012 and 2013 taxation years respectively, constituted "government assistance" within the meaning of subsection 127(9) of the ITA?
2. Was the Minister correctin finding that the amounts of $57,084,395 and $59,148,888 that CAE received or was entitled to receive under the SADI Agreement should be subtracted from the amount of SR&ED expenditures eligible for purposes of computing CAE's investment tax credit for the 2012 and 2013 taxation years respectively, pursuant to subsection 127(18) of the ITA?
3. Was the Minister correct in finding that the amounts of $41,003,491 and $40,652,951[1] that CAE received under the SADI Agreement for the 2012 and 2013 taxation years should be subtracted from the amount of SR&ED expenditures deductible from CAE's income for the 2012 and 2013 taxation years, respectively, pursuant to paragraph 37(1)(d) of the ITA?
4. Was the Minister correct in finding that the amount of $14,806,939 was to be included in computing CAE's income for the 2012 taxation year pursuant to subparagraph 12(1)(x)(iv) of the ITA?
(8) In the alternative, if the Court were to conclude that the amounts that CAE received under the SADI Agreement did not constitute a form of "government assistance" within the meaning of subsection 127(9) of the ITA, the Court will have to answer the following question:
Did the amounts that CAE received under the SADI Agreement during the 2012 and 2013 taxation years, respectively, constitute inducements, reimbursements or contributions within the meaning of subparagraphs 12(1)(x)(iii) and (iv) of the ITA?
III. RELEVANT STATUTORY PROVISIONS
(9) The relevant statutory provisions are as follows:
Income Tax Act, R.S.C., 1985, c. 1 (5th Supp.)
12 (1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable
(x) any particular amount (other than a prescribed amount) received by the taxpayer in the year, in the course of earning income from a business or property, from
(i) a person or partnership (in this paragraph referred to as the “payer”) who pays the particular amount
(A) in the course of earning income from a business or property,
(B) in order to achieve a benefit or advantage for the payer or for persons with whom the payer does not deal at arm’s length, or
(C) in circumstances where it is reasonable to conclude that the payer would not have paid the amount but for the receipt by the payer of amounts from a payer, government, municipality or public authority described in this subparagraph or in subparagraph (ii), or
(ii) a government, municipality or other public authority,
where the particular amount can reasonably be considered to have been received
(iii) as an inducement, whether as a grant, subsidy, forgivable loan, deduction from tax, allowance or any other form of inducement, or
(iv) as a refund, reimbursement, contribution or allowance or as assistance, whether as a grant, subsidy, forgivable loan, deduction from tax, allowance or any other form of assistance, in respect of
(A) an amount included in, or deducted as, the cost of property, or
(B) an outlay or expense,
to the extent that the particular amount
(v) was not otherwise included in computing the taxpayer’s income, or deducted in computing, for the purposes of this Act, any balance of undeducted outlays, expenses or other amounts, for the year or a preceding taxation year,
(v.1) is not an amount received by the taxpayer in respect of a restrictive covenant, as defined by subsection 56.4(1), that was included, under subsection 56.4(2), in computing the income of a person related to the taxpayer,
(vi) except as provided by subsection 127(11.1), 127(11.5) or 127(11.6), does not reduce, for the purpose of an assessment made or that may be made under this Act, the cost or capital cost of the property or the amount of the outlay or expense, as the case may be,
(vii) does not reduce, under subsection 12(2.2) or 13(7.4) or paragraph 53(2)(s), the cost or capital cost of the property or the amount of the outlay or expense, as the case may be, and
(viii) may not reasonably be considered to be a payment made in respect of the acquisition by the payer or the public authority of an interest in the taxpayer, an interest in, or for civil law a right in, the taxpayer’s business or an interest in, or for civil law a real right in, the taxpayer’s property;
37 (1) Where a taxpayer carried on a business in Canada in a taxation year, there may be deducted in computing the taxpayer’s income from the business for the year such amount as the taxpayer claims not exceeding the amount, if any, by which the total of
(. . .)
(c) the total of all amounts each of which is an expenditure made by the taxpayer in the year or in a preceding taxation year ending after 1973 by way of repayment of amounts described in paragraph 37(1)(d),
(. . .)
exceeds the total of
(d) the total of all amounts each of which is the amount of any government assistance or non-government assistance (as defined in subsection 127(9)) in respect of an expenditure described in paragraph (a) or (b), as paragraph (a) or (b), as the case may be, read in its application in respect of the expenditure, that at the taxpayer’s filing-due date for the year the taxpayer has received, is entitled to receive or can reasonably be expected to receive,
67. In computing income, no deduction shall be made in respect of an outlay or expense in respect of which any amount is otherwise deductible under this Act, except to the extent that the outlay or expense was reasonable in the circumstances.
127 (9) In this section
government assistance means assistance from a government, municipality or other public authority whether as a grant, subsidy, forgivable loan, deduction from tax, investment allowance or as any other form of assistance other than as a deduction under subsection 127(5) or 127(6); (aide gouvernementale)
non-governmental assistance means an amount that would be included in income under paragraph 12(1)(x) if that paragraph were read without reference to subparagraphs 12(1)(x)(v) to (vii); (aide non gouvernementale)
127 (18) Where on or before the filing-due date for a taxation year of a person or partnership (referred to in this subsection as the “taxpayer”) the taxpayer has received, is entitled to receive or can reasonably be expected to receive a particular amount that is government assistance, non-government assistance or a contract payment that can reasonably be considered to be in respect of scientific research and experimental development, the amount by which the particular amount exceeds all amounts applied for preceding taxation years under this subsection or subsection 127(19) or 127(20) in respect of the particular amount shall be applied to reduce the taxpayer’s qualified expenditures otherwise incurred in the year that can reasonably be considered to be in respect of the scientific research and experimental development.
Interpretation Act, R.S.C., 1985, c. I-21
Rules of Construction
Property and Civil Rights
Duality of legal traditions and application of provincial law
8.1 Both the common law and the civil law are equally authoritative and recognized sources of the law of property and civil rights in Canada and, unless otherwise provided by law, if in interpreting an enactment it is necessary to refer to a province’s rules, principles or concepts forming part of the law of property and civil rights, reference must be made to the rules, principles and concepts in force in the province at the time the enactment is being applied.
Civil Code of Québec, CQLR, c CCQ-1991
BOOK FOUR – PROPERTY
TITLE TWO – OWNERSHIP
CHAPTER I – NATURE AND EXTENT OF THE RIGHT OF OWNERSHIP
947. Ownership is the right to use, enjoy and dispose of property fully and freely, subject to the limits and conditions for doing so determined by law.
Ownership may be in various modalities and dismemberments.
BOOK FIVE – OBLIGATIONS
TITLE ONE – OBLIGATIONS IN GENERAL
CHAPTER II – CONTRACTS
DIVISION IV – NTERPRETATION OF CONTRACTS
1425. The common intention of the parties rather than adherence to the literal meaning of the words shall be sought in interpreting a contract.
1426. In interpreting a contract, the nature of the contract, the circumstances in which it was formed, the interpretation which has already been given to it by the parties or which it may have received, and usage, are all taken into account.
1427. Each clause of a contract is interpreted in light of the others so that each is given the meaning derived from the contract as a whole.
1428. A clause is given a meaning that gives it some effect rather than one that gives it no effect.
1429. Words susceptible of two meanings shall be given the meaning that best conforms to the subject matter of the contract.
1430. A clause intended to eliminate doubt as to the application of the contract to a specific situation does not restrict the scope of a contract otherwise expressed in general terms.
1431. The clauses of a contract cover only what it appears that the parties intended to include, however general the terms used.
1432. In case of doubt, a contract is interpreted in favour of the person who contracted the obligation and against the person who stipulated it. In all cases, it is interpreted in favour of the adhering party or the consumer.
TITLE TWO – NOMINATE CONTRACTS
CHAPTER XII – LOAN
DIVISION I – NATURE AND KINDS OF LOANS
2312. There are two kinds of loans: loan for use and simple loan.
2314. A simple loan is a contract by which the lender hands over a certain quantity of money or other property that is consumed by use to the borrower, who binds himself to return a like quantity of the same kind and quality to the lender after a certain time.
2315. A simple loan is presumed to be by gratuitous title unless otherwise stipulated or unless it is a loan of money, in which case it is presumed to be by onerous title.
DIVISION III – SIMPLE LOAN
2327. By simple loan, the borrower becomes the owner of the property loaned and he bears the risks of loss of the property from the time it is handed over to him.
IV. FACTS
A. Background (10) CAE is a Canadian company that was founded in 1947. Its head office is located in Ville Saint-Laurent in the Province of Quebec[2]. CAE is a public corporation listed on the Toronto Stock Exchange[3]. CAE is primarily engaged in the manufacture, sale and maintenance of flight simulators. The company also provides training sessions in flight simulators for the civil and military aviation industries. The company operates in more than 30 countries and employs approximately 9,000 people worldwide[4].
(11) In 2007, as part of a strategic initiative targeting the aerospace and defence industries, the Minister of Industry Canada created the Strategic Aerospace and Defence Initiative, the "SADI Program"[5].
(12) The SADI Program objectives were as follows:
1. Promote research and strategic development leading to innovation and excellence in products, services and processes;
2. Make Canadian businesses more competitive;
3. Foster collaboration between research institutes, universities, colleges and the private sector[6].
(13) Under the SADI Program, a financial contribution to a research and development project could be granted to a company operating in the aerospace, space or defence sectors[7]. The Department of Industry Canada's Industrial Technologies Office administered this program[8].
B. SADI Agreement (14) On March 30, 2009, the Minister of Industry Canada and CAE entered into an agreement regarding the SADI Program[9]. This agreement, the SADI Agreement pertained to the CAE's SR&ED "Project Falcon." This project required SR&ED expenditures of $700,000,000 over a five-year period, from 2009 to 2014[10]. It bore on the development of flight simulator and health sector technologies[11]. Under the agreement, the Minister of Industry Canada contributed financially to the project by making "contributions" to CAE between 2009 and 2014 inclusive. These contributions are defined in the agreement as "financial assistance" intended to fund CAE's SR&ED activities in connection with Project Falcon[12]. These contributions constituted 35% of the total “eligible expenses”[13] incurred by CAE in connection with Project Falcon and could not exceed $250,000,000[14]. More specifically, the annual contributions that could be paid to CAE were not to exceed the following amounts[15]:
Government fiscal years
Maximum contributions payable
2009/2010
$31,750,000
2010/2011
$53,250,000
2011/2012
$57,100,000
2012/2013
$63,000,000
2013/2014
$44,900,000
TOTAL
$250,000,000
(15) CAE received $250,000,000, the maximum amount payable to it under the SADI Agreement.
(16) During the 2012 and 2013 taxation years, the amounts CAE received or was entitled to receive under the SADI Agreement were $57,084,395 and $59,148,888 respectively[16]. Only a portion of these amounts was used by CAE to pay for SR&ED expenditures incurred in relation to the Falcon Project, i.e., $41,003,491 in 2012 and $40,652,951 in 2013[17].
(17) Under the SADI Agreement, reimbursement of contributions must be made in 15 annual installments. The total reimbursement is the amount equivalent to the total contributions paid to CAE multiplied by a factor of 1.35. CAE received contributions totalling $250,000,000, therefore, the total amount to be reimbursed is $337,500,000 ($250,000,000 X 1.35)[18].
(18) According to the SADI Agreement, the reimbursement of contributions is unconditional and not subject to any security[19]. Contributions must be reimbursed according to the schedule and the conditions set out in the agreement. Annual reimbursements must be made no later than July 31 of each year starting in 2015, approximately six years after receipt of the first contributions. The last of the 15 reimbursements is due on July 31, 2029[20]. Under the terms of reimbursement set out in the Agreement, contributions made to CAE implicitly provide the Minister of Industry Canada with an approximate annual rate of return of 2.50%[21].
(19) The amounts to be reimbursed annually by CAE under the SADI Agreement are as follows[22]:
Reimbursements
Payment
Year
1
$11,250,000
2015
2
$11,250,000
2016
3
$11,250,000
2017
4
$11,250,000
2018
5
$22,500,000
2019
6
$22,500,000
2020
7
$22,500,000
2021
8
$22,500,000
2022
9
$22,500,000
2023
10
$22,500,000
2024
11
$33,750,000
2025
12
$33,750,000
2026
13
$33,750,000
2027
14
$33,750,000
2028
15
$33,750,000
2029
TOTAL
$337,500,000
En blanc/Blank
(20) Under the terms of the SADI Agreement, CAE is subject to certain restrictions. For example, CAE is committed to exclusively manufacturing all Project Falcon products in Canada, and certain other restrictions apply to CAE's ability to transfer titles or intellectual property rights relating to the Project[23]. CAE is also required to notify the Minister of Industry Canada of any other government financial assistance requested or received in connection with the Project. If such assistance were to be received, the contributions receivable could be reduced[24]. In addition, in order to be eligible to receive funds under the SADI Program, CAE had to establish a cooperation plan with accredited post-secondary institutions in Canada and allocate them at least 1.0% of the Project's total eligible SR&ED expenditures[25].
(21) The SADI Agreement stipulates that meetings may be organized between the parties to review the results of the SR&ED work undertaken under Project Falcon and to verify whether the SADI Program's performance objectives are being met[26]. Also, CAE must periodically send the Minister of Industry Canada reports on the following subjects[27]:
1. Progress on the Falcon Project's SR&ED work[28];
2. Results achieved[29];
3. SADI Program yields[30].
(22) The SADI Agreement may be terminated by CAE upon early reimbursement of all contributions received and payment of an amount equal to a 2.75% annual return on investment with respect to amounts reimbursed ahead of time[31].
C. Testimony provided by Constantino Malatesta (23) Mr. Malatesta has been working for CAE since 2006. He was appointed Vice President of Finance and Controller in 2016. During the negotiations leading to the signing of the SADI Agreement, Mr. Malatesta was in charge of CAE's "Complex Accounting Group"[32]. He first noted that, as CAE is a public corporation listed on the Toronto and New York Stock Exchanges; its financial statements are audited by independent auditors on a quarterly basis, and an audit report is produced annually[33].
(24) According to Mr. Malatesta, CAE used the SADI Program to fund its SR&ED projects[34]. Mr. Malatesta's role was to provide opinions on the funding and accounting aspects of such projects including when agreements similar to the SADI Agreement were entered into[35].
(25) Mr. Malatesta testified as to the circumstances surrounding the signing of the SADI Agreement. He did not participate directly in the negotiations, but was involved in the CAE negotiating team's discussions[36]. Nathalie Bourque negotiated on behalf of CAE, and Mr. Lemieux negotiated on behalf of the Minister of Industry Canada[37]. The negotiations leading to the signing of the agreement lasted several months.
(26) In October 2008, CAE considered a reimbursement option whereby it could reimburse government contributions on the basis of a percentage of earned income based on sales growth ("conditional reimbursement")[38]. Ultimately, CAE did not pursue this option. CAE chose the funding option that involved a reimbursement independent of sales growth, i.e., a fixed installment payment program ("unconditional reimbursement"), because it found that this provided CAE with more liquidity and a lower incurred effective interest rate[39]. This aspect of the agreement was the subject of negotiations between the parties[40].
(27) CAE made the reimbursements and, according to Mr. Malatesta, it was always able to make them[41]. According to CAE's consolidated financial statements for 2010 and 2012, revenues and assets were in the billions of dollars, and they were expected to grow from year to year[42]. Although CAE did not provide a surety to guarantee reimbursement of contributions received, it is a public corporation and, therefore, financial statements and other public documents could be used to assess its reimbursement capacity[43].
(28) With respect to the accounting treatment of the contributions received from the Minister of Industry Canada, they were generally characterized as long-term obligations in CAE's consolidated financial statements[44]. In order to comply with generally accepted accounting principles (GAAP)[45], certain accounting adjustments had to be made. According to Mr. Malatesta, the contributions received did not really reflect CAE's financial obligation, given the terms of reimbursement[46]. Therefore, the amounts received were adjusted to reflect their real values[47]. The amount of contributions received has been reduced according to the prevailing market interest rate for such funding[48]. These reductions take into account the duration of the agreement, including the reimbursement period.
(29) CAE concluded that the effective interest rate for the SADI Agreement was approximately 2.7%[49]. CAE adjusted this rate to reflect the interest rate that would have been paid in a comparable transaction made at the prevailing market rate of interest, which is its fair market value[50]. The cash value of the difference between the effective interest rate and the interest rate that would have been determined in a transaction at fair market value is added in the computation of income for accounting purposes in accordance with GAAP[51]. This growth component, along with the effective rate, is what it costs CAE to fund the Agreement[52].
(30) Ultimately, the total interest that would have been payable on a fair market value loan, i.e., $210,475,399, was deducted as a funding expense in the financial statements[53]. The amount of $122,975,399 representing the growth component was recorded as income. It constituted a reduction in operating expenses or a reduction in capitalized expenditures[54]. The $210,475,399 financing cost was effectively reduced by the growth component. This reduced the interest expense in the financial statements to $87,500,000, the amount of interest actually paid by CAE under the terms of the agreement[55].
(31) In order to determine the fair market value of the interest rate payable in an agreement comparable to the SADI Agreement, CAE examined the interest rate that private corporations agreed upon in such transactions[56]. It looked at the interest rate paid on bonds[57], as well as the rates payable in other transactions where the party that was to receive funds had a credit rating similar to CAE's[58]. It used the highest market rates because its Agreement entailed a greater risk given that it did not provide the government with the same guarantees and protections provided in similar transactions and considering that the amounts receivable would be used for SR&ED activities[59].
(32) According to Mr. Malatesta, the difference between the total amount of interest payable on contributions received under the SADI Agreement and the total amount of interest that should have been paid by CAE if it had had to pay interest on those contributions at the market interest rate, i.e., $122,975,399 ($210,475,399 - $87,500,000), was described as a "government benefit" in CAE's financial statements[60].
D. Testimony provided by Sylvie Brossard (33) Ms. Brossard has been working for CAE since 2007. At the time of the trial, she was Vice President of CAE's Tax Department. Much of Ms. Brossard's testimony focused on the accounting treatment of contributions that CAE received under the SADI Agreement.
(34) Ms. Brossard testified that CAE did not include in its income the amounts received as contributions under the SADI Agreement, because CAE considered them amounts received from a loan and not received as "government assistance"[61]. For the same reason, CAE did not use these amounts to reduce its eligible SR&ED expenditures[62].
(35) CAE included in its 2012 income statements a fictitious profit generated by this loan, which was obtained at a preferential rate. CAE also included in these very 2012 statements a fictitious interest expense equal to the difference between the amounts paid as interest under the SADI Agreement and the amounts that should have been paid as interest if the loan had been granted at the market rate of interest. This amount was "offset" by the addition of a non-deductible expense that cancelled the fictitious profit generated by the preferential interest rate in CAE's financial statements[63].
E. Testimony provided by Jean Lemieux (36) Mr. Lemieux has been working at the Department of Industry Canada's Strategic Innovation Fund since 2006. He was the Manager and Senior Investment Analyst and, as such, prepared the documents required to enter into the SADI Agreement.
(37) According to Mr. Lemieux, the Industrial Technologies Office implemented the SADI Program in 2007 to promote research and development projects and collaboration with universities, colleges, post-secondary institutions and research institutes within the framework of such projects. The Program also sought to promote the economic development of the aerospace, defence, space and security industries by contributing financially to research and development projects of companies operating in these sectors. Mr. Lemieux also said these industries are important to Canada and have traditionally always been heavily subsidized[64].
(38) The objective of the SADI Program was not to generate a return on contributions, and the program does not have a target rate of return. However, an agreement entered into under the Program could not be limited to providing for the reimbursement of contributions paid to a company. The Agreement was supposed to provide for a reasonable rate of return on "investment" in order to comply with World Trade Organization rules[65].
(39) According to Mr. Lemieux, the amounts received from companies under the SADI Program are, for the most part, transferred to the government's consolidated fund. Only part of these amounts is retained and included in the Program budget.
(40) The SADI Program is a so-called "contribution" program. According to Mr. Lemieux, this is why the SADI Agreement does not characterize the Program as a loan. In addition, the relevant government documents do not stipulate that a loan may be obtained under the Program[66].
(41) The most important criterion that a company must meet in order to benefit from the SADI Program is to demonstrate that Canada will benefit from the project[67]. According to Mr. Lemieux, CAE was able to benefit from the program because it demonstrated that it was a well-established flight simulator company and that the amounts obtained under the Program would allow Canada and the company to maintain its leadership in the flight simulator industry. In addition, the Canadian workforce would benefit from the training that would be provided to them through CAE's participation in the Program, and the Canadian population would benefit as well because using flight simulators for training purposes is beneficial to the environment. Finally, Canadian companies collaborating with CAE would indirectly benefit from CAE's participation in the program[68].
(42) Mr. Lemieux explained that under the SADI Program, a maximum contribution equal to 30% of the total SR&ED expenditures incurred for a project could be paid. During the negotiation of the SADI Agreement, the Minister of Industry Canada offered CAE two options for reimbursement of the contributions to be paid to the Minister, i.e., a conditional reimbursement and an unconditional reimbursement. The option that was originally proposed was an agreement with a conditional reimbursement based on the company's sales. In order to establish the terms of a conditional reimbursement, a mathematical formula was used to calculate a royalty rate that was then applied to the company's sales. The result of this calculation was increased by an adjustment factor that varied according to the company's income. When the company's sales increased, the adjustment factor was increased; therefore, in years when a company's sales were growing, the amounts reimbursements were that much greater. A company could also opt for an unconditional reimbursement. Under that option, a fixed amount determined in advance had to be reimbursed annually[69]. However, it was possible to choose a reimbursement plan according to which the amounts reimbursed gradually increased over the years.
(43) Mr. Lemieux explained that the process leading to the signing of the SADI Agreement began following a proposal from CAE. Discussions to enter into a contribution agreement were then initiated. In accordance with the SADI Proposal Preparation Guide, CAE submitted a first proposal and sent it to the Department of Industry Canada in October 2008. As part of this proposal, CAE asked for a total contribution equal to 35% of the Falcon Project's SR&ED expenditures. The proposed reimbursement plan provided for a conditional reimbursement and a 0.28% royalty rate. Mr. Lemieux performed an audit to determine whether the information that CAE produced in its proposal complied with current standards and began a due diligence process including a risk analysis. After this process was completed, he offered CAE two options, a conditional reimbursement option and an unconditional reimbursement option.
(44) However, the conditions for reimbursement of contributions submitted by CAE as well as the expense-sharing ratio defined in its initial proposal did not meet the standards established by the Department of Industry Canada. In January 2009, CAE submitted a second proposal that complied with existing standards. In this proposal, CAE requested a total contribution equivalent to 30% of the SR&ED expenditures incurred. The total contribution was not to exceed $250,000,000. The contributions were to be reimbursed over a period of 15 years, and the amount reimbursed by CAE was to be equal to the total amount of the contributions received multiplied by a minimum adjustment factor of 1.5. The adjustment factor to be used could increase based on the company's sales or sales growth[70].
(45) Negotiations focused on the total amount of contributions to be paid as well as the period over which reimbursements would be made. The reimbursement ratio was set at 1.35, and the total amount of contributions to be paid was increased to an amount equivalent to 35% of the research and development expenditures incurred[71]. In return, the Department of Industry Canada waived some of the research activities deemed to be riskier. The Department proposed two reimbursement options. Both options included a five-year grace period. The first reimbursement option was conditional and dependent on CAE's sales growth. Contributions were to be reimbursed over an eight-year period[72]. As for the second option, the reimbursement of contributions was unconditional and provided for fixed amounts to be reimbursed over a 15-year period[73]. CAE chose the second option[74]. According to Mr. Lemieux, CAE was not required to provide any guarantees or sureties because the SADI Program does not usually require them.
(46) Mr. Lemieux testified that clause 8.17 of the Agreement, which stipulates that CAE can prematurely terminate the Agreement by reimbursing the contributions received in addition to a 2.75% "annual return on investment," was added at CAE's request. The Minister of Industry Canada did not oppose this request even though the addition of this clause could reduce his yield if CAE were to exercise it[75]. As for Clause 6, it stipulated that CAE was required to report any government assistance that it obtained, it was included in the Agreement because, pursuant to a Treasury Board directive, the total percentage of government assistance that a company may receive as contributions under the SADI Program is 75%[76]. Low interest loans must be factored into this total[77]. According to this directive, contributions must be reimbursable to a for-profit company[78]. The clause prohibiting payment of dividends is a standard clause included in all agreements entered into under the SADI Program. However, such clauses only apply if, after an audit, a company reports that it is unable to make the reimbursements stipulated in the agreement or if the deadlines set out in the agreement are not met[79].
(47) SR&ED projects are monitored on an annual or quarterly basis depending on the level of risk associated with the project. An audit is performed as soon as a claim for reimbursement of SR&ED expenditures is filed because a report must be attached to it.
(48) According to Mr. Lemieux, in the event that CAE had encountered financial difficulties, a new risk analysis would have been performed, and the terms of the SADI Agreement would have been renegotiated[80]. It was only as a last resort that the Minister of Industry Canada would have put CAE into default[81]. In some cases, the debt can be written off[82]. If any renegotiations had taken place, they would have sought to ensure that Canada would still benefit from the deal[83]. During his cross-examination, Mr. Lemieux said the government was doing this in order to protect its rights[84].
F. Neil de Gray's testimony 1. Mr. de Gray's mandate (49) Mr. de Gray is the Director of Disputes and Investigations at Duff & Phelps. Since 2010, his firm has specialized in corporate and securities valuation, damage quantification and corporate finance advisory services[85]. The respondent retained his services as an expert in corporate finance and the valuation of debt instruments and securities. Mr. de Gray's services were retained to assist the Court. Mr. de Gray was asked to say whether, in his opinion, the SADI Agreement has the attributes of a "business" and constitutes an "ordinary business arrangement." More specifically, the respondent asked him whether, in his opinion, the payments made pursuant to the SADI Agreement were made "in exactly the same manner and for exactly the same reasons as the payments made by private companies, that is to say in order to promote the interests of the payer"[86]. Mr. de Gray was aware that the parties disagreed as to whether the agreement constituted a loan agreement or some other type of agreement. He was not asked for his opinion on this matter[87].
2. Mr. de Gray's analysis
(50) In assessing the "nature" of the SADI Agreement and determining whether this Agreement has the attributes of a "business enterprise" and constitutes an "ordinary business agreement," Mr. de Gray considered the main conditions of the Agreement which, according to him, are as follows:
a) reimbursement;
b) the SADI Agreement's internal rate of return;
c) clauses and restrictions;
d) other conditions[88].
(51) Mr. de Gray analyzed the terms of the SADI Agreement and concluded that, in general, those terms were based on a higher risk profile and therefore a return at the higher end of the spectrum of returns available with comparable "instruments" on the market[89]. Below, this Court provides a summary of Mr. de Gray's conclusions regarding each of those terms.
(a) Reimbursement
(52) Schedule 3 of the SADI Agreement sets out the terms for reimbursing contributions. They require full unconditional reimbursement of all contributions received by CAE. Reimbursements must be made within a period of 15 years starting in 2015. Overdue amounts earn interest at the "bank rate" plus 3%, compounded monthly[90]. Mr. de Gray found that the requirement to reimburse all contributions received under the Agreement and interest accrued on overdue amounts is generally consistent with the terms of a "business agreement"[91].
(53) Mr. de Gray believed that the deferral of interest and principal payments during the first five years of the SADI Agreement and the 15-year reimbursement period increase the lender's risk associated with the loan agreement. According to Mr. de Gray, it is unusual for a business loan agreement to provide for a five-year deferral of interest and principal. Mr. de Gray said a business loan agreement usually requires some form of reimbursement over the life of the agreement, and deferral periods are usually less than five years[92].
(b) SADI Agreement's implied internal rate of return
(54) Mr. de Gray noted that the SADI Agreement provides the Minister of Industry Canada with a rate of return on funds advanced to CAE. Under the Agreement, CAE must reimburse the full face value of the total amount of contributions received, plus an amount equal to the total amount multiplied by a maximum factor of 0.35 over a period of 15 years[93].
(55) To determine whether the SADI Agreement has the attributes of a "business enterprise" and constitutes an "ordinary business agreement," Mr. de Gray examined whether the "implied" rate of return of the Agreement was a fair market rate of return taking into account the risk profile of the "investment." It is an "implied" rate of return because the Agreement does not make any reference to a rate of return.
(56) Based on the total contributions that CAE received ($250,000,000) and the total reimbursements to be made ($337,500,000), Mr. de Gray found that the SADI Agreement provided an $87,500,000 return ($337,500,000 – $250,000,000)[94]. Mr. de Gray determined what this dollar return meant in terms of the annual rate of return. He calculated the implied rate of return based on the cash flow projections in the Agreement and subsequent amendments to the Agreement. He found that the impl