Telecomsyst Services Inc. v. The Queen, 97 DTC 684, [1997] 1 CTC 2256 (TCC)

Dussault J.T.C.C.: — The only point at issue in this appeal concerns the right of the appellant, TELECOMSYST SERVICES INC. (“TSI”), to an investment tax credit and a refundable investment tax credit of $40,440 for its 1987 taxation year under the provisions of subsection 127(5) et seq. and section 127.1 of the Income Tax Act (the “Act”). The appellant claimed that it incurred total expenses of $115,543 in respect of scientific research and experimental development activities that qualify as eligible expenses for the purposes of those credits. The respondent contended that the expenses in question did not meet the conditions stated in section 2900 of the Income Tax Regulations (the “Regulations”) defining such activities which provides as follows:

For the purposes of this Part and paragraphs 37(7)(b) and 37. l(5)(e) of the Act, “scientific research and experimental development” 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.

Preliminary Questions

Before addressing the merits of the case, it is important to point out a certain number of difficulties that occurred during the hearing, which, though having no significant effect on the conclusion I have reached, are nevertheless worthy of note.

First, Maurice Malka, the president of the appellant, was authorized by a decision by Judge Lamarre Proulx dated May 26, 1993 to represent the appellant for the purpose of the hearing of this appeal. Mr. Malka, who is an engineer specialized in telecommunications, was also the principal witness for the appellant, although he required the testimony of other persons who had already been or were currently employed by the appellant or who had had business relations with it. However, despite the fact that no expert report was filed by the appellant in advance in accordance with the rules of the Court, [1] Mr. Malka and those other persons not only testified as to the facts relevant to the 1987 taxation year and even a number of subsequent years, but also gave their opinion on the very nature of the activities in relation to the conditions stated in the Regulations with respect to their eligibility. Counsel for the respondent made a number of objec tions on this point and I advised Mr. Malka on numerous occasions to try to keep to the facts without seeking to give or trying to obtain from other witnesses an opinion characterizing the appellant’s activities. I clearly took this difficulty into account in analysing the evidence.

A second difficulty concerned the expert witness produced by the respondent, François Perrier. Although the rules of procedure were complied with in this case, Mr. Malka objected to the Court’s recognizing him as an expert for a number of reasons. Mr. Malka’s first objection concerned the professional status of Mr. Perrier, a retired engineer who was an active member of the Association of Professional Engineers of the Province of Ontario until 1990 but not of the Ordre des ingénieurs du Québec, whose authority in giving a judgment or opinion on Mr. Malka’s telecommunications engineering work carried out for the appellant in Québec Mr. Malka disputed.

This objection was without foundation. To dismiss it, it is sufficient to say that the only relevant criterion that the Court must use in allowing a person to testify as an expert witness is precisely his qualifications as an expert in the matter, not his professional status. Furthermore, on numerous occasions, our courts have reiterated the principle that it is knowledge and expertise in a field that count, not the manner in which that knowledge and expertise have been acquired. In Marquardt [2] McLachlin J. relied on the remarks of Sopinka, Lederman and Bryant in their work The Law of Evidence in Canada (1992), at pages 536-37:

The admissibility of such [expert] evidence does not depend upon the means by which that skill was acquired. As long as the court is satisfied that the witness is sufficiently experienced in the subject-matter at issue, the court will not be concerned with whether his or her skill was derived from specific studies or by practical training, although that may affect the weight to be given to the evidence? [3]

In my view, the fact that one has been admitted to practise in one Canadian province rather than another is not really likely to enlighten the Court on the relevant point.

This leads me to address the second objection by Mr. Malka to Mr. Perrier’s testimony as an expert. This objection concerned the very heart of the matter since it was intended to determine whether Mr. Perrier had the necessary knowledge and expertise to give his views on the nature of the appellant’s activities, more precisely to give his opinion on the question as to whether those activities constituted eligible scientific research and experimental development activities.

Mr. Perrier is a retired engineer. His education in communications and electronics and the numerous positions he has held in private industry and the public service in those fields as an engineer and manager of research projects attest to a productive and brilliant career. However, now 79 years of age and being retired from active practice for more than 12 years, he himself admitted that he had not worked on the problem of signal compression and that of voice, facsimile, data and video integration which have formed the core of the appellant’s activities over a number of years. Similarly, he stated that he was qualified in the field of telephony in an “overall sense”, although he admitted that he did not know the meaning of the terms used in signal digitization technology, an advanced technology in this field. Two passages from the transcript of his testimony are sufficient to illustrate this point. The first is as follows:

Q. Mr. Perrier, have you ever worked on signal compression for transmission purposes?

A. No.

Q. Thank you. I’ll ask my question again: do you still feel qualified to provide a judgment in the field of voice, data and video compression?

A. I feel qualified, no to your answer [sic], but yes in an overall sense for evaluating research findings, that is reports, patents, knowing the speed, the findings of studies. So, on that point, my answer is yes. [4]

[Translation.]

The second reads as follows:

Q. What is a DS-1?

A. It is a means of communication with certain characteristics that supposedly increase speed. I do not know the details; I simply know that it is a means of communication.

Q. Do you know what a DS-2 is? A DS-3?

A. No.

Q. Ah! You don’t know the digital hierarchy?

A. Correct.

Q. Do you at least know what “DS” means?

A. No.

Q. You don’t know what “digital speed” means. Do you recognize that this potential experiment is different from Republic Telecom?

A. That’s not clear.

Q. For you.

A. For me, yes; that is correct, yes.

Q. And you are an expert in telecommunications? Excuse me, you are knowledgeable in telecommunications?

A. Yes.

Q. And you don’t know what works at DS-0, DS-1, DS-2 or DS-3?

A. Precisely.

Q. And you believe that your practice does not require that, that you be able to read, digest and understand reports like this without knowing what the words mean?

A. I readily understand the results of this kind of experiment very well, whether it be DS-1 or 25; I was expecting to find on the taxpayer’s premises data that said: we have tested a network that we have called DS-1 or which introduces a technology that we have called DS-1. And I wanted to see the results of those experiments.

So seeing as this is just a plan, a proposal, I understand that the taxpayer was able to elaborate in his proposal on what it wanted to test with one thing here, two things there and to integrate that in order to convince the taxpayer that that would give him a benefit in performance and economic terms. That was how I read this documentation.

Q. So you are telling me that, in reading this report, you understood absolutely nothing about the merits of what was proposed here?

A. No, that is not true.

Q. You understood the form — it’s a new proposal - but you could not recognize that it no longer had anything to do with Republic; you did not know that it involved Stratacom; you did not know what technology was being referred to?

A. Yes... [5]

[Translation.]

Without wishing to sully Mr. Perrier’s reputation, I am forced by the whole of his testimony to note that he had not necessarily followed high technology developments in telephony in recent years.

A number of decisions by the Supreme Court of Canada concerned the admissibility of expert evidence. In a recent decision in Mohan, supra, Sopinka J. discussed the pre-condition in this area, that is that concerning

the necessity of helping the trier of fact, in the following terms:

This pre-condition [the necessity of helping the trier of fact] is often expressed in terms as to whether the evidence would be helpful to the trier of fact. The word “helpful” is not quite appropriate and sets too low a standard. However, I would not judge necessity by too strict a standard. What is required is that the opinion be necessary in the sense that it provide information “which is likely to be outside the experience and knowledge of a judge or jury”: as quoted by Dickson J. in R. v. Abbey, supra. [6]

If the question whether a taxpayer’s activities constitute eligible scientific research and experimental development activities within the meaning of section 2900 of the Regulations is ultimately one of law, one may easily conceive that it is nevertheless necessary to have an expert’s assistance in order to explain the context, nature and importance of the activities in specialized fields in which the judge clearly has very limited knowledge. Generally speaking, it may be said that this necessity becomes increasingly obvious as the activities become increasingly numerous and complex. However, to the extent that the facts adduced in evidence show that the activities were very limited, it seems less clear that it is necessary to call upon an expert. Thus, if I had to take into account all the appellant’s activities during the years from 1986 to 1995 for the purposes of rendering a decision, it seems to me that the need for an expert’s assistance in the advanced technologies of telephony would have been greater. However, as I have to rule on the point at issue only in respect of the appellant’s 1987 taxation year, this does not at all appear to me to be essential. I will simply add that it also appears from the Supreme Court of Canada’s decisions, particularly in Marquard, supra, that an expert must show he has expertise in the specific field of the activities respecting which he is asked to give an opinion before the Court can agree to consider his testimony. As this was not shown to my satisfaction, I find that it would not be appropriate in the circumstances to take into account the testimony of the expert produced by the respondent either.

Summary of Facts and Analysis

The appellant, TSI, is a Canadian-controlled private corporation providing consulting engineering services in telecommunications.

Some time prior to the year in issue, the Canadian Radio-Television and Telecommunications Commission (“CRTC”) began to deregulate certain telecommunications services so as to enable those services to be shared and resold by certain groups, without however authorizing direct competition with servers such as Bell Canada and CNCP at that time.

Wishing to take advantage of this opportunity, TSI established a project to create a group of sharers designated as the “Telecommunications Professional Group” (“TPG”) and to provide them with a telecommunications network integrating voice, data, facsimile and video transmission. TSI’s purpose was in fact to develop the architecture of an integrated network that, while complying with ISDN [7] standards, would offer advanced technologies and reliable service at about half the cost of what was then offered by traditional telephone suppliers such as Bell Canada and CNCP.

It is important to emphasize that TSI was also very active at the time in making representations to the CRTC for the liberalization of the telecommunications market.

To establish its network, TSI approached a number of potential clients including the Montreal Stock Exchange, the Toronto Stock Exchange, the Canada Post Corporation and the Telecommunications Branch of the Ministry of Communications Quebec (“TB”). TSI saw TB as eventually being the core of the group of sharers of the network that it wished to create and manage.

In pursuing this commercial objective, TSI thus took a number of actions, in particular approaching the TB by making a number of unsolicited proposals.

On November 27, 1986, TSI submitted to the TB a [translation] “proposal for the field testing of an intercity transmission system utilizing packet switched voice transmission technologies” on the TB intercity network. [8] In fact, TSI was essentially proposing a test run of a voice compression technology making it possible to increase the number of simultaneous conversations between two cities, which was likely to result in considerable savings for the TB. This technology developed by Republic Telcom Systems Corporation (“Republic”) of Boulder, Colorado, U.S.A., had, according to the proposal signed by Mr. Malka, president of TSI, [translation] “already proven itself in the U.S.A.”. Furthermore, Mr. Malka had previously travelled to Boulder and conducted a trial of the compression system in a communication with a colleague who had remained in Montréal. This unique communication in English, then in French under various load conditions had made it possible to realize that the compression algorithms developed for English were not very well suited to French and that there was a major deterioration in the quality of the communication. TSI could not undertake research into compression technologies alone. In his testimony, Mr. Malka described the problem in the following terms:

As I told you, I personally spent more than two months familiarizing myself with the entire question of compression, which was enough for me to realize that it was dangerous since I did not have enough thorough studies in that field. [9]

[Translation.]

For this reason, TSI approached the Centre de recherche informatique of the University of Montréal (“CRIM”) in 1987 with regard to the possible development of French-language compression algorithms, anticipating a technology transfer and the provision of equipment by Republic. However, as Republic did not want to supply the necessary equipment unless a large order was placed, which TSI could not afford to do, matter remained at that point and no further action was taken on the pilot project proposed to the TB in November 1986.

On July 23, 1987, however, TSI submitted a new proposal to TB entitled [translation] “Proposal for a timeliness/feasibility study and participation in the sharers group (TPG) pilot project”. [10] According to the terms of the proposal, the timeliness/feasibility study’s aim was firstly to identify the TB’s particular needs and the technological choices based in particular on the use of a digital (rather than analog) transmission technology at DS-1, the integration of voice and data transmission on a single connection as well as the compression of conversational silences. The proposal also provided that if this first study confirmed the “project’s viability” and if the TB decided to go ahead, a pilot project would be carried out by the group on the Québec-Montréal route.

According to Mr. Malka, it was important from the outset, and in respect of each of the proposals made by TSI, that the TB allow access to its network so that experiments could be conducted on a “live” network under various load conditions. Although the Ministry of Communications had stated in a letter of July 15, 1987 [11] that it had been “favourably impressed” by a preliminary presentation of the TPG project by Mr. Malka a few weeks earlier and even that it had stated it was interested in pursuing the work with TSI, no concrete action was taken by the TB on the proposal in 1987 or even in 1988 and no experiment was conducted on the network in those years. In September 1987, Mr. Malka conducted other tests on Republic’s equipment installed in Montréal at a business show organized by the Canadian Business Telecommunication Alliance. On that occasion, the tests, which lasted a total of approximately an hour and a half on two consecutive evenings, concerned compression in the transmission of facsimiles and data. According to Mr. Malka, these trials made it possible to observe the limits in the performance of equipment under load where the compression rate used exceeded three to one. This was in fact the only experiment that could be documented in 1987.

It was not until other proposals had been made, including one dated November 2, 1989, that the TB decided to commission a $9,500 study on the feasibility of using 32 kbit/sec. connections for transmission between facsimile machines and between switched computer terminals on the government long distance network that TSI was at last able to conduct certain experiments. [12] In fact, to complete this study, TSI, at the TB’s request, obtained certain information from CNCP on experiments previously conducted by the latter. However, under Mr. Malka’s supervision, TSI proceeded with compression experiments on the premises of Bell Canada in 1990. The report was submitted to the TB by TSI on March 12, 1990.

On May 29, 1990, in response to the liberalization of the CRTC’s regulatory framework and rate structure respecting reselling and sharing, TSI made a new proposal to the TB [translation] “for a planning and technology selection study as well as a voice and data compression and transmission experimentation proposal”. [13] Once again, this was an attempt by TSI to get the TB to accept TPG in particular as “a supplier or sharer member” of DS-1 channels and a DS-3 channel for the Montréal-Québec intercity network with a view to reducing the operating costs of the government’s long distance network. The TB did not act on the proposal, preferring to make direct use of the services offered by Bell Canada.

I will not dwell any further on TSI’s activities during the years after the year in issue, as the very nature of the appeal, which concerns only the 1987 taxation year, require me to consider only those activities that took place during that year in relation to the conditions stated in the first paragraph of section 2900 of the Regulations, even though Mr. Malka insisted that those activities must be considered in an overall context. Mr. Malka made the following comments on this point:

And in relation to scientific research and experimental development, the criticism that was made of my situation is that there were no experiments in 1987. The account that I have given on a number of occasions is that it was impossible to conduct experiments in the year when we began planning and obtain the mandate, obtain a network on which we could work. As you can understand, there were certain political problems with regard to the awarding of the contract. And that ultimately went on until 1990. [14]

Your Honour, I must prove that if experimentation took place, and if it took place in 1989 or 1990, that must be taken into account. [15]

[Translation.]

Paul Pichoir, who was hired by Mr. Malka as a consultant at the relevant time, explained the complexity of the TPG project and its context in the following terms in his examination by Mr. Malka:

Q. Well, then, Mr. Pichoir, we are going to continue. Could you please continue to explain to the Court in your own words how complex the project was?

A. Well, the project’s complexity was in finding technical and financial solutions so that — as was said, we had to offer a service that would cost TPG perhaps 50 per cent of what the telephone companies normally offered - so that substantial reductions could be offered to its suppliers so that they would want to switch from the existing service to the new service and, second, to ensure that there was enough room to manoeuvre in the price war that would follow so that we could remain a viable entity in the following years. Hence the search for maximum compression and studies that were conducted to support that technology. The engineers conducting the tests encountered failures, as a result of which there were reorientations through the use of certain methods to obtain the same thing. But that was not in 1987. [1]

[Translation.]

And further on:

Q. Mr. Pichoir, TSI’s program was spread over how many years?

A. Well, we ... it is hard to find an idea that develops in accordance with, in a “business” sense, but it probably started in 1986 or around then, but the possibility came about as a result of the introduction of deregulation in the telecommunications industry and made it possible to advance in the following years and to make the progress that it has made to date, where we see that there are a host of companies offering various services and that there is strong development in a number of sellers, whereas there were only two before that. In the years around 1987, that was the very start, and moreover ...

Q. So to your knowledge, what was the first thing to do in order to test the concept at a fundamental level?

A. As TSI was essentially a consulting company working for TPG, it decided to conduct tests on the premises of two equipment suppliers, Republic and Stratacom.

JUDGE:

Q. Would you please speak louder because I find it hard to hear you?

A. I’m sorry. Excuse me. One was Republic and the other was Stratacom. In order to see whether TSI could purchase this equipment for TPG, or TPG could purchase it, depending on the credit arrangement, and use it for its users. This was equipment that in fact introduced the compression technologies. [17]

[Translation.]

It may be seen that there was talk of Republic’s equipment, which has already been mentioned and which Mr. Malka had already tested in Boulder, Colorado, around the end of 1986 and also in Montréal in September 1987. It is also known that TSI had negotiated with the U.S. firm Stratacom in 1987 for a technology transfer of their products, as attested by a letter dated May 23, 1989 from Mr. Malka to Michel Lefebvre of Revenue Canada. [18] There was an appendix to this letter in which the project was specifically defined in the following terms:

The purpose of this research is also to discover the characteristics of integrated services digital networks (ISDN) that may enable TSI to introduce new signal compression and processing processes, to acquire those existing in the United States and to adapt them to the sharer and reseller market unique to Canada. Lastly, it is expected that, following experiments and pilot projects, it will be possible for TSI to derive new and unique products and services that will provide added value on the common carrier market.

The project concerns research into technological methods for telecommunications signal compression that are on the technological cutting edge and that meet ISDN standards proposed by CCITT for application in the context of a sharer/reseller group called TPG- Telecommunications Professional Group.

The following compression technologies have been selected: low bit rate encoding systems and packet switching systems. These technologies are desirable for the purposes of technology transfer, product development in a Francophone environment and adjustment to the sharer and reseller market. The 4:1 and 10:1 compression technology was still at the experimental stage in 1987 and as a result is just barely emerging and available on the “normal” share/reseller market in 1989.

Thus, the applied research, analysis and experimentation proposed and conducted by TSI in 1987 illustrate the problems involved in the transmission of French on these systems and the appropriate algorithms developed were precursors and were already highly advanced. Once discovered and developed, these technologies will help derive products that will make it possible to establish sharer and reseller businesses in Canada with international

repercussions.!?

repercussions. [19]

[Translation.]

This description suggests that TSI was conducting research on telecommunications signal compression, compression technology selection, product development in a Francophone environment and on adjustments to the sharer and reseller market. The last paragraph goes even further, stating that [translation] “applied research, analysis and experimentation proposed and conducted by TSI in 1987 illustrate the problems involved in the transmission of French ... and the appropriate algorithms developed were precursors and already highly advanced”. The text even claimed that, [translation] “Once discovered and developed, these technologies will help derive products that will make it possible to establish sharer and reseller businesses in Canada with international repercussions.” This text in fact suggests that TSI was developing compression technologies for use in a Francophone environment by directing its research toward the discovery and development of algorithms appropriate to the transmission of communications in French. the evidence shows in fact that after problems in communicating in French using compression equipment were discovered, entirely by chance moreover, in 1986, TSI conducted no research in this field since it did not have the necessary expertise and could not agree with CRIM in this area because Republic had refused to supply the necessary equipment and to make a technology transfer unless a large order was placed.

As to the so-called research [translation] “to discover the characteristics” of ISDN, the idea was not for TSI to do so in order to [translation] “introduce new signal compression and processing processes”, as stated in the first paragraph of the letter of May 23, 1989 to Mr. Lefebvre, but essentially to become familiar with the concepts in order to acquire existing equipment in the United States. Jean- Guy Dubois, who testified for the appellant, outlined his work in the following terms:

So my research in this area was mainly to see, to familiarize myself first with the various ISDN concepts, then to see in the market which equipment could be used to provide ISDN service, then try to establish a customer base in order to implement ISDN. [20]

[Translation.]

In fact, during the year in issue, TSI limited itself to conducting a few additional tests in Montréal in September 1987 on Republic facsimile and data transmission equipment, then turned to the technology developed by the firm Stratacom. What it was doing here in any case was only testing devices already on the market that had been designed from technologies developed in the United States.

One final point is worthy of note. A comparison of the description of TSI’s research proposal filed in a schedule to the T661 form respecting scientific research and experimental development for its 1986 [21] and 1987 [22] taxation years respectively shows that the two are identical in every respect (in fact, they are two photocopies of the same document) except for the dates indicated in subparagraph (d) of page 7 entitled “Progress to date”, which have been amended to read one year later.

For 1986, they read as follows:

(d) Progress to date

(i) Analysis of the impact of CRTC deregulation: September I to September 31, 1986

(ii) Analysis of tariffs: September 1 to November 15, 1986

(iii) Analysis of equipment: October 15 to December 31, 1986.

A feasibility study will be completed in 1987 followed by experimentation in 1988. [23]

For 1987, they read as follows:

(d) Progress to date

(i) Analysis of the impact of CRTC deregulation: September 1 to September 31,1987

(ii) Analysis of tariffs: September 1 to November 15, 1987

(iii) Analysis of equipment: October 15 to December 31, 1987.

A feasibility study will be completed in 1988 followed by experimentation in 1989. [24]

In Sass, [25] Judge Sarchuk of this Court analyzed the requirements stated in Regulation 2900:

In my view Regulation 2900 requires an appellant to adduce cogent evidence of such investigation or search. Systematic investigation connotes the existence of controlled experiments and of highly accurate measurements and involves the testing of one’s theories against empirical evidence. Scientific research must mean the enterprise of explaining and predicting and the gaining knowledge of whatever the subject matter of the hypothesis is. This surely would include repeatable experiments in which the steps, the various changes made and the results are carefully noted. There is no evidence of such an approach in the case at bar, either in the context of applied research or development. [26]

Even if it is accepted that, in 1987, TSI continued to analyze the CRTC’s regulatory framework and rate schedule, to examine the ISDN standards and characteristics of compression equipment designed and developed in the United States for the purpose of the unsolicited proposal to the TB on July 23 of that year and possibly of proposals to other potential customers, it was not shown that those activities met the requirements of Regulation 2900 in accordance with the interpretation given it in Sass, supra. Consideration of the CRTC’s regulatory framework and rate structure for the purpose of making representations to that agency or commercial proposals to potential customers does not constitute a scientific research and experimental development activity, nor does familiarizing oneself with ISDN standards. As to the tests on the devices developed in the United States which were observed in 1987, they lasted less than two hours and definitely cannot be considered as an activity of “systematic investigation”. TSI of course proceeded with certain experiments; unfortunately, they did not take place during 1987, the year in issue.

The appeal is accordingly dismissed, with costs to the respondent.

Appeal dismissed.