Date: 20011108
Docket: 1999-4847-IT-G
BETWEEN:
MIMETIX PHARMACEUTICALS INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasonsfor
Judgment
Lamarre, J.T.C.C.
[1]
This is an appeal from an assessment made by the Minister of
National Revenue ("Minister") under the Income Tax
Act ("Act") with respect to the
appellant's 1996 taxation year. In assessing the appellant,
the Minister:
(a) revised the
qualified expenditures for the purposes of investment tax credits
from $1,964,600 as claimed by the appellant[1] down to $1,755,573, the difference of
$209,027 having been disallowed as a qualified expenditure;
(b) calculated
investment tax credits at a rate of 20 per cent instead of the
35 per cent rate used by the appellant;[2] and
(c) denied
refundable investment tax credits in the amount of $600,599
claimed by the appellant.
[2]
With respect to paragraph 1(a) above, it is my understanding that
the qualified expenditures were reduced by an amount of $209,027
with respect to a piece of equipment, the "Collette
mixer", that the appellant had leased prior to its
acquisition thereof. The respondent submits that the Collette
mixer had been used by the appellant before its acquisition and
consequently that the expenditure for its acquisition was a
prescribed expenditure within the meaning of
paragraph 2902(b) of the Income Tax
Regulations ("Regulations"). Therefore, the
expenditure was not a qualified expenditure within the meaning of
subsection 127(9) of the Act for purposes of the
investment tax credit provided for in subsection 127(5) of the
Act.
[3]
With respect to paragraph 1(b) above, the respondent submits that
under subsections 127(5) and 127(9) of the Act the
appellant was only entitled to deduct as investment tax credits
from tax otherwise payable 20 per cent of qualified expenditures
and not the 35 per cent claimed by the appellant,
which, if I understand correctly, tried to take advantage of an
additional investment tax credit under subsection 127(10.1) of
the Act. The respondent took the position that the
appellant was not a Canadian-controlled private corporation
("CCPC") within the meaning of subsection 125(7) of the
Act during the 1996 taxation year, and therefore was not
allowed to deduct more than 20 per cent of qualified expenditures
as investment tax credits.
[4]
Finally, with respect to paragraph 1(c) above, the respondent
submits that for the same reason, i.e. that it was not a CCPC in
1996, the appellant did not meet the definition of
"qualifying corporation" set out in subsection 127.1(2)
of the Act and was therefore not entitled to a refundable
scientific research and experimental development
("SR & ED") tax credit for that year pursuant to
subsection 127.1(1) of the Act.[3]
Statutory Provisions
[5]
The relevant portions of the sections of the Act and the
Regulations referred to above are reproduced below:
Income Tax Act
4125(7)3
(7) Definitions. In this section,
. . .
"Canadian-controlled private corporation"
- "Canadian-controlled private corporation" means
a private corporation that is a Canadian corporation other than a
corporation
(a) controlled, directly or indirectly in any manner
whatever, by one or more non-resident persons, by one or more
public corporations (other than a prescribed venture capital
corporation), or by any combination thereof,
(b) that would, if each share of the capital stock of a
corporation that is owned by a non-resident person or a public
corporation (other than a prescribed venture capital corporation)
were owned by a particular person, be controlled by the
particular person, or
(c) a class of the shares of the capital stock of which
is listed on a prescribed stock exchange;
4127(5)3
(5) Investment tax credit. There may be deducted from the
tax otherwise payable by a taxpayer under this Part for a
taxation year an amount not exceeding the lesser of
(a) the total of
(i) the taxpayer's investment tax credit at the end of the
year in respect of property acquired before the end of the year
or of the taxpayer's SR & ED qualified expenditure pool at
the end of the year or of a preceding taxation year, and
(ii) the lesser of
(A) the taxpayer's investment tax credit at the end of the
year in respect of property acquired in a subsequent taxation
year or of the taxpayer's SR & ED qualified expenditure
pool at the end of a subsequent taxation year to the extent that
an investment tax credit was not deductible under this subsection
or subsection 180.1(1.2) for the subsequent year, and
(B) the amount, if any, by which the taxpayer's tax
otherwise payable under this Part for the year exceeds the
amount, if any, determined under subparagraph (i), and . . .
4127(9)3
(9) Idem. In this section,
"investment tax credit" -
"investment tax credit" of a taxpayer at the end of a
taxation year means the amount, if any, by which the total of
(a) the total of all amounts each of which is the
specified percentage of the capital cost to the taxpayer of
certified property or qualified property acquired by the taxpayer
in the year,
(a.1) 20% of the taxpayer's SR & ED qualified
expenditure pool at the end of the year . . .
"non-qualifying corporation" -
"non-qualifying corporation" at any time means
(a) a corporation that is, at that time, not a
Canadian-controlled private corporation . . .
"qualified expenditure" -
"qualified expenditure" incurred by a taxpayer in a
taxation year means
(a) an amount that is an expenditure incurred in the
year by the taxpayer in respect of scientific research and
experimental development that is an expenditure
. . .
but does not include
(c) a prescribed expenditure incurred in the year by
the taxpayer . . .
"specified percentage" -
"specified percentage" means
. . .
(e) in respect of a qualified expenditure
. . .
(iv) made by a taxpayer
(A) after the taxpayer's 1984 taxation year and before
1995, or
(B) after 1994 under a written agreement entered into by the
taxpayer before February 22, 1994,
(other than a qualified expenditure in respect of which
subparagraph (ii) applies) in respect of scientific research and
experimental development to be carried out in
(C) the Province of Newfoundland, Prince Edward Island, Nova
Scotia or New Brunswick or the Gaspé Peninsula, 30%,
and
(D) in any other area in Canada, 20%, and
(v) made by a taxpayer after 1994, 20% where the amount is not
an amount to which clause (iv)(B) applies . . .
4127(10.1)3
(10.1) Additions to investment tax credit. For the purpose
of paragraph (e) of the definition "investment tax
credit" in subsection (9), where a corporation was
throughout a taxation year a Canadian-controlled private
corporation, there shall be added in computing the
corporation's investment tax credit at the end of the year
the amount that is 15% of the least of
(a) such amount as the corporation claims;
(b) the SR & ED qualified expenditure pool of the
corporation at the end of the year; and
(c) the corporation's expenditure limit for the
year.
SECTION 127.1: Refundable investment tax credit.
(1) Where a taxpayer (other than a person exempt from tax
under section 149) files
(a) with the taxpayer's return of income (other
than a return of income filed under subsection 70(2) or 104(23),
paragraph 128(2)(f) or subsection 150(4)) for a taxation
year, or
(b) with a prescribed form amending a return referred to
in paragraph (a)
a prescribed form containing prescribed information, the
taxpayer is deemed to have paid on the taxpayer's balance-due
day for the year an amount on account of the taxpayer's tax
payable under this Part for the year equal to the lesser of
(c) the taxpayer's refundable investment tax credit
for the year, and
(d) the amount designated by the taxpayer in the
prescribed form.
4127.1(2)3
(2) Definitions. In this section,
. . .
"qualifying corporation" -
"qualifying corporation" for a particular taxation year
that ends in a calendar year means
(a) a corporation that is a Canadian-controlled private
corporation throughout the particular year (other than a
corporation associated with another corporation in the particular
year) the taxable income of which for its immediately preceding
taxation year (determined before taking into consideration the
specified future tax consequences for that preceding year) does
not exceed its business limit for that preceding year, or
(b) a corporation that is a Canadian-controlled private
corporation throughout the particular year and associated with
another corporation in the particular year, where the total of
all amounts each of which is the taxable income of the
corporation or such an associated corporation for its last
taxation year that ended in the preceding calendar year
(determined before taking into consideration the specified future
tax consequences for that last year) does not exceed the total of
all amounts each of which is the business limit of the
corporation or such an associated corporation for that last
year;
"refundable investment tax credit" -
"refundable investment tax credit" of a taxpayer for a
taxation year means, in the case of a taxpayer who is
(a) a qualifying corporation for the year,
(b) an individual other than a trust, or
(c) a trust each beneficiary of which is a person
referred to in paragraph (a) or (b),
an amount equal to 40% of the amount, if any . . .
Income Tax Regulations
2902. For the purposes of the definition "qualified
expenditure" in subsection 127(9) of the Act, a prescribed
expenditure is
. . .
(b) an expenditure of a capital nature incurred by a
taxpayer in respect of
. . .
(iii) the acquisition of property that has been used or
acquired for use or lease, for any purpose whatever before it was
acquired by the taxpayer.
Issues
[6]
The parties agree that this appeal can be narrowed down to two
issues. The first is whether the appellant was a CCPC in its 1996
taxation year. The second is whether the acquisition of the
Collette mixer was a prescribed expenditure within the meaning of
subparagraph 2902(b)(iii) of the Regulations.
I.
First issue: Was the appellant a CCPC in its 1996 taxation
year?
[7]
The appellant will be considered a CCPC in 1996 if it can be
shown that it was not in that year a corporation controlled,
directly or indirectly in any manner whatever, by one or more
non-resident persons, as required by subsection 125(7) of the
Act. Both parties agreed that no one had de jure
control over the appellant. The issue is rather whether the
appellant was controlled in fact, directly or indirectly in any
manner whatever, by a non-resident. In other words, it has
to be determined whether the non-resident corporation
Mimetix Inc. ("Mimetix"), which owned
50 per cent of the voting shares of the appellant in
1996, exercised de facto control over the latter
corporation within the meaning of subsection 256(5.1) of the
Act which reads as follows:
4256(5.1)3
(5.1) Control in fact. For the purposes of this Act, where
the expression "controlled, directly or indirectly in any
manner whatever," is used, a corporation shall be considered
to be so controlled by another corporation, person or group of
persons (in this subsection referred to as the
"controller") at any time where, at that time, the
controller has any direct or indirect influence that, if
exercised, would result in control in fact of the corporation,
except that, where the corporation and the controller are dealing
with each other at arm's length and the influence is derived
from a franchise, licence, lease, distribution, supply or
management agreement or other similar agreement or arrangement,
the main purpose of which is to govern the relationship between
the corporation and the controller regarding the manner in which
a business carried on by the corporation is to be conducted, the
corporation shall not be considered to be controlled, directly or
indirectly in any manner whatever, by the controller by reason
only of that agreement or arrangement.
Facts
[8]
The appellant was incorporated in Canada in 1994 to carry out
research and development with respect to a pharmaceutical product
known as DIAC, a powdered form of diatomic iodine devised as an
effective treatment for women with fibrocystic breast disease.
The original patent for the DIAC formula was registered by the
late Dr. Ghent, who resided in Kingston, Ontario, at that time.
In 1993, Dr. Ghent's estate negotiated with Mimetix, an
American company, a licensing arrangement with respect to DIAC
under which Mimetix would own an exclusive licence for that
product. Mimetix paid a licence fee of US$100,000. In January
1995, Mimetix sub-licensed to the appellant, for no
consideration, the non-exclusive right to conduct in Canada
the clinical trials and other investigations involving the
licensed product and to manufacture and proceed with the
development of the product with a view to obtaining approval for
commercial sale in Canada.
[9]
Under the sub-licence agreement, the appellant had the right to
utilize third party contractors, subject to prior approval by
Mimetix, to perform or to conduct certain aspects of such
development. The appellant thus hired contractors or consultants
to carry out the clinical trials, both in Canada and in the U.S.
The appellant also hired a firm named Custom Pharmaceuticals
("Custom"), a wholly-owned subsidiary of a
Canadian company named Patheon Inc. (which had invested in
Mimetix in 1994), located in Fort Erie, Ontario, to look after
the day-to-day manufacturing of the product. The appellant
used land owned by Custom to build a plant in Fort Erie. The
appellant invested approximately $600,000 in that plant according
to its balance sheet as of December 31, 1996.
[10] The
administration of the appellant was carried out from San
Francisco in the U.S. by Mimetix because, as James Wooder, the
only director of the appellant to testify explained, that was a
lot cheaper for the appellant. It is not clear from his testimony
whether Mimetix charged the appellant any fee for the
administration services provided, although it appears from the
appellant's financial statements for the 1996 taxation year
that the appellant did pay someone administration fees totalling
$12,000 in that year. However, at his examination for discovery,
Mr. Wooder testified that no payments were made for those
services.
[11] At the
time of its incorporation in November 1994 the appellant issued
100 common voting shares at $1.00 each, of which 50 were
subscribed for by Mimetix, and the other 50 by Robert Tedford, a
Canadian resident and a senior director at Patheon. At that time,
there were three directors elected to the appellant's board
of directors: Robert Tedford, Donald Eaton, an American resident
who was the chairman and chief executive officer of Mimetix, and
a third person, Nick DiPietro, a Canadian resident.
[12] On June
20, 1995, Nick DiPietro and Robert Tedford tendered their
resignations as directors of the appellant. On the same date, Dr.
Marie-Madeleine Bernard, a Canadian resident who apparently was
employed by the appellant as its Canadian medical director, and
Ewart Budgell, also a Canadian resident, who is apparently an
accountant and an occasional consultant for Patheon, were elected
to fill the vacancies created on the appellant's board of
directors. Robert Tedford, however, remained an officer of
the appellant, along with Donald Eaton. On January 31, 1996, Dr.
Marie-Madeleine Bernard tendered her resignation as a director of
the appellant and she was replaced on the same day by James
Wooder,[4] a
Canadian resident who is vice-president of Helix Investments,
Canada, a Canadian venture capital firm investing in early-stage
technology companies, that had just invested $3 million in
Mimetix. On the same date, Robert Tedford transferred
25 common shares to James Wooder.[5] Messrs. Wooder, Eaton and
Tedford were also appointed as officers of the appellant: Mr.
Wooder as president, Mr. Eaton as vice-president and
secretary/treasurer, and Mr. Tedford also as a
vice-president.
[13] To
summarize, from January 31, 1996 and during the balance of
that year, Mimetix owned 50 common shares in the capital stock of
the appellant, and Robert Tedford and James Wooder owned 25
common shares each. There were three directors elected to the
board of directors, namely Donald Eaton, James Wooder and
Ewart Budgell. In addition, Donald Eaton, James Wooder and
Robert Tedford were appointed as officers of the
appellant.
[14] According
to Mr. Wooder's testimony, he became a shareholder and was
elected as a director of the appellant when Helix (the
corporation for which he was acting as vice-president) invested
$3 million in Mimetix. If Helix had not invested in Mimetix, he
would not have become a shareholder and director of the
appellant. As a matter of fact, he was elected at the same time
to Mimetix's board of directors.
[15] In his
testimony, Mr. Wooder said that he never met or talked to the
appellant's other Canadian director, Mr. Budgell. Although
they both signed the resolutions of the board of directors, they
signed them separately and never discussed anything together, as
they did not know each other. Mr. Wooder also said that he
occasionally met Mr. Eaton or Mr. Tedford in San Francisco in the
U.S. or in Toronto, Canada, to "get an update on what was
happening in both companies [the appellant and Mimetix]".[6] Although every
director was an authorized signing officer for the appellant, it
appears that in June 1995, Mr. Eaton unilaterally added an
authorized signing officer Sam Teichman, M.D., an American
cardiologist hired as president and chief operating officer for
Mimetix.[7] This
was done without any resolution of the appellant's board of
directors. Apparently Dr. Teichman was appointed for his
expertise in clinical trials and in the pharmaceutical industry.
From then on, it was Dr. Teichman who approved and signed
all the appellant's invoices, entered into contracts with
different contractors, signed agreements for the conduct of
clinical trials and generally took care of the appellant's
business administration. In fact, it appears that the reason for
Dr. Marie-Madeleine Bernard's departure in January
1996 was a conflict in views between her and Dr. Teichman.
According to a letter sent by the appellant's counsel,
Mark L. Siegel, to Revenue Canada on April 21, 1999,[8] "[f]ollowing
[Dr. Bernard's] departure from the [appellant] Corporation,
[the appellant] made the decision that, since the [appellant]
Corporation had established a structure which could rely upon the
medical expertise and research planning and management provided
by persons employed by the research companies retained by the
[appellant] Corporation, it would make economic sense to
eliminate the cost of having a separate medical director in
Canada. . . . Dr. Teichman signed the contracts with the
research companies since, given his medical expertise, he was in
a position to provide the professional knowledge necessary to
ensure that the contracts would meet the needs of the Canadian
[appellant] corporation".
[16] Mr.
Wooder testified that he had met Dr. Teichman either in
San Francisco or in Toronto. However, In Mr. Wooder's
own words, Mr. Eaton was the sole director who had been involved
with the appellant since its creation. Apart from
Dr. Teichman, it seems that only Mr. Eaton signed cheques
and other documents for the appellant. Moreover, it was Mr. Eaton
who signed the sub-licence agreement on behalf of Mimetix
and the appellant. As a matter of fact, Mimetix had been
investing in redeemable and retractable preferred shares of the
appellant since December 1994. By the end of 1996 Mimetix had
invested $3 million in the appellant, and close to $4,5 million
by the end of 1997.[9] Mimetix had also loaned the appellant an amount of
$1,1 million, interest free, as per the appellant's 1996
financial statements. No other shareholder owned preferred shares
in 1996 or loaned money to the appellant in that year.
[17] Mr.
Wooder, who is experienced in the field of venture capital and
who sat on the boards of directors of many different companies,
explained that he agreed to become a director and officer of the
appellant solely because he viewed the appellant as a virtual
corporation, i.e. a corporation with virtually no employees that
utilized the services of several major pharmaceutical research
companies in Canada to carry out its day-to-day research
activities, rather than having its own employees. Those
companies, using their expertise in the relevant area, would
provide the management and planning functions with respect to the
research studies. In Mr. Wooder's view, the directors and
officers of a virtual corporation have little to do and it is not
necessary for them to have real knowledge of its operations or to
be involved in day-to-day management functions. As a matter of
fact, it was demonstrated in cross-examination that
Mr. Wooder had very little knowledge not only of the
appellant's business operations but also of its board of
directors, even though he was the president of the appellant.
[18] Mr.
Wooder's vision of his role as a director of the appellant is
in direct contradiction of the remarks made by Mr. Eaton in a
letter sent to Revenue Canada on May 20, 1998.[10] In that letter, Mr. Eaton
stated that "[t]he overall responsibility for the
[appellant's] day to day operations during 1996, rested with
the [appellant's] Board of Directors, who, from time to time
were assisted by Sam Teichman, M.D.,
Marie-Madeleine Bernard, M.D. (for a portion of 1996),
Cato Pharma Canada [the Custom Pharmaceuticals division of
Patheon Inc. in Toronto], Alison Ghent [Dr. Ghent's wife],
and Custom Pharmaceuticals (Patheon)". Mr. Eaton also said
in that letter that "[d]uring 1996, the [appellant's]
Directors performed the normal functions of a board of directors,
which included management of the day to day operations of the
business, plus approving corporate policies and
resolutions".
[19] Mr.
Wooder disagreed with Mr. Eaton's statement that the board of
directors was responsible for day-to-day operations. He tried to
explain that Mr. Eaton probably meant to say that the board
of directors was responsible for day-to-day administration. Mr.
Wooder explained that in fact Mr. Eaton was heavily involved in
administration, for he was signing the cheques and contracts and
was working closely with Dr. Teichman. Also, all documentation
went through Mimetix in San Francisco (including the
appellant's tax return, which showed Mimetix's address,
and the bank statements).
[20] In 1997
the clinical trials were completed and the licensed product did
not prove to be effective. Mr. Wooder testified that just prior
to the completion of the trials the appellant raised
US$3 million from a Canadian company by the name of Working
Ventures Canadian Fund Inc. ("Working Ventures") in
consideration of 800,000 preferred shares of the appellant. At
that time, Working Venture had one of its representatives elected
to the appellant's board of directors and a resolution of the
board was apparently passed requiring at least two signatures for
transactions involving the bank account (this resolution was not,
however, filed in evidence). From then on, Mr. Eaton apparently
could not unilaterally transfer funds to Mimetix and he
eventually resigned as a director.
Appellant's Arguments
[21] Counsel
for the appellant submits that the appellant was at all times a
CCPC within the meaning of subsections 125(7) and 256(5.1) of the
Act. The appellant was not in the taxation year at issue
directly controlled by one or more non-resident persons. Indeed,
50 per cent of the voting shares were owned by residents of
Canada. Furthermore, counsel submits that the appellant was not
indirectly controlled by one or more non-resident persons, since
its board of directors was controlled by residents of Canada (two
directors out of three were Canadian residents). In his view, the
fact that administrative personnel of Mimetix was performing
bookkeeping, banking and contract-signing functions for the
appellant did not mean that the board of directors' control
of the appellant had been usurped, since that administrative
personnel was acting under the authority of the board of
directors.
[22]
Furthermore, counsel submits that many other factors are present
which enable one to conclude that control was exercised in
Canada. The DIAC product was invented in Canada and approved by
the Health Protection Branch of Health Canada. All the
pharmaceutical activities took place in Canada out of a plant
built by the appellant in Fort Erie, Ontario. The research was
done in Canada through different Canadian contractors hired by
the appellant, and the manufacturing of the product was done by
Custom, a Canadian company located in Fort Erie. The majority of
the board of directors were Canadian residents and included
Mr. Wooder, who had extensive knowledge as a venture
capitalist and as a director of corporations. The majority of the
officers of the appellant were Canadian residents, including
Mr. Tedford, who was vice-president of the appellant, a
major investor through Patheon and the owner of Custom, both of
which companies are Canadian. Mr. Tedford had knowledge of
the pharmaceutical field and there was therefore no need for the
board of directors to take an active role in the
day-to-day operations of the appellant.
[23] In
counsel's view, the fact that Mimetix owned a significant
number of non-voting retractable preferred shares in the
appellant, or that the appellant was indebted to its non-resident
shareholder Mimetix, does not mean that Mimetix had effective
control of the appellant. He submits that the preferred shares
were acquired by Mimetix as part of its long-term investment in
the appellant. The mere fact that a type of share would allow a
shareholder to call for the redemption of such shares does not in
itself result in that shareholder being in a position to control
the corporation in which it holds those shares. Indeed, under the
Canada Business Corporations Act ("CBC
Act"), shares cannot be redeemed if that would render
the company insolvent (see subsection 36(2) of the CBC
Act).
[24] With
respect to the intercompany debt owed to Mimetix, it related to
the acquisition of equipment by the appellant for use in its
business activities in Canada. In counsel's view, the loan
was made for commercial purposes and did not result in the
appellant being made subject to financial pressure or control by
Mimetix.
[25] Counsel
referred to the decision by the Federal Court of Appeal in
Robson Leather Co. Ltd. v. M.N.R., 77 DTC 5106, in stating
that those factors (a debt relationship existing between a
shareholder and a corporation, or a shareholder holding
retractable preferred shares in the corporation) can only be
considered to give control to a shareholder where the corporation
is in financial difficulty and the other shareholders are not in
as financially secure a position as the shareholder holding the
debt or the retractable shares. In the present case, the
appellant was not in financial difficulty, as evidenced by the
financial statements showing that the appellant spent millions of
dollars in Canada on scientific research relating to the
development of a pharmaceutical product. In addition, the
resident shareholders of the appellant and its directors were
financially stable and would not be subject to economic pressure
from the non-resident shareholder, Mimetix.
[26] Counsel
also referred to this Court's decision in Zinkhofer et al.
v. M.N.R., 91 DTC 643, in which Judge Sobier, as he then
was, held that the existence of a debt relationship or of
retractable preferred shares could not result in control since
one consequence of that would be that major creditors who are not
shareholders of the corporation would be considered to control
the corporation.
[27] Counsel
also referred to Birmount Holdings Ltd. v. The Queen, 78
DTC 6254 (F.C.A.), in emphasizing that the control and central
management of a corporation is a factor to be considered in
determining who controls the corporation. In his view, the fact
that the appellant was incorporated in Canada, that it carried on
all its business activities in Canada, that it filed Canadian
income tax returns and that Mimetix did not overrule the Canadian
directors of the appellant in terms of their decisions with
respect to the operations of the appellant, demonstrates that the
central management and control was in Canada.
[28] Counsel
finally concludes that if the evidence has not shown to the
Court's satisfaction that control of the appellant was
exercised by Canadian residents (which he does not believe to be
the case), it certainly has demonstrated that control was not
exercised in the U.S. by the non-resident shareholder Mimetix,
and that is sufficient to be able to declare that the appellant
was a CCPC in 1996. The best illustration of that is that in 1997
Mr. Eaton was blocked by the appellant's board of directors
in his attempt to transfer money from the appellant to
Mimetix.
Respondent's Argument
[29] Counsel
for the respondent submits that the meaning of control, as
defined in Buckerfield's Ltd. et al. v. M.N.R., 64 DTC
5301 (Ex. Ct. of Canada), has changed, at least since the
addition of subsection 256(5.1), in defining the concept of
control in the Act by including de facto control.
(See Société Foncière
d'Investissement Inc. v. Canada, [1995] T.C.J.
No. 1568 (T.C.C.) (Q.L.).)
[30] Counsel
for the respondent submits that the appellant was controlled in
fact by a non-resident person in 1996. In his view, the
appellant was indeed controlled by Mimetix, the American
shareholder, in 1996. The fact that Mimetix had invested
$3 million in preferred shares and made an interest-free
loan of $1,1 million to the appellant is, in his view, very
relevant to the present matter, especially if we take into
account that the other shareholders had only invested $25 each in
common shares. How can one say that with an investment of $25
each the Canadian shareholders had control over the appellant
when the non-resident shareholder had invested over $4
million in the appellant? Indeed, the evidence disclosed that
Mimetix, through Mr. Eaton, kept a very close eye on the
appellant's affairs. All the exhibits show that the documents
relating to the appellant's business went through Mimetix or
through Dr. Teichman, the expert in the pharmaceutical
industry who was hired on Mimetix's own decision.
[31] Counsel
submits that where the research is done is not relevant nor is it
relevant that the equipment used in the appellant's business
was located in Canada. What is relevant for the purpose of
determining whether the appellant was a CCPC is to find out who
in 1996 controlled that corporation in fact within the meaning of
subsection 256(5.1) of the Act, regardless of whether
it was a virtual corporation, as argued by counsel for the
appellant, or not.
[32] In
counsel's view, it is abundantly clear from the evidence that
the two Canadian directors, who, according to the appellant's
argument, were supposed to control the appellant, in fact knew
almost nothing about the appellant (for example, Mr. Wooder
did not know at the time of his examination for discovery how
many employees were working for the appellant, who had signing
authority for the appellant, etc.).
[33] Counsel
is of the opinion that Mimetix had financial control over the
appellant and had a controlling influence over the
appellant's affairs. This is best illustrated, in his view,
by the fact that Dr. Marie-Madeleine Bernard, who was a
Canadian director of the appellant, had to leave following a
conflict with Dr. Teichman, who was not even a shareholder,
director or officer of the appellant, but was hired by Mr. Eaton
on his own decision, without any resolution of the board of
directors. Counsel submits that it is difficult to argue in the
circumstances that the board of directors in Canada had control
over the appellant's affairs. In his view, the situation
might have changed in 1997 with the arrival of a new shareholder,
Working Venture. But things were different in 1996 and this Court
is called upon to deal with the 1996 taxation year only.
[34] For these
reasons, counsel submits that the appellant was controlled by the
non-resident corporation Mimetix in 1996 and therefore did not
qualify as a CCPC.
Analysis
[35] The
appellant has to show that it was a CCPC throughout its 1996
taxation year in order to benefit from a higher rate of
investment tax credit and from a refundable investment tax credit
(see subsection 127(10.1) and section 127.1 of the
Act).
[36] In order
for a corporation to qualify as a CCPC, it must be shown among
other things that that corporation was not in the year at issue
controlled, directly or indirectly in any manner whatever, by
non-residents. That is the issue here.
[37] The term
"control" is not defined in the Act. Control
usually means the right of control that rests on ownership of
such a number of shares as carries with it the right to a
majority of the votes in the election of the board of directors
(see Buckerfield's, supra). Such control is referred
to as de jure control. In other words, the owners of the
majority of the voting power in a company are de jure the
persons who are in effective control of its affairs and fortunes
(which statement has been approved by the Supreme Court of Canada
in M.N.R. v. Dworkin Furs(Pembroke) Ltd. et
al., 67 DTC 5035 and more recently in Duha Printers
(Western) Ltd. v. The Queen,98 DTC 6334).
[38] However,
subsection 256(5.1) has incorporated a de facto
control concept for the purposes of the Act. As
Iacobucci J. observed in Duha Printers, supra,
at p. 6344:
52. . . . Parliament has now recognized the distinction between
de jure and de facto control, adopting the latter
as the new standard for the associated corporation rules by means
of s. 256(5.1) of the Income Tax Act, enacted in 1988.
[39] Under
subsection 256(5.1), a corporation is considered to be
controlled, directly or indirectly in any manner whatever, by
another person (the "controller") if the controller has
any direct or indirect influence that, if exercised, would result
in control in fact of the corporation. This is de facto
control, and determining its existence necessitates a review of
all the facts in each particular situation. Subsection 256(5.1)
provides an exception to the above rule where the corporation and
the controller are dealing at arm's length and the
controller's influence is derived from an agreement or
similar arrangement, the main purpose of which is to govern the
relationship between the parties regarding the manner in which a
business carried on by the corporation is to be conducted. This
exception has not been argued in the present case.
[40] In the
recent Interpretation Bulletin IT-64R4 entitled Corporations:
Association and Control - Final Draft, dated June 26,
2001, subsection 256(5.1) and the concept of de facto
control are discussed in the following terms at paragraphs 21 and
23:
21. De facto control goes beyond de jure control
and includes the ability to control "in fact" by any
direct or indirect influence. De facto control may exist
even without the ownership of any shares. It can take many forms,
e.g., the ability of a person to change the board of directors or
reverse its decisions, to make alternative decisions concerning
the actions of the corporation in the short, medium or long term,
to directly or indirectly terminate the corporation or its
business, or to appropriate its profits and property. The
existence of any such influence, even if it is not actually
exercised, would be sufficient to result in de facto
control.
. . .
23. Whether a person or group of persons can be said to have
de facto control of a corporation, notwithstanding that
they do not legally control more than 50 per cent of its voting
shares, will depend on each factual situation. The following are
some general factors that may be used in determining whether
de facto control exists:
(a) the percentage of ownership of voting shares (when such
ownership is not more than 50 per cent) in relation to the
holdings of other shareholders;
(b) ownership of a large debt of a corporation which may
become payable on demand (unless exempted by subsection 256(3) or
(6)) or a substantial investment in retractable preferred
shares;
(c) shareholder agreements including the holding of a casting
vote;
(d) commercial or contractual relationships of the
corporation, e.g., economic dependence on a single supplier or
customer;
(e) possession of a unique expertise that is required to
operate the business; and
(f) the influence that a family member, who is a shareholder,
creditor, supplier, etc., of a corporation, may have over another
family member who is a shareholder of the corporation.
. . .
In addition to the general factors described above, the
composition of the board of directors and the control of
day-to-day management and operation of the business would be
considered.
[41] In
Duha Printers, supra, Iacobucci J. alluded to the
fact that although external agreements should not have any place
in the analysis of control de jure, they were relevant in
determining the existence of de facto control
(p. 6345).
[42] In the
present case, several elements must be examined in conjunction
with each other to determine whether de facto control
existed in 1996.
[43] In my
view, the evidence discloses that not only did Mr. Eaton and
Dr. Teichman control the day-to-day operations of the
appellant from San Francisco but they also controlled its
fortune by making all the decisions. Counsel for the appellant
argued that all decisions were nevertheless taken under the
authority of its board of directors. The board of directors was
composed of three people, namely Messrs. Wooder, Eaton and
Budgell. No evidence was adduced as to Mr. Budgell's
role in the appellant. The only thing we know is that he is
Canadian, that he was an accountant working occasionally for
Custom and that he never met the other Canadian director, Mr.
Wooder. As for Mr. Wooder, he was a director and the president of
the appellant. One would assume that, holding these positions, he
would be relatively well informed about the appellant. This
assumption is reinforced by the duties of the president as stated
in the "Organizational and General Administrative
Resolutions of the Board of Directors of [the appellant] . .
.". Those duties are described as follows in
Exhibit A-2, Tab 44, pp. 8-9:
(a) PRESIDENT. The President shall be the chief
operating officer and shall have the powers and duties conferred
upon him by the by-laws of the Corporation and by this resolution
and such other powers and duties as the Board of Directors may
determine. The President shall exercise a general control of and
supervision over the affairs and business of the Corporation,
except to the extent that the Board of Directors shall otherwise
determine.
[44] It is
obvious from the evidence that Mr. Wooder did not exercise such
control and supervision over the affairs and business of the
appellant. With respect to the administrative services provided
by Mimetix to the appellant, Mr. Wooder testified that the
sole reason for having the services provided by Mimetix was that
they were thereby obtained at a lesser cost than if they were
provided in Canada. Mr. Wooder did not know if any monies were
paid for the administrative services but assumed that the $12,000
shown for the year on the appellant's financial statements
represented the consideration for those services. In addition,
Mr. Wooder did not even know who the authorized signing officers
for the appellant were, and he never met the other Canadian
director, Mr. Budgell. Furthermore, with the exception of
the acquisition of the Collette mixer, he was not aware of any of
the contracts signed by the appellant in the operation of its
business. It seems quite unusual for a director and president of
a company to be uninformed to such a degree. Mr. Wooder
admitted that if Helix had not invested $3 million in Mimetix, he
would not have been appointed to the appellant's board of
directors. It is therefore erroneous to assert, as does counsel
for the appellant, that the administrative personnel in the U.S.
was acting under the authority and supervision of the
appellant's board of directors. Mr. Eaton alone was not
the board of directors.
[45] Indeed
the evidence discloses that the only director that exercised such
control and supervision was Mr. Eaton, the
non-resident director. He was the one who took or approved
all of the decisions, the main one being the hiring of
Dr. Teichman, who replaced the Canadian medical doctor, Dr.
Bernard. That decision was taken without the approval of the
board of directors. It does not appear that either
Mr. Wooder or Mr. Budgell was consulted at that time; at
least the evidence does not show that to have been the case.
[46] Dr.
Teichman was authorized by Mr. Eaton to sign all agreements,
invoices and cheques with respect to the appellant's business
operations. All work contracted out to third parties was
authorized and approved not by the board of directors but by Mr.
Eaton and Dr. Teichman. What all this shows is that Mimetix in
fact had control over the appellant. Indeed, the
non-resident corporation Mimetix was, through
Dr. Teichman and Mr. Eaton, both non-residents of
Canada, the controlling mind of the appellant. Furthermore, no
evidence was brought forward as to the role played by Mr.
Tedford, one Canadian officer of the appellant. The only thing we
know is that Patheon, for which Mr. Tedford was working, invested
in Mimetix in 1994, not in the appellant. I will not therefore
give any weight to the appellant's counsel's submission
that Mr. Tedford had influence over the appellant in 1996. At
least, the documentary evidence does not reveal that to have been
the case.
[47] To
explain Mr. Wooder's lack of knowledge and authority, the
appellant's counsel submitted that the appellant was a
virtual corporation and as such would employ individuals
possessing the requisite expertise to carry out work on a
contract basis. These contractors would not only perform the
required task but would also look after the management aspect of
that task. Therefore, the directors and officers would have
little knowledge of the activities of the appellant. This
explanation is however inconsistent with the role played by
Mr. Eaton in the 1996 taxation year. He, as a director, was
the only one who was at all times aware of the expertise that the
appellant required and he acted appropriately to meet those
requirements.
[48]
Furthermore, even though the appellant was not in as bad a
financial situation as existed in Robson, supra
(although I note that the appellant suffered a $1,6 million loss
in 1996 and a $2,5 million loss in 1997), I would nevertheless
conclude that Mimetix, being the only investor in the
appellant's business in 1996, was in a position to exert the
kind of pressure that enabled it to have its will prevail with
respect to that business. This conclusion is reinforced, in my
view, by other instances in which the appellant has not dealt
with Mimetix on a commercial basis. Indeed, it was seen that even
though Mimetix paid US$100,000 to acquire the licence for DIAC, a
sub-licence was granted to the appellant for no consideration. As
well, when Mimetix loaned $1,1 million to the appellant, there
was no interest charged. With respect to the administrative
services, the evidence is unclear as to the cost to the appellant
of such services but if there were any costs they would have been
minimal. All this, in my view, certainly constitutes a form of
economic controlling influence exercised by Mimetix over the
appellant in 1996, and that is precisely what is covered by the
definition of de facto control in subsection 256(5.1)
of the Act.
[49] That
being so, and since the concept of control has been broadened
with the addition of subsection 256(5.1), I do not find that the
appellant can rely on the Zinkhofer decision,
supra, which had to do with capital losses suffered in
taxation years preceding that amendment to the Act.
Indeed, economic controlling influence does not have any bearing
on de jure control, which was, in my view, the basis of
Judge Sobier's decision in Zinkhofer.
[50]
Furthermore, de facto control of a corporation may shift
from one shareholder to another based on external factors, as is
recognized in the following terms in one academic commentary
referred to by counsel for the appellant (D.S. Ewens and
S.J. Hugo, "The Effect of Bill C-139 on Certain
Corporate Reorganizations." 88 Canadian Tax Journal
1021 at pp. 1032-33):
. . . With the new factual control test, a shareholder may
find himself considered to be in control of a corporation because
of changes in economic conditions, either external or internal to
the corporation.
Such could have been the case here in 1997, with the injection
of new funds by a new shareholder, Working Ventures, but that is
not at issue here.
[51] Finally,
I do not find that the decision of the Federal Court of Appeal in
Birmount Holdings Ltd., supra, referred to by
counsel for the appellant has any relevance in the present case.
In Birmount, the Federal Court of Appeal had to examine
whether the central management and control of a corporation was
in Canada in order to determine whether that corporation was a
Canadian resident. That case did not deal with the issue of who
was controlling the corporation but rather had to do with where
the central management and control was exercised for residency
purposes. In any matter, I certainly do not agree with counsel
for the appellant's assertion that Mimetix did not overrule
the Canadian directors of the appellant in terms of their
decisions with respect to the operations of the appellant. To the
contrary, the evidence rather supports the position that the
Canadian directors made no decisions regarding the
appellant's operations at all.
Conclusion
[52] I
therefore conclude from all the facts that the appellant was in
fact controlled by Mimetix, the non-resident shareholder, in
1996, and consequently was not a CCPC in that year, within the
meaning of subsections 125(7) and 256(5.1) of the Act.
II.
Second issue: The Collette mixer
[53] With
respect to that second issue, it has to be determined whether the
Collette mixer had been used, or acquired for use or lease, for
any purpose whatever before it was acquired by the appellant. If
the answer to that question is affirmative, then the acquisition
of the Collette mixer would have to be classified as a prescribed
expenditure within the meaning of subparagraph
2902(b)(iii) of the Regulations and therefore would
not qualify for the investment tax credit under subsections
127(5) and 127(9) of the Act. If, on the other hand, the
answer is negative, the acquisition of the Collette mixer by the
appellant would not be a prescribed expenditure and would qualify
for the investment tax credit.
Facts
[54] The
Collette mixer was a critical piece of equipment used for the
production of the diatomic iodine in powdered form. In April 1995
it was shipped brand new to Custom in Fort Erie and was only used
in the appellant's facility there. It was first rented by the
appellant from the owner GEI Processing, Inc.[11]
[55] The
rental charge was $15,000 per month for a minimum rental period
of six months and thereafter rental was to be on a month-to-month
basis. The renter (the appellant) had to carry at its own
expense, the necessary insurance to protect the owner and renter
against all risks to the equipment or any liability arising from
the use of the said equipment. The insurance value was to be
$300,000.
[56] The
rental agreement stated that the title to the rented equipment
was to remain in the name of the owner. It also stated that all
materials to be processed with the rental equipment had to be
disclosed to the owner for approval prior to introduction into
the equipment. At the end of the rental period, the equipment had
to be returned thoroughly cleaned, free of all residues, and this
cleaning was to be done at the renter's expense. The material
and labour costs for repair or replacement of damaged or missing
components were to be billed to the renter at cost plus 10 per
cent. Furthermore, the cost of component failures due to
misoperation, accident, etc. was to be the renter's
responsibility. However, the cost of component failure during
normal operation was to be assumed by the owner. Under the
agreement, no credit was to be given towards purchase.
[57] In
October 1996, that is, 18 months later, the appellant purchased
the Collette mixer from the owner for $288,241 less a 50 per cent
credit for rental ($105,000) that was negotiated at that time to
reduce the purchase price. It accordingly made out a cheque to
GEI Processing Inc. in the amount of $183,241.
Appellant's Argument
[58] It is the
position of the appellant that the method of financing the
acquisition of the Collette mixer -- through a lease and purchase
mechanism -- was no different than a situation where a
purchaser chooses to finance the acquisition of an asset through
installment payments. It is not disputed that the physical
location of the Collette mixer never changed from the date of its
delivery to the plant in Fort Erie and that that new piece of
equipment had only been used by the appellant. The appellant
submits that where an initial user and lessee of eligible
property acquires ownership of such property from the original
lessor of the property (which is the case here), that user should
be entitled to an investment tax credit with respect to its
acquisition cost of the property and the expenditure for such
property should not be a prescribed expenditure within the
meaning of subparagraph 2902(b)(iii) of the
Regulations.
Respondent's Argument
[59] Counsel
for the respondent submits that the appellant acquired the
Collette mixer not when it signed the lease agreement in April
1995 but rather when it purchased it in October 1996. When the
appellant purchased the Collette mixer in 1996, that piece of
equipment had been used.
[60] Counsel
submits that the acquisition of property signifies acquisition of
the ownership of that property. In his view, the lease agreement
has all the ingredients of the rental, and not sale, of property.
Particularly, clause 5 of that agreement[12] indicates that the title to the
rented equipment was to remain in the name of the lessor (GEI
Processing Inc.). Moreover, clause 9 says that the material
and labour cost for repair or replacement of damaged or missing
components is to be billed to the renter at cost plus
10 per cent. In counsel's view, if the appellant
had been the owner under the rental agreement, there would not
have been an extra 10 per cent payable.
[61] Counsel
for the respondent therefore concludes that the Collette mixer
was only acquired by the appellant in October 1996 and that at
that time it had been used. The Collette mixer therefore
represented a prescribed expenditure within the meaning of
subparagraph 2902(b)(iii) of the Regulations.
Analysis
[62] An
expenditure of a capital nature will be a prescribed expenditure
pursuant to subparagraph 2902(b)(iii) if it relates to the
acquisition of property that has been used or acquired for use or
lease, for any purpose whatever before it was acquired by the
taxpayer.
[63] It is not
disputed that the Collette mixer was used by the appellant right
from the moment it was leased. The question that remains is
whether it was acquired by the appellant at the time the rental
agreement was entered into in April 1995, in which case it would
not be a prescribed expenditure, or at the time it was finally
purchased in October 1996, in which case it would be a prescribed
expenditure.
[64] The
meaning of the word "acquired" was considered in
M.N.R. v. Wardean Drilling Ltd., 69 DTC 5194 (Ex. Ct. of
Canada), a case in which Cattanach J. had to determine when
an oil platform was "acquired" in order to ascertain
when capital cost allowance might be claimed. He stated at
p. 5197:
In my opinion the proper test as to when property is acquired
must relate to the title to the property in question or to the
normal incidents of title, either actual or constructive, such as
possession, use and risk.
[65] In R.
v. Construction Bérou Inc., 1999 CarswellNat 2502
(F.C.A.), a leasing company acquired trucks from a supplier and
entered into a leasing contract with the taxpayer regarding the
trucks for a term of 65 months with an option to purchase at the
60th month at a favourable price. The leasing contract made the
taxpayer liable to indemnify the leasing company for any loss
resulting from the use of the trucks and to continue to make
monthly payments regardless of the use or destruction of the
trucks, and prevented him from selling or subleasing the trucks.
The contract also stipulated that the taxpayer would not acquire
title or the right of ownership unless the full purchase option
price was paid.
[66] The
majority of the Federal Court of Appeal decided that the lease
agreement was not an ordinary lease but was in substance a sale
agreement as the taxpayer had acquired the beneficial ownership
of trucks although not the legal title. The majority of the Court
therefore considered that the trucks were acquired by the
taxpayer at the time it entered into the lease agreement. In his
dissenting judgment, Noël J.A. decided that the leasing
contract did not have the effect of a sale of any kind. Noël
J.A. stated that one common principle of contract law in both
common law and civil law is the concept of the "intent"
of the parties in interpreting a contract between them. In his
view, the intent of the parties was that the ownership of the
trucks was not to be transferred at the time the leasing contract
was entered into.
[67] Here I do
find that the majority decision in Construction
Bérou, supra, can be distinguished on
the facts. Indeed, the appellant had agreed to lease the
equipment for a minimum period of only six months, after which
the rental was to be on a month-to-month basis. No option to
purchase was referred to in the lease agreement, even though it
was specified that there would be no credit towards purchase.
[68] What is
involved here is obviously not a long-term lease with an option
to purchase at a price substantially less than the probable fair
market value of the property at the time of exercising the
option. In fact, as I said before, there was no option to
purchase provided for in the lease agreement, which presupposes
that the owner did not want to commit itself at the time of that
agreement (this is reinforced by the clause stating that there
would be no credit towards purchase). Furthermore, there was no
evidence brought forward concerning the fair market value of the
Collette mixer, with the exception of the insurance clause that
provides an approximate value of the rental equipment at the time
the rental agreement was entered into. That value was established
at $300,000 and the purchase price was fixed 18 months later at
$288,241 and reduced by an amount of $105,000, which corresponded
to only seven months of rental payments. This is certainly not a
case where, as in Construction Bérou, supra,
the renter was offered the possibility of acquiring the property
at the end of the rental period at a very favourable price.
[69]
Furthermore, it is not a case where the appellant (the renter)
bore all the risks attached to ownership. For example, the cost
of component failure of the Collette mixer during normal
operation was to be borne by the owner.
[70] Finally,
as noted by counsel for the respondent, if the appellant had
acquired the property when the lease agreement was entered into,
it is most probable that it would not have accepted a clause in
that agreement charging the renter (the appellant) cost plus 10
per cent for the repair or replacement of damaged or missing
components.
Conclusion
[71] For all
these reasons, I therefore conclude that the appellant did not
acquire the Collette mixer in April 1995, when it entered into a
lease agreement with GEI Processing, Inc., but rather acquired it
in October 1996, when the purchase agreement was signed.
[72] The
Collette mixer having already been used when acquired by the
appellant, the acquisition of that piece of equipment was
therefore a prescribed expenditure within the meaning of
subparagraph 2902(b)(iii) of the Regulations and
did not qualify for an investment tax credit within the meaning
of subsection 127(9) of the Act.
Decision
[73] From the
foregoing, the appeal is dismissed, with costs.
Signed at Ottawa, Canada, this 8th day of November 2001.
"Lucie Lamarre"
J.T.C.C.
COURT FILE
NO.:
1999-4847(IT)G
STYLE OF
CAUSE:
Mimetix Pharmaceuticals Inc. v. The Queen
PLACE OF
HEARING:
Ottawa, Ontario
DATE OF
HEARING:
March 7, 2001
REASONS FOR JUDGMENT
BY:
The Honourable Judge Lucie Lamarre
DATE OF
JUDGMENT:
November 8, 2001
APPEARANCES:
Counsel for the
Appellant:
Alan P. Gardner
Counsel for the
Respondent:
Richard Gobeil
COUNSEL OF RECORD:
For the
Appellant:
Name:
Alan P. Gardner
Firm:
Gowling Lafleur Henderson, LLP
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
1999-4847(IT)G
BETWEEN:
MIMETIX PHARMACEUTICALS INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on March 7, 2001, at Ottawa,
Ontario, by
the Honourable Judge Lucie Lamarre
Appearances
Counsel for the
Appellant: Alan
P. Gardner
Counsel for the Respondent: Richard
Gobeil
JUDGMENT
The
appeal from the assessment made under the Income Tax Act
for the 1996 taxation year is dismissed, with costs.
Signed at Ottawa, Canada, this 8th day of November 2001.
J.T.C.C.
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