G.A. Borstad Associates Ltd. v. MNR, 92 DTC 1743, [1992] 2 CTC 2146 (TCC)

Garon, T.C.C.J.:—This is an appeal from a reassessment dated May 12, 1988, in respect of the appellants 1987 taxation year. By this reassessment the Minister of National Revenue reduced the investment tax credit from $31,609 to $22,204. This reduction in the tax credit was made by the Minister of National Revenue on the basis that the accrued salaries at the end of the appellants 1987 taxation year in the amount of $55,000 did not constitute qualified expenditures for the purposes of computing the investment tax credit.

An agreed statement of facts was filed at the hearing of this appeal. This agreed statement reads as follows:

(1) the appellant is a corporation resident in Canada and at all relevant times carried on the business of scientific research.

(2) For the fiscal year ended March 31, 1987, the appellant accrued as payable salaries for its shareholders in the amount of $55,000 for its 1987 taxation year.

(3) By journal entry, the accrued salaries were paid by credit to the shareholder loan account for Garry Borstad in the amount of $35,000 in April, 1987 and for Lorraine Borstad in the amount of $20,000 in May, 1987 in the appellant's 1988 taxation year.

(4) In filing its return of income for the 1987 taxation year, the appellant claimed an investment tax credit of 31,609.

(5) In computing the investment tax credit, the appellant included the salaries which had been accrued but not paid by the end of the appellant's 1987 taxation year.

(6) By Notice of Assessment dated May 12, 1988, the Minister of National Revenue reduced the appellant's investment tax credit on the basis that the accrued salaries of $55,000 did not qualify as qualified expenditures for the purposes of computing the investment tax credit.

This agreed statement of facts was supplemented by the evidence given by Mrs. Lorraine Borstad, who was at the relevant time, and still is, a shareholder, director and corporate secretary of the appellant. Her husband, Mr. Garry Borstad, was and still is the appellant's president. Both Mr. and Mrs. Borstad possess ‘university degrees in the scientific field. From Mrs. Borstad's very short testimony it was learned that the appellant had only four employees, apart from Mr. Borstad and Mrs. Borstad. The appellant was incorporated in April, 1983. For some years, the appellant has adopted the practice of accruing salaries at the end of each of its taxation years and paying those salaries within six months from the end of such taxation year. A document filed as exhibit showing, over a period running from 1984 to 1991, the salaries accrued at the appellant's fiscal year-end and the actual dates of payment of such salary confirmed this practice over the years. Also, the remittances in respect of income tax and unemployment insurance premiums deducted at source respecting the two above-named appellant's employees were paid in the appellant's taxation year immediately following the taxation year in which the salaries had been accrued by the appellant. This practice, to which I have just referred, was, at least in part, dictated by cash flow considerations.

Submission of the parties

The appellants submission is that the salaries in question should be considered to be paid when the legal obligation to pay them was recorded in appellant's accounting books having regard more particularly to the fact that the appellant's pattern of paying such salary has been clearly established by the evidence. Counsel for the appellant also submitted that in the absence of a prohibition to the contrary in computing the investment tax credit to which the appellant was entitled the accrued salaries should be taken into account as they represent expenditures in respect of scientific research or experimental development. Counsel for the appellant also referred the Court to the decisions of this Court in the cases of Earlscourt Sheet Metal Mechanical Ltd. v. M.N.R., [1988] 1 C.T.C. 2045, 88 D.T.C. 1029 and Alex Tadman v. M.N.R., [1988] 1 C.T.C. 2281, 88 D.T.C. 1116.

Counsel for the Minister of National Revenue relied on paragraph 37(7)(c), subsection 127(9) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"), and more particularly section 2902(b) of the Income Tax Regulations. It is his view that the scheme of the Act, due regard being given to section 78 of the Income Tax Act and to the Income Tax Regulations, is that no tax credit is to be allowed to a taxpayer unless there has been an actual payment of the salaries in question.

Analysis

In considering the matter of the appellant's entitlement to the investment tax credit in respect of the salaries of the appellant's two employees mentioned earlier, it is apposite to make a brief review of the import of the applicable provisions of the Income Tax Act and the Income Tax Regulations, respecting the income tax treatment of expenditures on scientific research and experimental development in effect in respect of the period in issue in the present appeal.

First, paragraph 20(1)(t) of the Income Tax Act grants a deduction from income of "such amount in respect of expenditures on scientific research and experimental development as is permitted by section 37 or 37.1” of the Act.

Paragraph 37(1)(a) provides that a taxpayer who carries on a business in Canada in a taxation year and made expenditures in respect of scientific research and experimental development in the year may deduct, inter alia, expenditures in respect of scientific research and experimental development of a current nature made in the year or in a preceding taxation year ending after 1973, on scientific research and experimental development directly related to the taxpayer's business and undertaken by or on behalf of the taxpayer. Also, payments relating to expenses of a current nature made in Canada in respect of scientific research and experimental development to approved associations, institutions and to certain classes of corporations can also be deducted under paragraph 37(1)(a) of the Act by a taxpayer who carried on a business in Canada and made expenditures in respect of scientific research and experimental development.

Paragraph 37(1)(b) of the Income Tax Act goes further and allows a taxpayer to deduct expenditures of a capital nature, made in Canada (by acquiring property other than land) in the year or any previous taxation year ending after 1958, on scientific research and experimental development carried on in Canada relating to the business of the taxpayer and directly undertaken by or on behalf of the taxpayer.

These deductions of both current and capital expenditures on scientific research and experimental development in Canada to which I have just made reference are allowed to the extent that they exceed the aggregate of all amounts referred to in paragraphs 37(1)(d) to (h) of the Income Tax Act.

As appears from the above, the foregoing provisions of paragraphs 20(1)(t), 37(1)(a), 37(7)(b) of the Act lay down the general principles regarding the extent to which expenditures on scientific research and experimental development may be deducted by a taxpayer in computing his income from a business carried on in Canada.

It is not necessary for our purposes to consider the impact of section 37.1 of the Income Tax Act which grants to corporate taxpayers an additional allowance on account of expenditures on scientific research and experimental development. Subject to certain transitional provisions, this deduction, which is equal to 50 per cent of qualified expenditures made by a corporation in a year exceeding the expenditure base of the corporation for the year and certain other amounts paid to the corporation by the Government of Canada or the government of a province or by certain classes of corporations, is generally applicable in respect of expenditures made in taxation years ending after 1977 and before November, 1983.

In the present case, we are not concerned either with the scientific research and experimental development tax credit (SRTC) provided by section 127.3 of the Act. This section permits a taxpayer to deduct from the tax otherwise payable for a taxation year under Part I of the Income Tax Act, as provided by subsection 127.3(1), an amount not exceeding the aggregate of his scientific research and experimental development tax credit for the year and his unused scientific research and experimental tax credit for the immediately following taxation year. The purpose of this tax credit is to pass on a tax benefit to eligible investors who acquire qualifying shares (generally the first registered holders of such securities) in a taxable Canadian corporation which has incurred expenditures on scientific research and experimental development if the issuing corporation has made a designation in a prescribed form filed with the Minister of National Revenue under subsection 194(4) (Part VIII of the Income Tax Act) in respect of the consideration for which it was issued. A refundable tax equal to 50 per cent of the amount designated by a corporation is imposed under Part VIII of the Act on the corporation which has made such a designation.

Finally, subsection 127(5) of the Act provides a deduction from the tax otherwise payable, commonly referred to as an investment tax credit, in respect of qualified expenditures on scientific research and experimental development. Incidentally, this subsection also entitles a taxpayer to an investment tax credit in respect of qualified property acquisitions but this particular angle of subsection 127(5) is of no interest here.

Against this general background relating to the income tax treatment of expenditures on scientific research and experimental development, it is now appropriate to consider more fully the provisions of the Income Tax Act and Income Tax Regulations dealing with the matter of the computation of the investment tax credit in respect of certain expenditures on scientific research and experimental development.

First, subsection 127(5) of the Act, as it applied to the appellant's 1987 taxation year, reads as follows:

There may be deducted from the tax otherwise payable by the taxpayer under this Part for a taxation year an amount equal to the aggregate of

(a) an amount not exceeding the lesser of

(i) his investment tax credit at the end of the year in respect of property acquired, or an expenditure made, before April 1983, and

(ii) the aggregate of

(A) $15,000, and

(B) ‘2 the amount, if any, by which the tax otherwise payable by him under this Part for the year exceeds $15,000;

(b) an amount not exceeding the lesser of

(i) his investment tax credit at the end of the year in respect of property acquired, or an expenditure made, after April 19, 1983 and before the end of the year, and

(ii) the amount, if any, by which the tax otherwise payable by him under this Part for the year exceeds the amount, if any, determined under paragraph (a); and

(c) an amount not exceeding the lesser of

(i) his investment tax credit at the end of the year in respect of property acquired, or an expenditure made, in a subsequent taxation year and after April 19, 1983, to the extent that the investment tax credit was not deductible under this subsection in the taxation year in which the property was acquired, or the expenditure was made, as the case may be, and

(ii) the amount, if any, by which the tax otherwise payable by him under this Part for the year exceeds the aggregate of the amounts, if any, determined under paragraphs (a) and (b).

From subsection 127(5) it is apparent that the determination of the amount to be deducted from the tax otherwise payable is in a large measure dependent upon the notion of the investment tax credit at the end of the year in respect of an expenditure made within the time frame set out in this subsection. This phrase" investment tax credit” is defined in subsection 127(9) and it is sufficient for our purposes to reproduce the following portion of the definition:

“investment tax credit” of a taxpayer at the end of a taxation year means the amount, if any, by which the aggregate of

(a) the aggregate of all amounts each of which is the specified percentage of

(i) the capital cost to him of a qualified property, qualified transportation equipment, qualified construction equipment, approved project property or certified property acquired by him in the year,

(ii) a qualified expenditure made by him in the year or,

(iii) his qualified Canadian exploration expenditure for the year,

(b) . . .

(c) the aggregate of all amounts each of which is

(i) an amount determined under paragraph (a) or (b) in respect of the taxpayer for any of the 5 taxation years immediately preceding the year, where the property was acquired, or the qualified expenditure was made, before April 20, 1983, or

(ii) an amount determined under paragraph (a) or (b) in respect of the taxpayer for any of the 7 taxation years immediately preceding or the 3 taxation years immediately following the year, where the property was acquired, or the qualified expenditure was made, after April 19, 1983 or the qualified Canadian exploration expenditure was for a taxation year ending after November 30, 1985.

It is to be noted that in the definition of the expression "investment tax credit” there is a reference to a “qualified expenditure” which is given the following meaning in the same subsection 127(9) of the Act:

"qualified expenditure" means an expenditure in respect of scientific research and experimental development made by a taxpayer after March 31, 1977 that qualifies as an expenditure described in paragraph 37(1)(a) or subparagraph 37(1)(b)(i), but does not include

(a) a prescribed expenditure, nor

(b) in the case of a taxpayer that is a corporation, an expenditure specified by the taxpayer for the purposes of clause 194(2)(a)(ii)(A).

By these definitions it is made clear that the investment tax credit is computed, as far as expenditures are concerned, by taking into account an expenditure that qualifies as an expenditure described in paragraph 37(1)(a) or subparagraph 37(1)(b)(i) of the Income Tax Act. In view of the fact that the particular type of expenditures on scientific research and experimental development that is in issue in the present case is accrued salaries payable to the appellant's two above-mentioned employees who were either undertaking or supervising on the appellant's behalf the prosecution of scientific research and experimental development, it is apparent that we are dealing with expenditures of a current nature as opposed to expenditures of a capital nature. Paragraph 37(1)(a) and not paragraph 37(1)(b) must, therefore, govern this deduction.

In order to gain a complete understanding of paragraph 37(7)(a), it is necessary to bear in mind the meaning of certain terms and expressions used in that paragraph that are defined in subsection 37(7). The only definition found in the definitions subsection 37(7) that is of particular interest here in the resolution of the issue at hand, is that set out in paragraph 37(7)(c) which has to do with the references in section 37 to“ expenditures on scientific research and experimental development". The relevant portion of paragraph 37(7)(c) reads as follows:

In this section,

(c) references to expenditures on or in respect of scientific research and experimental development

(i) . . .

(ii) where the references occur other than in subsection 2, include only

(A) expenditures each of which was an expenditure incurred for and all or substantially all of which was attributable to the prosecution” or to the provision of premises, facilities or equipment for the prosecution, of scientific research and experimental development in Canada, and

(B) expenditures of a current nature that were directly attributable, as determined by regulation, to the prosecution, or to the provision of premises, facilities or equipment for the prosecution, of scientific research and experimental development in Canada.

Subsections 2900(2) and (3) of the Income Tax Regulations expand the interpretation of paragraph 37(7)(c). Only subsection 2900(2) is capable of having a bearing on the present matter. This subsection provides thus:

(2) For the purpose of clauses 37(7)(c)(i)(B) and (ii)(B) of the Act, the following expenditures are directly attributable to the prosecution of scientific research and experimental development:

(a) the cost of materials consumed in such prosecution;

(b) where an employee directly undertakes, supervises or supports such prosecution, the portion of the salaries or wages and related benefits paid to or for that employee that can reasonably be considered to relate thereto; and

(c) other expenditures that are directly related to such prosecution and that

would not have been incurred if such prosecution had not occurred.

I cannot agree with the appellants submission that in the context of the aforementioned provisions of the Income Tax Act and the Income Tax Regulations the salaries payable to the two employees in question at the year-end of the appellants 1987 taxation year and effectively paid after such year-end are deductible by the appellant in its 1987 taxation year because they should be considered as paid within the spirit and intention of the Act on account of the existence of the obligation to pay such salaries. Such contention is not, in my view, consonant with the scheme of the relevant provisions of the Act and the Regulations.

First of all, subsection 127(5) of the Income Tax Act refers to the investment tax credit in respect of an expenditure made within a particular time limit. The concept of "investment tax credit" relates, among other things, to "a qualified expenditure made by a taxpayer” before or after a particular point in time or during a stated period of time. The expression "qualified expenditure” is defined to mean an expenditure in respect of scientific research and experimental development made by a taxpayer that qualifies in particular as an expenditure described in paragraph 37(1)(a). The latter paragraph contemplates the deduction of expenditures in respect of scientific research and experimental development made in the year or in a preceding taxation year after 1973.

It is apparent that all these provisions in the Income Tax Act that have a bearing on the deduction of an expense of the type that we are concerned with here have reference to an expenditure made in contradistinction to an expenditure incurred. In this connection, it is to be noted that in many provisions of the Income Tax Act the deduction or non-deduction of a particular type of expense is stated in terms of both an expense made or incurred. See, for instance, paragraphs 18(1)(a) and 18(1)(c) of the Act. There are other instances where, like in paragraph 18(1)(h), the reference is only made to expenses incurred.

In addition, paragraph 2900(2)(b) of the Income Tax Regulations, in express terms refer to "salaries or wages and related benefits paid to or for” an employee who directly undertakes, supervises or supports the prosecution of scientific research and experimental development.

I see no reason why this term "paid" in paragraph 2900(2)(b) of the Income Tax Regulations should be given a meaning different from its ordinary mean- ing. I cannot see any ambiguity in this provision. It would have been easy for the Governor in Council who has enacted the Income Tax Regulations to refer to salaries or wages paid or payable. He has not done so and I cannot add words to the wording of paragraph 2900(2)(b). In this connection, it is particularly instructive to consider the language used in the provisions of paragraph 20(1)(c) and section 78 of the Income Tax Act. It is not disputed that by the year- end of the appellants 1987 taxation year a legal obligation to pay the subject salaries had been created but such salaries were effectively paid in the appellant's 1988 taxation year, as set out in paragraph 3 of the agreed statement of facts.

In the final analysis, it seems to be in conformity with the scheme of the Income Tax Act that a direct deduction from the tax otherwise payable by the appellant can only be granted if an expenditure in the form of salaries and wages has resulted in an outlay being effectively made by a taxpayer in a particular taxation year.

I should add that I have not found any assistance in the two decisions of this Court invoked by counsel for the appellant, the Earlscourt Sheet Metal case and the Tadman case, which were cited earlier.

In the Earlscourt Sheet Metal case, the question in issue was whether the accrued salaries were, inter alia, deductible in accordance with paragraph 18(1)(a) of the Income Tax Act. The Court found that the taxpayer has a legal obligation to pay the accrued salaries and that the expense represented by such salaries had been incurred for the purpose of earning income from a business. This result was to be expected since paragraph 18(1)(a) refers at the same time to an outlay or expense made and incurred. The Court in that case also considered the application of subsection 245(1) of the Income Tax Act, and found that the deduction in question did not result in an artificial reduction of income. This case had nothing to do with the computation of the investment tax credit in respect of an expenditure on scientific research and experimental development.

The Tadman case deals with the taxpayer's entitlement to a deduction in respect of scientific research and experimental development tax credit under subsection 127.3(1) of the Act. As I have attempted to show in my general overview of the provisions of the Act dealing with the treatment of expenditures on scientific research and experimental development a totally different section of the Act (section 127.3) is involved and this section establishes a type of tax credit governed by a different set of rules.

I am therefore of the view that the reassessment in issue was properly made by the respondent.

For these reasons the appeal is dismissed.

Appeal dismissed.