Citation: 2009 FCA 48
HER MAJESTY THE QUEEN
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HER MAJESTY THE QUEEN
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HER MAJESTY THE QUEEN
REASONS FOR JUDGMENT
has before it three appeals joined for the purpose of the proceedings and joint
hearing pursuant to an order dated May 6, 2008.
appellants submitted a specific issue which, if decided against them, is sufficient
to dispose of their appeals. They allege that Mr. Justice Angers of the Tax
Court of Canada (judge) erred when he found at paragraph 121 of his reasons for
judgment that the Canadian Institute of Chartered Accountants (CICA) Handbook was
silent about the generally accepted accounting principles (GAAP) that applied
in Canada to the financial statements
of partnerships CMRA and CMRA 2. They contend that, because the GAAP included rules
prescribing the discounting of promissory notes in an inflationary context, the
judge made an error of law by applying US accounting principles to the
determination of the value of the research and development expenditures recorded
by these two partnerships in their financial statements.
If, on the
contrary, this Court was to accept this first submission made by the
appellants, three other corollary issues then ensue on which this Court must
rule. Was there actually a research project undertaken by these two
partnerships? Were the scientific research and experimental development
(SR&ED) expenditures claimed by the appellants reasonable within the
meaning of section 67 of the Income Tax Act, R.S.C. 1985, c. 1 (5th
Supp.), as amended (Act)? Finally, did the deductions claimed
have the effect of unduly or artificially reducing the income of the appellants
under subsection 245(1) of the Act as it read at the relevant time?
the appellants are seeking costs both here and before the Tax Court of Canada
if they succeed on appeal. Conversely, in view of the respondent's consent to
judgment for some of the expenditures claimed, which would still not prevent
their appeals from being dismissed for the most part, they are asking to be exempted
from costs here.
They are also
asking to be released from the order by the Tax Court of Canada to pay the costs
of the respondent's three experts (Dr. Kenneth, Dr. Borgard and Dr. Brodeur),
who were called to testify about matters concerning the research undertaken by
the two partnerships.
my findings on the issue of the applicable GAAP, it will not be necessary to
deal extensively with the corollary issues. It is sufficient to state the
hearing of the three cases before the judge was the forum for an all-out
experts' war between the parties (expert report and rebuttal report) in
connection with the issues to determine whether
research for which the deductions were claimed was scientific research (see
paragraphs 41 to 66 of the reasons for decision);
(b) this research contributed to the advancement of
science and technology (ibid);
(c) the expenditures
were truly incurred on account of promissory notes payable in Brazilian
currency (ibid at paragraphs 67 to 71);
(d) it was
"known that the Brazilian currency was undergoing rapid devaluations and
that inflation was on the rise" (ibid, at paragraphs 71, 83 to 90);
practices in Brazil were adapted to inflation (ibid,
at paragraphs 91 to 96);
(f) the earnings
of the two partnerships in question (CMRA and CMRA 2) were presented in a
manner that provided the most accurate picture of their affairs according to
generally accepted accounting principles (ibid at paragraphs 98 to 121);
(g) the expenditures
incurred in the circumstances were reasonable (ibid at paragraphs 129 to
143, on which point no fewer than four experts were heard with a rebuttal
transactions for which deductions were claimed were carried out in accordance
with normal business customs or practices (ibid at paragraphs 154 to
In his 65-page
reasons for judgment, the judge meticulously examined and discussed in great detail
the evidence that was submitted to him, especially that of the experts heard on
the three corollary issues.
for the appellants takes issue with the judge for not having accepted the
testimony given by the appellants and for not having mentioned their testimony
in his judgment. However, counsel does acknowledge that it was up to the judge
to assess the evidence and that we cannot replace his assessment with ours.
v. Nikolaisen,  2 S.C.R. 235, at paragraph 18, under the heading "Recognizing the Expertise of the Trial Judge and His or Her
the Supreme Court indicated as follows how an appellate court should deal with findings
The trial judge is better situated to make factual findings owing to his or her
extensive exposure to the evidence, the advantage of hearing testimony viva
voce, and the judge’s familiarity with the case as a whole. Because
the primary role of the trial judge is to weigh and assess voluminous
quantities of evidence, the expertise and insight of the trial judge in this
area should be respected.
was perfectly entitled, on the basis of the expert evidence before him, to make
the findings he did. The appellants were unable to show any palpable or
overriding errors that would justify any intervention from us.
me to the discussion of the main issue. Truthfully speaking, I could do so
without any description of the facts. However, for a better understanding of
the issue, I will set out some of the general facts and others that are more
specific to the issue in this appeal.
Minister of National Revenue (Minister) disallowed the business losses deducted
by the appellants on account of their interest in the CMRA and CMRA 2
described the origins of the two partnerships at paragraphs 4 to 9 of the
reasons for judgment. He wrote the following:
 CMRA was
formed on July 16, 1985, by Corporation Planagex Ltée (Planagex) and
Investmed R.B. Inc. (Investmed). Both of these tax consulting companies
were controlled by CMRA's promoters, namely the Appellants Oleg Romar and
Yves Beaudry. The CMRA partnership contract refers to an issue price of
C$1.00 per partnership share. Under the terms of clause 4.2 of that
contract, 24.528% of this price was payable in Canadian funds upon the issuance
or acquisition of the shares, and 75.472% was in the form of a
promissory note, payable in four equal annual instalments commencing in the
seventh year and ending in the tenth year after the issuance of the shares. The
four annual instalments were payable in Brazilian funds, and the amount,
payable in cruzeiros, was fixed at the exchange rate in effect on the date of
issuance of the partnership shares, that is to say, the rate when the shares
were issued in 1985. Simple interest on the four annual instalments, at a
rate of 11.5%, was payable with each instalment.
 In the course
of its fiscal year, which ended December 31, 1985, CMRA received C$18,199,908
from its members. It also received promissory notes worth a total of
369,199,023,074 Brazilian cruzeiros, payable from the seventh to the tenth year
following their issuance, at a rate of 11.5%. During the same fiscal year, CMRA
paid Investmed C$4,199,750, which is 23.08% of the amount of Canadian funds
that CMRA received from its members on account of subscription, administration
and other fees.
 The CMRA 2
partnership was formed on February 25, 1986, also under the laws of Ontario, by the same
promoters who formed CMRA. The partnership contract refers to an issue price of
C$1.00 per share, and, under clause 4.2 of the contract, the price of each
share was payable in the same manner as with CMRA: 24.528% in Canadian funds,
and the balance, 75.472%, in the form of notes, each of which was payable, in
Brazilian funds, in four equal annual instalments commencing in the seventh
year and ending in the tenth year following the issuance of the partnership
shares, and the amount, payable in cruzeiros, was fixed at the exchange rate in
effect on the 1986 issue date of the shares. Simple interest on the four annual
instalments, at a rate of 11%, was payable with each instalment.
 CMRA 2's
fiscal year ended on December 31, 1986. In the course of that year, CMRA 2
received a total of C$19,050,413 in Canadian funds from its members.
It received 612,358,624 cruzeiros worth of promissory notes payable 7‑10
years later at a rate of 11%. CMRA 2 paid Techmed 23.08% of the
Canadian funds received. This amounts to C$4,396,010.
 During their
respective fiscal years, both partnerships entered into scientific research and
experimental development (SR&ED) contracts with Coral Sociedade Brasilieira
De Pesquisas & Desenvolvimento ("Coral"), a corporation
controlled by Texas businessman Allen F. Campbell through a Dutch
company that he controlled, with a view to setting up and heading research
activities at its laboratory in Cambridge, England, and at another laboratory
 Thus, the
funds invested in CMRA and CMRA 2 were to be used for Coral's research. CMRA's
contract was entered into on July 16, 1985, and CMRA 2's contract was
entered into on February 25, 1986.
at paragraphs 12, 13, 20 and 21, he described the payments made to Coral by
each of the two partnerships:
 In the course
of its fiscal year 1985, CMRA paid Coral C$350,000 for each product, that is to
say, C$14,000,158, by cheque issued to Coral and transferred to Coral's
Canadian bank account. During the same fiscal year, CMRA issued 18 notes
to Coral, denominated in Brazilian currency, in connection with the
40 Coral projects. Based on the exchange rates in effect at the time of
the transactions between CMRA and Coral in 1985, the Canadian-dollar equivalent
of the principal amount of 369,199,023,074 cruzeiros was C$56,000,623, which
amounts to C$1,400,000 for each of the 40 projects.
 In its
financial statements for the period from July 16 to
December 31, 1985, CMRA entered an expense of C$70,000,781 on account
of the contract signed with Coral. CMRA relied not only on the
C$14,000,158 in cash payments to Coral, but also on the principal amount of the
term notes denominated in Brazilian currency and signed by CMRA in favour of
Coral, in the amount of 369,199,023,074 cruzeiros, which it converted into
C$56,000,623 based on the exchange rate in effect on the date of the
transaction with Coral.
. . .
 Over the
course of its fiscal year ended December 31, 1986, CMRA 2 paid Coral
C$14,654,404, which amounts to roughly C$350,000 for each of the
42 projects. CMRA also issued Brazilian-currency-denominated notes
payable to Coral in respect of the 42 projects, in the amount of 612,358,624
 In its
financial statements for the period from February 25 to
December 31, 1986, CMRA 2 entered a research expense of C$73,272,012
on account of the service contract entered into with Coral on February 25,
1986. In order to arrive at this amount, CMRA 2 did the same thing as CMRA:
it entered the initial amount paid in cash as well as the value of the
Brazilian-currency-denominated term notes converted into Canadian dollars based
on the exchange rate in effect on the date of the transactions entered into
cases, the eighteen (18) term notes in Brazilian currency signed by CMRA as
well as the thirteen (13) CMRA 2 notes signed or issued to the order of Coral
did not have any inflation indexation formula, no monetary adjustment formula
and no exchange rate adjustment formula. Although a hedge agreement protecting CMRA
and CMRA 2 and their members in the event of an appreciation in the value of
Brazilian currency had been concluded between the two partnerships and Coral,
there was none to ensure Coral's protection in the event of a devaluation of Brazilian
the notes were assigned by Coral to Medical Research Trust. Neither Coral nor
Trust claimed payment of the notes at maturity, and consequently the two
partnerships and their members were never required to pay anything on these
of the research was to develop diagnostic kits. It was conducted in the Coral
laboratories in Cambridge, England. However, no
research was conducted at its premises in Brazil.
partnerships claimed SR&ED expenditures of more than C$143,272,793, which
gave rise to equivalent losses for 1985 and 1986.
Respondent's consent to judgment
the judge found that all the SR&ED expenditures recorded in the financial
statements of the two partnerships were unreasonable in the circumstances, the
respondent indicated her willingness to consent to judgment for certain amounts
paid in cash to Coral by the two partnerships.
case of CMRA, the amount is C$1,750,020, corresponding to five products having
a possible diagnostic utility at an estimated cost of C$348,914 each.
respondent will accept payments of C$348,914 per product paid by CMRA 2 to
Coral for the forty-two (42) products included in its contract with Coral.
Accordingly, the total amounts to C$14,654,404.
the appellants were members of both partnerships, along with some six hundred
(600) other partners, the respondent agrees that only a portion of the
above-mentioned amounts would be apportioned to the appellants, corresponding
to their respective interest in each of these two partnerships.
the judgment to be rendered in each of these three dockets will take this
concession by the respondent into consideration.
the CICA Handbook silent on the GAAP applicable in Canada and did the judge err in applying
American accounting principles on a supplementary basis?
to better understand the significance of the issue of the application of GAAP,
it is important to contrast the positions of the two opposing parties.
for the appellants contends that the value of the SR&ED expenditures
appreciates from the initial amount. In the context of this case, this means
that expenditures incurred by means of the promissory notes payable in
Brazilian currency must be calculated according to the exchange rate in
Canadian dollars applicable at the time these notes were issued. On the basis
of this method of calculation, the CMRA and CMRA 2 partnerships respectively posted
research expenditures of 70 and 73 million Canadian dollars in their financial
statements for the 1985 and 1986 taxation years respectively.
acknowledging the initial step of taking into consideration the original cost
to determine the value of the research expenditures, the respondent submits,
and I agree, that the basic objective of the exercise is to establish an
accurate picture of the taxpayer's affairs and of his actual earnings for the
year in question. She cites Canderel Ltée v. Canada,  1 S.C.R.
147, at paragraphs 33 to 37 and 53, in support of her opinion: see also Bernick
v. The Queen, 2004 D.T.C. 6409, at paragraph 26 (F.C.A.).
judge had ruled, the respondent asserts that, in order to do so, "one had
to discount the value of the long-term payments, except if the interest rates
had been reasonable, which they were not in the instant case": see
paragraph 121 of the reasons for judgment.
In my opinion,
determining whether, at that time, that is, in 1985 – 1986, the CICA Handbook
had GAAP covering, as in this case, a situation involving transactions with
deferred payments in a highly inflationary economy, is a mere question of fact.
Either the Handbook dealt the matter or it did not.
in an attempt to turn this into a question of law, the appellants refer us to
sections 1650.05 to 1650.10 of the June 1983 version of the Handbook. Their
interpretation of these sections, according to them, covers transactions with
deferred payments. According to their reasoning, the interpretation of these
sections or, if we prefer, the scope of these sections would then involve a
question of law.
approach does not lack ingenuity, but it requires an interpretation of these
provisions that goes far beyond what the purpose and wording of these sections
excerpts to which we are referred deal with the conversion of foreign currency
and the objectives of conversion in a context in which the final goal of the conversion
is to express in Canadian currency the entries of the financial statements of a
foreign establishment. Sections 1650.05 and 1650.06 reflect this reality:
1650.05 For foreign
currency transactions: the objective of the translation is to express
such transactions in a manner that achieves consistency with the accounting
treatment for domestic transactions. Since domestic transactions are
automatically measured in Canadian dollars, the Canadian dollar is the
appropriate unit of measure for foreign currency transactions. Accordingly, the
temporal method should be used to translate foreign currency transactions.
1650.06 For foreign
operations: the ultimate objective of the translation is to express
financial statements of the foreign operation in Canada in a manner which best reflects
the reporting enterprise's exposure to exchange rate charges as determined
by the economic facts and circumstances.
It seems fairly
clear to me that these provisions do not specifically deal with the manner in
which transactions subject to deferred long-term payments and to spiralling
inflation, which, I would add, is anticipated to be more than 200%, are to be reported
in the financial statements of Canadian partnerships.
One of the
accounting experts, Mr. Weiner, who testified on behalf of the respondent, stated
in his testimony that the CICA Handbook did not mention anything on this point:
see Volume III of the Excerpts of Documents for Hearing, at pages 9756 and 9757.
this omission in the GAAP, he conducted research in order to arrive at an
opinion. He studied accounting practices, literature on this topic and the
standards published by organizations empowered in foreign jurisdictions to
develop accounting practices: ibid at page 9756.
publications he read on this point, he noted one published by Ross Skinner in
1972, a Canadian author who the judge mistakenly considered was American. It is
interesting to note that the author insisted on the necessity of discounting
the amount of the transaction when the payment of the amounts promised is
deferred over a long period at unreasonable interest rates in a highly inflationary
context, and, I would add, exacerbated by the fact that they are not compounded.
conducting his research, Mr. Weiner discovered an opinion of the Accounting
Principles Board, on the basis of which the American organization issued a
directive as early as August 1971. I will reproduce it in its entirety while
underlining some of the more relevant sections:
In respect of
discounting, APB Opinion No. 21: Interest on Receivables and Payables
addressing the specific issue of discounting was issued (August 1971) by the
Accounting Principles Board:
12. Note exchanged
for property, goods, or services. When a note is exchanged for property,
goods, or service in a bargained transaction entered into at arm’s length,
there should be a general presumption that the rate of interest stipulated by
the parties to the transaction represents fair and adequate compensation to the
supplier for the use of the related funds. That presumption, however, must
not permit the form of the transaction to prevail over its economic substance
and thus would not apply if
(1) interest is not
stated interest rate is unreasonable (emphasis added by author); or
stated face amount of the note is materially different from the current cash
sales price for the same or similar items or from the market value of the note
at the date of the transaction.
In these circumstances,
the note, the sales price, and the cost of the property, goods, or service
exchanged for the note should be recorded of [sic] the fair value of the
property, goods, or services or at an amount that reasonably approximates the
market value of the note, whichever is the more clearly determinable. The
amount may or may not be the same as its face amount, and any resulting
discount of premium should be accounted for as an element of interest over the
life of the note. In the absence of established exchange prices for the
related property, goods, or service or evidence of the market value of the
note, the present value of a note that stipulates either no interest or a
rate of interest that is clearly unreasonable (emphasis added by author)
should be determined by discounting all future payments on the notes using an
imputed rate of interest as described in paragraphs 13 and 14. This
determination should be made at the time the note is issued, assumed or
acquired; any subsequent changes in the prevailing interest rates should be
agreed with Mr. Weiner's testimony. He wrote the following at paragraph 110 of
his reasons for judgment:
 The witness noted
that the GAAP that he followed in his report were those in effect in 1985 and
1986. Since the CICA's handbook was silent with respect to the way in which to
post delayed-payment transactions, the witness consulted certain publications,
notably one by the American Ross M. Skinner, entitled
"Accounting Principles: A Canadian Viewpoint" (1972), the
relevant excerpt of which is at page 48:
In transactions where
payment is not called for within a short period of time after performance it is
clear that fair measurement of the amount of the transaction requires that the
payments provided for under the contract be discounted, unless a reasonable
rate of interest is provided for in the contract (emphasis added by
Thus, while this concept
of discounting delayed payment transactions is obviously economically sound, it
has complications in practice. Since most business transactions do not involve
abnormal payment delays there may be a tendency in practice to ignore the
discount factor implicit in the occasional transactions involving delayed
The error in this has
recently been recognized in APB Opinion No. 21, entitled "Interest on
Receivables and Payables".
In Canada, there has
been no equivalent official recommendation. In its absence, occasional examples
may be encountered of delayed payment amounts being recorded of face value
rather than fair value. The practice, however, should no longer be regarded as
respect, it was up to the trial judge to assess the evidence, especially that
of the experts given to help him in reaching his decision. I would breach my duty
of deference if I were to interfere in a process of challenging the decision on
would be all the more flagrant and reprehensible considering that the judgment
is supported by two recent opinions of the most respected accounting firms.
as mentioned by the judge on the basis of the evidence adduced before him, the firm
Clarkson Gordon, which did business in the 1980s, was tasked with auditing the
financial statements of CMRA as at December 31, 1985: see paragraph 99 of the
reasons for judgment.
services of this firm were retained the following year by CMRA 2 to prepare its
financial statements. That is when it noted that the interest rate of 11% was markedly
insufficient because the notes were payable in Brazilian currency. It should be
noted that in the three years ending on December 31, 1984, the cumulative rate
of inflation in Brazil amounted to 1321%: see the
opinion of the accounting firm Peat Marwick, dated March 4, 1986, forwarded to
the accounting firm Clarkson Gordon, Volume III of the Excerpts of Documents
for Hearing at page 9427.
paragraph 101 of his reasons for judgment, the judge noted the following
excerpt from the testimony of Doug Cameron, who worked for the Clarkson Gordon
The consequence of that
was that we felt that the value of the notes was overstated in these
financial statements, the value of the notes and the research expense was
overstated in these financial statements by a significant amount.
Clarkson Gordon firm discovered that as of February 27, 1986, the standard interest
rate for a short-term loan in Brazil of three months was already
225%, but was only 11% for the CMRA and CMRA 2 transactions for a long term of
seven to ten years. It therefore consulted the Peat Marwick firm to obtain an
opinion about its accounting analysis of the CMRA financial statements for 1985.
4, 1986, Peat Marwick sent Clarkson Gordon an opinion based on the GAAP in Canada: see Volume III of the
Excerpts of Documents for Hearing at page 9423. This opinion also mentioned the
fact that the CICA Handbook was silent on several accounting issues, including discounting
in the case of long-term debts. Like Mr. Weiner, the accounting expert, the
Peat Marwick firm consulted the statements of other professional accounting
organizations, working documents and research in Canada and the United States,
practices adopted by regulatory authorities or under legislation and, finally,
methods that were being used at that time: ibid, pages 9425 and 9427.
9429, the accounting firm stressed that the opinion issued in the United States in August 1971 for the
purpose of American GAAP (opinion recommending the necessity of discounting
future payments when the interest rates are unreasonable) is generally followed
in Canada. It added that the high
interest rates in Canada since 1980 meant that the practice of discounting in
financial statements in Canada was used more often.
specifically to the financial statements of CMRA, it unequivocally concluded
that it was necessary to discount the promissory notes. I will reproduce this
conclusion found on pages 9433 and 9434:
represented by the Research and Development Proposal and Agreement is so
pervasive a component of the Partnership’s financial statements, and the
failure to discount would have so material an impact on those financial
statements, that we cannot conclude with credibility that failure to discount
would be a generally accepted practice in this circumstance. Consequently, we
believe the promissory note in question should be discounted at a rate that
provides a reasonable return on the borrowing, which would require
consideration of both a monetary correction factor and a higher rate of
interest. Failure to discount, in our view, would result in an overstatement of
the R&D expense and the related liability.
Similarly, the notes
receivable by the Partnership from individual investors should be discounted,
as their terms in aggregate are identical to the terms of the notes payable.
We believe every effort
should be made to determine a reasonable discount rate as this would be the
most meaningful disclosure. If a reasonable estimate of the fair value of the
transaction cannot be made because a reasonable discount rate cannot be
determined, then a denial of opinion on the financial statements would be the
this opinion, the firm Clarkson Gordon withdrew the financial statements for
1985 that it had prepared for CMRA.
I am aware
of the fact that this part of the evidence that I have just summarized does not
do justice to the detailed analysis made by the judge, but it supports and
warrants the judge's finding that the value of the long-term payments had to be
discounted in view of the unreasonable interest rates: see paragraph 121 of his
reasons for judgment.
the appeal is allowed in part to give effect to the respondent's consent to
judgment, one fact remains. The appellants did not discontinue their appeals.
They attempted, but without success, to have SR&ED expenditures of more
than 143 million Canadian dollars acknowledged. They are liable for the costs
they incurred on appeal in the pursuit of this objective that goes far beyond
the consent to judgment.
As far as
the costs of the three experts who testified for the respondent before the Tax
Court of Canada are concerned, I am of the opinion that it is not appropriate
to grant the appellants' request to be exempted from their payment. The
appellants had experts testify on matters concerning research undertaken by CMRA
and CMRA 2. In these circumstances, expert evidence by the respondent became
necessary for all intents and purposes. In addition, this evidence was useful
for the determination of the issue.
reasons, I would allow the appeal only to give effect to the respondent's
consent. Pursuant to this consent, I would acknowledge the appellants’
entitlement to their respective share of the non-capital losses generated by
the cash payments of C$1,750,020 in the CMRA partnership and C$14,654,404 in
the CMRA 2 partnership.
other points, I would dismiss the appeals with costs, which are limited to one
set for the joint hearing.
these reasons will be filed in Dockets A-87-08 and A-86-08 in support of the
judgments to be made therein.
like to thank counsel for each of the parties for the quality of their memoranda
of fact and law as well as for the effectiveness of their oral submissions at