Archambault T.C.J.:
Réjean Caron, Murray Waxman and Martin Crête are disputing their notices of assessment made by the Minister of National Revenue (Minister) for the 1987 taxation year. As at December 31, 1987, each of the three appellants was a member of Société en commandite Agriboeuf (Agriboeuf), which, in 1987, began scientific research and experimental development
(R&D) work relating to steer breeding. The Minister considered that a large portion of the expenditures incurred by Agriboeuf were ordinary operating expenses, not qualified R&D expenditures.
As the appellants’ chief source of income was neither farming nor a combination of farming and some other source of income, the Minister applied to them the restrictions set out in section 31 of the Income Tax Act^ (Act). R&D expenditures contemplated in section 37 of the Act are not taken into account in computing the restricted farm loss. The fact that the Minister treated some of Agriboeuf’s expenditures as ordinary expenses and not R&D expenditures thus had the consequence of restricting the amount of the loss that each of the appellants could deduct in 1987.
Furthermore, the Minister reduced the amount of the investment tax credit that each of the appellants could claim since the amount of the credit in the instant case depended on the amount of R&D expenditures which were qualified for that purpose. The appellants do not dispute the application of section 31 of the Act, but submit that all the amounts claimed as R&D expenditures constituted such expenditures for the purposes of section 37 of the Act.
Facts (L16/R5180/T0/BT0) test_marked_paragraph_end (638) 1.045 1200_6543_6675
Factual Context
In his testimony, Gatien Rompré confirmed that he was the promoter of Agriboeuf. In 1974, following a career in construction, he began operating a 135-acre farm. From 1974 to 1978, Mr. Rompré carried on a cow-calf operation for Ferme G. Rompré Inc. (Ferme Rompré). Starting in 1979, he decided to specialize in raising steers, adopting for that purpose a feedlot setup.
In 1986-1987, Mr. Rompré noticed that Quebec-bred steers had an average daily growth rate of approximately two kilograms, whereas the rate was 2.8 kilos in western Canada. For Quebec producers to be able to compete with those from the West, they had to improve production methods and increase the average daily growth rate to 2.8 kilos.
Mr. Rompré is very much involved in various associations of cattle producers at both the regional and provincial levels. In the past, he has also taken part in certain research projects carried out by the Deschambault experimental farm and has collaborated with Laval University researchers. In addition, his farm also takes in every year students from that University’s Faculty of Agricultural Science and Food (Faculté des sciences de l’agriculture et de l’alimentation) (FSAA).
To make his farm operation profitable, Mr. Rompré decided to set up a limited partnership that would carry out R&D projects with a view to determining the best diet for steers having regard to hay and grain production in Quebec and more particularly in the Sainte-Anne-de-la-Pérade area. Another objective was to determine the importance of sheltering steers during the winter. He got the idea of forming the partnership from a similar project relating to pig breeding.
Mr. Rompré wished to carry out his research projects on commercial farms rather than on an experimental farm where breeding conditions were, in his view, not the same. The conditions in which R&D is carried out on an experimental farm are ideal and optimum conditions for livestock breeding. In his view, the findings of research in an ordinary operating environment are more convincing for farmers.
Agriboeuf
Agriboeuf was formed as a limited partnership under Quebec law on October 5, 1987, and made an initial public offering by prospectus (prospectus) on December 18, 1987. 2530-2324 Québec Inc. acted as general partner. Its only two shareholders were Gatien Rompré and Luc Marcotte.
In their notices of appeal, the appellants state that Agriboeuf operated a farming business in 1987. The Minister admitted this fact in his reply. However, the prospectus, in which there appears a summary of the limited partnership agreement, describes Agriboeuf’s business as follows:
[TRANSLATION]
The business of the partnership is to conduct scientific research work. This work will subsequently be used for the purposes of commercial production of beef cattle.
[My emphasis.]
In addition, the partnership’s activities are described therein as follows:
[TRANSLATION]
Activities of the Partnership (L490/R3262/T2/BT2) test_linespace (272>217.60) 0.859 1202_1527_1665
The partnership will engage in scientific research on the diet of beef cattle, herd management and preventive medicine. The term of the research projects will be one and a half years. For this purpose, the partnership intends to acquire approximately 3,750 head of cattle if the minimum offering is subscribed and 8,050 head if the maximum offering is sold. The said research work will subsequently be used in the commercial production of beef cattle. There will be no salaries in 1988 as all the livestock production will be done on a contract basis.
General (L500/R4590/T2/BT2) test_marked_paragraph_end (3758) 0.871 1202_3229_3339
The purchases of the beef cattle necessary to form the partnership’s herd will be made by Ferme G. Rompré Inc. These beef cattle will be resold to the partnership at market price.
[My emphasis.]
Agriboeuf did not have the staff or the facilities to enable it to maintain so large a herd. Instead it secured the services of beef producers with whom it negotiated lump sum production contracts. These producers used their own facilities and provided their own equipment for rearing the animals, with the exception of a small number of pieces of equipment which Agriboeuf provided. Agriboeuf converted the box of a truck and installed therein a mixer, purchased additional scales for $7,336 and put in some water bowls at a cost of $1,007. The evidence showed that these pieces of equipment were not used by Ferme Rompré after it acquired Agriboeuf’s assets in 1988, as will be seen below.
The total cost of the animals used by Agriboeuf in its R&D work was $2,713,918, which, according to the financial statements, included the contract cattle production costs. These costs represented the customary payment for the commercial production of steers, to which Agriboeuf added an allowance of $86,850 to compensate the producers for the additional work required for the R&D.
The prospectus states that Agriboeuf obtained from Ferme Rompré an undertaking whereby it promised to make available to Agriboeuf revolving credit of $1,000,000 if the minimum subscription level was reached and $2,100,000 if the maximum amount was subscribed. The money lent bore interest at 12 per cent per annum. This revolving credit was used in particular to purchase the livestock. A bank overdraft of $591,114 and a bank loan of $1,420,000 appear in the balance sheet to December 31, 1987.
In October and November 1987, Ferme Rompré acquired many of the animals needed for the R&D projects. During that period, it prepared them for the research projects that Agriboeuf would commence in December 1987. This preparation included, among other things, identifying the animals and fitting up facilities on the premises of the various producers. The animals purchased for the R&D projects were of different breeds normally used by Quebec producers.
R &D Projects
Having raised $2,950,000, from which it deducted investment expenses and the $286,910 remuneration of the best efforts underwriter, Agriboeuf was able to undertake seven scientific research projects with the aid of a number of researchers from Laval University and from the zootechnical research service of the Quebec Department of Agriculture, Fisheries and Food (Ministère de l’Agriculture, des Pêcheries et de 1’Alimentation du Québec)
(MAPAQ) in Deschambault. Dr. Dominique D. Rony of the MAPAQ’s zootechnical research service directed one of these projects. In that project, he attempted to determine the performance of steers subjected to various diets with or without “Ralgro”. Raymond Bergeron, the Minister’s scientific adviser, gave the following description in his report dated June 10, 1991:
[TRANSLATION]
4.1 DIETARY TRIALS CONDUCTED BY DR. D.D. RONY (L506/R1138/T2/BT2) test_linespace (244>217.60) 0.848 1203_5701_5815
These trials were conducted on the farm of Gatien Rompré, who is both a producer and a senior officer of the partnership, in Ste-Anne-de-la-Pérade. They were carried out on 10 groups of feedlot steers, each group comprising 55 head for a total of 550 head.
The study began in December 1987 and extended over 168 days, or slightly less than six months.
The research objective was to determine the effect on growth of the addition of three dietary supplements: fish meal, canola meal and meat meal. These trials were conducted with or without Ralgro, a growth promoter used in this industry.
For rations 1 (fish meal) and 2 (canola meal), there were four repetitions (i.e. four groups) of 55 head per repetition or group.
For ration 3, there were only two repetitions.
The sampling unit for statistical purposes in this project was the group (that is, 55 head).
4.1.1 S&T CONTENT
The planning and implementation of this project meet Revenue Canada Taxation’s S&T content requirements. Although conducting such trials in a produc- tion context may entail certain constraints with respect to the control of environmental conditions and experimental requirements, there is every indication that the scientific supervision which was carried out made it possible to minimize those constraints.
Data gathering included:
(a) weighing each animal at the start and at the end of the feeding period and every 56 days in between;
(b) weighing feed and recording feed weights each day before feeding;
(c) weighing and recording each day the quantities of feed refused by each group;
(d) continuing and special checking of each animal’s health;
(e) taking blood samples every 56 days from five animals, including one control animal, from each group for metabolic profile analyses;
(f) taking food samples from each ration every two weeks for chemical and biochemical analysis.
4.1.2 S&T QUESTIONS
This project involved a number of questions. For example, given the higher cost of using fish meal as a supplement, is its use in large quantities throughout the growth period justifiable from the standpoint of both zootechnical performance and cost? And what would be the relative value (yield and costs) of other supplements such as canola meal and meat meal?
4.1.3 S & T ADVANCEMENT
In general, this project contributed to increased knowledge of the effects of various dietary supplements, whether combined with Ralgro or not, on the growth of beef cattle. More particularly, this project made it possible to establish the zoo- technical basis of a diet including fish meal, canola meal or meat meal in steer production. In practical terms, it favoured better use of fish meal in steer production.
The projects directed by Dr. J.R. Seoane of the department of zootechnics of the FSAA at Laval University are described as follows in the same report:
[TRANSLATION]
4.2 DIETARY TRIALS CONDUCTED BY DR.J.R. SEOANE OF THE (L498/R246/T2/BT2) 0.832 DEPARTMENT OF ZOOTECHNICS, LAVAL UNIVERSITY (L498/R988/T2/BT2) test_linespace (246>217.60) 0.828 1204_8131_8425
Dr. Seoane developed and directed three research projects on the effects of various diets on steer growth performance.
These trials were conducted respectively in three buildings:
(a) on the farm of Léo Couture in Ste-Geneviève near Sainte-Anne-de-la- Pérade;
(b) on the farm of H. Couture in Ste-Geneviève near Sainte-Anne-de-la- Pérade;
(c) on the farm of Mr. Snyder in Grand-Mère.
In each case, the trials focused on the prefinishing stage and lasted some 90 days from December 1987 to March 1988.
4.2.1 TRIAL INVOLVING TWO RATIONS, ONE CONSISTING OF CORN SILAGE AND CORN, THE OTHER OF CORN SILAGE AND BARLEY
These finishing trials initially involved two groups of steers. According to the interview, one comprised 185 head and the other 188, for a total of 373. However, as some of the data were lost along the way, findings are available for only 180 head....
The main problem in this project was to determine what dietary conditions might achieve optimum efficiency. This project helped advance knowledge of the comparative ability of barley-and corn-based diets to meet zootechnical requirements for steer production....
4.2.2 RATE OF INTAKE AND DIGESTIBILITY FOR STEERS FED HAY SUPPLEMENTED WITH CORN OR BARLEY AND FISH MEAL OR SOYBEAN MEAL
This was a study on energy and protein sources for steers and was conducted on the breeding farm of H. Couture in Ste-Geneviève, Quebec. According to the interview conducted on May 31, 1991, 200* steers divided into four groups of 50 were fed different diets for a period of 90 days....
The make-up of the diets was as follows:
— hay/com/soybean; ay/corn/fish meal;
— hay/barley/soybean; hay/barley/fish meal.
The question was whether, having regard to rate of intake and digestibility, the nutritional value of a hay diet was greater with barley or with corn and to what extent the addition of fish meal or soybean influenced that nutritional value. The research helped advance knowledge in the area of animal dietetics and zootechnics.
4.2.3 COMPARATIVE VALUE OF AN ALFALFA SILAGE-BASED DIET
The purpose of this project was to determine the maximum use that could be made of alfalfa in the food ration of steers during the backgrounding period. According to the information obtained in the interview, this project was conducted from mid-December 1987 to June 1988 on 240 steers divided into four groups of 60 head each. Four diets were tested and they were made up as follows (apart from their other components):
— 69% high moisture corn I 26% alfalfa silage
— 58% ........ I 40% ........
— 44% ........ / 54% ........
— 31% high moisture corn I 68% alfalfa silage.
The question was which of these rations was most favourable from the standpoints of zootechnical performance and cost. According to the findings, a diet consisting of 58 per cent corn/40 per cent alfalfa seemed to be the most desirable, and this contributed to an advancement of knowledge in this area. Furthermore, this research project served as an incentive to greater use of alfalfa in steer production.
This project is considered as qualifying under section 2900(1) of the Income Tax Regulations.
Lastly, in Mr. Bergeron’s report there is a description of the projects conducted by Professor A. Marquis of the Department of Agricultural Engineering (Département de génie rural) of the FSAA at Laval University. Professor Marquis carried out three research projects on the effects of equipment, infrastructure and, more generally, herd management on animal production performance. Mr. Bergeron provided the following description:
[TRANSLATION]
4.3 RESEARCH CONDUCTED BY PROFESSOR A. MARQUIS OF THE (L500/R248/T2/BT2) 0.841 DEPARTMENT OF AGRICULTURAL ENGINEERING, FSAA, LAVAL (L500/R246/T2/BT2) 0.841 UNIVERSITY (L500/R4152/T2/BT2) test_linespace (250>217.60) 0.848 1206_4447_4923
This research was conducted in the farm buildings of producer G. Rompré in Sainte-Anne-de-la-Pérade, Quebec.
4.3.1. EFFECT OF DENSITY IN QUEBEC WINTER CONDITIONS ON STEER-FINISHING PERFORMANCE
The purpose of this project was to assess the effect of three different densities on the performance of penned steers.
For this purpose, three groups of steers comprising respectively 93, 114 and 130 head were raised in pens in different density conditions, i.e. 2.2 m /head, 1.7
m /head and 1.5 m /head respectively. Based on the information obtained during our visit, this project was conducted from December 1987 to March 1988. According to a research report dated March 31, 1989, the experiment as such (measurement taking) lasted 67 days, i.e. from December 13, 1987, to February 19, 1988. These trials were conducted in Sainte-Anne-de-la-Pérade.
The optimum breeding density (from the standpoint of the effect on finishing performance) in wintering conditions in Quebec is the main question in this project. The findings helped advance knowledge of herd management conditions, particularly as regards the optimum number of animals per unit area. This research was the subject of a publication project....
4.3.2 EFFECT OF THREE DIFFERENT TYPES OF BUILDINGS ON STEER FINISHING PERFORMANCE
These trials were conducted in Sainte-Anne-de-la-Pérade.
For their finishing phase, three groups of steers were placed in three types of unheated buildings in accordance with the following experimental arrangement:
— 386 head in a conventional building with open walls and at a density of 2.61 m /head;
— 286 head in a full-walled building with slatted floors and at a density of 1.75 m /head;
— 310 head in a full-walled building with non-slatted floors and at a density of 2.51 m /head.
The purpose of the project was to verify the effect of these shelter conditions and more particularly of the ambient temperature on certain zootechnical parameters such as rate of weight gain and feed efficiency. Based on the information obtained during our visit, this project was conducted from December 1987 to March 1988. According to a research report dated March 31, 1989, the experiment as such lasted 64 days, i.e. from December 23,1997, to February 25, 1988.
Data gathering included:
— weighing daily rations;
— weighing the animals every 32 days;
— indoor and outdoor temperature measurements;
— mortality;
— incidence of disease.
The main question in this project was how shelter conditions would affect these zootechnical parameters. The findings helped advance knowledge of beef cattle herd management. This project was the subject of a report (March 31, 1989) presented jointly to the Agriboeuf limited partnership by Professor A. Marquis and S. Godbout....
4.3.3 STEER PRODUCTION TRIALS WITH OR WITHOUT PROTECTION
These trials began in December 1987 and lasted 260 days. They took place in Ste-Geneviève near Sainte-Anne-de-la-Pérade and consisted in studying the comparative effect of raising steers either in conventional open buildings (87 head) or in the field without shelter (93 head). The idea was to determine whether there might be any benefit from a zootechnical standpoint to constructing a building for production purposes. That was the question in this project. The trials made it possible to determine that the performance of steers raised without shelter was not as good in winter as that of steers raised in the barn; however, during the rest of their finishing phase, the steers raised without shelter managed to make up the ground that was lost during their growth period, suggesting that production in buildings is not necessarily wholly justified. These trials thus contributed to an improvement in cattle-raising methods.
This project is therefore considered as qualifying under subsection 2900(1) of the Income Tax Regulations.
The three researchers produced research reports after their scientific research projects were completed. Some of the findings of that research were published in scientific reviews.
Steer production in the context of R&D projects requires more manpower than ordinary commercial operations. According to Mr. Rompré, the daily operation of a commercial feedlot requires approximately half a man- day, whereas stock-rearing in the context of an R&D project requires three or four man days per day. This is due to the fact that the steers must be weighed much more often and the quantity of food provided to them must be measured more accurately.
In other respects, Agriboeuf’s steer production was different from production in a commercial context. In particular, Agriboeuf could not replace certain feed with other types based on fluctuations in purchase prices. The research protocol as set out by the researchers had to be followed. According to that protocol, the producers also had to discard all feed not consumed by the steers at the end of each day. In a normal commercial operation, that feed would have been given to the animals the next day.
Rapid Succession of Securities Transactions (“Quick Flips”)
The prospectus informed investors that Ferme Rompré intended to acquire control of Agriboeuf in order to continue R&D on its own account and to apply the findings to the commercial production of beef cattle. Furthermore, there is to be found on page 1 of the prospectus a description of the limited partners’ right to sell all or part of their shares to Ferme Rompré around March 15, 1988. The purchase price had to be equal to the fair market value of the shares at December 31, 1987, to a maximum of $150 per share. If more than 75 per cent of the limited partners present at a special meeting called for that purpose exercised this option, Ferme Rompré was required to purchase all the shares of the limited partners. The prospectus provided that, if all the shares were redeemed in this manner, Agriboeuf would be automatically dissolved 30 days after the option was exercised, and that Ferme Rompré would acquire ownership of Agriboeuf’s assets.
Around March 18, 1988, Ferme Rompré acquired all of Agriboeuf’s shares. It would also appear that Agriboeuf’s financial statements were prepared only to December 31, 1987. Agriboeuf’s income statement to December 31, 1987, shows no “sale of products from research” and indicates research expenditures of $310,213, general partner’s fees of $2,000, professional fees of $10,000, administrative expenses of $750 and fixed assets depreciation of $472, for a total of $323,435.
The Court was given no reason as to why Agriboeuf considered 90 per cent of the share issue expenses as an R&D expenditure and 10 per cent as a farm operating expense.
After acquiring Agriboeuf’s assets and once the R&D program was finished, Ferme Rompré sold the steers to slaughterhouses in the area. Mr. Rompré stated that Ferme Rompré incurred a loss upon completion of the entire operation. However, Ferme Rompré used Agriboeuf’s R&D findings in the operation of its business, which, according to Mr. Rompré, enabled it to increase the profitability of that business.
Today, Ferme Rompré owns 1,250 acres of agricultural land and leases some 450 more, for a total of 1,700. These lands are used to grow the grain crops required for feeding Ferme Rompré’s steer herd. Ferme Rompré has a permit to raise as many as 2,000 head. Mr. Rompré stated that Ferme Rompré was earning profits from its farming operations.
Minister’s Audit and Assessment
In the course of his audit and upon reviewing Agriboeuf’s 1987 financial statements, the Minister’s auditor noted that the main R&D expenditure claimed was the animal inventory cost representing approximately 89 per cent of such expenditures. He requested the opinion of Mr. Bergeron, a scientific adviser, as to whether Agriboeuf’s seven research projects were qualified projects. Mr. Bergeron considered them as qualifying as R&D projects for the purposes of subsection 2900(1) of the Income Tax Regulations (Regulations), either as applied research or as experimental development. The auditor also asked him for clarification of the following points:
[TRANSLATION]
-Sampling:
Was it reasonable given the research conducted?
Who determined the nature of the sampling (researchers or others)?
How was it determined?
-Inventory:
Did the experiments affect the normal production cycle?
(meat quality, marketing of animals, etc.)
-Scope of research:
Date research began
Date research ended
Mr. Bergeron provided him with the following comments:
[TRANSLATION]
1. CONTEXT OF IMPLEMENTATION OF RESEARCH PROJECTS (L502/R458/T2/BT3) test_linespace (256>208.90) 0.841 1210_911_1021
These research projects were implemented in a production context. The trials were conducted, on farms specializing in steer raising, on groups of steers whose numbers were in keeping with the capacity of those farms to accommodate them, and care was taken not to disrupt the normal production process nor to affect the animals unduly, so as to avoid compromising their zootechnical quality and commercial value. In particular, this was done to ensure that the findings would as far as possible be applicable to ordinary commercial production.
By analogy, these experimental trials could be compared to trial production runs in a factory, though without taking the comparison too far because trial production runs in a factory do not necessarily have the same commercial value as regular production runs, whereas the trials in this instance do not appear in general to have resulted in a reduction in the steers’ commercial value.
2. NUMBER OF ANIMALS SUBJECTED TO TRIALS (L490/R1420/T2/BT3) test_linespace (258>217.60) 0.841 1210_3743_3855
We have two sources of information on this point: the interviews we had with each of the researchers and the documentation they provided to us.
According to Dr. Rony, 550 head were subjected to his trials at the farm of G. Rompré in Sainte-Anne-de-la-Pérade. This is consistent with the data in the research report he produced.
The projects conducted by Dr. Seoane involved respectively 180 (Léo Couture’s farm), 200 (Henri Couture’s farm) and 240 head (Snyder farm), for a total of 620 head.
The projects conducted by Professor Marquis involved respectively 337, 982 and 180 head, for a total of 1,499 head.
Thus, a total of 2,669 steers, more or less, underwent trials sponsored by the Agriboeuf limited partnership in 1988, which trials likely got under way in December 1987.
It is clear that, in purely statistical terms, if these projects had been conducted in the context of and in the conditions peculiar to an experimental farm (university type research), it would have been sufficient to use a much smaller sample to obtain findings of scientific value. For example, in the case of Dr. Rony’s project, it would have been sufficient to perform the trials on eight to 10 head per group (80 to 100 head in all) rather than on 55 head per group (550 in all), which is one-fifth of the number of animals that were actually used for these trials.
There are justifications for the use of a number of animals consistent with the farms' production capacity, the main one being so that it may be determined whether a treatment remains applicable, valid and profitable in a normal production management context.
The second, which is closely akin to the first, is the mistrust that producers may have of overly academic research that does not adequately take into account the realities and requirements of common practice. Furthermore, conducting these kinds of trials in a production context generally also imposes constraints related mainly to the difficulty of properly controlling the various experimental variables. In addition, according to our information, there are restrictions as to the potential impact of the research on herd quality and production value.
3. IMPORTANCE FOR RESEARCHERS (L498/R2346/T2/BT3) test_linespace (253>217.60) 0.841 1211_2359_2469
By and large, for a researcher, designing and conducting a research project in production conditions is not necessarily an ideal situation. However, it nevertheless affords him an opportunity, perhaps a rare one, to have the resources and equipment to conduct research, involve his students and young researchers in his research projects and produce the publications that are essential to maintaining his credibility as a researcher. The researcher also hopes that, in this way, his work can help improve animal breeding industries.
4. CONSTRAINTS PLACED ON PRODUCTION BY THE CONDUCT (L504/R250/T2/BT3) 0.841 OF EXPERIMENTAL TRIALS (L506/R3000/T2/BT2) test_linespace (254>217.60) 0.841 1211_4017_4311
Introducing experimental requirements into a process that is normally dedicated to production necessarily imposes certain constraints. At the same time, these constraints constitute that (activities, expenses, etc.) which is properly attributable to research requirements. Some of these constraints or requirements may be enumerated here:
— the hiring of researchers and technicians to plan and carry out the research project and to analyze and interpret findings;
— the hiring of additional support staff (farm hands, labourers, etc.) to perform work related to the research, or granting overtime to existing personnel so that they might perform such work;
— the time required of the company’s directors and managers to plan, Supervise and carry out the work;
— the improvements that may have been made in the facilities (breeding farms) for the purposes of the research that was to be performed; if these improvements are subsequently dismantled, it may be said that they were made solely for research purposes;
— the instruments or equipment that were purchased specifically for the purposes of the research and that were used solely for the research during their entire useful life;
— the activities that are not necessary for production, but that are necessary in carrying out the research project, for example:
. weighing feed each day;
. weighing animals more frequently;
. specific tests (e.g., digestibility) on a certain number of animals;
. blood samples and analyses if made necessary by research requirements;
— losses of animals that could be associated with research activities (e.g., from stress caused by excessive handling) or loss of value attributable to research activities;
— increased frequency of supervision and treatment, by a veterinarian for example, necessitated by the research project context;
— the addition to diets of foods or growth promoters required by the research.
4. IMPONDERABLES (L496/R3620/T2/BT3) test_linespace (246>217.60) 0.841 1212_2865_2971
The addition of an experimental context to a production process may have various effects that are impossible to assess.
First, there is the stress caused to the producer and to the livestock by the introduction of experimental requirements. This stress is not really quantifiable. It may perhaps be partly responsible for any livestock losses incurred.
Adjusting to the changes introduced in the production system is another question mark. Even if the changes in the Agriboeuf limited partnership’s projects do not appear significant, there were nevertheless a few, such as more frequent weighing of feed and more frequent observation of the livestock.
The business had to adjust to a slightly less stereotyped form of production; it was not necessarily easy to have the producers accept certain requirements on which the researchers might insist.
SUMMARY (L504/R4304/T2/BT2) test_marked_paragraph_end (1330) 0.841 1212_5605_5711
Although these various projects were carried out in a production context, they seem to me, in zootechnical and steer-breeding terms, to constitute a highly valid contribution to ST & ED.
[My emphasis]
In his testimony, Professor Seoane also acknowledged the usefulness of carrying out R&D projects with such a large number of animals in the context of a commercial farm operation. He gave the example of a professor at Cornell University who was conducting similar experiments. Professor Seoane confirmed that he had requested changes consisting in the installation of certain gates and the construction of certain pens to make it possible to separate the various groups and ensure a better rotation of animals.
In its expenses incurred in the fiscal year ending on December 31, 1987, Agriboeuf included R&D expenditures totalling $3,208,482. The Minister allowed only $149,446. This amount essentially represented additional expenditures directly attributable to R&D, that is to say salary expenses for the researchers and project managers. It did not include expenses relating to the purchase and raising of the animals since, according to the Minister, those were expenses relating to “normal” operations. The following table provides a summary of the expenses incurred by Agriboeuf and their tax treatment by the Minister:
Agriboeuf Limited Partnership (L498/R3074/T2/BT2) test_linespace (392>217.75) 0.864 1213_1709_1843
Qualified Research Expenditures and I.T.C - December 31, 1987 -
| AGRIBOEUF | | MINIS |
| TER OF |
| NA- |
| TIONAL |
| REVE |
| NUE |
Expenditures of a capital nature | |
Truck, box, mixer | $ | 20,000 | $ | 0 |
Water bowls | | 1,007 | | 0 |
Scales | |
TOTAL | $ | 28,343 | $ | |
Expenditures of a current nature Salaries | |
and wages | |
Salaries and wages | |
— researchers | | 4,930 | | 4,930 |
— project manager | | 8,000 | | 8,000 |
— contractor | | 47,531 | | 47,531 |
Materials used | |
— purchases of | | 2,713,918 | | 0 |
3,000 head of cattle | |
— production costs | | 84,018 | | 0 |
— compensation for | | 86,850 | | 86,850 |
producers | |
(disruption caused | |
by R&D) | |
Direct expenses | |
— notebooks, sta- | | 2,135 | | 2,135 |
tionery, etc. | |
— interest expenses | | 2,881 | | 0 |
share issue expenses | | 258,219 | |
TOTAL | $ 3,208,482 | $ 149,446 |
Total expenditures of capital and current | | 3,236,825 | | 149,446 |
nature | |
Less: | |
I.T.C. claimed and/or granted (20% or | 419,000 | 29,889 |
maximum $100/share) | |
Total Qualified Expenditures | $ 2,817,825 | $ 199,557 |
As appears from the following table, the Minister considered all the claimed current R&D expenditures that he disallowed to be ordinary operating expenses:
Agriboeuf Limited Partnership (L496/R3070/T2/BT2) test_linespace (394>217.60) 0.864 1214_2585_2723
Reconciliation of Farming Loss - December 31, 1987 -
| Agriboeuf | | Minister of |
| National |
| Revenue |
Farming loss claimed | |
Share issue expenses (10% X | $ 28,691 | $ | 28,691 |
$286,910) | |
General partner’s fees | 2,000 | | 2,000 |
Professional fees | 10,000 | | 10,000 |
Administrative expenses | 750 | | 750 |
| $ 41,441 | $ | 41,441 |
Plus: | |
Current research expenditures disal | |
lowed | |
— Purchases of cattle | - | | 2,713,918 |
— Contract livestock production | - | | 84,018 |
expenses | |
— Interest expenses | - | | 2,881 |
— Share issue expenses (90 X | - | | 258,219 |
$286,910) | |
Farming loss | $ 41,441 | | 43,100,477 |
In his T20 report (Exhibit 1-13), the auditor Mr. Gélinas explained in the following terms why he refused to consider some of Agriboeuf’s expenses as being qualified research expenditures:
[TRANSLATION]
According to subparagraph 37(7)(c)(ii), only expenditures all or substantially all of which were attributable to scientific research qualify as R&D expenditures. Paragraphs 10 and 21 of IT-151R3 state that the “all or substantially all” test is normally met if the assets acquired as a result of the research are to be used for at least 90 per cent of the time throughout their expected useful life for R&D in Canada. /t is our opinion that the cattle purchases, contract livestock production expenses, interest expenses, share issue expenses and capital expenditures can- not be considered to be all or substantially all attributable to the prosecution of R&D. In the case of the Agriboeuf limited partnership, the research activities did not make the meat unsuitable for consumption, the value of the cattle was not affected and the cattle were sold as part of a normal agricultural production business. Less than ninety per cent of the capital expenditures was used for R&D.
[My emphasis.]
Relevant Statutory Provisions (L8/R3218/T0/BT0) test_linespace (284>256.00) 1.023 1215_2345_2479
The relevant provisions of the Act respecting deductions of R&D expenditures appear in subsection 37(1) and subparagraphs 37(7)(b) and (c):
37(1) Where a taxpayer files with his return of income under this Part for a taxation year a prescribed form containing prescribed information, carried on a business in Canada and made expenditures in respect of scientific research and experimental development in the year, there may be deducted in computing his income for the year the amount, if any, by which the aggregate of
(a) such amounts as may be claimed by the taxpayer not exceeding all expenditures of a current nature made in Canada by the taxpayer in the year or in any previous taxation year ending after 1973
(i) on scientific research and experimental development related to the business and directly undertaken by or on behalf of the taxpayer,
(b) such amount as may be claimed by the taxpayer not exceeding the lesser of
(i) the expenditures of a capital nature made in Canada (by acquiring property other than land) in the year and any previous year ending after 1958 on scientific research and experimental development relating to the business and directly undertaken by or on behalf of the taxpayer, and
(ii) the undepreciated capital cost to the taxpayer of the property so acquired as of the end of the taxation year (before making any deduction under this paragraph in computing the income of the taxpayer for the taxation year),
(c) ... exceeds the aggregate of
(c.1) ...
(d) all amounts paid to him in the year or in any previous taxation year ending after 1973 under an Appropriation Act and on terms and conditions described in paragraph (c),
(e) that portion of the aggregate of all amounts deducted under subsection 127(5) in computing the tax otherwise payable by the taxpayer under this Part for the year or any previous taxation year that may reasonably be attributed to expenditures of a current nature made in Canada in the year or in any previous taxation year that were qualified expenditures in respect of scientific research and experimental development within the meaning of paragraph 127(10. l)(c),
(f) all amounts deducted by virtue of this subsection and paragraph 20(l)(Z) in computing the taxpayer’s income for any preceding taxation year, except amounts described in subsection (6),
(g) -
(h) ...
37(7) In this section,
(b) “scientific research and experimental development” has the meaning given to that expression by regulation;
(c) references to expenditures on or in respect of scientific research and experimental development
(1)
(11) 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;
[My emphasis.]
Subsection 96(1) of the Act states the rules for computing the income of a limited partner in a limited partnership:
96(1) Where a taxpayer is a member of a partnership, his income, non-capital loss, net capital loss, restricted farm loss and farm loss, if any, for a taxation year, or his taxable income earned in Canada for a taxation year, as the case may be, shall be computed as if
(a) the partnership were a separate person resident in Canada;
(b) the taxation year of the partnership were its fiscal period;
(c) each partnership activity (including the ownership of property) were carried on by the partnership as a separate person, and a computation were made of the amount of
(1) each taxable capital gain and allowable capital loss of the partnership from the disposition of property, and
(ii) each income and loss of the partnership from each other source or from sources in a particular place,
for each taxation year of the partnership;
(d) each income or loss of the partnership for a taxation year were computed as if this Act were read without reference to subsections 66.1(1), 66.2(1) and 66.4(1) and as if no deduction were permitted by section 29 of the Income Tax Application Rules, 1971, subsection 65(1) or section 66, 66.1, 66.2 or 66.4;
(e) each gain of the partnership from the disposition of land used in a farming business of the partnership were computed as if this Act were read without reference to paragraph 53(1)(Z);
(f) the amount of the income of the partnership for a taxation year from any source or from sources in a particular place were the income of the taxpayer from that source or from sources in that particular place, as the case may be, for the taxation year of the taxpayer in which the partnership’s taxation year ends, to the extent of the taxpayer’s share thereof; and
(g) the amount of the loss of the partnership for a taxation year from any source or from sources in a particular place were the loss of the taxpayer from that source or from sources in that particular place, as the case may be, for the taxation year of the taxpayer in which the partnership’s taxation year ends, to the extent of the taxpayer’s share thereof.
[My emphasis. ]
Subsection 127(9) of the Act defines qualified expenditures for the purposes of the investment tax credit:
127(9) In this section and section 127.1,
“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,
[My emphasis. I
Sections 2900 and 2902 of the Regulations define R&D expenditures for the purposes of section 37 and subsection 127(9) of the Act:
2900(1) For the purposes of this Part and paragraphs 37(7)(ô) and 37.1(5)(e) of the Act, “scientific research and experimental development” means systematic investigation or search carried out in a field of science or technology by means of experiment or analysis, that is to say,
(a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view,
(b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or
(c) development, namely, use of the results of basic or applied research for the purpose of creating new, or improving existing, materials, devices, products or processes,
and, where such activities are undertaken directly in support of activities described in paragraph (a), (b) or (c), includes activities with respect to engineering or design, operations research, mathematical analysis or computer programming and psychological research, but does not include activities with respect to
(d) market research or sales promotion;
(e) quality control or routine testing of materials, devices or products;
(f) research in the social sciences or the humanities;
(g) prospecting, exploring or drilling for or producing minerals, petroleum or natural gas;
(h) the commercial production of a new or improved material, device or product or the commercial use of a new or improved process;
(i) style changes; or
(j) routine data collection.
(2) For the purposes 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.
(3) For the purposes of clause 37(7)(c)(ii)(B) of the Act, the following expenditures are directly attributable to the provision of premises, facilities or equipment for the prosecution of scientific research and experimental development:
(a) the cost of the maintenance and upkeep of such premises, facilities or equipment; and
(b) other expenditures that are directly related to such provision and that would not have been incurred if such premises, facilities or equipment had not existed.
2902. For the purposes of the definition “qualified expenditure” in subsection 127(9) of the Act, a prescribed expenditure is
(a) an expenditure of a current nature incurred by a taxpayer in respect of
(i) the general administration or management of a business, including
(A) administrative salary or wages and related benefits in respect of a person whose duties are not all or substantially all directed to the prosecution of scientific research and experimental development, except to the extent that such expenditure is described in subsection 2900(2) or (3),
(B) a legal or accounting fee,
(C) an amount described in any of paragraphs 20(1)(c) to
(g) of the Act,
(D) an entertainment expense,
(E) an advertising or selling expense,
(F) a convention expense,
(G) a due or fee in respect of membership in a scientific or technical society or organization, and
(H) a fine or penalty, or
(ii) the maintenance and upkeep of premises, facilities or equipment to the extent that such expenditure is not attributable to the prosecution of scientific research and experimental development,
except any such expenditure incurred by a taxpayer who derives all or substantially all of his revenue from the prosecution of scientific research and experimental development or the sale of rights in or arising out of scientific research and experimental development carried on by him;
(b) an expenditure of a capital nature incurred by a taxpayer in respect of
(i) the acquisition of property, except any such expenditure that was incurred for and was all or substantially all attributable to the prosecution, or to the provision of premises, facilities or equipment for the prosecution, of scientific research and experimental development,
(ii) the acquisition of property that is qualified property within the meaning assigned by subsection 127(9) of the Act, or
(iii) the acquisition of property that has been used for any purpose whatever before it was acquired by the taxpayer;
[My emphasis.]
Analysis (L0/R4944/T0/BT0) test_marked_paragraph_end (794) 1.034 1220_929_1097
The only ground for the Minister’s refusal to allow as R&D expenditures and as qualified expenditures for the purposes of computing the investment tax credit the expenses incurred by Agriboeuf is that he believed that the acquisition cost of the steers and the contract livestock production costs, interest expenses, share issue expenses and the expenditures of a capital nature could not be considered as all or substantially all attributable to the prosecution of R&D The Minister assumed that Agriboeuf was operating a farming business and that the steers were purchased for the purpose of reselling them at a profit in the ordinary course of that business.
In my view, the taxpayers have succeeded in showing that this perception of the Minister’s was incorrect. All the expenses that the Minister disallowed were expenditures all or substantially all of which were attributable to R&D. This is true of both the expenditures of a current nature and those of a capital nature.
As appears from the questions put to his scientific adviser Mr. Bergeron, the Minister wondered whether the sampling used by Agriboeuf was reasonable in light of Agriboeuf’s objectives. The Minister concluded that the steers had not been purchased for R&D purposes. I believe, however, that the evidence shows that all the animals were acquired for such purposes and were used in Agriboeuf’s seven R&D projects. For the purpose of its systematic investigation or search carried out in a field of science or technology, Agriboeuf could choose whether its projects would be based on a limited sampling in an experimental farm setting or on a broader sampling in a commercial farm setting. Mr. Rompré indicated that he considered the findings of research conducted on an experimental farm in ideal conditions to be less convincing. Instead he wanted his projects to be carried out in an ordinary commercial farming environment. Not only did Professor Seoane acknowledge the usefulness of carrying out such projects in this manner, but the Minister’s scientific adviser himself stated that research so conducted seemed to him “in zootechnical and steer-breeding terms, to constitute a highly valid ... contribution”.
The Minister did not recognize the cost of any of the steers purchased by Agriboeuf as an R&D expenditure. I fail to see how one can undertake an R&D program having to do with the effects of diet and various herd management methods on production performance without using steers for that purpose.
Nor do I believe that Agriboeuf purchased the steers for the purpose of raising them for resale at a profit. Rather the steers were acquired for the purpose of carrying out the R&D projects. The approach adopted by Agriboeuf confirms this fact. Agriboeuf did not raise its steers with a view to maximizing its resale profits. If this had been the case, it would have used a half man-day of manpower per day, whereas four or five persons were used for the R&D program. In addition, they would have changed the feed in accordance with market-price fluctuations instead of staying with the feed specified in the R&D protocol. Lastly, in a commercial operation, feed not consumed by the livestock would not have been thrown out at the end of the day, but rather kept for the next day.
I find this approach adopted by Agriboeuf wholly consistent with the business described in the limited partnership agreement: “The business of the partnership is to conduct scientific research work. This work will subsequently be used for the purposes of commercial production of beef cattle.” Accordingly, the acquisition cost of the cattle and the contract livestock production expenses constituted R&D expenditures all or substantially all of which were attributable to R&D.
As to the expenditures of a capital nature, the evidence demonstrated that the equipment in question was used only for the R&D projects. This equipment was not subsequently used in Ferme Rompré’s operations. These expenditures were therefore all or substantially all attributable to R&D.
There remain the interest expenses and share issue expenses. The evidence showed that all or substantially all of the amounts raised either by means of the prospectus or through loans were used to pay the acquisition cost of the steers and R&D equipment. The evidence did not show any other use of these funds. All of Agriboeuf’s activities to December 31, 1987, were devoted to R&D. It follows therefore that these expenses were all or substantially all attributable to the prosecution of R&D.
For these same reasons, the expenses disallowed by the Minister are qualified expenditures for the purposes of subsection 127(9) of the Act, that is to say, for the purposes of the investment tax credit.
Although I believe that Agriboeuf’s approach was quite consistent with a scientific research approach, one may wonder, however, whether it was also as consistent with that of a person operating a “commercial enterprise”. Would a contractor operating a business for profit and wishing to conduct this type of R&D have used such broad sampling? I believe this question could have been debated if the case had turned on whether Agriboeuf genu- inely operated a business in 1987. The existence of a business is one of the essential conditions for an expenditure to be qualified for the purposes of section 37 of the Act. Section 37 provides that, where the expenditure is of a current nature, it must be an R&D expenditure “related to the business ... of the taxpayer”. Where it is an expenditure of a capital nature, it must be an R&D expenditure “relating to the business ... of the taxpayer”.
In this appeal, the Minister not only did not bring up any problem with respect to the application of this condition, but he even admitted in his reply that Agriboeuf was operating a farming business. On the evidence I heard, I have serious doubts as to whether Agriboeuf truly operated a farming business in 1987 and even 1988. Even putting to one side the entire question of the size of the sampling, it is far from certain that Agriboeuf was operating a business. Agriboeuf sold no steers and its income statement contained no item concerning the sale of steers. The only item that can be found is entitled “products of research” and no proceeds of sales are indicated thereunder. We know that Agriboeuf was dissolved before the R&D program was even completed, and Mr. Rompré indicated for his part that Ferme Rompré had incurred a loss as a result of this series of operations. It seems to me that Agriboeuf was started up strictly for the purpose of financing the R&D program. I do not believe that Agriboeuf ever intended to operate a farming business. Agriboeuf was only formed on October 5, 1987; its public offering was closed between December 18 and 31, 1987; and it was dissolved shortly after March 18, 1988.
It is clear from the prospectus that Ferme Rompré was going to acquire all the shares of Agriboeuf and that the limited partner investors were going to sell their shares in March 1988 at the agreed price of $150 per share. It is a well-known fact that limited partnership investors investing in this type of limited partnership generally do so with the firm intention of exercising the option that is offered to them to sell their interest at a predetermined price. This is essentially the only way they have of selling their investment since there is no market for this kind of investment. The chances that fewer than 75 per cent of the individuals present at the special meeting would exercise their option are practically nil and, if this percentage is reached, the promoter is required to purchase all the shares of all the limited partners. I do not believe it was a coincidence that all of Agriboeuf’s limited partners sold their shares to Ferme Rompré on March 18, 1988.
Ferme Rompré clearly had an interest in obtaining the R&D findings in order to improve the management of its own livestock. I have no doubt that the R&D program, if conducted by Ferme Rompré, would have been ori- ented towards its business. It seems to me that Agriboeuf’s sole object was to carry out R&D projects and to pass its costs on to the limited partners so that they could deduct them in computing their incomes for tax purposes. The Act provides for R&D incentives and it is possible for a limited partnership to incur R&D expenditures for which deductions may be claimed by the limited partners. However, and this is an important proviso, all the conditions of the Act must be met and those who set up such financing arrangements must ensure that they comply not only with the spirit but also the letter of the Acct.
I do not believe that the limited partners intended, through Agriboeuf, to operate a farming business or to share in the proceeds of the sale of the R&D findings. In any case, it is not certain that there was a market for the results of this kind of research. The limited partners were not interested in anything other than the deduction of the R&D expenditures for tax purposes and the $150-per-share selling price of their shares.
if it had been established that Agriboeuf did not operate a business, not only would the R&D expenditures not have been qualified expenditures for the purposes of section 37 and thus for the purposes of the investment tax credit, but there would also be the possibility that the limited partnership had not been validly constituted. One of the conditions essential to the formation of a partnership is that the partnership “should be for the common profit of the partners” (art. 1830 Civil Code of Lower Canada). In this instance, it may be questioned whether the partnership really intended to make a profit for its partners. For an example relating to a limited partnership established in a common law province, see the decision rendered by the Federal Court of Appeal in Continental Bank of Canada v. R., (1996), 96 D.T.C. 6355 (Fed. C.A.).
In conclusion, it is possible that Agriboeuf did not operate a farming business in 1987. However, since the Minister admitted in his reply that Agriboeuf had operated a farming business, the appellants did not have to adduce any evidence to convince me that Agriboeuf did actually operate such a business. It is therefore not appropriate in the circumstances to conclude that Agriboeuf did not operate a farming business. The appellants have thus succeeded in discharging their onus of establishing that the R&D expenditures that Agriboeuf incurred and that the Minister disallowed were all or substantially all attributable to R&D
For these reasons, the appeals are allowed and the income tax assessments are referred back to the Minister for reconsideration and reassessment on the basis that all the expenses that the Minister disallowed as R&D expenditures are qualified expenditures for the purposes of section 37 and subsection 127(9) of the Act. The appellants are entitled to costs.
Appeal allowed.