Power v. MNR, 89 DTC 449, [1989] 2 CTC 2233 (TCC)

Mogan, T.C.J.: —In 1982, the appellant became a limited partner in Janicek Associates, a limited partnership established for the purpose of conducting basic and applied scientific research in orbital mechanics and related fields of science and technology. In the years 1982,1983 and 1984, the appellant made capital contributions to the partnership in the following respective amounts $10,000, $3,300 and $29,500. In computing her income for those three years, the appellant deducted $8,000, $3,481 and $21,735 respectively with respect to her above capital contributions to the partnership. The respondent disallowed such deductions on the ground that they were capital outlays. The appellant acknowledges that the amounts in question are capital outlays but she claims that they are deductible under section 37 of the Income Tax Act as expenditures in respect of scientific research. The only issue which was argued in this appeal was the interpretation of paragraph 37(1)(b) of the Income Tax Act.

There were ten partners in the limited partnership Janicek Associates which was formed in 1981 under the laws of Ontario. The respondent conducted a field audit of the partnership and the parties appear to be in agreement that (a) the partnership was bona fide throughout the years 1982, 1983 and 1984, although no partnership agreement was signed until 1986; (b) the partnership was engaged in scientific research within the meaning of section 37 of the Income Tax Act; and (c) the appellant made capital contributions to the partnership in the amounts claimed. Because the only issue involves the interpretation of paragraph 37(1)(b) of the Act, it should be set out in full:

Sec. 37 (1) There may be deducted in computing the income for a taxation year of a taxpayer who carried on a business in Canada and made expenditures in respect of scientific research in the year the amount by which the aggregate of

(a) . . .

(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 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),

The appellant submits specifically that the amounts in question are deductible under subparagraph 37(1)(b)(1):

— as expenditures of a capital nature made in Canada by acquiring property (i.e. the appellant's partnership interest) ;

— as expenditures on scientific research relating to the business carried on by all members of the partnership through the partnership itself; and

— as expenditures on scientific research directly undertaken by or on behalf of the appellant through the partnership.

The appellant's representative cited the decision of the Federal Court- Trial Division in International Nickel Co. of Can. Ltd. v. M.N.R., [1971] F.C. 213; [1971] C.T.C. 604; 71 D.T.C. 5332 at page 5349 for the proposition that an expenditure on scientific research was a capital expenditure. That proposition is well founded, The appellant also relies on the decision of this Court in Topolewski v. M.N.R., [1986] 2 C.T.C. 2405; 86 D.T.C. 1824 to demonstrate, by analogy, that section 37 applies at the partner level and not at the partnership level. In my view, the Topolewski case which was concerned with the restricted farm loss under section 31 does not apply to the appeal herein concerning expenditures on scientific research.

The respondent submits that the appellant did not, within the meaning of subparagraph 37(1)(b)(i), have any "expenditures of a capital nature made in Canada on scientific research . . .” because only the partnership made such expenditures.

The respondent also makes two arguments with respect to the interpretation of "property" in paragraph 37(1)(b). Firstly, the respondent submits that the word "property" in subparagraphs (i) and (ii) must have the same meaning because subparagraph (ii) refers to "the property so acquired”. Because property in subparagraph (ii) must be depreciable property, then the property in subparagraph (i) must also be depreciable property. The appellant acquired only a partnership interest with her expenditures in question and, since a partnership interest cannot be depreciable property, the appellant's expenditures cannot come within paragraph 37(1)(b). And secondly, the respondent submits that paragraph 37(1)(b) permits the deduction of the lesser of the amounts in subparagraphs (i) and (ii); and for the appellant, the amount in subparagraph (ii) is nil.

In my opinion, the interpretation of section 37 put forward on behalf of the respondent is the more reasonable interpretation. There is no doubt that paragraph 37(1)(b) permits a taxpayer to deduct in computing income a capital outlay which would otherwise be prohibited by paragraph 18(1)(b). This exception to the general rule in paragraph 18(1)(b) is restricted to expenditures of a capital nature on scientific research.

When the appellant made the capital expenditures in question, she acquired only an interest in the partnership. Although the partnership may have been engaged only in scientific research, a capital outlay by a partner to acquire an interest in the partnership is different from a capital outlay by the partnership on scientific research. Leaving aside the wording of subparagraph 37(1)(b)(ii), I cannot construe the word "property" in subparagraph 37(1)(b)(i) as including a partnership interest because "the expenditure of a capital nature" in subparagraph 37(1)(b)(i) must be "on scientific research" and a capital outlay to acquire a partnership interest is clearly not an expenditure of a capital nature on scientific research.

Referring now to the wording of subparagraph 37(1)(b)(ii), I am reinforced in my conclusion that the word "property" in subparagraph 37(1)(b)(i) cannot include a partnership interest because subparagraph 37(1)(b)(ii) uses the words "the undepreciated capital cost . . . of the property so acquired”. To me, these words indicate that the expenditure of a capital nature on scientific research in subparagraph 37(1)(b)(i) must be made to acquire depreciable property; and the amount deductible under paragraph 37(1)(b) cannot exceed the undepreciated capital cost of such property at year end before claiming any deduction under paragraph 37(1)(b).

Regulation 1102(1)(d) excludes from depreciable property any property that was acquired by an expenditure in respect of which the taxpayer was allowed a deduction under section 37. Subparagraph 37(1)(b)(ii) is carefully worded, however, to describe the undepreciated capital cost of property at year end before making any deduction under paragraph 37(1)(b). In other words, the property acquired under subparagraph 37(1)(b)(i) must be depreciable property at the time of acquisition even though it may fall out of that class after year end according to Regulations 1102(1 )(d) if the taxpayer claims a deduction under section 37(1)(b) when computing his income at year end.

The effect of Regulation 1102(1)(d) appears to be that no capital cost allowance is permitted in respect of scientific research property if the cost of that property is deducted under section 37 as it is incurred.

Section 96 requires a partnership to be regarded as if it were a separate person resident in Canada. A partnership adopts its own fiscal period and computes its own income. In my view, a deduction under section 37 must be made at the partnership level and not at the partner level unless expressly excluded as a partnership deduction. For example, a deduction with respect to exploration and development is expressly excluded by paragraph 96(1)(d) but I do not find any similar exclusion for scientific research expenditures under section 37. The extraordinary aspect of subsection 96(1) is the allocation of profit and loss among the partners under paragraphs 96(1 )(f) and (g) but, as already stated, such profit or loss will be allocated after any relevant deduction under section 37 is made by the partnership.

For the above reasons, the appeal herein is dismissed.

Appeal dismissed.