Morley v. The Queen, 2004 DTC 2604, 2004 TCC 280, briefly aff'd 2006 DTC 6351, 2006 FCA 171

Citation: 2004TCC280

Date: 20040413

Docket: 2000-3716(IT)G

BETWEEN:

DAVID MORLEY,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

REASONS FOR JUDGMENT

Archambault, J.

          As a retired senior partner from Coopers Lybrand said to me this morning, parts of the private sector have brought this on themselves by being both greedy and dumb. Unfortunately, we have been caught up in the process.[1]

[1]      This statement, written by Mr. David Morley himself, sets the tone for the events that led to these appeals. On December 8, 1993, Mr. Morley became a limited partner of the Agensys (Canada) Limited Partnership (Partnership), formerly known as the Continental Limited Partnership. On December 31, 1993, the Partnership allocated to him a loss of $217,282, mostly attributable to capital cost allowance (CCA) claimed in respect of a software (Software) acquired by the Partnership for a disclosed price of $12,150,000. A portion of the $217,282 loss, namely $36,028, was claimed as a carried over non-capital loss in computing Mr. Morley's taxable income for the 1990 taxation year.

[2]      By Notice of Reassessment dated November 21, 1997, the Minister of National Revenue (Minister, Revenue Canada or CCRA) disallowed Mr. Morley's share of the Partnership losses for its 1993 fiscal period. He also disallowed the deduction of the $36,028 non-capital loss for the 1990 taxation year. Finally, he assessed penalties aggregating $50,495.35 pursuant to 163(2) of the Income Tax Act (Act), R.S.C. 1985, c.1 (5th Supp.).

[3]      A reading of the Reply to the Amended Notice of Appeal identifies the following 14 issues raised by these appeals:

1.        Did the Partnership constitute a valid partnership?

2.        Did the Partnership carry on any business for the purpose of earning a profit from the exploitation of the Software and did it have a reasonable expectation of profit, or was it formed for the sole purpose of creating tax refunds for investors by claiming CCA relating to the Software?

3.        Did Mr. Morley participate in the Partnership for the purpose of gaining or producing income and did he have a reasonable expectation of profit?

4.        Was the Software acquired for the purpose of gaining or producing income as required by paragraph 1102(1)(c) of the Income Tax Regulations (Regulations)? If not, it would not constitute depreciable property.

5.        Did the Software constitute property described in paragraph (o) of Class 12 of Schedule II of the Regulations, or did it constitute a "systems software" within the meaning of section 1104 of the Regulations or property described in Class 14 of Schedule II of the Regulations?

6.        Was the Software "available for use" in 1993 within the meaning of subsections 13(26) and (27) of the Act? If not, no CCA could be claimed by the Partnership in 1993.

7.        When was the Software acquired: in December 1992, as claimed by Mr. Morley, or in 1993, as claimed by the respondent? If it was in 1993, the claim for CCA would be subject to the so-called "half-year rule" under subsection 1100(2) of the Regulations.

8.        What was the cost of the Software to the Partnership? Was it limited to the cash payment of $960,000 or was it equal to the amount of the promissory note (Acquisition Note) for $12,150,000 issued when the Software was acquired? The respondent claims that neither the Partnership nor the vendor of the Software, Agensys Corporation (Agensys T & C), an entity incorporated under the laws of the Turks and Caicos Islands, ever intended to create a legal liability under the Acquisition Note. Furthermore, the respondent claims that Agensys T & C never intended to collect on the Acquisition Note.

9.        Did Mr. Morley, the Partnership and Agensys T & C deal with each other at arm's length or not, and what was the Software's fair market value (FMV)?

10.      Was the amount claimed on account of CCA prohibited by section 67 of the Act as not reasonable in the circumstances?

11.      Was Mr. Morley subject to the so-called "at-risk rules" under subsection 96(2.1) of the Act, so as to reduce his share of the Partnership loss to $35,025, the amount he actually disbursed for the acquisition of his Partnership units?

12.      Was Mr. Morley entitled to deduct the $36,028 non-capital loss in computing his 1990 taxable income?

13.      Did Mr. Morley knowingly, or in circumstances amounting to gross negligence, make a false statement in his tax return, such that the penalty provided for in paragraph 163(2) of the Act is applicable?

14.      Did the Minister in the course of his audit obtain any information or documentation in violation of Mr. Morley's Charter rights, and if so, what is the remedy?

[4]      Either at the outset of the hearing or in the course thereof, both parties made admissions that resulted in the elimination of some of these issues. First, the respondent admitted that the Software was neither a systems software nor Class 14 property. The respondent also abandoned the claim that penalties should be assessed against Mr. Morley pursuant to subsection 163(2) of the Act. As for Mr. Morley, he conceded, for the purpose of these appeals, that the Software was acquired by the Partnership in December 1993, although, he claimed, there was evidence supporting a finding that it was so acquired in December 1992. As a result, the Partnership was subject in 1993 to the half-year rule.

I         Factual Background[2]

[5]      The hearing of these appeals lasted 14 long days[3] over a three-week period. Hundreds of exhibits were filed, representing several thousand pages.[4] I do not intend to review all the relevant facts in this summary. I will deal with the more crucial ones in the body of my analysis. However, it is useful to provide at this point a general overview of the facts and a description of the main actors in this saga.

[6]      Mr. Morley is a tall, charming person who, after graduating from the University of British Columbia in 1958,[5] had a distinguished career in the Public Service of Canada. This was recognized in a personal letter of March 1978 from then Prime Minister Trudeau when Mr. Morley resigned temporarily from the Public Service. Following a few business endeavours in the private sector, including acquiring an interest in and becoming president of a software design company (Omnitech Graphics Systems), he returned to the Federal Public Service. It appears that he retired for good from the Public Service sometime in 1993, when he decided to start his own consulting firm.

[7]      In September 1993, he was introduced to the Partnership by a securities broker, Mr. Mark Farmer. He received at that time a copy of a confidential offering memorandum relating to the Partnership units, a copy of the Software acquisition agreement and a copy of the source codes escrow agreement.[6] In carrying out a considerable and unusual amount of due diligence, he obtained a copy of an appraisal report (1993 Pritchard Evaluation or Report) dated June 28, 1993, prepared by Mr. Bob Pritchard, together with an undated 49-page document entitled "The Future of Information Management" describing among other things the Software, its benefits and its competitive position on the market. Included with this latter document were testimonials[7] from users as well as from a professor who, the document claims, conducted an "independent Product Evaluation of AGENSYS" (that is, the Software). Mr. Morley also consulted two software consultants in Ottawa to obtain their opinion on the Software. He even had, together with these consultants, a telephone conference call with the creator of the Software, Mr. Howard Kale, who was living in Black Canyon City, Arizona.

[8]      On the basis of different marketing materials relating to the Software, Mr. Howard Johnson of Campbell Valuation Partners Limited, the valuation expert who testified at the request of the respondent, provided the following description of the Software and its benefits at pages 7 to 12 of his report (Johnson Evaluation or Report) dated May 23, 2003:

General description

The Software was described as an information management system and language for designing, creating, enhancing and documenting applications software. Developers could use the Software to create applications to manage information. Administrators could use the Software to provide security and management control of the environment. For users the Software provided an easy way to manipulate and manage their information.

The Software enabled professional application design and implementation without a prerequisite mastery of computer science. The Software created a user environment and logical instruction set, similar to Lotus 1-2-3 in the spreadsheet environment, where the developer instructed the computer what to do without having to program how to do it. Therefore, the Software enabled the programmer to concentrate on the logical processes required to do the application and not on all of the intense, detailed programming instructions required for the computer to do its tasks. The Software differed from Lotus 1-2-3 in that the Software addressed the much larger world of information and database management and applications development.

The Software included the following functions:

Benefits of the Software

The benefits of the Software in contrast to other products available around the Valuation Date were purported to include the following:

·                     the main strength of the Software was its ability to handle very complex information management applications beyond the capabilities of other automated tools. The Software automatically understood basic commands to input, display, print, and process information, and it has a file system that allowed it to effectively access all required information;

·                     simplicity - users did not have to know a lot about computers, or understand how they worked, to use the Software effectively. The Software assumed the responsibility for instructing the computer what to do and when a command should be executed. The Software, therefore, eliminated the problem of having to be an expert in computer science;

·                     structured sentences - when the Software was instructed to execute a command, it was done using a structured sentence with a verb, adverb, object, and adjectives. As result of the users' familiarity with English language sentence construction, this resulted in a very fast learning curve for programmers, who could become an expert in less than three months. This, together with the automatic error correction feature, made it easier to verify that the Software applications are correct and bug free. The use of structured sentences was the fundamental breakthrough and the paradigm shift offered by the Software;

·                     productivity, responsiveness and reduced costs - the Software helped to speed up application development and to reduce costs by applying the concepts of reduce, reuse and recycle towards software development. That is, the Software had reusable components in its architecture, which reduced the programming required to develop an application by up to 80% relative to traditional languages and tools. The Software tools also reduced the time and cost required to develop applications by eliminating most programming errors when they were entered and by finding the remaining errors with continuous testing. By supporting the re-engineering of legacy systems, the Software made it possible to recycle existing data and processes when moving to client/server architectures;

[Emphasis added and, unless otherwise indicated, footnotes omitted.]

[9]      To understand this description and avoid some of the confusion that was prevalent during the hearing, one has to distinguish between two key elements or features of the Software: "application development" and "application usage". First of all, an application (application or business application), in the computer world, is a software whose ultimate purpose is the automation of business or human activity; examples are the well-known Microsoft Word (for word processing) and Microsoft Excel (for spreadsheet computations). What is meant by an "application development" feature is a tool or production kit that allows an application developer (i.e. the software creator) to "create" an application. In other words, it is a software that creates another software. The "application usage" feature is the tool that allows a user to use the application created by the development application. In other words, it is the end-user business application. Often, software companies that create information management systems license their product in either of two ways, one being as a version with the application usage only, also called a runtime version. This can be described as a light version of the information management system, because it only allows the user to perform the basic functions of the application and thereby enjoy its use. It excludes most of the advanced functions that allow and facilitate the creation of applications.

[10]     Here, the Software offers both features: "application development" (Development Version or AGP) and "application usage" (Runtime Version or AGS). Given that the Software is described as "Agensys Development System", it is not surprising that the above-quoted technical and marketing description emphasizes its development features. What the Partnership bought was first and foremost the AGP feature of the Software, that is what it intended to sell initially to its Canadian customers. It could not sell the Runtime Version (AGS) alone because one needed first to create an application with the AGP before that application could be used with the AGS. From these explanations, it can be readily understood that the AGP is the most valuable feature of the Software. It is with this feature that one can make money either by licensing it or by using it to create business applications for resale.

[11]     Mr. Larry Gamble was the promoter of the Partnership, its initial limited partner and the sole shareholder of 616927 Ontario Inc. (GP), which was the general partner of the Partnership. After graduating with a teaching degree, he became a teacher in 1970. After four years, he decided to reorient his professional life by moving into the field of real estate and securities. He joined A.E. LePage's securities division. He left that firm in 1988 to start his own real estate and securities firm, which he sold in 1990. Mr. Gamble hired a former colleague, Mr. Nicholas Barisheff, to manage the Partnership with him. Mr. Barisheff graduated with a business degree from Ryerson and started working in 1969. After five years as a consultant, he joined A.E. LePage in 1974 as a securities salesman. He left the firm in 1981. From 1981 to 1992, he was a consultant in a variety of securities and real estate transactions.

[12]     It was Mr. Barisheff who, allegedly in the spring of 1992, introduced Mr. Gamble to Mr. Kale, who was looking for US$500,000 to fund a software venture. The latter was described to Mr. Gamble as the creator of a software known as "Kammand Software" (Kammand). According to Mr. Gamble, the Partnership acquired a revised version of Kammand known as the "Agensys Software".[9] It was the rights to this software that were purchased by the Partnership, according to Mr. Gamble, on December 20, 1992. Those rights were limited to the use and the marketing of the Software in Canada. A copy of the purchase agreement (1992 Acquisition Agreement) was filed at Tab 40 and Tab 55, subtab 6. This agreement was amended and restated as of June 30, 1993. Pursuant to the restated agreement (1993 Acquisition Agreement), the Partnership acquired from Agensys T & C certain exclusive intellectual rights associated with the Software for a stated purchase price of $12,150,000 paid by the issuance of the Acquisition Note. The Partnership was obliged to pay Agensys T & C for the purchase an additional consideration equal to 10% of its annual gross revenues after cumulative sales in Canada had exceeded $120 million.

[13]     Pursuant to the 1993 Acquisition Agreement, the Partnership acquired more specifically the rights to:

-     use, exploit, modify, develop, change, improve and maintain the Software,

-     market the Software and provide related services in Canada, and

-     copy or reproduce the Software and related manuals in Canada.

The source codes provided[10] to the Partnership were for execution on the following three operating system platforms:[11]

-     MS-DOS version 3.3 + (Microsoft 'C' Compiler V. 6.0, and Borland 'C' Compiler V. 6.0);

-     Unix - SCO SV R-3.2; and

-     Sun OS.

Under the 1993 Acquisition Agreement, Agensys T & C agreed to:

-     provide training (to no more than two of the Partnership's software engineers) and technical consultation (up to two person-months per year) to designated representatives of the Partnership,

-     engage in promotional activities (at up to six trade shows or retail outlets during a two-year period) for a fee of a $500 per day (plus travel expenses),

-     provide to the Partnership all Basic Enhancements[12] and Maintenance Modifications[13] that it developed,

-     within a reasonable period of "written request therefore [sic] by the Partnership", develop the Support Software[14] (Support Software) and transfer the Canadian copyright therein to the Partnership "at no charge to the Partnership but in consideration of a commercially reasonable royalty or like fee",

-     provide to the Partnership on commercially reasonable terms "Enhancements"[15] required in order for the Software to remain competitive in the marketplace,

-     launch within a year a national marketing and promotional campaign for the Software in the United States and provide the Partnership with copies of user testimonials.

[14]     The purchase price (the lump sum portion) described in the 1992 Acquisition Agreement was payable by the delivery by the Partnership of the Acquisition Note in the amount of $12,150,000. The note did not bear any interest until December 20, 1993, and then bore simple interest at prime (at the Royal Bank of Canada) plus 0.5% commencing on December 21, 1993. The interest was to accrue until December 20, 2002, at which time the accrued and unpaid interest was to be capitalized and to form part of the unpaid principal. Thereafter, interest on the unpaid principal was to be calculated and payable on a quarterly basis starting on March 20, 2003. The principal amount was to be repayable as follows: $960,000 in cash (representing 7.9% of the purchase price) on or before December 20, 1993, and thereafter by quarterly instalments commencing March 20, 1994. Payments prior to December 20, 2002, however, were to be limited to 50% of the net distributable cash of the Partnership. In respect of the quarterly payments starting on and continuing after March 20, 2003, they were to be made whether there was any distributable cash or not, and the Partnership had to pay in full by December 20, 2012, the principal and interest owing.

[15]     On October 19, 1993, Mr. Morley subscribed for 15 Partnership units for a total purchase price of $232,500 ($15,500 per unit), payable $35,025 in cash and, as to the balance of $197,475, by way of a note (Subscription Note). The terms of the Subscription Notes issued by the limited partners (Limited Partners) regarding the calculation and the payment of interest and regarding the payment of principal are identical to those of the Acquisition Note issued by the Partnership except for one major difference: the interest rate is prime plus 1%, and not 0.5%.[16]

[16]     Mr. Gamble was not only the promoter of the Partnership, the sole shareholder of the GP and the initial limited partner, he was also an important[17] Limited Partner. He acquired 63 units for a total cost of $950,000, for which he disbursed only $143,113. As for Mr. Barisheff, he stated that his financial situation did not allow him to become a partner in the Partnership. Following the closing, on December 8, 1993, of the Partnership's private placement, Agensys T & C received as payment in full of the Acquisition Note issued for the Software $960,000 in cash[18] together with Subscription Notes issued by the Limited Partners aggregating $11,190,000. The Limited Partners' units were also pledged as security.

[17]     Mr. Gamble also promoted 11 other partnerships (11 Partnerships) formed to acquire the rights to market the Software in other countries, such as Australia and New Zealand, the United Kingdom, France and Italy. These partnerships distributed their units in Canada through confidential offering memoranda from 1993 to 1996. The units of the Partnership and the 11 Partnerships (together hereinafter referred to as the 12 Partnerships)[19] were marketed as tax shelters by Mr. Gamble. Accordingly, the Partnership's lawyer obtained from the Minister a tax shelter number pursuant to section 237.1 of the Act. Mr. Morley acknowledged during his testimony that there were significant tax advantages to becoming a limited partner of the Partnership.[20] Mr. Morley claimed a business loss of $217,282, although his actual disbursement was only $35,025 in 1993, which represents just 15% of the total cost of his Partnership units. For Limited Partners who could claim the full amount of the Partnership losses at the 50% marginal tax rate, this represented an almost immediate return of 310%.[21] For Mr. Morley, the actual return would have been marginally lower, given that he had to carry back to 1990 a portion of his losses. Obviously, the "tax profit" (the difference between the tax savings and the cash disbursement) would be reduced if the Limited Partners were required to pay their Subscription Notes and to pay tax on their pro rata share of the Partnership income. However, the Partnership never - that is, from 1993 to February 28, 1997, when it was dissolved - made any sale of the Software and never received any gross revenues from the exploitation of the Software. Mr. Morley (as in all likelihood all the other Limited Partners) has never been required to make any payment on his Subscription Note, either on the principal or in respect of any interest owing thereon; nor is it expected that he will ever have to.[22]

[18]     On December 31, 1993, the Partnership entered into an exclusive marketing agreement (Marketing Agreement) for a period of 10 years (renewable for two additional five-year periods) with Compucor Marketing Inc. (Marketing), whose name was eventually changed to Agensys Marketing Inc., to promote and market the Software to prospective end-users.[23] According to the Partnership's 1994 financial statements, the Agensys Partnerships entered into a similar agreement.[24] Mr. Gamble indicated that Mr. Barisheff and he each held 50% of Marketing's shares. However, this is in contradiction with the above-mentioned financial statements, which indicate that Mr. Gamble owned indirectly 100% of Marketing.[25]

[19]     Pursuant to article 8.1 of the Marketing Agreement, Marketing was entitled to retain, in exchange for its services, 50% of all gross sales (whether made by Marketing or not) of the Software. Under article 6.1 of that agreement, Marketing was also authorized to offer to end-users ancillary services in support of the Software, including assistance with installation, technical training and a telephone hotline. Marketing was entitled to retain 90% of the fees paid for those services. Finally, pursuant to article 8.2, the Partnership was required to reimburse such out-of-pocket expenses incurred by Marketing in the performance of its duties "as the Partnership may in its sole discretion consider advisable". In any event, the Partnership was to advance up to $500,000 to Marketing for the establishment of training and support services and facilities, as well as provide and advance against initial reimbursable marketing and promotional expenses. [26]

[20]     Mr. Morley's role was not limited to that of a passive limited partner. He also joined the "management group"[27] that looked after the affairs of the Partnership. Starting early[28] in 1994, he became involved in the marketing of the Software. Although he stated during his testimony that he worked on an "unpaid basis" from March 1994 to July 1994, it is apparent from the correspondence filed in evidence that Mr. Morley was hoping to earn commission income on sales of the Software and a percentage of the service fees for providing custom application software to the federal government and other potential clients of the 12 Partnerships. However, in August 1994, Mr. Morley decided it would be more advantageous for him to charge the management group a management fee of $5,000 per month ($60,000 per year). As will become apparent below, he must have realized early on that sales were going to be very difficult to achieve and that it would take much more time than anticipated before he could earn his commission income. Given that no sale was ever made, that proved to be the right move for him, and even more so when his management fee was increased to $7,500 per month for the second year ($90,000 per year). On April 20, 1997, this arrangement was modified in favour of a fee of $75 per hour.[29]

[21]     The witnesses heard at the hearing did not give a good description of the interrelationship of the 12 Partnerships, of the role of Agensys T & C and Agensys U.S., or of the Software's attributes over the years. Some light is shed thereon by an undated memorandum (February 8, 1995, Batton Memo) (found in Tab 60) from Mr. John Batton, president of Agensys U.S., to Mr. Gamble. The most likely date of the memorandum is February 8, 1995, which corresponds to the date printed on it by the fax machine. It refers to attached undated documents, such as Agensys T & C's "Operational Plan" and "Development Plan", which two documents were received by Agensys U.S. in May 1994.[30]

[22]     The first two pages of the "Operational Plan" are enlightening:

Agensys Corporation

Operational Plan

Agensys Corporation[31] has the Domestic and International Rights to the Agensys Development System. It has contracted with:

Domestic (USA)

Agensys Inc.,[32] a Texas Corporation has the right[33] to sell and distribute the Agensys Development System.[34] Agensys Inc. is charged with creating the following marketplaces for the Agensys Development System:

Value Added Reseller Marketplace - Agensys Inc. is charged with getting VAR's to utilize the Agensys Development System as their base technology and developing applications for distribution into the Retail and Corporate marketplace.

Application Marketplace - Agensys Inc. is charged with creating applications with the Agensys Development System that can be resold into the Retail and Corporate Marketplace.

Agensys Inc. is charged with entering into joint ventures that will create applications with the Agensys Development System to be resold into the Corporate and Retail Marketplace.

Agensys Inc. is charged with creating a demand for the Agensys Development System in the Corporate Information Management Arena. This effort will be centered around offering solutions developed by a consulting staff with the Agensys Development System being the core technology for this staff.

These rights and charter are non-exclusive. The payment for these rights is a % Gross royalty on the Agensys Development System Licenses to be paid on a quarterly basis to Agensys Corporation. The royalty stream is assignable to a Limited Partnership.[35] Upon notification Agensys Inc. will re-direct its royalty stream to the assignee.[36]

International

A series of Limited Partnerships will be established to purchase the software for discrete countries, the following are the countries and their respective percentage to the whole:

Country	Price[37]	%
Canada*	$ 12,150,000	5.2%
Aust/NZ*	7,300,000	3.26%
France*	16,900,000	7.56%
Italy	11,500,000	5.03%
United Kingdom	18,000,000	7.87%
Germany	22,000,000	9.62%
South Africa	2,500,000	1.09%
Mexico	4,000,000	1.75%
Austria	3,700,000	1.62%
Switzerland	3,700,000	1.62%
Spain/Port	8,000,000	3.5%
Holl/Lux/Bel	9,000,000	3.94%
Nor/Swe/Den	9,900,000	4.33%
Chi/HK/Mai/Sing/ Phil/Thai/Ind	5,000,000	2.19%
USA	95,000,000	41.55%
* These countries have Limited Partnerships that are active as of the beginning of 1994.

The Revision of the Agensys Development System that is being purchased by these Limited Partnerships is the 1993 MS-DOS and SCO-UNIX platforms.

Payment for the country rights comes in two forms:

A payment at the time the limited partnership actually purchases the rights.

The payment of a loan agreement that comes out of a royalty agreement on the sales of the Agensys Development System.

[Emphasis added.]

[23]     In internal memoranda of the Internal Revenue Service (IRS) written in the fall of 1995, Agensys U.S. is described as a corporation based in Dallas, Texas, and "owned and operated" by John Batton.[38] "Mr. Kale, "it is stated", is not related to this company." He only provided his services. Moreover, Mr. Kale had informed the IRS that he was not an "investor, shareholder, or officer/employee" of Agensys U.S. and Agensys T & C; nor was he related to Agensys T & C. Mr. Batton for his part had stated that he had "not dealt with anyone [at Agensys T & C] except the lawyer". He acknowledged that "Mr. Howard Kale occasionally acted as a technical conduit between" Agensys T & C and Agensys U.S. In their testimony, Messrs. Gamble, Barisheff and Morley stated that they did not have any kind of interest in Agensys T & C and were not related to that corporation. They did not know to whom it belonged, but they thought it belonged to Mr. Kale or his family. In draft minutes of the Partnership's management meeting held on February 28, 1995 (at which meeting Mr. Kale is not listed as being in attendance), we find this statement: "After a discussion between Howard Kale and Larry Gamble, Howard advised that he is in sole control of Agensys Corp. in the Turks & Caicos" (Tab 177).

[24]     In January and July 1997, all the assets of the 12 Partnerships were transferred to Agensys International. Mr. Gamble indicated that this had been his plan all along, namely, first, to finance the acquisition of the Software through limited partnerships and, eventually to have the assets of the partnerships transferred to a new corporation, whose shares would be listed on a stock exchange. For reasons that will be discussed below, Agensys International ceased its operations at the end of August 1998 and, like the Partnership, it never made any sale of the Software and never received any gross revenues from the exploitation of the Software. Altogether, the 12 Partnerships raised $69 million which, net of the amount of the Subscription Notes, represented $13 million. Of the $13 million, $6 million were paid to Agensys T & C for the different territorial rights with respect to the Software and $4.6 million were used in the operations of the 12 Partnerships and of Agensys International from 1993 to 1997.[39]

[25]     On July 22, 1994, the Minister wrote to Mr. Gamble to inform him that the Partnership and four of the 11 Partnerships would be audited. This audit was carried out by the tax avoidance section. On July 31, 1996, this section informed the Partnership that, in the Minister's view, the Software had no value and that the Partnership was not carrying on any business. The Minister would therefore be reassessing the Limited Partners, disallowing their share of the Partnership's losses. Most of the partners were reassessed in November 1996.[40] Mr. Morley was an exception, he was only reassessed on November 21, 1997.

[26]     On September 19, 1996, the Revenue Canada Special Investigations Unit (SI) (responsible for penal (criminal) investigations) was notified by the tax avoidance section that Mr. Gamble, assisted by some individuals (including Mr. Morley), was running a major scam and that fraudulent deductions were being claimed. On August 8, 1997, Mr. Gamble was notified by the Assistant Director, Verification & Enforcement Division, that the Partnership's file had been referred to SI. The letter stated: "In order to ensure that your rights are protected, I have been advised to refer your matter over to the Chief of Special Investigations". On October 7, 1997, an SI investigator filed a detailed Information to Obtain a Search Warrant (Form 1, section 487 of the Criminal Code) (SI Information Statement) with a judge of the Ontario Court. Agensys International's attempt to have this warrant quashed for deliberate deception was unsuccessful,[41] but in the end, none of the persons involved in the affairs of the Partnership were charged with tax evasion pursuant to section 239 of the Act.

II        Analysis

(A)      Onus of Proof

[27]     Before the specific issues raised by these appeals are dealt with, it should be stated that it is Mr. Morley who has the burden of demolishing the facts assumed by the Minister in issuing his assessments. Counsel for Mr. Morley gave the following description of the rules on onus in his written closing arguments which I reproduce here in part:

The Hickman case is also very important because of what it says about onus of proof. At page 5376, Justice L'Heureux-Dubé says as follows:

It is trite law that in taxation the standard of proof is the civil balance of probabilities: Dobieco v. M.N.R. [1966] S.C.R. 95, and that within balance of probabilities, there can be varying degrees of proof required in order to discharge the onus, depending on the subject matter: Continental Insurance v. Dalton Cartage, [1982] 1 S.C.R. 164; Pallan et al. v. M.N.R., 90 DTC 1102 (T.C.C.) at p. 1106. The Minister, in making assessments, proceeds on assumptions (Bayridge Estates v. M.N.R., 59 DTC 1098 (Ex. Ct.), at p. 1101) and the initial onus is on the taxpayer to "demolish" the Minister's assumptions in the assessment (Johnston v. M.N.R. [1948] S.C.R. 486 [sic, actually 496]; Kennedy v. M.N.R., 73 DTC 5359 (F.C.A.), at p. 5361). The initial burden is only to "demolish" the exact assumptions made by the Minister but no more: First Fund Genesis v. The Queen, 90 DTC 6337 (F.C.T.D.), at p. 6340.

This initial onus of "demolishing" the Minister's exact assumptions is met where the appellant makes out at least a prima facie case: Kamin v. M.N.R., 93 DTC 62 (T.C.C.); Goodwin (sic. Goodwyn) v. M.N.R., 82 DTC 1679 (T.R.B.). ... The law is settled that unchallenged and uncontradicted evidence "demolishes" the Minister's assumptions: see for example MacIsaac v. M.N.R., 74 DTC 6380 (F.C.A.) at p. 6381; Zink v. M.N.R., 87 DTC 652 (T.C.C.).

... Where the Minister's assumptions have been "demolished" by the appellant, "the onus shifts to the Minister to rebut the prima facie case" made out by the appellant and to prove the assumptions: Maglib (sic. Magilb) Development Corp. Ltd. v. The Queen, 87 DTC 5012 (F.C.T.D.) at p. 5018. ...

Where the burden has shifted to the Minister, and the Minister adduces no evidence whatsoever, the taxpayer is entitled to succeed: see for example MacIsaac, supra, where the Federal Court of Appeal set aside the judgment of the Trial Division, on the grounds that (at pp. 6381-2) the "evidence was not challenged or contradicted and no objection of any kind was taken thereto." See also Waxstein v. M.N.R., 80 DTC 1348 (T.R.B.); Roselawn Investments Limited v. M.N.R., 80 DTC 1271 (T.R.B.).

It is submitted that the following principles are clearly set out by Justice L'Heureux-Dubé in dealing with the question of onus:

1.          In making reassessments, the Minister proceeds by assumptions and the initial onus is on the taxpayer to demolish these assumptions.

2.          An Appellant has met its onus to demolish the assumptions of fact made by the Minister if the Appellant makes out a prima facie case.

3.          Unchallenged and uncontradicted evidence demolishes the Minister's assumptions.

4.          If the Appellant makes a prima facie case and demolishes the Minister's assumptions, the onus shifts to the Respondent to rebut the prima facie case.

5.          Where the onus shifts to the Minister and the Minister adduces no evidence, the Appellant is entitled to succeed.

In other words, the Appellant does not have an absolute burden of proof the way the Crown would in a criminal case. Rather, the Appellant can demolish the assumptions on which the reassessment is based, simply by making a prima facie case. Once the Appellant does this, the onus shifts to the Minister and if the Minister adduces no evidence, the Appellant is entitled to succeed.

Justice L'Heureux-Dubé goes on to say at page 5377:

As Rip, T.C.J. stated in Gelber v. M.N.R., 91 DTC 1030 at p. 1033 '[the Minister] is not the arbiter of what is right or wrong in tax law'. As Brulé, T.C.J. stated in Kamin, supra, at p. 64: the Minister should be able to rebut such [prima facie] evidence and bring forth some foundation for his assumptions.

The Minister does not have a carte blanche in terms of setting out any assumption which suits his convenience. On being challenged by evidence in chief, he must be expected to present something more concrete than a simple assumption. [42]

[28]     I agree in general with this description. However, I would add the following two comments. First, the prima facie evidence that has to be adduced by the taxpayer must be credible. Second, where the Minister adduces some evidence, it is for the judge to make an overall assessment of the weight of the evidence introduced by both sides and to come to a conclusion, on a balance of probabilities, as to whether a case has been made by the taxpayer. Mr. Morley's counsel stated at the hearing that he agreed with both of these comments.

(B)      Was the Partnership formed for the purpose of exploiting the Software for a profit? Did it carry on a business in 1993?

[29]     Of the 14 issues identified above, only eleven remain. The first four can all be dealt with together because they relate to the same basic issue : whether the Partnership was carrying on a business with a reasonable expectation of profit during the 1993 taxation year. Given that the main raison d'être of the Partnership was to acquire the Software, this issue comes down to determining whether the Partnership was formed for the purpose of exploiting the Software for a profit or whether its sole purpose was to create tax refunds for its Limited Partners by claiming CCA with respect to the Software. The answer to these questions will resolve, in my view, all four issues.

[30]     In subparagraph 21(h) of its Reply to the Amended Notice of Appeal, the respondent stated that the Minister relied on the following assumption relating to this particular issue in issuing his assessment:

21(h)     the alleged Partnership was formed by Larry Gamble for the sole purpose of creating tax refunds for investors from claiming capital cost allowance.

[31]     In his written argument, counsel for the respondent takes a slightly different approach. He focuses mainly on the 1993 taxation year and states that no business was being carried on in that particular year. Here is his position:

A.         NO PARTNERSHIP IN 1993

3.          A partnership is two or more persons carrying on business in common with a view to profit. There is no longer any doubt that one must satisfy the three essential ingredients of (a) business; (b) carried on in common; and (c) view to profit in order to demonstrate that a partnership exists.

Backman v. Canada, [2001] 1 S.C.R. 367 [Tab 20]

4.          The Respondent would submit that no partnership existed in 1993 on the basis that the partners had no view to profit from sales in relation to the software. This is borne out by the fact that (i) a thorough examination of the software was not conducted prior to purchase, (ii) at least until 1994 Agensys Canada had no technical staff, (iii) the software was evidently not "delivered" or examined until December, 1993; (iv) all of Agensys Canada's energy, at least until 1994, was devoted to the promotion and sales of limited partnership units, not software applications.

5.          Indeed, the Respondent would submit that if any "business" existed in 1993 it was promoted as a tax savings vehicle to limited partners, with little if any concern about the capacity of Agensys Canada to capitalize on the use of the software purchased, and that there could be no expectation that Agensys Canada could profit from the use of the software until the software was examined in December 1993. The Respondent would further submit that the Appellant has failed to demonstrate an expectation of profit which is exemplified by the fact that no revenues were generated whatsoever, nor were any efforts made to maintain the software as state-of-the-art in order to facilitate such sales.

6.          The Supreme Court of Canada has indicated that "to ascertain the existence of a partnership the courts must inquire into whether the objective, documentary evidence and the surrounding facts, including what the parties actually did, are consistent with the subjective intention to carry on business in common with a view to profit".

Backman, supra, paragraph 25

7.          As such, the Court must look at the totality of the circumstances and avoid a mechanical application of a checklist or test with more precisely defined parameters. The Court must be pragmatic in their approach to the three essential ingredients of partnership. Whether a partnership exists depends on an analysis and weighing of the relevant factors in the context of all the surrounding circumstances.

Backman, supra, paragraph 26

8.          That the partnership documents and other documents indicate an intention to form a partnership is not sufficient to satisfy the requirements for a partnership. Fundamental criteria of partnership must still be met.

Backman, supra, paragraph 27

9.          In summary, the Respondent would submit that there was no view to profit by Agensys Canada in 1993, nor any business carried on in 1993. The activity that took place related to the sale of the partnership units. The partnership was not in a financial position to begin a marketing effort until 1994. In the result, there was no partnership, at least not in 1993.

[32]     Mr. Morley's position is that "there can be little doubt that the activities carried on by the taxpayer were of a commercial nature and the reasonable expectation of profit doctrine could not possibly have any application" (page 21 of his counsel's written argument). In support of this position, his counsel relied on the pronouncements of the Supreme Court of Canada in Stewart v. The Queen, 2002 CarswellNat 1070, 2002 SCC 46, 2002 CarswellNat 1071, 212 D.L.R. (4th) 577, 2002 DTC 6969, par. 53:

We emphasize that this "pursuit of profit" source test will only require analysis in situations where there is some personal or hobby element to the activity in question. With respect, in our view, courts have erred in the past in applying the REOP test to activities such as law practices and restaurants where there exists no such personal element. . . . Where the nature of an activity is clearly commercial, there is no need to analyze the taxpayer's business decisions. Such endeavours necessarily involve the pursuit of profit. As such, a source of income by definition exists, and there is no need to take the inquiry any further.

[Emphasis added by counsel.]

[33]     Counsel also added (at page 26 of his written argument) that it "is clear that the position of the Supreme Court of Canada today is that even if a taxpayer is clearly motivated by tax motivations, such tax motivations do not affect the validity of transactions for tax purposes unless the transaction constitutes a sham." In support, he cited The Queen v. Walls, 2002 CarswellNat 1072, 2002 SCC 47, 212 D.L.R. (4th) 606, 2002 DTC 6960, par. 22:

Although the respondents in this case were clearly motivated by tax considerations when they purchased their interests in the Partnership, this does not detract from the commercial nature of the storage park operation or its characterization as a source of income for the purposes of s. 9 of the Act. It is a well-established proposition that a tax motivation does not affect the validity of transactions for tax purposes: Backman v. Canada, [2001 DTC 5149] [2001] 1 S.C.R. 367, 2001 SCC 10, at para. 22; Shell Canada Ltd. v. Canada [99 DTC 5669] [1999] 3 S.C.R. 622; Canada v. Antosko [94 DTC 6314], [1994] 2 S.C.R. 312; Stubart Investments Ltd. v. The Queen [84 DTC 6305], [1984] 1 S.C.R. 536, at p. 540. In addition, we reiterate the caution stated in Stewart at para. 65 that, given the specific anti-avoidance provisions in the Act, courts should not be quick to embellish its provisions in response to tax avoidance concerns: see also Ludco Enterprises Ltd. v. Canada [2001 DTC 5505], [2001] 2 R.C.S. 1082, 2001 SCC 62, at para. 39; Neuman v. M.N.R. [98 DTC 6297], [1998] 1 S.C.R. 770, at para. 63.

[Emphasis added by counsel.]

[34]     Although it is very troubling that the Partnership never made any sales, it is my view, on a balance of probabilities, that the evidence introduced by both parties at the hearing supports the position of Mr. Morley that a partnership was validly in existence on June 30, 1993, and that it did carry on a business in 1993. First, there was a partnership agreement executed in writing on June 30, 1993, between two persons: Mr. Gamble, as the initial limited partner, and the GP, as the general partner. Their intent, as indicated in article 2.2 of that agreement, was to carry on the business of "reproducing, marketing and distributing the [Software] and other computer software within Canada and to provide ancillary, support development, management and related services, all with a view to making a profit from such business". Obviously, this, in and of itself, would not be sufficient evidence that a partnership existed. The conduct of the partners must be consistent with this statement in the partnership agreement.

[35]     It is true that most of the efforts of Mr. Gamble and the Partnership in 1993 were directed toward raising capital for the Partnership by way of a private placement. Mr. Gamble stated that, to that end, early in 1993[43] he retained Mr. Allan Beach of Fasken, Campbell, Godfrey. That firm prepared a confidential offering memorandum (the final draft of which is dated July 20, 1993), offering 850 Partnership units, with a minimum subscription of $155,000 per investor. Mr. Beach and Mr. Gamble were also busy finalizing the terms of the 1993 Acquisition Agreement, which was executed on June 30, 1993.[44] The Partnership's financing was completed on the December 8, 1993, subscription closing date, when 34 investors subscribed for Partnership units, the aggregate amount of the subscription was $13,175,000.

[36]     At the same time, the Partnership was also working on its marketing plan and some demonstrations were given. According to Mr. Gamble, a Mr. Bergerson had been retained sometime in 1992 to prepare an evaluation of the Software and of the Canadian market. Like many documents[45] allegedly prepared in 1992 and 1993, the document titled "KAMMAND: Canadian Market Research" and presented as Mr. Bergerson's report (Exhibit A-3) is not dated, nor is it identified as a document prepared by him.[46] A copy of an agenda for a Software demonstration to be given in Toronto in September 1993 by Mr. Kale himself was also filed (Tab 52), among the persons shown as attending are IBM or former IBM people. Mr. Kale may[47] have provided those services pursuant to a retainer agreement between Messrs. Kale and Gamble described in a letter from the former to the latter dated January 17, 1993. Furthermore, as mentioned above, the Partnership entered into the Marketing Agreement with Marketing on December 31, 1993.

[37]     In 1994, the Partnership leased on Woodbine Avenue in Toronto 1,500 square feet of office space plus a room for demonstrations. The Partnership moved sometime in 1995 to larger offices (3,000 or 4,000 square feet) located on Consumers Road in Toronto.

[38]     Basically, three individuals - Mr. Barisheff, Mr. Gamble and Mr. Morley - were involved in the management of Marketing and the Partnership in 1994. Mr. Barisheff seems to have been the person in charge of the whole operation. According to his testimony, he devoted 100% of his time from September 1992 to September 1998 to the Partnership and Agensys International. He was involved in the strategic direction of the Partnership and dealt with marketing and technical issues as well as securities matters. He also met with the accountants and the lawyers and was responsible for the hiring of staff. By way of remuneration, he received 50% of the GP's fees; these fees represented $80,000 in 1993, $60,000 in 1994, $150,000 in 1995, and $180,000 in 1996.[48] Mr. Gamble apparently devoted 75% of his time to the Partnership; however, the description of his duties is vague: he described himself as a "facilitator". I assume that a fair portion of his time was spent on promoting the sale of the units of the 12 Partnerships.

[39]     In 1994, Mr. Morley was devoting three or four days of his time to the Partnership or to Marketing. In addition to trying to open doors at the federal government and its agencies, he was also attempting to establish "software factories" in Canada and foreign networks for the 11 Partnerships. One of the sources from which he obtained the names of potential business partners in foreign markets was the Department of Foreign Affairs. One such lead, involving an Italian corporation, appears to have been serious. However, nothing ever came of it.

[40]     One of the very first activities of the Partnership in 1994 seems to have been having its management team attend a training session given in Arizona by Western International University. Attending the session were Messrs. Gamble, Barisheff, Morley, Kale and Batton.

[41]     According to Mr. Barisheff, the initial plan (product approach) to sell the Software itself to potential end-users was abandoned after that training session.[49] The Partnership then adopted the marketing strategy (consultating approach) pursued by Agensys U.S., which consisted in developing for government and business organizations the custom applications required by them for the management of their information. These organizations were grouped by sectors (described as "vertical markets"), such as the federal government sector, the aviation sector and the financial services sector. It appears Mr. Morley was given the goal of developing the government sector, Mr. Farmer, of developing the securities sector, and a Mr. Bert Smalley, a pilot, of developing the aviation sector.

[42]     There are a internal memoranda and some correspondence which show that Mr. Morley started to get involved in the Partnership's marketing activities in January 1994.[50] The very first memo, dated January 17, 199[4], and addressed to Messrs. Gamble and Barisheff is very interesting because, first, it shows that Mr. Morley at least, believed that the Partnership was carrying on a genuine business and, second, that he was able to diagnose very early some of the weaknesses of its business plan.[51] Here is an extract from that memo:

Before committing more time to the development of an approach to marketing Agensys to the Public Sector, I would like to have a clearer idea of how you plan to segment the Canadian market. I also would like some more specific indication as to if and where you see myself fitting into Agensys Canada's (AC) plans.

I appreciated being brought into the discussion last week. Two impressions: the immense amount of work that has to be done before a successful Canadian launch is possible; and, concern on relying too long on US applications programming support. Canadian governments will be particularly concerned about this aspect. Speaking as a limited partner, when some cash flow develops, a Canadian software factory could become a vaible [sic] AC profit centre. A third concern relates to the very modest funding base that is supporting AC.

. . .

To underline my earlier point about personal contacts. Last week I was speaking to a friend of mine who is the senior V-P responsible for the Bank of Montreal's foreign exchange operations. . . . He asked for a presentation when AC is operational. . . .

When you have had a chance, please give me a call. I am interested in being associated with marketing AC and in covering my own start-up costs. For this reason, I would appreciate your being as specific as you can about any future relationship you might envision.

[Emphasis added.]

[43]     Actually, there is a significant number of letters and internal memoranda filed as exhibits that show Mr. Morley to have been busy trying to get different government officials, corporate executives and individuals from foreign countries interested in the Partnership's consultating services.[52] One of the strategies for developing the Partnership's business was, it appears, to create "Canadian software factories", which would have developed the business applications required by its clients. Mr. Morley put a great deal of effort into getting some Canadian provincial governments interested in offering tax incentives for the establishment of such factories. However, nothing seems to have come of those endeavours.

[44]     It is rather confounding (not to say pathetic) that the Partnership should have been trying, especially in 1994 and 1995, to market its services as a developer of business applications without having a proper knowledge of its own Software, without the proper personnel to develop those applications[53] and without all the functionalities of the Software in place. A good example is found at Tab 102, a letter from Mr. Morley to a Mr. Barron of the Department of Economic Development, dated June 14, 19[9]4, to which Mr. Morley attached an appendix, "Agensys: a paradigm shift in application development", describing in the following terms the platform independence of the Software:

Applications modules developed under AGENSYS are independent of all Hardware and Operating System constraints, Data Structure dependencies, as well as network and environmental dependencies.

[Emphasis added.]

Object Systems Inc. states in its product evaluation of the software, dated September 6, 1994, that the Software did "not provide cross platform interoperability nor [did] it support access to an acceptable range of files and databases" (Tab 128, p. 6 of the Executive Summary). So Mr. Morley's statement is quite misleading![54]

[45]     In fact, during most of 1994 and 1995, the Partnership was not at all close to making any sales.[55] It had to hire consultants just to evaluate what the Software could or could not do, prepare numerous marketing evaluation documents and prepare demonstrations for potential customers and Revenue Canada, and correct the Software's defects (bugs).[56] For instance, in March of 1994, Object Systems Inc. was hired to assess and to prepare marketing materials for the Software.

[46]     To further illustrate these points, I will reproduce several extracts from memos, letters and reports. First, in his memo dated August 8, 1994, addressed to Larry Gamble and Nick Barisheff, Mr. Morley states (Tab 117):

Paul Blair[57] made an interesting observation about Howard [Kale]. He said that Howard does not necessarily separate in his own mind what AGENSYS is capable of doing from what the software can do in real life performance. Howard's hand written note, in reply to Larry's June 2 memo, is an example of his unrealistic expectations as to what software will be developed by "the end of 1994". (p. 2)

. . .

The information that Terry [Stanhope of Object Systems Inc.] will be bringing back from his USA trip will likely confirm that AGENSYS is not capable of performing as advertised. Some existing software will likely have to be debugged. For example, Paul mentioned that the AGENSYS Unix version, that Howard claimed was finished, developed a bug on the first command that Paul entered.[58] (p. 4)

[. . .]

As you know, I started marketing to the Federal Government because we had to get our own sense of how the product would be received. I stopped a month later because we had no way of verifying whether the claims that we have been making about its capabilities were fact or fiction. (p. 6)

[. . .]

If we do get our first application in the next six weeks, we are not organized to provide professional pre, during and post product development support services. There is much more involved that in getting the US to program the application. (p. 8)

[Emphasis added.]

[47]     The following is the assessment made by Object Systems Inc. in its "Product Evaluation AGENSYS Professional", dated September 6, 1994, at page 24 (Tab 128):

We have concluded that if potential customers were given AGENSYS for a day or two for the purpose of making a decision to buy or not, then they would decide not to buy. The documentation doesn't compete with today's standards set by Apple and Microsoft.

[48]     In 1995, Messrs. Paul Mighton and Gary McCann,[59] two persons with some experience in the software business, were hired as consultants but were devoting 100% of their time to the Partnership's activities. Also in 1995, Mr. Karnis was hired as a consultant to help the Partnership prepare a demonstration. The following memo, dated March 23, 1995 (Tab 189), from Mr. Morley to D. Strutt and J-P Bradford shows that nine months later not much progress had been achieved:

I told Larry [Gamble] and Nick [Barisheff] in July, 1994 that I had no intention of going back into the Federal Sector market place until we had a product where we could give a hands on demonstration of our claims, the senior bench strength to market and develop the technology and the infrastructure in place to support an application. They both understand that in a market sector so insular as the Federal Public Service, it is one strike and you are out. Terry was meant to provide us with the technical capability. We lost five months as a result of his not working out.

Until I have seen the demos that Gary McCann is preparing and the marketing, demo presentation and sales being put together by Paul, I will not commit ourselves to going back into the Ottawa market. However, I finally believe that we are now close to coming to grips with the issues that I have mentioned above. It is time to start planning the Public Sector Vertical Market (PSVMS) strategy. I would like your input into the thoughts that follow.[60]

What follows is predicated on our having the ability to implement a client-server application now. Paul [Mighton] and Gary [McCann] say that we can have a mainframe interface capability by July 31. We will probably target the AS 400, as it represents a large market in North America and has a 70% market share in Italy. Paul and Gary are currently in Dallas to help confirm what we have in terms of software and what still needs to be done. . . .

[Emphasis added.]

[49]     In his report dated May 7, 1995 (May 1995 Report) (Tab 207), Gary McCann (VP - Technology & Business Development) provides the following description:

Agensys - Clarification of What We Have

The million dollar question that people have been struggling with for some time has been, what exactly do we have in the way of versions, releases and so forth? Much documentation has been produced by several people identifying development plans and future releases over the last year.

My mission in going to Phoenix was to once and for all put this question to rest. There should be no further confusion on this topic since what we have is a text/character mode version of Agensys in DOS and SCO/Unix. That's it! Forget all the documentation on 1994 releases providing GUI development promises and deliverables in Windows, Windows NT, OS/2, Motif, Open look etc. There is nothing to indicate that this development was ever completed although it was part of a development plan and not a bad one at that. The Dallas trip raised some suspicion regarding this issue and the Phoenix trip laid to rest any doubt of what we have in our possession.

The fact that we don't have all the bells and whistles is something we should not worry about. It should not concern us in the short term. To reiterate, we have a stable and commercially viable product, whereby we can effectively build application solutions for our clients and commence to gain recognition and secure some credibility in the industry. In the longer term, we should be concerned as the market is and will continue to demand products that users find intuitive and entertaining. Unfortunate as this may seem, and irrespective of the fact this has little to do with managing information, this is reality and we aren't going to change it We have to embrace technological changes and advancement in end user computing and keep up with the trends or suffer the consequences and become another statistic in the tough software business. I'm speaking here of the end-user and not the developer. Since development will be our responsibility, we will remain in control and benefit from all the support services or functions that will become a direct spin-off of the development process, e.g. customer support, maintenance contracts, education and training to name but a few.

Therefore, we should plan on commencing a product development plan in Qtr III of 1995 which should include Database and Network interfaces as well as platform interfaces such as DEC's VMS and IBM's AIX and MVS. As a majority of legacy systems were developed and still reside on MVS platforms, this should be the first we work on. We should also focus on Graphical User Interface (GUI) development to make the product intuitive to the end user community. We should continue to enhance the Translation Manager module and implement a multi processing environment using various Agensys modules. By design, this would not be difficult to do. All future development activities will evolve do [sic] in part to a conscientious plan to position us in future and will be partly dictated by our client's [sic]. This development should be funded through future revenues and the plan should consider a minimum 20% of revenues be allocated the development activities.

[Emphasis added.]

[50]     The need for GUI in the Software together with database and communications interface capabilities was also recognized in a memo by Mr. Morley dated January 20, 1996, in which he summarized the feedback received from six demonstrations given by CGI. This well-known software consultancy firm had been hired by the Partnership to prepare and give demonstrations of the Software to potential clients, which included IT partners from Coopers & Lybrand, Ernst & Young, and Deloitte Touche, and to Revenue Canada. It appears that the demonstrations were given to the potential clients both before and after the presentation to Revenue Canada. This is the harsh assessment given by those potential clients (see Tab 296):

It was unanimous that none of the consultants' [sic] clients would consider using AGENSYS until we can demonstrate a Windows interface. We also have to be able to demonstrate database and communications interface capabilities. Through an independent group, such as CGI, we would also have to have the [sic] document the reliability and robustness of the AGENSYS nucleus. It would have to be bug free and have had to undergone rigorous testing and acceptance procedures to demonstrate that it was.

[Emphasis added.]

[51]     The demonstration given to Revenue Canada had been requested a long time - almost 12 months - before. Revenue Canada wanted to see the Software and its source codes in order to determine whether the Software actually existed, whether it performed as advertised and whether it had any value. The perception of the consultants hired by Revenue Canada who attended the demonstration held on January 16, 1996, was that the "product as it exists they would not recommend to anyone to buy it" (Tab 293). One of them "had recorded a series of functional gaps    - a list of 12 enhancement [sic] that has [sic] to be made to the product" (Tab 299).

[52]     There is also the assessment by Mr. Phil Irving,[61] Technical Product Manager, that presents quite a different picture from the one given in "The Future of Information Management" about the easiness of use of the Software. After having met Mr. Kale a few days earlier, he provided the following comments in his February 20, 1996, draft report (Tab 306):

4.3        Project Design and Development

1.          Project design is a complicated process, requiring both a good understanding of the business requirements and an excellent background in database design and development. As such, it is not recommended to have un-initiated designers develop the solution. Note AGS should not be marketed as a tool which can be used by just anyone to develop applications.

. . .

3.          Development work in AGS can be a long process, and could very well be handled by a team of client and Agensys programmers working in conjunction and under the management of the technical database resources.

[Emphasis added.]

[53]     Finally, there is this overall assessment by Mr. David Gillman, who states in his business plan of August 13, 1996 (Tab 336):

Marketing Howard Kale's product as a development tool has met with stiff resistance for a number of reasons. The technical limitations with respect of GUI, multiple platforms, a viable methodology, track history have often been mentioned. Secondly our competition is formidable and entrenched. Thirdly, there was no clear direction of the market niche the product would occupy. The wrong competitive advantages were postulated as benefits.

Despite the technical and other limitations, I believe that we can open a door for the product as an Object Oriented Development Environment, and we should focus our entire image on this market. . . .

. . .

Approach

We are at least a year away from formulating and marketing a set of products that will tackle this market. Our approach should be to obtain success in the services and applications arena with the tool and methodology, develop success stories and independent benchmarks, before tackling all but the smallest companies with the tool as a product in and of itself. It is too early to expend the time and expense to sell an unproven product now. And I emphasize now. Once all the technical problems are solved and the products clearly defined to the marketplace, we should be in a position to exploit the product benefits.

[Emphasis added.]

[54]     As these extracts exemplify, it is quite evident that Mr. Morley was trying to market to potential customers a software product that had allegedly very attractive functionalities but those functionalities were, to a great extent, not in place when the marketing efforts were going on from 1994 to 1996. Not only was the Software not yet ready to fulfil all the promises but neither the Partnership nor Marketing had on its staff in 1994 and 1995 the required human resources to create the enhancements and to develop the business applications. They had to rely on Agensys T & C which, under the 1993 Acquisition Agreement, was to deliver some of the required enhancements described as Support Software "within a reasonable period of written request therefore [sic]" and to provide any other enhancements on commercially reasonable terms. Since, it appears, Agensys T & C had no employees, it had to rely on Agensys U.S., but there was no contractual relation between the Partnership and Agensys U.S.!

[55]     In view of all this, it is not surprising that the CCRA's auditors got the impression that all the marketing material being developed by the Partnership and the demonstrations being given seemed to have as their main purpose satisfying Revenue Canada's tax requirements.[62]

[56]     Sometime in 1996, the business plan of the Partnership was modified again: it abandoned the consultating approach and decided to create generic applications (generic application approach) following a suggestion that they adopt the same approach as SAP, a well-known German software corporation. The first generic application was AGS Mortgage, a canadian mortgage servicing solution that was launched by the Partnership late in 1996. A new general manager, Mr. Frank Snape, had been hired in September 1996, after Messrs. Mighton and McCann had decided to leave. Mr. Snape had some management experience with different corporations, including high-tech companies. He remained with the Partnership until the rollover in 1997 and continued thereafter with Agensys International until that corporation ceased its operations at the end of August 1998. He hired several programmers to build and create the generic business applications. It took approximately six months to define the specifications for AGS Mortgage and six months to program it. This application seems to have been completed early in 1998. So most of the work performed by Mr. Snape was done for the benefit of Agensys International. In addition to AGS Mortgage, Agensys International worked on developing other applications such as AGS Canadian Property Management.

[57]     There is no doubt that the 12 Partnerships were set up in order to maximize the tax benefits for investors and that these partnerships were used by the promoter to raise money in order to purchase rights to the Software in different countries. The ultimate plan was to rollover the Software to Agensys International and to get that corporation listed on a Stock Exchange such as NASDAQ. In my view, the fact that little business planning took place in 1993, except with respect to acquiring the Software and raising the capital for the Partnership and at least one of the 11 Partnerships (the one set up for the Australia and New Zealand rights to the Software), does not mean that the Partnership was not carrying on business in 1993 and that a valid partnership was not formed. When a partnership is being formed, it is normal that its energies be devoted initially to raising the capital necessary to finance its business activities. In his written argument, counsel for the respondent does not claim that the Partnership was not carrying on a business from 1994 to 1996. He focuses his attention mainly on the 1993 taxation year. In my view, if the subsequent activities of the Partnership in 1994 and thereafter amounted to a business being carried on, then that business was in existence in 1993, when the financing activities and the initial planning for the marketing of the Software were taking place.

[58]     Although the course of action followed by the Partnership in carrying on its business appears to have had a lot of shortcomings, the Supreme Court of Canada has ruled that the courts are not to judge businessmen's acumen. Being required to follow that Court's rulings, I conclude that the Partnership was duly constituted in June 1993, that it carried on a business for profit and that the Software was acquired for the purpose of earning income therefrom. I believe that Mr. Morley truly attempted to exploit the Software so as to make a profit. Although Mr. Morley is capable of making untrue statements in his marketing activities,[63] I cannot conclude that all the correspondence which he generated and all the meetings which he attended to promote both the Software and the Partnership's services were just window dressing intended to give a false appearance of a business being carried on. I do not believe that he would have approached so many government and business acquaintances for no genuine business purpose. A memo dated April 23, 1994 (Tab 74, page 2), illustrates this point:

Another factor that I care about is our personal reputations. . . . I can deliver on the sales front because I am known and trusted. None of us want to lose our reputations because of ineffective planning and management down south. . . .

As the months and the years went by, more qualified personnel was hired to work on premises leased for the Partnership's activities. The efforts became more and more serious.

[59]     The reasons why this business failed are numerous. Obviously, it was badly planned and implemented. This may be due in large part to the fact that too much attention was given to and reliance placed on the tax shelter benefits. There are plenty of examples to illustrate that tax incentives may achieve opposite results to those which were intended when the legislator enacted them. I should add that this is more prevalent when such incentives are not used in the way that they were intended, as is the case here. I am convinced that Agensys U.S. was a lot more successful and profitable developing in the U.S. business applications using the Software, for which it paid only a royalty.[64]

[60]     In any event, the business activities carried on by the Partnership constituted the business of Mr. Morley and, pursuant to section 96 of the Act, he is entitled to deduct in computing his income his allocated share of the business losses computed at the Partnership's level. The amount of those losses will depend on how the other issues are resolved.

(C)     What was the cost of the software acquired by the Partnership?[65]

[61]     There are a number of facts relating to the cost of the Software listed in paragraph 21 of the Reply to the Amended Notice of Appeal, on which the Minister relied in assessing Mr. Morley, namely:

(t)          neither Agensys Corporation nor the alleged Partnership intended to create a legal liability under the Acquisition Note;

(u)         the Acquisition Note did not create an absolute liability on the part of the [Partnership] to pay any amount to the holder of the Acquisition Note;

. . .

(dd)       neither the alleged Partnership nor the Appellant intended to create a legal liability under the Subscription Note;

(ee)       at no time did the alleged Partnership or Agensys Corporation intend to collect on the Subscription Note;

(ff)         the Subscription Note did not create an absolute liability on the part of the Appellant to pay any amount to the holder of the Subscription Note.

[62]     Counsel for Mr. Morley argued that the evidence introduced during the hearing constituted a prima facie case that the cost of the Software amounted to $12,150,000. He essentially relied on the terms of the Software acquisition agreement and the Acquisition Note and on the acknowledgment of payment of that note by way of the assignment of the Subscription Notes of the 34 Limited Partners together with the payment of $960,000 in cash. In addition, he relied on the testimony of Mr. Gamble and Mr. Barisheff that the Software acquisition agreement basically constituted the whole of the agreement and that there was no secret covenant.[66]

[63]     On a balance of probabilities, considering all the evidence introduced before me, I come to the conclusion that Agensys T & C and the Partnership never intended to create a legal liability under the Acquisition Note and that the former never intended to collect on the Acquisition Note and the Subscription Notes which were assigned to it. The Acquisition Note, and the Subscription Notes which replaced it, can be described as a sham. They do not reflect the "actual legal rights and obligations (if any) which the parties intend[ed] to create".[67] I believe that the price paid for the Software is limited to $960,000, being the amount of money actually transferred to Agensys T & C in December 1993. There are several reasons for coming to this conclusion:

(1)      The Subscription Notes were never paid. The Limited Partners, including Mr. Morley, were never asked to pay any principal or interest on these notes.

(2)      There is no corroboration by Agensys T & C, the vendor, that the purchase price for the Software was truly $12,150,000. Neither Mr. Kale nor any representatives of Agensys T & C testified at the hearing.

(3)      The evidence of Mr. Gamble is not credible on the issue of the price paid for the Software.

(4)      The FMV of the Software does not exceed $960,000.

(5)      According to the SI Investigation Statement, one (Partner A) of the Limited Partners indicated that there was never any intention to pay the Subscription Notes.

(6)      At best, the Subscription Notes represented a contingent obligation to pay a royalty when and if profit arose.

(1)      Subscription Notes Never Paid

[64]     The strongest initial evidence that the intention of the parties was to limit the price of the Software to $960,000 is the fact that only that amount was ever paid to Agensys T & C. More than ten years after the alleged acquisition of the Software in December 1992, there had never been any partial payment of the Subscription Notes by the Limited Partners. Partial payments were due in March, June and September 2003, whether or not there was any net Partnership distribution (or Agensys International dividend), and on September 15, 2003, Mr. Morley testified that no request for any such payment had been made because the only recourse that Agensys T & C had against him and the other former Limited Partners following the settlement of a dispute in 1996 was limited to the Agensys International shares, and those shares were worthless as a result of a search and seizure that took place on October 8, 1997, and the closing down of Agensys International in August 1998. Those shares were transferred to the partners of the Partnership on February 28, 1997, when the Partnership was dissolved following the rollover of the Partnership's assets to Agensys International on January 1, 1997.

(2)      No Corroboration by Agensys T & C or Mr. Kale

[65]     Nobody representing Agensys T & C testified at the hearing. That includes Mr. Kale and that corporation's legal representatives with whom the Partnership was dealing at the time of the acquisition of the Software and at the time of the aforementioned dispute. To explain Mr. Kale's absence, counsel for Mr. Morley relied on Mr. Barisheff's testimony "that there was present an antagonistic relationship with Howard Kale". This is what Mr. Barisheff actually said when I asked him at the end of his testimony what had become of Mr. Kale: "I have no idea. . . . He and I haven't been on good terms since the lawsuit." However, as far as I recall, no such statements were made by or in respect of either Mr. Morley or Mr. Gamble, who was the promoter of the Partnership, the sole beneficial owner of the GP and, according to the Partnership's financial statements, the sole beneficial owner of Marketing. Mr. Barisheff, according to Mr. Gamble, was just a go-between. It would have been of great interest to have Mr. Kale explain how the terms of the 1993 Acquisition Agreement were negotiated in 1992 and 1993 and to hear his version of the 1996 dispute and why he gave the 12 Partnerships and their partners an astonishing settlement, which included converting general recourse notes into a limited recourse against shares of a private corporation. Even if Mr. Kale had refused to testify, there were means to compel his attendance.[68] I draw a negative inference from the absence of Mr. Kale and assume that his testimony would have been adverse to the position advanced by Mr. Morley. I adopt the same approach as that followed by Judge Sarchuk in Enns v. Minister of National Revenue, 1987 CarswellNat 397, par. 9, [1987] 1 C.T.C. 2256, 87 DTC 208, and by many judges of this court in other cases:

In The Law of Evidence in Civil Cases, by Sopinka and Lederman, the authors comment on the effect of failure to call a witness and I quote:

In Blatch v. Archer, (1774) 1 Cowp. 63, at p. 65) Lord Mansfield stated:

It is certainly a maxim that all evidence is to be weighed according to the proof which it was in the power of one side to have produced, and in the power of the other to have contradicted.

The application of this maxim has led to a well-recognized rule that the failure of a party or a witness to give evidence, which it was in the power of the party or witness to give and by which the facts might have been elucidated, justifies the court in drawing the inference that the evidence of the party or witness would have been unfavourable to the party to whom the failure was attributed.

In the case of a plaintiff who has the evidentiary burden of establishing an issue, the effect of such an inference may be that the evidence led will be insufficient to discharge the burden. (Levesque et al. v. Comeau et al., [1970] S.C.R. 1010; (1971), 16 D.L.R. (3d) 425.)

[Emphasis added by Judge Sarchuk.]

(3)      No Credible Evidence

• Vague and contradictory description of how the acquisition price was negotiated

[66]     It is necessary at this point to go over in greater depth the relevant facts that surrounded both the negotiation of the price of the Software in 1992 and 1993 and the alleged dispute that arose in mid-1996. Mr. Gamble indicated that when the decision was made in the middle of the summer of 1992 to acquire the Software, he decided to use Mr. Barisheff as his agent to distance himself from Mr. Kale, who was allegedly negotiating on behalf of Agensys T & C. According to Mr. Gamble, he had very limited contact with Mr. Kale during the course of the negotiations that took place between Messrs. Barisheff and Kale. One would thus have expected Mr. Barisheff to shed a lot of light on those negotiations during his testimony. Surprisingly, he provided only a vague description thereof. For instance, Mr. Barisheff was not able to indicate Mr. Kale's initial asking price.[69] He said that he could only remember a vague statement by Mr. Kale that a company owning the Software might be worth $100 million. Mr. Barisheff did not even recall what his own initial offer on behalf of Mr. Gamble had been: he only remembered a vague $10 million. Nor did Mr. Barisheff provide many details as to how the cash portion of the price was arrived at. He merely stated that Mr. Kale's initial cash demand was about $2 million.[70] Mr Gamble gave a different account but, in the end, the purchaser of the Software did not really know how the negotiations had gone. He gave the following answers to my questions (at page 938 of the transcript of his evidence):

Q. Had you offered to pay fully cash, how much would have been paid?

A. The thing that he was looking for was 12 million.

Q. 12 million.

A. Or 14 million, or whatever. He wanted cash. That was his first thing. And we said we couldn't afford 12.

Q. 12 or 14?

A. Well, don't quote me on the number. I'm just saying that --

Q. Because it wasn't you again?

A. I was not dealing with this so it's speculating again on my part.

[67]     The only contact that Mr. Gamble acknowledged he had with Mr. Kale during the negotiations was when he received a phone call from Mr. Kale complaining that these were not progressing fast enough. His reply was that Mr. Kale would have to make a more reasonable offer. Mr. Barisheff indicated that at one point Mr. Kale asked $12,150,000 and this was agreed to early in the fall of 1992 by Mr. Gamble.

[68]     Mr. Gamble said that, in order to determine the fairness of the price, he consulted his nephew, who was working for CGI and had some knowledge in that regard. However, the nephew did not present himself to attest to that. Mr. Gamble also indicated that he had talked to Mr. Batton in order to obtain information about comparable software in the U.S. market. It is worth repeating that Mr. Batton never agreed to pay any large up-front amount when he acquired the non-exclusive right to market the Software in the U.S. through Agensys U.S.: the sole consideration he provided was through a royalty-type arrangement.

• Regarding the date of acquisition

[69]     According to Mr. Gamble, the Software was acquired on December 20, 1992, pursuant to the 1992 Acquisition Agreement. There is no statement in that agreement as to the date on which it was executed; there is only a statement that it was made "as of the 20th day of December, 1992". According to Mr. Gamble, that document was prepared by Agensys T & C's lawyers, and was signed by him on the 20th or the 21st day of December 1992 at the office of his real estate lawyer, Mr. Kutner, before he left for his Christmas holidays and after it had been reviewed by Mr. Kutner. Mr. Kutner did not testify to corroborate Mr. Gamble's testimony and no reasons were offered to explain his absence. When asked to corroborate the execution of the 1992 Acquisition Agreement in Mr. Kutner's office by Mr. Gamble, Mr. Barisheff responded, "it's my impression that this agreement and other documents respecting the partnership were signed at that time" not strong corroboration:[71]

[70]     Mr. Beach stated in his testimony that he met Mr. Gamble in early December 1992 and was then asked to "start thinking through the commercial transactions and the documentation necessary for them".[72] He also said that he was consulted about the 1992 Acquisition Agreement "at the time that it was being drafted".[73] This description does not fit Mr. Gamble's version of events. Mr. Gamble stated that Mr. Beach was hired in early 1993 and he referred to Mr. Kutner only as the lawyer who reviewed the 1992 Acquisition Agreement. Although he stated that the Partnership entered into the 1992 Acquisition Agreement in 1992,[74] Mr. Beach acknowledged that he did not draft that agreement and, in cross-examination, stated that he did not negotiate it, was not present when it was executed and did not know when it was executed. It is odd that a lawyer hired specifically for his knowledge in securities and software matters[75] would not have drafted such a document and would not have been - as, according to Mr. Gamble's version, he was not - consulted in 1992. It is very possible that Mr. Beach was consulted on that agreement, but only in 1993. The 1993 Acquisition Agreement, which he drafted, refers to the earlier agreement. For the reasons given below, I think that, at the very least, Mr. Beach is mistaken in his belief that this agreement took place in December 1992 and that he was consulted on it in 1992.

[71]     Mr. Gamble's testimony that he signed the 1992 Acquisition Agreement in the office of his lawyer on the 20th or 21st day of December 1992 before going away for the Christmas holidays is not credible. There are many reasons for coming to this conclusion. First, in an affidavit dated February 14, 1995 (Tab 161), Mr. Kale states that the Partnership acquired the Canadian rights to the Software on December 15, 1993[76] - not on December 20, 1992, as claimed by Mr. Gamble. Secondly, Mr. Morley informed the Chief, Tax Valuations in Toronto in his letter of January 13, 1995, that the valuation obtained by the Partnership was to help it in its negotiation of the purchase price.[77] The 1993 Pritchard Evaluation is dated June 28, 1993 - not 1992 -, which is consistent with both Mr. Kale's affidavit and Mr. Morley's statement.

[72]     Paragraph 5 of the 1992 Acquisition Agreement states that the source codes were to be delivered within three days of the execution of that agreement. There is an Escrow Agreement, dated "as of the 20th day of December, 1992" (Tab 43) between Agensys T & C, the Partnership and Temple Trust, which may appear to support that statement. However, according to Mr. Gamble, the source codes were delivered a year later, on December 20, 1993, when the Escrow Agreement was actually executed.[78] So we cannot assume that what is stated in the 1992 Acquisition Agreement truly represents reality. In fact, it makes more sense to conclude that the 1992 Acquisition Agreement was executed in the Turks and Caicos on December 20, 1993, at the same time as the Source Code Escrow Agreement was.

[73]     Thirdly, when an agreement is executed on a particular day, it is not the practice of lawyers (as confirmed by Mr. Beach) in drafting such an agreement to state therein that the agreement is made "as of" that date. That is generally the wording used in documenting a verbal agreement that took place at an earlier date. If one is signing a document dated the same day as it is being executed, the document would generally say something to the following effect: "executed this day".

[74]     Fourth, as pointed out by the respondent's counsel, the corporation identified as Agensys T & C (i.e. Agensys Corporation) did not have that name on December 20, 1992. Corporate documents obtained from the government of the Turks and Caicos Islands reveal that Agensys T & C was incorporated on March 30, 1992, as "Overseas Oil Consultants S.A." and that this name was changed to "Agensys Corporation" only on May 20, 1993!

[75]     Fifth, I do not believe that the Partnership was acquired by Mr. Gamble in the summer of 1992 as he stated. He testified that the Partnership was a shelf partnership[79] (Shelf Partnership) which had been formed in 1983 and which had been acquired from his lawyer, Mr. Kutner, in mid-1992. The corporate records of the GP and the documents that were filed by the Shelf Partnership with the Ontario government do not support this version of the facts. First, the notice of change regarding the Shelf Partnership was only made on February 5, 1993, and not in 1992. The repurchase agreement, dated December 9, 1993, and signed by Mr. Gamble himself, pursuant to which Mr. Gamble transferred his initial unit in the Partnership, states that he acquired that initial unit on February 5, 1993.[80] Secondly, even the notice of change does not describe Mr. Gamble as the new limited partner. It is silent in that regard. Thirdly, it describes the business of the Shelf Partnership as "real estate" and not as marketing or developing software. Fourth, the new address shown on the notice is not that of Mr. Gamble or one of his firms with which the Shelf Partnership is connected. The address of Mr. Gamble's firm is 301 Prudential Drive, Suite 107, Scarborough, Ontario,[81] while the address indicated in the notice is 100 Prudential Drive, Suite 112, Scarborough, Ontario. Fifth, it is the name of the person shown in the 1983 documents that appears in the notice of February 5, 1993, and not that of Mr. Gamble, as it would be reasonable to expect if he had acquired the Partnership on that date. Lastly, it is interesting to note that in his retainer letter of January 17, 1993 (Tab 45), in which he agrees to perform consulting services for the Partnership, Mr. Kale refers to the "Agensys Limited Partnership's" and not the "Continental Limited Partnership", as the Partnership was called in the 1992 and 1993 Acquisition Agreements. Why would Mr. Kale, who had just negotiated the sale of the Software a few days earlier, refer to the wrong name, a name that was eventually to be adopted some time after 1994? [82]

[76]     On a balance of probabilities, I believe that the 1992 Acquisition Agreement is a backdated document, which was only prepared and signed after January 17, 1993, the day Mr. Kale wrote his retainer letter. I suspect that it was only after this date that Mr. Gamble realized the impact of the half-year rule and that he attempted to correct the situation with the 1992 Acquisition Agreement. I was therefore not surprised that Mr. Morley's counsel indicated during the course of the hearing that his client would admit that the Software was acquired only in December 1993. However, this does not detract from the fact that Mr. Gamble's credibility had already been blemished.

• Regarding the first meeting with Mr. Kale

[77]     Mr. Gamble's testimony was contradicted on several other points. One relates to his description of his very first meeting with Mr. Kale. According to Mr. Gamble, that meeting took place in Toronto in late winter or early spring 1992. Present at that meeting were Messrs. Barisheff and Kale, Mr. Kale's lawyer and two software experts. Mr. Gamble indicated that the purpose of the meeting was twofold: first, to discuss the possibility of Mr. Gamble lending money to Mr. Kale on the security of a mortgage on Mr. Kale's ranch in Arizona; second, to describe a software to Canadian investors. On several occasions during his testimony, Mr. Gamble insisted (probably to distance himself from Mr. Kale) that he was there for no more than 40 minutes at the beginning of the meeting to discuss the loan and that he left before the discussion turned to the Software. This version of the events was contradicted by Mr. Barisheff, who stated that the loan had been out of the question from the beginning and, therefore, the purpose of the first meeting in Toronto was only to discuss the Software. That meeting lasted two or three hours and both Mr. Gamble and himself had been present throughout it.[83]

• Regarding the seriousness of the dispute

[78]     One of the reasons, it is alleged, why no payment was ever made on the Subscription Notes is that they were modified as a result of the settlement of a dispute that allegedly occurred in 1996. The holder of those notes could only exercise its rights against the Agensys International shares and, as a result of that corporation having closed its doors, these shares were worthless.

[79]     A notice of action dated September 23, 1996, was filed by the 12 Partnerships in the Ontario Court of Justice (General Division) and sent to Agensys T & C's and Temple Trust's attorneys. An application for process was filed on September 25, 1996 in the Supreme Court of the Turks and Caicos Islands against the same defendants. A statement of claim was prepared but apparently was not filed in the Ontario Court. In the statement of claim, $155,000,000 was claimed as damages for alleged breaches of acquisition agreements as follows: damages of $50 million for breach of warranty in respect of the Software and breach of covenant to provide certain services in connection with, among other things, "the support, training, maintenance, development, enhancement and promotion of the [Software]", damages of $50 million "for breach of certain collateral agreements", damages of $50 million for "fraudulent or negligent misrepresentation", as well as exemplary and punitive damages of $5 million. Neither the notice of action nor the statement of claim provide additional information relating to these alleged breaches. In addition to all of the above, there was a request for the return of certain funds held in trust for some of the 11 Partnerships.

[80]     The main reason for bringing the suit, according to Mr. Barisheff, Mr. Gamble and Mr. Beach, was that Agensys T & C was not living up to its obligation under the 1993 Acquisition Agreement to provide the Support Software at no front-end cost. Agensys T & C tried to get paid but the Partnership refused.[84] Messrs. Barisheff and Gamble also mentioned the lack of technical and marketing support. Mr. Gamble specifically referred to the U.S. marketing campaign that was never launched.

[81]     Although there is a fair degree of consensus on the cause of the action, there is conflicting testimony with respect to when the breaches took place. On one hand, there was, according to Mr. Morley, non-compliance regarding the delivery of the Support Software over a year and a half before the suit was brought. According to Mr. Beach, the dispute concerning the Support Software started at least a year prior to September 1996. (See page 320 of Mr. Beach's transcript.) Mr. Barisheff confirmed in his testimony that almost all of the enhancements (i.e. the Support Software) referred to in Schedule A to the 1993 Acquisition Agreement were never delivered by Agensys T & C. On the other hand, according to Mr. Gamble, the delivery of the Support Software was taking place without any problems until mid-1996! Here is what he stated at pages 524-26 of his transcript:

            Q. Did I hear you say that these difficulties arose in the spring of 1996? Is that what you said?

            A. In the spring it became very evident in the spring of 1996 because I was informed by AGENSYS Corporation that they were not going to do any of the support software that we requested without receiving up front money.

            Q. Had there been any difficulties with the AGENSYS Corporation over enhancements of any kind or any other kind, prior to the spring of 1996?

            A. There weren't anything that was substantial that I could pinpoint. Things were slower to be done than obviously I as the, and the Partnership, wanted them to. But things were getting done, we were getting support, things were moving along. And I really wouldn't have had any idea that we were into a potential Notice of Action until I was informed that in effect AGENSYS Corporation was not going to live up to the agreement and supply the support software we needed without charge, and then collect their compensation by way of the royalty that had been agreed to.

            Q. You received word that that was their decision?

            A. I was told by, directly, by Howard Kale.

            JUSTICE ARCHAMBAULT: And you are at what time now?

            THE WITNESS: That was in about, I would have to guess, May or June of 1996.

[Emphasis added.]

[82]     Again, Mr. Gamble's version of events is not only contradicted by other witnesses but does not correspond to the documentary evidence. In order to understand what the alleged dispute was all about, it is necessary to go over the chronology of events, starting with the 1993 Acquisition Agreement. Given that the details provided by the different witnesses concerning the alleged dispute are of a general nature and rather vague, it is necessary to rely on the documentary evidence, and in most instances without the benefit of the assistance of the authors. As far as I can gather, here is what took place. At the time of sale, the Described Software only provided some of the basic functionalities;[85] it was lacking several well-publicized functionalities, such as portability on numerous platforms, access to different databases, and GUI. Agensys T & C had to undertake to enhance the Software. This it did through the insertion in the 1993 Acquisition Agreement of an undertaking (clause 4.4) to deliver the Support Software. Nothing was supposed to be charged for this up front; only a royalty, to be negotiated, was to be paid. For a reason that escapes me, a written request was required for the Support Software and it was never made according to Mr. Barisheff. (Mr. Gamble did not know whether such a request was made.)

[83]     Agensys T & C did not have any employees to develop the Software. It had relied on a consultant, Mr. Kale, for that purpose.[86] In its correspondence, Agensys T & C was always represented by a Turks and Caicos Islands lawyer. After the sale of the Software to the Partnership, Agensys T & C on April 7, 1994, entered into an agreement (94 Development Agreement) (Tab 68) with Agensys U.S. to take over Mr. Kale's obligations to develop the future enhancements of the Software. The first project under this agreement is described in a "Work Statement" dated April 14, 1994 (Tab 68). The enhancements (94 Enhancements) to be developed correspond to a significant extent to the Support Software: they included five new operating platforms,[87] GUI for five different environments, and five communications protocols. Pursuant to the Work Statement, the total price for these enhancements was to be borne by "the organizations that are acquiring the exclusive country rights". Agensys T & C was to be billed by Agensys U.S. for work in progress. Fifty percent of the price was due "from the countries funded at the time of delivery of the beta object code" (Tab 68) (i.e. from those of the 12 Partnerships that had raised their funds by that time) and the balance from those same countries when the project was delivered and accepted. The Partnership's share was 5.2% of the price.[88]

[84]     On December 1, 1994, Agensys T & C (through its lawyer) advised Mr. Gamble that the beta copies of the 94 Enhancements had been received and indicated that "as agreed 50% of the monies agreed upon for this development are due and payable now" (Tab 145). The Partnership paid the first instalment of US$22,620. That sum represented one half of the Partnership's share of a total cost of US$870,000, which is detailed in an attached invoice. That invoice lists the same platforms as those shown in the Work Statement, except that Windows NT 3.5 is described as NT Win 16 and NT Win 32, and it adds the SCO Unix platform, which was supposed to have been part of the described Software delivered in 1993. A price of US$60,000 is charged for each of the seven platforms. An undated Toronto-Dominion accounting record shows that a sum of $22,620 was transferred to Agensys T & C's attorney in the Turks and Caicos. The February 8, 1995, Batton Memo confirms that the first half was paid by the Partnership (and two of the 11 Partnerships) (Tab 60).

[85]     In his memo of February 19, 1995, to Larry Gamble dealing with the Revenue Canada valuation audit, Mr. Morley reminds him that the Support Software was to be provided at no charge (except for a royalty or like fee) and that an amendment to the 1993 Acquisition Agreement that Mr. Gamble "discussed with Howard" would be necessary to deal with "the recent billing by John Batton" (Tab 167). Otherwise, "investors could also question the earlier arrangement that you made to provide [Agensys T & C] with US$60,000". Mr. Morley recommended that "the basis for the development and payment of Support Software should be reaffirmed with Howard and John Batton advised accordingly".

[86]     During a management meeting held two days later, on February 21, 1995 (Tab 177), Paul Mighton suggested that the Partnership "take control of the product development" and proposed hiring Mr. McCann as VP Technology.[89] Mr. Gamble suggested that "McCann's contract" and "all development costs should be funded from Turks & Caicos". He also insisted that "Howard Kale [had] to live up to his original agreement". At the management meeting held on March 8, 1995 (Tab 182), it was decided that Paul Mighton was to establish a development plan and that, because of Mr. Kale's "view on not accepting the position of developmental costs coming from Turks & Caicos", Mr. McCann's contract "be funded by [Marketing]".

[87]     Given that both Mr. Mighton and Mr. McCann were to go shortly to Dallas to meet Mr. Batton, the development plan was to be worked out within a few days after the Dallas visit (Tab 186). It was during that visit that Mr. Mighton advised Mr. Batton that the Partnership would not take delivery of the 94 Enhancements and that Marketing "was going to undertake the development project."[90] Therefore, the Partnership did not pay the second instalment owing under the Work Statement. This is confirmed in a letter[91] by Mr. Batton to Agensys T & C's lawyer, dated March 22, 1995 (with a copy to Paul Mighton).

[88]     Presumably, Mr. Mighton's trip was discussed at the March 28, 1995, management meeting but the minutes are not available, although they were approved at the April 11, 1995, management meeting (Tab 191). During this later meeting, Mr. McCann stated that he was going to visit Mr. Kale in Phoenix on April 19, 1995, "to review all aspects of Agensys. Howard [Kale] has advised that there are 6 interfaces completed but we do not have them in our office." Mr. McCann's May 1995 Report from the Phoenix trip is reproduced in part in paragraph 49 above.[92] In a memo dated May 23, 1995 from Mr. Mighton to Mr. Gamble, the first following Mr. McCann's May 1995 Report, we find the following statement respecting the status of the relationship with Mr. Kale and Agensys U.S.: "It took 6 weeks of elasped [sic] time to come to agreement on the working relationship among the Dallas office, Howard and us. Milestones that will allow us to be successful include . . ." (Tab 214).

[89]     Minutes of meetings held in June and a development plan dated July 31, 1995 reveal some cooperative work with Mr. Kale with respect to implementing certain enhancements, for instance, on the Sun Solaris platform, and with respect to the "networked demo presentation". At the annual general meeting of the Agensys Partnerships held on July 5, 1995, there was talk of a proposed roll-up of the Partnership and the Australian Partnership into a corporation (Tab 245). In September 1995, Mr. Mighton prepared a 1995-1996 business plan for Marketing, including a proposed development plan for the Software, which, to judge by its looks, style and content, seems intended to promote new offerings of Agensys Partnerships.

[90]     On January 26, 1996, Mr. Morley circulated among the members of the management group the "1996 Planning Objectives" for, among other things, corporate matters such as the roll-up of Agensys Partnerships by the end of April 1996 (Tab 297). That document also dealt with the development of the Software, which would involve a significant contribution by CGI, a minor contribution by one technical employee, Ron Mercier, and none by Mr. Kale. Among the activities to be carried out by CGI are "start client\server architecture design", "complete Unix-DOS co-processing" and "complete Phase I product enhancements". During a demonstration for Revenue Canada on January 16, 1996, Mr. Phil Irving of CGI had indicated, according to the tax avoidance auditor, that CGI "will do maintenance" and "CGI to assist in further development" of the Software. However, in a letter dated November 3, 1997, CGI wrote that "we were never engaged to develop new releases or versions of the product" (Tab 418). Their "engagement involved numerous activities such as: studying the position of Agensys with the market place . . . developing demonstration applications . . . and prioritizing future enhancements to the Agensys product".

[91]     From February 12 to 15, 1996, Mr. Irving was in Arizona to meet with Mr. Kale. In his report, he states: "This document summarizes the discussions and the accomplishments of the initial handover work period . . ."[93] [Emphasis added.] (Tab 306.) It describes ten "deliverables"[94] that were obtained and states that "10 pages of handwritten notes were made and 10 hours of conversations were recorded."

[92]     The only other report prior to the legal action brought on September 23, 1996, is the August 13, 1996, Gillman report, which provides yet another business plan analysis and also proposals (Tab 336). For instance, Mr. Gillman describes the Software as "Technologically Immature It need [sic] GUI, Designer, Multi Platform, Internet". One of Mr. Gillman's suggestions is "working hand in glove" with Paul Blair of Phoenix. Mr. Gillman describes as an obstacle "reliance on Howard Kale" with respect to development issues, but states that "there is no solution readily available here." He likewise sees as an obstacle reliance on Mr. Kale regarding support issues and suggests the following solution:

Let us concede the genius of Howard. He is a designer, not an ongoing process and support type of person. A support organization for our own development and for support of our clients need [sic] to be established and maintained.

One or two of the new grads trained in Agensys will be given extensive extra training and be designated the support person for current and new development. He will be paid for by Howard.

[Emphasis added.]

[93]     So contrary to the claims made by Mr. Gamble, Agensys and Mr. Kale did not stop providing Support Software in mid-1996. According to Mr. Barisheff, except for the user and reference guides (delivered in 1992) and the Sun Solaris and SCO Unix operating system delivered in 93/94 (in my view, more likely in 1994 and 1995), the Support Software was never delivered. If any breach consisting in the non-delivery of most of the Support Software existed, it was crystallized in March 1995 when the Partnership was asked to pay the second instalment for the 94 Enhancements and refused. So it was not in mid-1996. If there was a breach in March 1995 (as Mr. Morley testified), action had to be taken at that time, a year and a half before the notice of suit was filed September 1996.

[94]     I keep saying "alleged dispute" or "if any breach existed" because I am not convinced that any such breach ever did exist. If it had, mention of it would have been made in the offering memoranda of the Agensys Partnerships. These Partnerships raised a substantial sum of money after March 1995 and had entered into acquisition agreements with Agensys T & C similar to the 1993 Acquisition Agreement. For instance, in the confidential offering memorandum for Agensys (FR) 1995 Limited Partnership (French Partnership),[95] dated September 11, 1995, and the one for the Agensys (UK) 1995 Limited Partnership (U.K. Partnership),[96] dated February 1, 1996, there is no mention of any breach by Agensys T & C causing damages of $155 million. For example, on February 1, 1996, Mr. Gamble certified that he did not "omit to state a material fact that is required to be stated" in the confidential offering memorandum of the U.K. Partnership (Exhibit A-4, page 34). If such serious breaches causing $155 million of damages had existed, they would have constituted a material fact which would have had an impact on the value of the securities being offered by those partnerships.

[95]     In my view, no such serious breaches existed because I believe that there was no serious undertaking to provide the Support Software. Given that the Software lacked at the time of its purchase so many of the functionalities that made it so singular and attractive, one would have expected the purchaser to require that the vendor provide all the Support Software according to an agreed delivery schedule. Here, the parties only stipulated that the Support Software was to be supplied on "written request" by the Partnership and no such written request was ever made!

[96]     Another indication that the covenants were not serious is the fact that the "national advertising and promotion campaign in the United States" (provided for in article 4.5 of the 1993 Acquisition Agreement) was to have taken place no later than June 30, 1994. In his testimony, Mr. Barisheff recognized that the campaign had not taken place by February 1996. So it seems that no one cared if these "paper" covenants were fulfilled or not. This attitude is also apparent in the preparation of the private offering memoranda for the French and UK Partnerships' units because a similar "paper" covenant appears in them and no mention therein is made by Mr. Gamble of the fact that this covenant had never been fulfilled in the past by Agensys T & C (Page 11 of Exhibit A-4 and A-6)!

[97]     Be that as it may, how useful would a national American campaign be if your business is being carried on in France, the UK or Canada? Why would Agensys T & C have given such an undertaking when it was to receive only royalty payments from Agensys U.S. and no large up-front payments such as the $6 million paid by the 12 Partnerships? In any event, it could not force Agensys U.S. to launch such a "national . . . campaign" because there is in their agreement dated February 2, 1994, no covenant respecting such a campaign.[97] The national American campaign covenant does not appear to have any commercial reality.

[98]     With respect to the promotional, training and technical consultation obligations, only the latter was an ongoing obligation. It called for "two person - months per year." The promotional activities obligation was for a two-year period and the training obligation seems to have been limited to the initial period (see paragraph 13 above).

[99]     Another indication of the non-inexistence of a breach of the 1993 Acquisition Agreement is the lack of reaction to the alleged non-execution of the covenants. From June 1993 to August 1996,[98] the chronology of events described above reveals no evidence of a written request to Agensys T & C or Mr. Kale to deliver the Support Software[99] and to remedy the lack of technical or marketing support or the failure to carry out the promised U.S. marketing campaign. There is no evidence of any threat that failure to remedy the breaches of the 1993 Acquisition Agreement woud lead to legal proceedings being instituted. There is no evidence either of any threat of legal action when Mr. Kale refused on March 8, 1995, to fund Mr. McCann's contract for the provision of his development services to the management group. Mr. Gamble's only reaction was to pay Mr. McCann through Marketing. Nor is there any evidence of a threat of recourse to legal action to obtain delivery of the 94 Enhancements when, on March 22, 1995, the Partnership refused to pay the second instalment for the 94 Enhancements, knowing full well that Agensys T & C had refused to fund the development to be carried out by the Partnership. Mr. Mighton, on his return from Dallas, prepared a development plan for the management group. Eventhough the Partnership had paid in December 1994 the first instalment for the 94 Enhancements, of which delivery was not made, there is no evidence either of any threat of taking legal action to obtain a refund of that instalment, presumably paid by mistake. (Or was it paid by mistake?)

[100] On the contrary, in his May 23, 1995, memo, Mr. Mighton talks of "com[ing] to agreement on the working relationship among the Dallas office, Howard and us". Mr. Gamble and the rest of the management group continued to talk to Mr. Kale, to meet with him, and to work with him at least until February 1996, when there seems to have been a friendly "handover" of Mr. Kale's programming tools, his files, manuals and know-how. The impression is that Mr. Kale was closing his shop and retiring from active computer programming work, at least as far as Agensys was concerned. On August 13, 1996, Mr. Gillman suggested that Mr. Kale fund the cost for a new graduate who would be the support person. The next event was the legal action for $155 million. Is it possible that Mr. Kale's refusal - yet another - this time to pay for the "new grad" caused Mr. Gamble to take legal action on behalf of the 12 Partnerships? Was this breach worth the $155 million that the Partnership was seeking? Was it worth agreeing, with respect to Agensys T & C, to convert $11,190,000 of general recourse subscription notes to limited recourse notes?[100]

[101] The lack of action in 1994 and 1995 is difficult to explain. The Agensys Partnerships had paid and were paying to Agensys T & C many hundreds of thousands of dollars every year from 1993 to 1996 - $6 million altogether. Many millions of dollars of Subscription Notes were allegedly owing to Agensys T & C. One would thus have expected Mr. Gamble to have been in a good bargaining position to force Agensys T & C to live up to its obligations to the letter. Payments could have been withheld on disbursements for other Agensys Partnerships. Threat of non-payment on the Subscription Notes would have been another possibility. In any event, it would have been in the interest of Agensys T & C to provide the Partnership with all the agreed upon Support Software, training and support because the payments on the Subscription Notes were for the first 10 years dependent on net cash distributable to the partners. On the other hand, if there was no real legal obligation to pay these notes, then the situation would be understandable.

[102] The circumstances surrounding the legal proceedings also raise lot of suspicions. Within ten days of the filing of the notice of action, the Partnership's lawyers were informing their counterpart in the Turks and Caicos that Messrs. Gamble and Barisheff had "worked out with Howard Kale the structure for a proposed settlement" (Tab 347). When asked if this was true, Mr. Gamble said that it was not he but the Partnership's lawyers who had worked out that structure. When Mr. Barisheff was asked for his version, he said that it was the lawyers or Mr. Gamble. So, nobody negotiated the structure for the settlement! Nobody wanted to take credit for this quick and amazing achievement!

[103] The settlement of the alleged dispute was signed on October 31, 1996, 38 days after the notice of action was filed. It provided that a new corporation would be formed (Agensys International) and that this corporation would acquire for $1 all the world rights still possessed by Agensys T & C.[101] Agensys T & C would use some of the funds, aggregating $907,270,[102] which had been advanced in trust by some of the 11 Partnerships and not yet paid out to Agensys T & C, to subscribe for 90,727 common shares in Agensys International. Those shares represented only 0.09% of all common shares.[103] In addition, Agensys T & C would transfer for $1 all worldwide rights to the Software and to Kammand (which was acquired from Mr. Kale on the same date) not then held by the 12 Partnerships. It should be recalled that Agensys T & C's Operational Plan attached to the February 8, 1995, Batton Memo shows a value of approximately $95 million just for the U.S. rights of the Software. The total price contemplated aggregated more than $228 million. So the transfer for $1 of Agensys T & C's residual world rights to the Software and Kammand does not make any sense. The whole thing is just unreal. It has no commercial reality!

[104] All of this is astonishing enough in itself, but not as astonishing as Agensys T & C's agreeing to modify the partners' Subscription Notes and turn them into notes with a limited recourse, that recourse being restricted to the value of the Agensys International shares. Furthermore, not only did Agensys T & C give up its right to receive from the Limited Partners past interest on the Subscription Notes, it also waived any future interest. When asked to explain how this extraordinary result was achieved, Mr. Gamble indicated that it was suggested by his lawyers at Fasken. Mr. Gamble's version of events was not corroborated by Mr. Beach, who had testified before Mr. Gamble and who had not been questioned on this issue. No reasonable explanation was supplied during the course of the hearings as to why a supposedly arm's length party such as Agensys T & C would agree to forego its full recourse against each of the Limited Partners in exchange for limited recourse against the shares of a newly created private corporation. Mr. Gamble's only explanation during the hearing was that it was allowed under some new tax legislation. Even if that were true, it does not explain why an arm's length party would agree to grant such favourable terms to the Limited Partners. Mr. Barisheff estimated the whole cost of developing the Support Software at $2 million. So, even if there was a valid covenant to deliver the Support Software, Agensys T & C was giving up its general recourse of $11.2 million and all interest thereon on account of a breach of $2 million! And this is in addition to the agreement by Agensys T & C to give up (for the nominal sum of $1) its ownership of the Software and of Kammand, and its remaining territorial rights, which included the U.S.[104]

[105] Finally, it should be noted that this whole litigation took place in secrecy, without the knowledge of Mr. Snape, who had just been hired as the new general manager and of Mr. Morley, who had been part of the management group since 1994 and had for a very long time been critical of Mr. Kale and Mr. Batton of Agensys U.S.

[106] To me, this whole dispute saga does not make any sense. I draw two conclusions from the evidence on the dispute and the settlement. First, I do not believe that Mr. Gamble, as the controlling partner with respect to the affairs of the Partnership and as one who had made a substantial investment as a limited partner, and Agensys T & C ever intended that Agensys T & C be required to deliver the Support Software to the Partnership and to launch a national marketing campaign. In addition, there was established no serious breach that would justify the claim for $155 million, the legal action and the subsequent settlement. I believe rather that the lawsuit represents window dressing intended to support a conversion of the general recourse Subscription Notes into limited recourse notes and the waiver of interest.

(4)      FMV of the Software

[107] One more reason why I do not believe that the Acquisition Note created a true legal obligation and that Agensys T & C intended to collect on its Subscription Notes is that, in my opinion, the FMV of the Canadian marketing rights to the Software did not exceed $960,000.

[108] This brings me to the subject of the two valuation reports that were filed during the hearing as expert evidence concerning the FMV of the Software. The first report (2003 Pritchard Evaluation or Report) was prepared by Mr. Bob Pritchard, the same person who had prepared the 1993 Pritchard Evaluation which was referred to in the July 1993 offering memorandum. In the 1993 Pritchard Report, Mr. Pritchard estimated a FMV of $14,875,000 as of May 31, 1993. This value is reduced in the 2003 Pritchard Evaluation to $14,300,000 as of November 1993 due to charges in market conditions. Counsel for the respondent objected to the filing of this report because, in their view, Mr. Pritchard should not be considered as an expert witness. Their main reason for so contending was that Mr. Pritchard was neither a chartered business valuator, nor a chartered financial analyst nor a chartered accountant. I decided to allow the 2003 Pritchard Evaluation in and let Mr. Pritchard testify after counsel for Mr. Morley suggested that I should defer my decision on its admissibility until after I had heard Mr. Pritchard's evidence, to which counsel for the respondent agreed. One factor that made it useful for Mr. Pritchard to testify was that the respondent's expert, Mr. Johnson, had relied on some of his projections. Mr. Pritchard also gave factual evidence of what he saw and did in 1993.

[109] On the question of Mr. Pritchard's status as an expert, I conclude that he should not be recognized as such, mainly because of his lack of certification in the field in quesiton. I am also far from being convinced that he carried out a thorough evaluation.[105] Even if I had accepted Mr. Pritchard as an expert, I would not have adopted his opinion as to the value of the Software. I believe that the value determined by Mr. Johnson is a lot closer to the FMV of the Software in 1993. As will be seen below, I do have some reservations about even some of his assumptions, including the very generous cash flow projections made by Mr. Pritchard and on which Mr. Johnson relied. Mr. Johnson estimated the FMV as at December 20, 1992, to have been between $900,000 and $2.1 million. As stated in his report, if asked for a point estimate, he would have selected the mid-point of that range, namely $1.5 million. To establish the FMV of the Software, Mr. Johnson, like Mr Pritchard, used the discounted cash flow valuation methodology. Here are his explanations and conclusions :

The discounted cash flow methodology involves forecasting the annual discretionary cash flow (defined below) anticipated to be generated from the Software for a period of time (the 'Forecast Period', which in this case was 1992 through 2002) and discounting those projected discretionary cash flows at a rate of return that reflected the risks of achieving same. An estimate is then made of the value of the discretionary cash flows beyond the Forecast Period (i.e. beyond 2002), which is referred to as the 'Terminal Value'. The Terminal Value is determined by multiplying the expected average annual discretionary cash flows to be generated beyond the Forecast Period by a 'Terminal Value multiple'. The Terminal Value component is then discounted to the Valuation Date. The sum of the present value of the discretionary cash flows of the Forecast Period plus the present value of the Terminal Value represents the fair market value of the Software.

Given the issues surrounding the possible deficiencies of the Software, and the possible shortcomings of the Pritchard Projections, we determined the fair market value of the Software using a two-step process:

·                     as a starting point, we determined the Unadjusted Value[106] of the Software assuming that:

ü                  no deficiencies in the Software existed at the Valuation Date, and

ü                  the Pritchard Projections were reasonable.[107]

We calculated the 'Unadjusted Value' of the Software as the sum of the present value of the discretionary cash flows of the Forecast Period plus the present value of the Terminal Value, based on the Pritchard Projections,[108] and based on rates of return that we considered appropriate given the nature of the Software and the market in which it would be sold; and

·                     we then made adjustments (the Development Cost Adjustments) to the Unadjusted Value to reflect the:

ü                  Initial Development Costs required in order to remedy the deficiencies of the Software at the Valuation Date, as set out in the Brock Solutions Report,[109] and

ü                  deficiency in the Pritchard Projections in respect of Ongoing Development Costs that would be required in order for the Software to remain competitive over the long term.[110]

The amount of the Development Cost Adjustments is calculated[111] as the sum of the present value of the Initial Development Costs and Ongoing Development Costs in the Forecast Period plus the present value of the Ongoing Development Costs in the Terminal Value, based on rates of return that are consistent with those adopted for the purpose of calculating the Unadjusted Value.

In summary, the fair market value of the Software at the Valuation Date is calculated as the Unadjusted Value less the Development Cost Adjustments, as follows:

	Low	High
Unadjusted Value of the Software	$1,600,000	$2,638,000
Less: Development Cost Adjustments	(708,000)	(514,000)
Fair Market Value of the Software (rounded)	$900,000	$2,100,000

[110] In order to determine his cash flow projections and given that the Software had no track record, Mr. Pritchard made assumptions with respect to the size of the Canadian market for products such as the Software. Although his projections for that market over a ten-year period were characterized by him as close to the actual numbers that were achieved and were considered reasonable by Mr. Johnson, one of the key elements in determining the future cash flow from the Software was an estimate of the rate of penetration of the Canadian market by the Partnership. Different rates of penetration were assumed by Mr. Pritchard for various segments of the Canadian market. They varied from 0.1% in the year 1993 of the ten-year period considered to 5% in the year 1999 of that period; he acknowledged that these rates were based on his "best guess as to what was reasonable." In addition, it should be noted that his projections were based on the product approach business plan, which was abandoned early 1994 and replaced by the consultating approach.[112]

[111] Once Mr. Pritchard determined what would be the gross revenue from the Software over the ten-year period, he then determined what would be the net cash flow by estimating the expenses that would be incurred by the owner of the Software during that period. He relied on his business experience to come up with numbers which he described as "built from the bottom up". They represented not a percentage of income but what in his view was a fair estimate of expenses. However, there are no development expenses in his projections.[113]

[112] Once a net cash flow[114] had been estimated for the ten-year period, Mr. Pritchard then determined what would be a proper discount rate for calculating the net present value of this future cash flow. He used a 20% discount rate, which represented slightly more than twice the average rate of interest then being paid on five-year government-insured mortgages.

[113] Mr. Pritchard then computed the residual or terminal value of the Software at the end of the ten-year period. In order to establish that value, he decided to use the net cash flow generated in the tenth year and determined that this would represent a maintainable cash flow for the future, in perpetuity. He then applied to that maintainable net cash flow a multiple of 20. This multiple was less than the average price earnings ratio for the Standard & Poor's 500 Index of just over 23 in 1993. The value of the future cash flow starting in the eleventh year represented a substantial amount: $11,186,465 out of the value of $14,875,196 determined for the Software, or approximately 75.2% of that value!

[114] As indicated above, Mr. Johnson redid Mr. Pritchard's calculations of cash flow. He did so by making basically three major adjustments.[115] First he made an adjustment to the cash flow by adding development costs. Given that Mr. Travers had identified deficiencies existing in the Software at the valuation date, Mr. Johnson estimated that initial development costs of $100,000 to $250,000 would be required to remedy those deficiencies. These amounts represent only a fraction of the total development costs required for that purpose. This fraction amounts to 5.2% of the total and is the Partnership's share "pursuant to its ability to be part of a consortium of various parties[116] who collectively would be prepared to fund most of the total Initial Development Cost. If this were not the case, the Initial Development Costs may exceeded [sic] the Unadjusted Value, which would cause the fair market value of the Software to be nil." (Page 46 of the Johnson Report.)

[115] In addition to the initial development costs, ongoing development costs had to be incurred "in order to support the long-term competitiveness of the Software". In this regard, Mr. Johnson assumed that Agensys T & C would provide the required enhancements, as envisaged in the 1993 Acquisition Agreement, and that the cost would be a royalty type of payment in the range of 3% to 5% of sales. This assessment of Mr. Johnson's appears very reasonable, especially when one considers Mr. McCann's suggestion (see paragraph 49 above) that "a minimum 20% of revenues be allocated to the development activities."

[116] The second major modification made by Mr. Johnson was to use a discount rate of 35% to 40% (instead of the 20% adopted by Mr. Pritchard) for determining the net present value of the cash flow, and multiples of 9 and 11 (instead of the 20 adopted by Mr. Pritchard) for determining the terminal value. With respect to the discount rate, he came to his conclusion based upon his experience and after having discussed the issue with venture capitalists who are in the business of financing start-up software companies. Venture capitalists would use a similar net cash flow model to evaluate a corporation in which they are considering investing, even though the corporation might be a one-software corporation. Such venture capitalists would use a discount rate varying between 30% and 50% or sometimes 60%. On the basis of his discussions with venture capitalists, Mr. Johnson thought that a discount rate of 35% to 40% would be reasonable. However, it should be noted that when I questioned Mr. Johnson and brought it to his attention that those discount rates were rates used for valuating an operating corporation that had on staff qualified personnel to develop and use the software, he acknowledged that venture capitalists would not normally get involved in just a straight purchase of software. They would always buy an operating business.

[117] With respect to the multiple of 20 based on public equity market price-earnings multiples adopted by Mr. Pritchard, Mr. Johnson wrote that it was unrealistic:

The use of price-earnings multiples of established, diversified publicly held corporations is fundamentally inconsistent with the valuation of a single product with a restricted market, such as the Software. Furthermore, . . . [this multiple] far exceeds the residual value multiple of 5X that was used when determining the fair market value of AGENSYS in other developed countries around the same valuation date.[117]

[Emphasis added.]

[118] The third major adjustment made by Mr. Johnson had to do with how the discount rate should be applied. Mr. Pritchard had adopted an after-tax multiple of 20 and applied it to a before-tax net cash flow. Mr. Johnson applied his discount rates and the multiples to the after-tax net cash flow. In his opinion, this was required in order to ensure the internal cohesion of the calculations and I agree with him.[118] For these purposes, he assumed that a purchaser would be in a position to obtain tax savings generated by claiming CCA.[119] Given that he had assumed that the Partnership had acquired the Software in 1992 and given also the half-year rule, the tax shield was enjoyed over a two-year period and a positive cash flow resulted in 1992 and 1993.

[119] In my view, a more cautious approach should be adopted. The asset being valued here is a software which had no track record. It is true that the Software was a newer version of an existing software, Kammand, that had been marketed to a limited extent in the U.S. However, the Software was different from Kammand because it had been rewritten using a different language in order to give it portability and interoperability on and with different platforms and database software, features that Kammand did not have. So it was more like a new software. It was also a software that had great limitations and that required major enhancements to make it the attractive product it was marketed as. Basically, it was a work-in-progress, at a very early stage in its development.

[120] Even assuming that the Software was not that different from Kammand, the Partnership was buying just a software and not an operating business. As mentioned before, venture capitalists would not have touched the Software without the proper personnel being there to continue its development. Here, not only did the Partnership not have on staff people who had the knowledge to create the Software but it did not have the programmers to create the business applications it wanted to market to end-users. Whenever it was necessary to make a presentation, the Partnership had to ask Mr. Kale or some other U.S. or Canadian consultant to get the Software running. In my view, purchasing a software alone, without the team that created it, had the effect of increasing significantly the risk which would normally be borne by venture capitalists. Therefore, I believe that a higher discount rate should be adopted. A minimum rate between 40% and 45% would be required in the circumstances of this case.

[121] The cash flow projections are not based on an existing business for which probable maintainable profit or cash flow projections can be made. Here, even though one can forecast fairly accurately how the whole industry is likely to develop over a 10-year period, the determination of the market penetration rate of a new product marketed by a new player in the market (without the proper personnel) is more an act of blind faith than any serious exercise in speculation.[120] The rate of penetration depends on so many factors, including the competence of the marketing force, the attributes of the product itself, the financial resources of the marketer and the existence of serious competitors.

[122] Furthermore, the projections made by Mr. Pritchard are based on the assumption that the Software would appeal to medium to large organizations primarily for use in one of three distinct applications described at page 19 of the Johnson Report:

[123] In fact, as Mr. Johnson wrote at page 21 of his report: Mr. Travers "concluded that many of the features required to be competitive for the applications and customer base targeted by the Software were not resident in the Software at the Valuation Date". Mr. Johnson added that "the Software

·         was best suited for single user and small work group applications; and

·         lacked features that were critical to large and mid-sized companies who were seeking to replace their legacy or mainframe systems."[121]

[124] So it is quite appalling to find out that, in Mr. Pritchard's projections, 80% of the sales projected by him for 1994 and 1995 are shown as coming from mainframe accounts (government and other) and mid-range accounts (government and other). Needless to say, this does little for the credibility to Mr. Pritchard's work.

[125] In addition, I find it difficult to give much residual value to a software that was purchased by a team that did not have the in-house know-how to build and develop it and was dependent upon a non-resident corporation established in the Turks and Caicos Islands without any employee for ensuring its development. Likewise, consideration has to be given to the fact that the Software was facing competition from well-established companies marketing established software. The Canadian market for programming software such as the Software was, at that time, a crowded market.[122] In my view, it would have been very difficult for a new company with a new software to establish itself in that market and to compete in it against competitors with strong financial backing. The likelihood of there being any residual value after ten years was very slim. The history of software is full of cases of good software that could not survive more than a few years. It is also important to give some weight to the information that Mr. Johnson obtained from Mr. Batton, the president of Agensys U.S., who had a very good knowledge of the Software[123] and who estimated that its expected life was about seven or eight years[124] and that there was an 80% to 85% risk of failure.

[126] There is also the following statement found in a technical white paper prepared by Object Systems Inc.:[125]

Software Project Failure Rates

The U.S. National Research Council recently reported that up to 95% of all software projects are not satisfactorily completed in time to be of any use to their intended users. The software industry responded indignantly that the actual failure rate was only 70% of all projects that are started. Regardless of whose numbers you use, the failure rate for software projects is totally unacceptable and would not be tolerated from any other professional discipline.

[127] In my view, higher discount rates such as 40% and 45% have to be used to take into account the higher risk involved in acquiring a product with only limited territorial rights as opposed to a corporation, even a one-software corporation. Furthermore, given the high risk of a short life on the market, the use of lower multiples, such as 7 and 9, to evaluate future cash flow after the forecast period would be more appropriate.

[128] One more modification that I feel is required to the computation of FMV made by Mr. Johnson is with respect to the adjustment to take into account the initial development cost for remedying the defects identified by Mr. Travers. For the following reasons, I believe that adjustment should be omitted. First, I am not comfortable with the estimate of the cost for correcting such defects. Not enough information is available to allow one to come to any conclusion in this regard. Another reason for my discomfort is that a full adjustment is made for the lower value and only a partial one for the higher one. Finally, I believe that a vendor has the obligation to deliver a functional software and, therefore, has the obligation to correct any initial defects in the software. In any event, I have adopted a higher discount rate and that compensates in part for the elimination of the initial development cost adjustment; Mr. Johnson would have done likewise had he not taken this factor into account. [126]

[129] Finally, Mr. Johnson's evaluation was made as of December 20, 1992. As I have concluded that the Software was not acquired before June 30, 1993, when the restated Acquisition Agreement was executed, Mr. Johnson's computations have to be modified accordingly; in particular, the tax shield for the cost of the Software has to be deferred by one year.

[130] As appears in greater detail in the tables appended to these reasons, the FMV resulting from the above adjustments to Mr. Johnson's calculations would be as follows :

	Low	High
Unadjusted Value of the Software	$798,500	$1,356,000
Less: Development Cost Adjustments	(250,900)	(220,900)
Fair Market Value of the Software (rounded)	$548,000	$1,135,000

[131] The mid-point value of this range of FMV would be $841,500. So, in my view, it is clear that the FMV of the Software acquired from Agensys T & C could not have been more than $960,000, the amount paid in cash by the Partnership. That amount is within my range and that established by Mr. Johnson. For the reasons already mentioned, the Software may well be worth much less than that amount of $960,000. Therefore, the fact that it was not worth more than $960,000 makes it very unlikely that the parties would have agreed to an amount in excess of $960,000. This constitutes one more element justifying my conclusion that the parties did not intend to create a binding obligation to pay the balance owing on the purchase of the Software, that is, $11,190,000, a number almost equal to the terminal value as computed by Mr. Pritchard.

(5)      Corroboration by Partner A

[132] In addition to the fact that the Limited Partners were never asked to pay any money, interest included, owing on the Subscription Notes, the fact that no representative of Agensys T & C testified to demolish the facts that the Minister assumed - in particular the allegation that Agensys T & C never had any intention of collecting on the Subscription Notes - and the fact that the FMV of the Software was not in excess of $960,000, there is confirmation by Partner A, referred to in the SI Information Statement (Tab 412), that the Limited Partners would not have to pay their Subscription Notes. Partner A held units in several of the 12 Partnerships including the Partnership.[127] After receiving his assessment from the Minister, he spoke to one of the Minister's officers in the tax avoidance section and confirmed to him that he "was not feeling well about this [Partnership] and thought that it might be a scam". Partner A also stated that he was told verbally that the amount owing on the Subscription Notes "payable in 10 years would never be collected and that this amount would be forgiven". Even though interest would have to be paid on subsequent limited partnership offerings, due to new legislation, it would be "given back . . . 'under the table'".

[133] It is true that Partner A stated in a subsequent affidavit that "at no time did I provide independent information . . . to support the contention that I knew[128] that the Agensys Limited Partnerships were a 'scam'" (Exhibit A-27). However, he never recanted his specific statements regarding the non-collection on the Subscription Notes and the reimbursement of the interest under the table.

[134] It is unfortunate that neither the tax avoidance auditor nor Partner A testified in court. When asked during argument why Partner A had not testified, counsel for the respondent indicated that he did not know. He added "[w]hile I think you could rely on it [the assertion attributed to Partner A in the SI Information Statement that the amount owing on the Subscription Notes would never be collected and would be forgiven], I think it should be a question of weight Your Honour". Counsel for Mr. Morley stated in his argument that "there were many hundreds if not thousands of pages of documents contained in the joint book of documents and they were filed and became part of the evidence before this court." The SI Information Statement is filed in that "joint book" of documents at Tab 412, which is one of the last tabs of Binder 12. The subsequent affidavit was filed during argument, with the consent of counsel for the respondent, after I had raised the disturbing discovery of the above-mentioned statement.

[135] I cannot give a lot of evidentiary weight to either the statement in the SI Information Statement or the statement in the affidavit, given that Partner A and the tax avoidance auditor whom he met did not testify before me and given the damaging nature of those statements. However, in view of my analysis of the circumstantial evidence, Mr. Gamble's lack of credibility, and the inference I draw from them, I consider Partner A's statement described in the SI Information Statement as one more element supporting and justifying my conclusion on the true cost of the Software.

(6)      At Best a Contingent Obligation

[136] Consequently, I do not believe that Agensys T & C ever intended to collect more than $960,000 for the sale of the Canadian rights to the Software to the Partnership. The Acquisition Note and the Subscription Notes which replaced it did not constitute a binding agreement. If anything, they were at best a contingent covenant for a royalty type of payment or, to use the words of the Agensys T & C Operational Plan (paragraph 22 above), "the payment of a loan agreement that comes out of a royalty agreement" on the sales of the Software. This contingent obligation cannot be part of the cost of the Software.[129]

(D)     Subsection 69(1) and Non-Arm's-Length Relationships

[137] I believe that the conclusion I have reached with respect to the true cost of the acquisition of the software does not require that I deal with the application of subsection 69(1) of the Act. However, if it had been required, I would have certainly come to the conclusion that a non-arm's-length relationship existed between the Partnership and Agensys T & C and that the FMV could not have exceeded $960,000.

[138] In coming to that conclusion, I would have relied on the circumstances described above and, in addition, on the very non-commercial nature of the terms of the Acquisition Note and the Subscription Notes. When I questioned Mr. Barisheff on this, he acknowledged that he had not encountered such terms in any of the many securities and real estate transactions in which he had been involved. In his written submissions, counsel for the respondent provided the following review of the case law dealing with the notion of arm's length in situations similar to this case. I will cite paragraphs 10 to 16 of his notes:

B.         Arm's Length & section 69

10.        Whether Agensys Canada and Agensys Corporation dealt at arm's length is a question of fact, as prescribed by paragraph 251(1)(c) Income Tax Act (paragraph 251(b) in 1993). In Brown v. Canada, [2001] T.C.J. No. 763 [Tab 1] Judge Rip identified a number of factors, many, if not all of which, exist in the Morley appeal so as to denote a non-arm's length relationship:

§         Inflated promissory note over term exceeding the shelf life of the software;

§         Disparity between purchase price and estimated FMV;

§         Other additional factors such as arbitrary decision making as to which game platforms were to be included in the purchase and sale and apparent disorganization in determining game titles.

11.        With regard to the promissory notes, Judge Rip observed as follows at paragraph 79 of Brown:

The Acquisition Note was not a debt instrument that would have been transacted by parties at arm's length. The Acquisition Note was to mature on December 31, 2003, ten years after the transaction and beyond the time when it was reasonable to assume that the computer games would generate income. Mr. Main expected the market for the 16-bit machines to last five years; Mr. Grossman expected the 16-bit market to continue until 1996. The note was not assignable and the security for the note was units of the Partnership. There was no evidence that was reasonable to conclude that an arm's length vendor would agree to defer the balance of the purchase price for the computer programs, approximately US$5,000,000, on the strength of such a note.

The Respondent would submit that the above passage is directly applicable to the within appeal.

12.        Finally, Judge Rip considered the following additional factors, at paragraph 79 [sic, actually 80], in determining the existence of a non-arm's length relationship:

There were also transactions after 1993 which suggest that ASC and [the partnership] were not dealing at arm's length. This includes the exchange of an unknown and presumably unsuccessful computer program by the partnership for the Super Copa game, a game which had already been marketed under other names and the apparent arbitrary inclusion of games to be played on the Pico platform without approval by, or prior notice to, the partners. Games and their titles were also not determined until after 1993.

Agensys Canada's apparent disinterest in whether it was purchasing "Kammand" or "Agensys", and the differences, if any, between them, is noteworthy in this regard.

13.        Petro Canada v. The Queen (2002), 2003 DTC 94 [Tab 4] provides further guidance. The Appellant in that case purchased seismic data at an allegedly inflated price for purpose of advantageous CCA [sic, actually CEE] treatment. The purchase price was $46,751,752.00 whereas FMV was determined at $8,884,497.00. On the "arm's length" issue, the court made reference to the following facts: (i) the Appellant's [sic] could provide no specifics of where and when the data was actually utilized (paragraph 71); (ii) the purchaser evidently purchased the data without any concern about the location of where the data came from (paragraph 72); (iii) the Appellant's [sic] only actually made use of approximately 6% of the data it purchased (para 73); (iv) "[t]here was no evidence to show that the [purchaser] made any serious effort to bargain with vendors as to prices paid for the seismic data" (para 83); (v) the selection of the data to be provided was left to the vendor to decide (para 84); (vi) it was in both the vendor's and purchaser's interests to set as high a purchase price "as the parties could justify" (paragraph 85); (vii) the funds to pay for the actual development or use of the data was to come through the advantageous CEE treatment (paragraph 85).

14.        Judge Bowie concluded at paragraph 82 that "the evidence leaves no doubt that [the] transactions did not reflect ordinary commercial dealings between the vendors and the purchasers acting in their own interests and so were not at arm's length" [emphasis added].

15.        Finally, at paragraph 19 of Gestion v. Canada, [2000] T.C.J. No. 872 [Tab 5] the Court observed that the "failure to carry out a transaction at FMV may be indicative of a non-arm's length transaction."[130] The Respondent would submit that the marked disparity between the Respondent's valuation, and the stated purchase price of the software, calls into question whether the software was purchased for FMV.

16.        In concluding that an arm's length relationship existed the Court was persuaded by the absence of "special circumstances"[131] signalling the existence of a non-arm's length relationship. The Court emphasized that evidence of "collusion, scheming, or underhand[ed] dealing[s]" would indicate a non-arm's length relationship.

[139] Also, it is interesting to note the following comments made by counsel for Mr. Morley in his written submissions:

It is submitted that in interpreting these two provisions paragraph 69(1)(a) and paragraph 251(1)(b), the obvious sequence in determining whether actual cost should be replaced by fair market value would be to determine first whether the purchaser and vendor were acting at arm's length and then, if it is found that they were not, either because they were related or did not deal with each [sic] at arm's length as a factual matter, then subsection 69(1) could be applied.

The Respondent's position, however, appears to be the reverse - that is, that we should look at whether the property acquired had a fair market value equal to the cost to the purchaser and if it did not, then we can necessarily conclude, that the parties were not acting at arm's length. The Respondent's approach appears to work backwards and suggests that if a lack of fair market value can be demonstrated, this is essentially conclusive evidence that the parties were not acting at arm's length.

It is submitted that this reversal of the obvious intent of the legislation is to be avoided or, at a minimum, adopted with great caution. Section 69 should not be applied unless there are factors external to section 69 itself which support a finding that the parties were not acting at arm's length.

Although the fair market value of the property in question for purposes of subsection 69(1) may be a factor to be taken into account, it should not, in and by itself, be conclusive of a non-arm's-length relationship which then, in turn, permits the Respondent to rely on subsection 69(1). This, I submit, is what the Respondent has attempted to do, as reflected in the argument put forward on behalf of the Respondent. During that argument, no basis for applying subsection 69(1) was raised other than that the purchase price paid for the Agensys software by the Partnership exceeded fair market value.

[140] I agree with the statement by counsel for Mr. Morley in his written submissions that the existence of a discrepancy between the FMV and the price paid should not in and of itself be conclusive as to the existence of a non-arm's-length relationship. It would be dangerous to apply subsection 69(1) in such circumstances. However, I also agree that such a discrepancy is a factor to be taken into account; it should be considered in combination with other indications that the price was not determined under conditions in which two competing interests were involved. It should be acknowledged that it is difficult to determine whether one party was exerting undue influence on the other when the price was being negotiated, especially when there is no appearance of any blood relationship, or of any financial or economic relationship between the two parties. However, in the determination as to whether the price was fixed under appropriate circumstances, a large discrepancy between the price arrived at and the FMV of the asset should certainly be a very relevant factor to take into account.

(E)      Section 67 and Reasonableness of Expenses

[141] Given that the respondent has been successful on the issue of the true cost of the Software and would likewise have been successful under subsection 69(1) had it been necessary to apply that provision, I will make no ruling regarding the application of section 67 since I have some doubt as to its applicability in these circumstances and since no cases dealing with this issue were drawn to my attention.[132] In my view, it is clear that an allowance would not represent an outlay or an expense and therefore it is possible, at least on a narrow interpretation of section 67, that it should not be applicable. However, a good argument could well be made that section 67 is applicable with respect to the cost of the acquisition of the Software itself.[133] Given my conclusions above and the fact that this issue was not properly debated before me, I have decided not to resolve it in these appeals.

(F)      At-Risk Amount

[142] I do not believe that it is necessary to resort to the application of subsection 96(2.1) of the Act given that I have concluded that the cost of the Software did not exceed $960,000. In these circumstances, Mr. Morley's share of the Partnership losses is not likely to be in excess of his monetary contribution to, and liability toward, the Partnership.

(G)     Was the Software available for use in 1993?

[143] In assessing Mr. Morley, the Minister relied, inter alia, on the following assumptions in paragraph 21 of the Reply to the Amended Notice of Appeal, on the basis of which he concluded that the Software was not available for use in 1993:

(mm)     the alleged Partnership has not developed a marketable product nor does the alleged Partnership have the financial resources necessary to develop and market any product;

(nn)       from the time of the acquisition of the Canadian copyright in the Agensys software to the present time, the alleged Partnership has never used the Canadian copyright for the purpose of earning income;

(oo)       from the time of the acquisition of the Canadian copyright by the alleged Partnership, the Agensys software was not available or ready for commercial use or sale.

[144] The relevant statutory provisions for determining this issue are subsections 13(26) and (27) of the Act:

13(26) Restriction on deduction before available for use.

In applying the definition "undepreciated capital cost" in subsection (21) for the purpose of paragraph 20(1)(a) and any regulations made for the purpose of that paragraph, in computing a taxpayer's income for a taxation year from a business or property, no amount shall be included in calculating the undepreciated capital cost to the taxpayer of depreciable property of a prescribed class in respect of the capital cost to the taxpayer of a property of that class (other than property that is a certified production, as defined by regulations made for the purpose of paragraph 20(1)(a)) before the time the property is considered to have become available for use by the taxpayer.

13(27) Interpretation - available for use.

For the purposes of subsection (26) and subject to subsection (29), property (other than a building or part thereof) acquired by a taxpayer shall be considered to have become available for use by the taxpayer at the earliest of

(a)         the time the property is first used by the taxpayer for the purpose of earning income,

. . .

(d)         the time the property

(i)          is delivered to the taxpayer, or to a person or partnership (in this paragraph referred to as the "other person") that will use the property for the benefit of the taxpayer, or, where the property is not of a type that is deliverable, is made available to the taxpayer or the other person, and

(ii)         is capable, either alone or in combination with other property in the possession at that time of the taxpayer or the other person, of being used by or for the benefit of the taxpayer or the other person to produce a commercially saleable product or to perform a commercially saleable service, including an intermediate product or service that is used or consumed, or to be used or consumed, by or for the benefit of the taxpayer or the other person in producing or performing any such product or service.

[Emphasis added.]

[145] There is some evidence that the Partnership had some object codes for the Software late in 1992. Mr. Gamble said the following in his testimony:

We had the object code provided to us actually as a test basis as early as October 1992. And we received absolute final up-to-date object code in December of 1992. So that we had it with all the user manuals, everything that we needed to produce applications. (Mr. Gamble's transcript, pp. 501-502)

[Emphasis added.]

[146] Is this version of the facts corroborated by the rest of the evidence? What was the status of these codes? Did the Software exist only in a beta version? Was it just a demo version with many defects (bugs), or was it a fully operational software capable of being used to produce a commercially saleable product or to perform a commercially saleable service?

[147] In my view, the best evidence introduced by Mr. Morley's counsel to establish that the Software was available for use in 1993 is Mr. Karnis's expert report relating to the Software as it existed in November 1993. That version of the Software (1993 Software) was compiled by him from source codes apparently held in escrow in 1993 in the Turks and Caicos Islands by Temple Trust. The technical identification of this compiled version is: AGENSYS-PRO-DOS, Rel. 3, Ver. 12.69TCX4-GDEMO, 11-1-93.

[148] More specifically, Mr. Karnis was asked to determine whether the 1993 Software was capable of creating, running and enhancing a large, complex application. To answer this question, Mr. Karnis attempted to run on the 1993 Software the Runtime Version of AGS Mortgage, which was created between 1996 and 1998 by Agensys International using the Development Version of the Software then in existence (1997 Software), in order to determine whether that application could have been created with the 1993 Software.[134] When he attempted to do so, he identified several computer defects. One of these resulted in a loss of "minor screen embellishments". The more serious one was a defect in one particular instruction (KMD-PR0G), which was found to occur 102 times in 70,314 lines of code in AGS Mortgage.[135] The purpose of that instruction was to suspend the current program to execute a subprogram. When the subprogram terminated, the current program was allowed to continue. Mr. Karnis found that this bug caused the 1993 Software "to stop functioning after approximately 28 executions of this instruction". He described the solution in the following terms at page 3 of his report (Exhibit A-15):

We developed a work around for KMD-PROG by using a similar (but not identical) Agensys instruction SUB-PROG. We successfully remediated one occurrence of KMD-PROG with SUB-PROG. Had we more time and resources we could have remediated all occurrences of KMD-PROG with SUB-PROG by restructuring the [AGS Mortgage] application. This single fix resulted in 5 additional lines of code being added to [AGS Mortgage].

As time and resources were limited, we attempted to identify and repair the actual cause of the KMD-PROG defect. We were able to determine that the defect was caused by a simple programming error in [the 1993 Software] (a memory leak). However, we were unable to develop a fix for the problem in the time available.

[Emphasis added.]

[149] Mr. Karnis added that this bug was actually corrected "sometime between 1993 and 1996" and that AGS Mortgage used on the 1997 Software "was subjected to extensive testing and use" and did not exhibit the same defect. He then concluded as follows at page 6 of his report:

Ongoing maintenance is part of any large software project and I believe the occurrence of a single defect in all of Agensys in no way detracts from the Agensys' overall technical merits as an application development tool.

Opinion

In my opinion, it is possible to use [the 1993 Software] to create, maintain, enhance and execute [AGS Mortgage] and that doing so would not require a significant increase in the amount of program code.

[Bold characters added by Mr. Karnis.]

[150] Mr. Bruce Travers of Brock Solutions was asked by the respondent to assist in the valuation of the 1993 Software. His evaluation focused on two areas:

•          Evaluating the claims made in the AGENSYS marketing and technical documentation by the Department of Justice.

•          Positioning AGENSYS relative to competitive products at the Valuation Date.

To evaluate AGENSYS we:

•          Created a basic payroll application to test AGENSYS functions and explore its capabilities and limitations

•          Reviewed sample applications provided with the software

•          Compared AGENSYS' functionality to that of competitors listed in the "KAMMAND Competitor Notes". (Page 1 of his report (Exhibit R-5))

[Emphasis added.]

[151] Here are some of Mr. Travers' conclusions:

During the development of our payroll application, we gained an understanding of the capabilities and limitations of AGENSYS. The following conclusions were reached:

•          It is possible to build business applications using AGENSYS.

. . .

•          AGENSYS is a programming language consisting of over 100 commands and 80 sub commands. We tested approximately 50% of the AGENSYS commands. The commands we tested, worked as described in the technical manuals.

. . .

•          AGENSYS Application Designer is basically an extension to the Documenting Utilities. AGENSYS does not include data modeling capabilities, which are the foundation of most application design tools. We experienced several software bugs when using Application Designer.[136] No instructions were provided on the use of Application Designer.

. . .

•          The version of AGENSYS we tested had two major technical shortcomings that would limit its use at large to mid sized organization[s]:

§                It did not interface with any of the popular databases (e.g. Oracle, IMS, Sybase, DB2, etc.). These databases are used to store the majority of the computer-based information found in large to mid size companies. Without these interfaces, data must be copied from external databases into AGENSYS using the "Transfer Files" utility. This results in duplication of data. Data duplication always raises questions of "which file is correct?" when files that should be identical are not. Data duplication should be avoided.

§                It did not journalize transactions - This functionality is critical to large-scale commercial applications. Journaling is a process whereby transactions that change data in a database are logged or journalized in a separate file. The Journal file is always located on a different disk drive than the database files. If the system fails due to disk failure, the database can be rebuilt by reloading the latest backup, then reprocessing the journal entries since the last backup. Without journaling, users must manually re-enter all transactions.

Therefore AGENSYS is not suited for use by large and mid sized companies seeking to replace their legacy or mainframe systems.

·         AGENSYS is best suited for the development of single user or small work group applications with small transaction volumes.

[Emphasis added.]

[152] It is important to state that the Court is not bound by any expert evidence. It is up to this Court to decide if the legal requirements of subsections 13(26) and (27) of the Act have been satisfied, taking into account the expert opinions and all the other evidence introduced by both parties at the hearing. It should also be noted that neither expert was asked specifically whether the Software was complete or capable of being used to a produce a "commercially saleable product" or to perform a "commercially saleable service". So let us review the whole of the evidence to make that determination.

[153] First, the Software was never sold by the Partnership to anybody. Not only that, but there is no evidence either that a sale was close to being made or could have been made. On the contrary, Mr. Gamble acknowledged that the Partnership was not close to any sale from 1993 to 1995. (See par. 45 above.) Nor is there any evidence that a price list was prepared by the Partnership. The only price list that was filed as an exhibit is dated April 1, 1997, and was prepared by Agensys International (Tab 380). Second, the first application ever created or developed with the Software was started sometime in 1996 and only completed in late 1997 or early 1998. That raises a serious doubt as to whether the Described Software was complete at the end of 1993. The fact that it was not complete may well explain why no sales took place in 1993, 1994 and 1995. It could well explain to a large extent why no business application was ever developed with the Software in that same period. It was only in the latter part of 1996 that the first steps toward creating AGS Mortgage were taken.

[154] The analysis of the internal memos, minutes of management meetings, reports and correspondence written from 1994 to 1996 does not alleviate these concerns. Quite the contrary. The picture painted by all the above-cited extracts (in particular in paragraphs 42 to 53) from such documents does not favour Mr. Morley's position. I will reproduce again here the most salient portions of those extracts and add one other excerpt: "[T]he immense amount of work that has to be done before a successful Canadian launch is possible. . . He asked for a presentation when AC is operational" (January 17, 199[4]). "The information that Terry [Stanhope of Object Systems Inc.] will be bringing back from his USA trip will likely confirm that AGENSYS is not capable of performing as advertised. Some existing software will likely have to be debugged. For example, Paul mentioned that the AGENSYS Unix version that Howard claimed was finished, developed a bug on the first command that Paul entered. . . .The availability of software that we thought was developed because of Howard's statements or because of claims in our literature, need [sic] to be confirmed. . . [W]e had no way of verifying whether the claims that we have been making about its capabilities were fact or fiction" (August 8, 1994). "We have concluded that if potential customers were given AGENSYS for a day or two for the purpose of making a decision to buy or not, then they would decide not to buy. The documentation doesn't compete with today's standards set by Apple and Microsoft" (September 6, 1994). "I told Larry [Gamble] and Nick [Barisheff] in July, 1994, that I had no intention of going back into the Federal Sector market place until we had a product where we could give a hands on demonstration of our claims, . . . Until I have seen the demos that Gary McCann is preparing and the marketing, demo presentation and sales being put together by Paul, I will not commit ourselves to going back into the Ottawa market. . . . Paul and Gary are currently in Dallas to help confirm what we have in terms of software and what still needs to be done" (March 23, 1995). [Emphasis added.] "The User Manual is now completed and currently being printed. Advised that there are functions on Agensys that does [sic] not work but has been told by Howard they are there. Gary to review with Howard also. . . . Gary to determine whether or not we do have a stabilized version of Agensys after visit with Howard" (Tab 191, April 11, 1995). [Emphasis added.] "Once all the technical problems are solved and the products clearly defined to the marketplace, we should be in a position to exploit the product benefits" (August 13, 1996).

[155] In my view, only a demo version of an incomplete software was made available to the Partnership in 1993. The fact that the technical description of the 1993 Software examined by the experts for the purposes of these appeals includes the word "DEMO" is a first indication that the Described Software was an unfinished product at the end of 1993. When consultants were hired between June and August 1994 to evaluate the Described Software's user interface and its documentation, they were using these two versions: Version 15.24 NTCX12DEMO and 15.59 PXN90DEMO. So more than a year after the Software was acquired, still only "demo versions" were available, which would tend to confirm that the final version of the Described Software had not yet been completed.

[156] Second, contrary to the impression that was intended to be created by the 1992 and 1993 Acquisition Agreements, the Software source codes were not delivered in 1992 or 1993, and one of the reasons for this, in my view, was that work remained to be done to complete the development of the Described Software. It should be recalled that, pursuant to the 1992 Acquisition Agreement, the source codes were supposed to have been delivered within three days of the execution of that agreement (Tab 55, subtab 6, par. 5). They were not. It is stated in article 3.2 of the 1993 Acquisition Agreement dated June 30, 1993, that the "Vendor has by modem electronically delivered to the Partnership, and the Partnership hereby acknowledges receipt, of . . . the Source Code". [Emphasis added.] This is a false statement. At the hearing, Mr. Gamble acknowledged that the delivery only took place around December 20, 1993, when he visited the Turks and Caicos Islands.

[157] Actually, the source codes were not even delivered to him on that date, rather, they were delivered to Temple Trust to be held in escrow under certain conditions pursuant to the "as of the 20th day of December, 1992" escrow agreement (Tab 43). Under that agreement, the source codes could not be released without the mutual consent of the parties. So Agensys T & C had to agree and could, therefore, refuse. The agreement also described certain circumstances, such as the "occurrence and continuance of a material breach by Agensys [T & C]" under which either party could obtain the source codes. That is not what I would call delivery of the source codes to the Partnership. It is more like a halfway measure to protect to a certain extent both Agensys T & C and the Partnership.

[158] Third, another indication that the Described Software was still in its development phase and had not been completed is the fact that, as of February 8, 1995, no acceptance test procedure had yet been carried out "to verify the [Software] [was] functional" so that it could "be deemed acceptable" and the "Partnership[s] ... be whole". These words do not come from the 1993 Acquisition Agreement, as one would have expected. Quite surprisingly, that agreement is silent on the matter. They come instead from an undated memo (93 Acceptance Test Memo) (Tab 60) which describes in detail the acceptance test procedure for the Software and the 94 Enhancements. Given its importance, I will reproduce that memo in full:

To: Larry Gamble

From: John Batton

Subject: SE Support

Attached please find a chart depicting the events that are proposed to occur over the next few weeks. This chart also reflects the items we have discussed and agreed to be accomplished prior to those events taking place. It is our belief that all of the actions can take place remotely prior to the demonstration support requested. The following is an explanation of that graph:

Agree to the details of the '93 Acceptance - The following acceptance test will be conducted on the Deliverables:

Platforms: The Platform C or C: : compilers (MS-DOS and SCO/UNIX[137] in character mode) will have to successfully compile the Agensys Development System Source Code. The compiled Platform Executables (MS-DOS and SCO/UNIX) will have to successfully execute the Agensys Development Test Suite to verify the Agensys Development System is functional. The Agensys Development System Test Suite contains and uses the Security System and the Design System as applications to run within AGS (runtime) to exercise it fully. The Test Suite also has a series of applications that will exercise each verb and verify that they perform according to specification.

Execute the '93 Acceptance Test -. Upon successful completion of the Agensys Development System Test Suite. [sic] he Agensys Development System will be deemed acceptable.

Preserve the '93 Partnerships - Upon completion of the '93 Acceptance Test the '93 Partnerships[138]will be whole.

Release '94 Funding - The monies collected for the purchase of partnership units in the '94 selling season shall be released to the Agensys Corporation. No further action can be taken until these funds are received in the bank accounts of the Agensys Corporation.

Access of Any Partnerships to '94 Deliverables - All beta software in the Canadian Office will cease to function on April 1, 1994. This software was loaned to Agensys Canada for demo purposes in December of 1994 in beta form. This software is ready to be delivered to Agensys Corporation for acceptance testing according to the Statement of Work.[139]

[Emphasis added.]

[159] The acceptance test procedure is the usual practice to follow when one pays a substantial price for a software.[140] That is what was done when Agensys T & C delivered the 94 Enhancements on December 1, 1994 (Tab 145). One half of the price was owing on delivery of the beta copies and the balance "upon completion and acceptance of the project". The 1994 Development Agreement (Tab 68) pursuant to which the 94 Enhancements were delivered contains this clause:

Section 8

DELIVERY AND ACCEPTANCE

Developer shall deliver all Deliverables specified in the Work Statement, upon completion, to Sponsor's Technical Coordinator for testing and acceptance. Developer shall memorialize such delivery in a Delivery Confirmation that sets forth the nature and condition of the Deliverables, the medium of delivery, and the date of their delivery. Sponsor's Technical Coordinator shall countersign such Delivery Confirmation so as to indicate its receipt of the contents described therein, and the Delivery Confirmation shall thereupon be transmitted to the parties' Contract Coordinators. Unless a different procedure for testing and acceptance is set forth in a Work Statement, sponsor's Technical Coordinator shall commence acceptance testing following its receipt of the Deliverables. Upon completion of such testing, Sponsor shall issue to Developer's Technical Coordinator notice of acceptance or rejection of the Deliverables. In the event of rejection, Sponsor shall give its reasons for rejection to Developer's Technical Coordinator in reasonable detail. Developer shall use all reasonable effort to correct any deficiencies or nonconformities and resubmit the rejected items as promptly as possible. If the Sponsor should decide to not accept the deliverable, any progress payments shall be forfeit and the rights of ownership will remain with the Developer.

[Emphasis added.]

[160] The Work Statement referred to in the above agreement provided for the following acceptance test procedure:

7. Acceptance Testing: The following acceptance tests will be conducted on the Deliverables:

Platforms: The Platform Executables will have to successfully execute the Agensys Development System Test Suite to verify that the Agensys Development System ported to the new environment will execute AGS. The Agensys Development System Test Suite contains and uses the Security System and the Design System as applications to run within AGS (runtime) to exercise it fully. The Test Suite also has a series of applications that will exercise each verb and verify that they perform according to specification.

Communication Capabilities: The Deliverables must display the capability of communicating over Ethernet with the protocols listed in section six. As Sun running Solaris 2.3 is the only supported platform with a product line with the scaleability to act as a full server no matter the application, the Sun platform will be used as the testing vehicle. Remote access to files using these protocols will be demonstrated over the Ethernet. . . .

[Emphasis added.]

[161] It is astonishing that such a procedure was stipulated in the 1994 Development Agreement with respect to the delivery of the 94 Enhancements, for which the price to be paid by the Partnership was US$45,240, while the 1993 Acquisition Agreement is silent with respect to such a procedure when the price was $12,150,000! In the minutes of the February 21, 1995, management meeting (Tab 177), Mr. Gamble is described as insisting that "Howard Kale has to live up to his original agreement with us which includes acceptance proceedures [sic], testing etc.". Those procedures are not described in the 1993 Acquisition Agreement! Contrary to what Mr. Gamble stated in his testimony, the 1993 Acquisition Agreement does not constitute the whole of the agreement. There is at least one unrecorded additional covenant. The 93 Acceptance Test Memo of February 8, 1995, is consistent with the "original [verbal] agreement".

[162] I agree with Mr. Morley who wrote in his February 19, 1995 memo to Mr. Gamble that the source codes could not be considered "complete in terms of the Software Acquisition Agreement" until the Software had been "subjected to an established acceptance testing procedure".[141] This memo deals with the "Revenue Canada Valuation Audit" and the request from Revenue Canada for "a demo in two weeks time". In his memo, Mr. Morley states that the Partnership "must be able to respond to the following type of questions":

Question 1. Article 1 of the Software Acquisition Agreement (SAA) defines "Source Code" and "Computer Program". Can you demonstrate that these have been delivered, have been compiled into "Object Code", and have been subjected to, and have passed the Partnership acceptance testing procedures"?

Current Status. This cannot be done until the AGENSYS Corp. completes delivery of the source code. CGI must confirm through their audit that the Source Code delivered is complete in terms of the Software Acquisition Agreement. This also cannot be done until the software has been subjected to an established acceptance testing procedure.

Action Required.

1. Have Mark Dennison[142] complete the audit and the activities set out in his February 17 proposal ASAP.

2. Proceed ASAP with the development of the acceptance testing procedures in cooperation with the AGENSYS Corp.

QUESTION 2. What components of the "Systems Overview", as set out in Schedule "D", have been delivered to the Partnership and can be demonstrated? Is support documentation available?

[Emphasis added.]

[163] The rest of the second question is not available because page 2 of the memo is missing.[143] However, there is this statement on page 3, most likely the third "action required" suggested by Mr. Morley in response to the issue raised by his unavailable third question:

3. All software releases, including those already delivered, should be subject to the acceptance testing procedures and a formal process instigated for its acceptance by the Partnerships with the AGENSYS Corp.

[Emphasis added.]

[164] So we can fairly conclude that the Described Software had not been properly tested in 1993 and infer therefrom that this was because it had not been completed before the end of 1993, the relevant taxation year here.

[165] Although the direct and indirect evidence is contradictory, it appears from a reading of the different documents produced in evidence that the Described Software was not fully delivered as complete in 1993. As mentioned in paragraph 13 above, the Described Software source codes provided to the Partnership were for execution on the following three platforms: MS-DOS, SCO Unix and Sun OS. In fact, it would appear from the December 1, 1994, letter (Tab 145) from Agensys T & C and the attached invoice, that the last two platforms were only delivered by Agensys T & C in beta form late in 1994 as part of the 94 Enhancements; the delivery of the final version of those enhancements on January 31, 1995 was refused by the Partnership in March 1995.[144]

[166] The earliest indication of a request to obtain the Sun OS platform is on June 2, 1994 (Tab 95). However, the first sign of that platform having been received is a year later, when Mr. Karnis attempted to install it for a network demonstration. I shall refer to that below.[145]

[167] On July 25, 1994, Mr. Morley in a memo to Larry Gamble Nick Barisheff, states that, according to John Batton, the "AGENSYS Version 14 [sic] and the Unix version of AGENSYS were sent to us in June. Did we receive them?" (Tab 116.) This implies that the Unix version may have been sent only in 1994. There may have been an earlier beta version or the information in the memo may have been erroneous. We do not have the reply to that memo. In addition, there is the statement by Mr. Morley in August 1994 that "the AGENSYS Unix version, that Howard claimed was finished, developed a bug on the first command". In his May 1995 Report, Mr. McCann states that the Software is only available in DOS and SCO Unix! (See par. 49 above.) This clearly indicates that the third platform (that is, Sun OS), on which the Described Software was to run, had not yet been completed in May 1995. Finally, it is interesting to note that the experts who testified at the hearing only used the DOS version to evaluate the 1993 Software.

[168] Another indication that the Described Software was not complete in 1993 is the lack of credible evidence that demonstrations of a complete Software took place in 1993. Although Mr. Morley was busy early in 1994 trying to sell the Partnership's services to develop custom made business applications for government and for business organizations, the earliest dates for which there is evidence of any live demonstration for independent potential customers are May 16 and 17, 1994. At that time, live demonstration and "an instructional workshop . . . at which a small application was developed" were held at the Partnership's offices (Tabs 419 and 416). This appears to have been a limited demonstration because Mr. Morley, in his memo of December 5, 1994, dealing with the 1994 work plan and 1995 priorities, states that we "must have completion by the end of 1994, a first rate demo and script" (Tab 147).

[169] When Revenue Canada asked for a demonstration of the Software early in 1995, it took almost a year before it could take place. It is true there was a big dispute over whether Revenue Canada's expert would give the Partnership a specific undertaking of confidentiality. However, this was not, in my view, the only reason for the delay. The Partnership hired consultants (CGI) to prepare such demonstration and they needed time to do so. It was apparently not sufficient to repeat the live demonstration given on May 16 and 17, 1994. In all likelihood, that demonstration was limited to the DOS platform. In order to be able to illustrate some of the Software's key features, for instance its portability and its interoperability, the Partnership obtained and installed, after a lot of debugging, the Sun OS/Solaris platform, with the assistance of Mr. Karnis.

[170] In addition to the testimony of Mr. Gamble (cited above) that the Partnership had received "absolute final up-to-date object codes in December of 1992", there is some other evidence supporting Mr. Morley's position. First, Agensys T & C's Development Plan (received by Agensys U.S. in May 1994 and included as an attachment to the February 8, 1995, Batton Memo) states that "at the end of '93, the Agensys Development System was supported by the MS-DOS and SCO/Unix platforms". This is described as the "base release" sold to the Agensys Partnerships (Tab 60). But there are also the following statements by Mr. Gamble:

Q. So the support module for the UNIX was delivered to you at what time?

A. It would be sometime, I believe, in '94, '95. I'm not sure of the exact time sir.[146]

. . .

Q. They were platforms?

A. Yes.

Q. Do you know which ones?

A. Yes. I've already testified as to the UNIX and the Sun Solaris.

Q. Okay. So that was done in '94, right?

A. Right.[147]

[171] In his written argument, counsel for Mr. Morley also relies inter alia on Mr. Pritchard's August 2003 Report, at page 4, to establish that the 1993 Software was capable of producing commercially saleable products in 1993. Mr. Pritchard states on that page that "[f]rom February 1993 through 1994, I witnessed demonstrations of the AGENSYS Software . . . Throughout this period of review, the [Software] was a fully developed and functional application development tool set . . . It was in working order and was capable of developing complex business applications."[148] However, in my view, this description by Mr. Pritchard is not credible. It is in direct contradiction with the testimony of Mr. Karnis, who stated that his evaluation of the 1993 Software revealed that he could not run the complex AGS Mortgage on the DOS platform with that software because of a defect, which defect was repaired, according to him, sometime between 1993 and 1996. So, how can Mr. Pritchard state that the Software was fully operational throughout the period "from February 1993 through 1994"? In my view, Mr. Pritchard is not meticulous and rigorous enough to give reliable and convincing evidence.[149]

[172] Mr. Pritchard claimed in his testimony that he saw the Software run on a Unix platform in May 1993. However, he may have been confused because when he was asked on what platform Kammand had been running before that, he replied on an IBM mini computer running "a basic assembler of some sort" (Mr. Pritchard's transcript, September 26, 2003, pp. 65-66). In fact, it was running on a PC with a DOS platform. He also stated that some of the versions of the Software were coming from "the Chicago area" (Mr. Pritchard's transcript, p. 68). No other witnesses made such a statement. Their testimony and the documentary evidence identify only Phoenix, Dallas and, in the case of Mr. Gamble's testimony, the Turks and Caicos, as the places of origin of enhancements to the Software.

[173] In addition, Object Systems Inc. states in its "Product Evaluation" of the Software, dated September 6, 1994, that the "SCO Unix" and "Solaris Unix" versions of the Software were evaluated to confirm that the Software ran on those platforms. However, Object Systems' assessment was focused mainly on the PC DOS platform. That appears to be in contradiction with the December 1, 1994, letter (Tab 145) and the McCann May 1995 Report (par. 49 above).

[174] One way to reconcile some of this contradictory evidence can be found in a report dated July 31, 1995 (July 1995 Report). First, though, it should be recalled that Mr. Karnis was hired in June 1995 to assist Mr. McCann in preparing a demonstration to illustrate the portability of the Software on DOS and Sun OS/Solaris. Mr. Karnis's attempts to compile the Software for the Sun Solaris platform met with a lot of difficulties. It took him several weeks to repair defects in the program. Here is an assessment of the problem made in the July 1995 Report. (Tab 240):

1) Howard Kale worked with Larry Karnis and myself to ensure Solaris version is successfully running on the Sun machine. Finally this was completed. . . . It was quite apparent that the development module of Agensys never worked when reviewing Dale Grantham's code. That's why no one ever saw the development module but just the run time version. Files received from Howard through Dale were incomplete and this took almost 3 weeks to resolve. We were able to get the run time version working but not the development module.

[175] The author of this report is unknown, but in all likelihood it is Mr. McCann, who had asked Mr. Karnis to assist him in the installation of the Sun/Solaris platform. The distinction between the Development Version (development module) and the Runtime Version is key and it offers an opportunity to reconcile the various contradictions in the evidence and the testimony. The Runtime Version for one or more platforms of the Described Software may have been available as early as 1993, but the all-important Development Version necessary to develop business applications was only made available late in 1994 and thereafter. For instance the Development Versions for the SCO Unix and the Sun OS/Solaris platforms were delivered in beta version on December 1, 1994, as part of the 94 Enhancements. But delivery of the final version on January 31, 1995, was turned down in March 1995. This seems to be consistent with paragraph 4 of the Work Statement (appended to the 94 Development Agreement, Tab 68), which reads as follows:

4. Summary of Purpose for this Statement of Work: The purpose of this Work Statement is to port and add functionality to the Agensys Development System. It is to add the platforms indentifies [sic] in the description of Deliverables, facilitate the communication protocols identified in the description of Deliverables and add the GUI facilities to the AGS (runtime) portion of the Agensys Development System identified in the description of Deliverables.

[Emphasis added.]

[176] This may also explain all the difficulties that were encountered in June and July 1995 when Mr. McCann tried to install the Development Version for the Sun OS/Solaris platform. So, in all likelihood, only the DOS version of the Software (the Runtime Version and maybe the Development Version) was available at the end of 1993. However, it would appear from Mr. Karnis's and Mr. Travers's expert evidence that the Software could neither create nor properly run AGS Mortgage because of defects.[150]

[177] In my view, the fact that Mr. Travers, the respondent's expert, was able to program a very simple application is not conclusive evidence that the Described Software was fully functional. It should be remembered that he only examined 50% of the commands and he identified "several software bugs" when using the Application Designer module. Mr. Karnis's examination also identified bugs in trying to program a more complex application, such as AGS Mortgage. He did not have enough time and resources to correct those bugs. So we do not know for sure if there would have been any problem with the full implementation of his solution and if there were other bugs that full testing of the 1993 Software could have revealed. His opinion was that the defects that he had identified "in no way [detracted] from the Agensys overall technical merits as an application development tool", and that it was possible to use the 1993 Software "to create, maintain, enhance and execute" a large and complex application such as AGS Mortgage.

[178] However, the issue here is whether the Software was "delivered" in 1993 and whether it was capable of "being used . . . to produce a commercially saleable product or to perform a commercially saleable service". It should be remembered that the business plan of the Partnership was in the beginning based on the product approach. I do not believe that the Described Software could have been sold to end-users before it had been fully tested pursuant to an "acceptance testing" procedure as described in the 93 Acceptance Test Memo and before the KMD-PROG instruction bug had been solved. Even if the consulting approach had been adopted in 1993, I do not believe that in 1993 the Described Software, with its existing defects, was capable of properly developing an application.

[179] It is important to state that I do not take the view that unless a software is free of defects, it cannot be considered to meet the test of paragraph 13(27)(d) of the Act. I am cognizant of the fact that softwares are all too often sold with defects. The existence of defects can only be one of the factors to consider in making the determination required by paragraph 13(27)(d) of the Act.

[180] One of the reasons for not giving much weight to the opinion of Mr. Karnis, who otherwise impressed me with his technical knowledge, is the fact that the Partnership did not run an acceptance testing procedure before February 1995. It is my conviction[151] that software companies would not sell products to their clients before having subjected them to a rigorous testing procedure. Only then could it be acceptable to have defects remaining in a software. To act otherwise would be irresponsible and suicidal for those companies. Therefore, if such testing was not done by the Partnership before February 1995, it was because the Software had not been completed; at least it had not by the end of 1993, which is, along with 1990, the only taxation year in issue in these appeals.

[181] Mr. Karnis's opinion can be compared to the half-full glass of water. That glass can also be described as half empty. Because the bulk of the evidence points towards the conclusion that the Described Software was not complete in 1993, I interpret his opinion as confirming that the 1993 Software was not functional in November 1993, the relevant time at which the source codes that he examined were created. Given the lack of evidence that the defects were repaired before the end of 1993, I cannot conclude that the Described Software was complete and functional in 1993.

[182] If there remained any doubt after taking into account all the circumstances surrounding the creation of the Described Software, that doubt would vanish once one had taken cognizance of the following devastating assessment by Mr. Paul Mighton in his Business Plan of September 1995, at page 8 (Tab 250), in discussing the historical perspective of the Software's development: "A time consuming impediment has been that the AGENSYS ADE[152] was not market ready upon acquisition of the Global Marketing Rights." [Emphasis added.]

[183] In my opinion, there is clear evidence to enable to conclude that in 1993 the Described Software was not "used by the taxpayer for the purpose earning of income", as required by paragraph 13(27)(a) of the Act. No sales of the Software were ever made and the Software was not used in 1993 to create business solutions for its potential clients. Nor am I convinced that the Described Software was delivered[153] (within the meaning of subparagraph 13(27)(d)(i) of the Act) before the end of 1993 and was at that time "capable . . . of being used . . . to produce a commercially saleable product or to perform a commercially saleable service" within the meaning of subparagraph 13(27)(d)(ii) of the Act. Mr. Morley had the burden of demolishing the Minister's assumption of fact that the Software was not available for use. He failed to discharge that burden.

(H)     If any Breach of Mr. Morley's Charter Rights?

[184] Mr. Morley alleges that his rights under the Charter were breached when the Minister commenced his investigation of potential tax evasion under section 239 of the Act. Specifically, Mr. Morley refers to sections 7 and 8 of the Canadian Charter of Rights and Freedoms, which read as follows:

7.          Everyone has the right to life, liberty and security of the person and the right not to be deprived thereof except in accordance with the principles of fundamental justice.

8.          Everyone has the right to be secure against unreasonable search or seizure.

[185] Here, Mr. Morley takes the position that the Minister began his criminal investigation as early as August 1995, when the tax avoidance auditor indicated in a draft memorandum to SI that he believed that a scam had been perpetrated by the promoter of the tax shelter and that the tax deductions were fraudulent. However, his request to send the memorandum was turned down, presumably by his superior, so it was in fact never sent to SI. Again, a similar memorandum, in practically the same terms was prepared on February 7, 1996, but it was not sent to SI either. It was only on September 19, 1996, that such a memorandum was actually sent and it was not until September 30, 1997, that a SI manager advised Mr. Gamble that a preliminary criminal investigation had been started and that Mr. Gamble had the right to remain silent.

[186] Mr. Morley was never informed of his rights because on October 8, 1997, when the search and seizure were performed at his house, he was not present: he was away on vacation. It was only on his return that he learned of the criminal investigation. Mr. Morley claims that his Charter rights were breached not only because he was never informed of his rights, but also because the criminal investigation had started, in his opinion, as early as August 1995. He was present at meetings, including one on April 29, 1996, in which he and Mr. Gamble were asked questions. At that time, the Minister never informed Mr. Morley or Mr. Gamble of their right to remain silent. Furthermore, it is also in evidence that the tax avoidance auditor who referred the file to SI was in communication with the investigator and provided him with information in support of his position paper. This paper consisted basically of his auditor's report concerning the Partnership and was used by the investigator in deciding whether there was sufficient reason to commence a criminal investigation and to pursue such an investigation. This process took place from September 1996 to August 8, 1997.

[187] It is useful to review the jurisprudence dealing with tainted evidence and the remedy that should be afforded by the Tax Court when dealing with an assessment of taxes and penalties where there is tainted evidence. One of the early cases dealing with the remedy to be granted by the Tax Court when a breach of Charter of rights has occurred is O'Neill Motors Limited v. The Queen, 96 DTC 1486, a decision dated November 9, 1995, subsequently confirmed by the Federal Court of Appeal at 98 DTC 6424. In that case, an investigation was declared to have been improperly carried out by the Minister's officials; counsel for the Minister acknowledged that should the evidence thus improperly obtained be inadmissible because it was tainted, he would not be in a position to justify the assessment. Faced with this acknowledgment, Judge Bowman (as he then was) decided to vacate the assessment. However, he cautioned that vacating the assessment should not be considered a normal course of action, but is only to be resorted to in extreme cases.

[188] Other decisions have taken a more flexible approach to the issue. For example, in Donovan v. The Queen, 98 DTC 2140, a decision of October 15, 1998, my colleague Judge Lamarre Proulx concluded that the evidence that the auditor had not appropriately warned the taxpayer on visiting him accompanied by an investigator from the SI was not sufficient to affect the validity of the ensuing assessments against the taxpayer, these being by their nature civil rather than criminal measures from the Minister's assessment. On appeal from that decision, the taxpayer alleged that four main wrongs had been committed against him with regard to the search and seizure. The Federal Court of Appeal, at 2000 DTC 6339, confirmed this Court's decision with respect to three of the wrongs. It was only with respect to the fourth that a portion of the assessment was vacated. That judgment by the Federal Court of Appeal was also issued before the Supreme Court of Canada's decision in R. v. Jarvis, [2002] SCJ No. 76 (Q.L.), 2002 SCC 73, discussed below.

[189] In order to determine whether Mr. Morley's Charter rights have been breached, it is important to review what powers the Minister has in prosecuting at the same time an investigation (investigation) for the purpose of determining penal (criminal) liability and an audit (audit) for assessing taxes owing by a taxpayer, including the assessment of a civil penalty. The most recent relevant judgment of the Supreme Court of Canada, that in Jarvis, is very enlightening in this regard. In paragraph 85 and following, the Court expresses its view on how to delineate the bounds between an audit and an investigation, stating in particular at paragraphs 88-94, and 97:

88         In our view, where the predominant purpose of a particular inquiry is the determination of penal liability, CCRA officials must relinquish the authority to use the inspection and requirement powers under ss. 231.1(1) and 231.2(1).    In essence, officials "cross the Rubicon" when the inquiry in question engages the adversarial relationship between the taxpayer and the state.    There is no clear formula that can answer whether or not this is the case.    Rather, to determine whether the predominant purpose of the inquiry in question is the determination of penal liability, one must look to all factors that bear upon the nature of that inquiry.

89         To begin with, the mere existence of reasonable grounds that an offence may have occurred is by itself insufficient to support the conclusion that the predominant purpose of an inquiry is the determination of penal liability. Even where reasonable grounds to suspect an offence exist, it will not always be true that the predominant purpose of an inquiry is the determination of penal liability.    In this regard, courts must guard against creating procedural shackles on regulatory officials; it would be undesirable to "force the regulatory hand" by removing the possibility of seeking the lesser administrative penalties on every occasion in which reasonable grounds existed of more culpable conduct. This point was clearly stated in McKinlay Transport, supra, at p. 648, where Wilson J. wrote: "The Minister must be capable of exercising these [broad supervisory] powers whether or not he has reasonable grounds for believing that a particular taxpayer has breached the Act." While reasonable grounds indeed constitute a necessary condition for the issuance of a search warrant to further a criminal investigation (s. 231.3 of the ITA; Criminal Code, s. 487), and might in certain cases serve to indicate that the audit powers were misused, their existence is not a sufficient indicator that the CCRA is conducting a de facto investigation. In most cases, if all ingredients of an offence are reasonably thought to have occurred, it is likely that the investigation function is triggered.

90         All the more, the test cannot be set at the level of mere suspicion that an offence has occurred. Auditors may, during the course of their inspections, suspect all manner of taxpayer wrongdoing, but it certainly cannot be the case that, from the moment such suspicion is formed, an investigation has begun. On what evidence could investigators ever obtain a search warrant if the whiff of suspicion were enough to freeze auditorial fact-finding? The state interest in prosecuting those who wilfully evade their taxes is of great importance, and we should be careful to avoid rendering nugatory the state's ability to investigate and obtain evidence of these offences.

91         The other pole of the continuum is no more attractive. It would be a fiction to say that the adversarial relationship only comes into being when charges are laid. Logically, this will only happen once the investigators believe that they have obtained evidence that indicates wrongdoing. Because the s. 239 offences contain an element of mental culpability, the state will, one must presume, usually have some evidence that the accused satisfied the mens rea requirements before laying an information or preferring an indictment. The active collection of such evidence indicates that the adversarial relationship has been engaged, since it is irrelevant to the determination of tax liability. Moreover, although there are judicial controls on the unauthorized exercise of power (Roncarelli v. Duplessis, [1959] S.C.R. 121; Babcock v. Canada (Attorney General), 2002 SCC 57, at para. 25), we believe that allowing CCRA officials to employ ss. 231.1(1) and 231.2(1) until the point where charges are laid, might promote bad faith on the part of the prosecutors. Quite conceivably, situations may arise in which charges are delayed in order to compel the taxpayer to provide evidence against himself or herself for the purposes of a s. 239 prosecution. Although the respondent argued that such situations could be remedied by the courts, we view it as preferable that such situations be avoided rather than remedied. It is for this reason that the test is as set out above.

92         Whether a matter has been sent to the investigations section is another factor in determining whether the adversarial relationship exists. Again, though, this, by itself, is not determinative. An auditor's recommendation that investigators look at a file might result in nothing in the way of a criminal investigation since there is always the possibility that the file will be sent back. Still, if, in an auditor's judgment, a matter should be sent to the investigators, a court must examine the following behaviour very closely. If the file is sent back, does it appear that the investigators have actually declined to take up the case and have returned the matter so that the audit can be completed? Or, does it appear, rather, that they have sent the file back as a matter of expediency, so that the auditor may use ss. 231.1(1) and 231.2(1) to obtain evidence for a prosecution (as was found to be the case in Norway Insulation, supra).

93         To reiterate, the determination of when the relationship between the state and the individual has reached the point where it is effectively adversarial is a contextual one, which takes account of all relevant factors. In our opinion, the following list of factors will assist in ascertaining whether the predominant purpose of an inquiry is the determination of penal liability. Apart from a clear decision to pursue a criminal investigation, no one factor is necessarily determinative in and of itself, but courts must assess the totality of the circumstances, and make a determination as to whether the inquiry or question in issue engages the adversarial relationship between the state and the individual

94         In this connection, the trial judge will look at all factors, including but not limited to such questions as:

(a)         Did the authorities have reasonable grounds to lay charges? Does it appear from the record that a decision to proceed with a criminal investigation could have been made?

(b)         Was the general conduct of the authorities such that it was consistent with the pursuit of a criminal investigation?

(c)         Had the auditor transferred his or her files and materials to the investigators?

(d)         Was the conduct of the auditor such that he or she was effectively acting as an agent for the investigators?

(e)         Does it appear that the investigators intended to use the auditor as their agent in the collection of evidence?

(f)          Is the evidence sought relevant to taxpayer liability generally? Or, as is the case with evidence as to the taxpayer's mens rea, is the evidence relevant only to the taxpayer's penal liability?

(g)         Are there any other circumstances or factors that can lead the trial judge to the conclusion that the compliance audit had in reality become a criminal investigation?

It should also be noted that in this case we are dealing with the CCRA. However, there may well be other provincial or federal governmental departments or agencies that have different organizational settings which in turn may mean that the above factors, as well as others, will have to be applied in those particular contexts.

. . .

97         The predominant purpose test does not thereby prevent the CCRA from conducting parallel criminal investigations and administrative audits. The fact that the CCRA is investigating a taxpayer's penal liability, does not preclude the possibility of a simultaneous investigation, the predominant purpose of which is a determination of the same taxpayer's tax liability. However, if an investigation into penal liability is subsequently commenced, the investigators can avail themselves of that information obtained pursuant to the audit powers prior to the commencement of the criminal investigation, but not with respect to information obtained pursuant to such powers subsequent to the commencement of the investigation into penal liability. This is no less true where the investigations into penal liability and tax liability are in respect of the same tax period. So long as the predominant purpose of the parallel investigation actually is the determination of tax liability, the auditors may continue to resort to ss. 231.1(1) and 231.2(1). . . . Put another way, the requirement powers of ss. 231.1(1) and 231.2(1) cannot be used to compel oral statements or written production for the purpose of advancing the criminal investigation.

[190] So, in light of the above, it is clear that it was possible here for the Minister to carry on at the same time an audit with a view to issuing a new assessment and an investigation for determining whether there were grounds to charge Mr. Morley (and other persons involved with the Partnership) under section 239.

[191] It is important to recall some relevant facts and key steps in the audit. The audit started sometime in July or August 1994. Actually, a letter dated July 22, 1994, was sent by an auditor at the tax avoidance section to Mr. Gamble. After a lenghty correspondence and a number of meetings, demonstrations and disputes over whether the source codes would be provided to the consultants hired by the Minister to assess the nature of the Software and its value, the audit was completed in July 1996. The tax avoidance auditor was ready to inform the Limited Partners of the minister's intention to reassess them on July 31, 1996 (Tab 335), but Mr. Beach was able to stonewall this process until October 1996 (Tabs 328, 338, 339, 341, 352 and 354). Mr. Morley's audit was formally completed only in November 1997, after he had requested more time to make representations to the Minister and, after he had signed a waiver to that end. But it was a case of applying to him the same determination as that which had been made with regard to the others. The meetings that took place after the November 1996 assessments were mainly at the request of Mr. Gamble. This was the case for the meeting held on April 29, 1997, at which Mr. Morley and the Director, Tax Avoidance were present (Tabs 389 and 390).

[192] It should be remembered that the fact that a tax avoidance auditor had reasonable grounds to believe that an offence had been committed is not sufficient in itself to justify a determination that an audit has turned into an investigation (paragraph 89 of Jarvis). It must be ascertained whether the predominant purpose of an inquiry is the determination of penal liability. Furthermore, the fact that the file had been sent to the investigations section is not in itself determinative with regard to an investigation having begun (see paragraph 92 of Jarvis).

[193] In addition, it is stated in paragraph 97 of Jarvis that it is possible to carry out at the same time a criminal investigation and a civil audit. For the purposes of the audit, there is no requirement that the taxpayer be informed of his right to remain silent. So, when all the facts are considered, it is difficult to conclude here that the work done by the tax avoidance auditor was performed in the course of a criminal investigation. I do not believe that his mere suspicion that there may have been reasonable grounds is sufficient to turn his activities into a criminal investigation. That his superior did not approve his referral of the case to SI may, moreover, be indicative of the fact that his grounds were not sufficient even for a referral to SI. In any event, it was not the tax avoidance auditor's job to investigate a criminal offence. That was the SI investigator's role. There is no evidence that the tax avoidance auditor acted as an agent for the SI investigator or that he passed on to the investigator any information obtained after the criminal investigation started.

[194] It is possible that the tax avoidance auditor's superior made his decision to postpone the referral of the tax avoidance auditor's file to SI for improper motives, but evidence of that was not adduced before me and I have no reason to believe that such was the case. Furthermore, there is no evidence that the information obtained by the tax avoidance auditor was so obtained for the main purpose of carrying out a criminal investigation. The fact that the audit process was almost finished in July 1996 and that it was completed sometime in November 1996 with respect to a large number of the Limited Partners supports the position that the meeting that took place subsequent to the referral to SI was in response to the request by the taxpayer for a meeting. Mr. Gamble was still hoping that he could convince the audit section that there were no grounds for disallowing the losses.

[195] In addition, there is no evidence that would indicate that the tax avoidance auditor provided to the SI investigator any information that was obtained after the completion of his information paper. When cross-examined during his examination for discovery, that auditor was not asked to detail the kind of information he would have provided to the SI officer. For all these reasons, I conclude that there is no proof that Mr. Morley's Charter rights have been breached.

[196] At the hearing of a pre-trial motion, I had informed the parties that the Charter violation issue would have to be raised at the time of the filing of the exhibits. At the hearing, no such issue was raised when these were filed. Since he consented to the production of most of the evidence, it would be difficult to imagine how Mr. Morley could put forward any ground for vacating the assessment. As indicated in his written argument, counsel for Mr. Morley submitted that the Charter argument might be more relevant in the determination of costs. Given that this issue has been raised, I indicated that I would not issue an order as to costs prior to having given both sides an opportunity to make representations.

III      Conclusion

[197] For all of these reasons, the appeals of Mr. Morley will be allowed and the assessments for the 1990 and 1993 taxation years will be referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that he is entitled to his share of the Partnership's losses, that these losses should be determined taking into account the fact that the Software was acquired by the Partnership in 1993 for the purpose of earning income from its business but was not available for use in that year, and that the penalties should be vacated.

Signed at Ottawa, Canada, this 13th day of April, 2004.

"Pierre Archambault"

Archambault, J.

	APPENDIX TO PARAGRAPH 130 OF THE REASONS FOR JUDGMENT
AGENSYS Software in Canada
Determination of Fair Market Value
At June 30, 1993
						Schedule 1
			Low			High
Unadjusted Value
	Low value range - Schedule 2A		798,500
	High value range - Schedule 2B					1,356,000
Less: Development Cost Adjustments
	Low range - Schedule 5A		(250,900)
	High range - Schedule 5B					(220,900)
Fair market value of the Software			547,600			1,135,100
	Rounded		548,000			1,135,000
Hypotheses
	For the LOW value, the discount rate is 45 % and the multiple is 7.
	For the HIGH value, the discount rate is 40 % and the multiple is 9.
	The Software was acquired and available in 1993.
	Only ongoing development costs are taken into account, no initial ones.
	Development costs are added to UCC and are subject to half -year rule.

Agensys Software in Canada
Unadjusted Value Determination
Low Value Range
																									Schedule 2A
																									Terminal
				1992	1993	1994		1995			1996	1997			1998		1999					2000	2001	2002	Value
Discretionary cash flow				0	(39,609)	62,242		(42,069)			144,651	476,630			864,584		1,302,679					1,636,598	1,715,194	1,833,413	1,904,751
	Schedule 3A
Terminal Value multiple																									7 X
Terminal Value						0		0			0	0			0		0					0	0	0	13,333,254
Present value at 45%				0	(27,315)	29,602		(13,798)			32,719	74,349			93,008		96,643					83,732	60,518	44,612	324,432
Present Value of:
		Forecast Period		474,068
		Terminal Value		324,432
		Unadjusted Value		798,500
				798,500	=(VAN(C$41,D$13:M$13))+VAN(C$41,E18:N18)

Agensys Software in Canada
Unadjusted Value Determination
High Value Range
													Schedule
													2B
													Terminal
		1992	1993	1994	1995	1996	1997	1998	1999	2000	2001	2002	Value
Discretionary cash flow		0	85,829	187,679	(42,069)	144,651	476,630	864,584	1,302,679	1,636,598	1,715,194	1,833,413	1,904,751
	Schedule 3B
Terminal Value multiple													9 X
Terminal Value				0	0	0	0	0	0	0	0	0	17,142,755
Present value at 40%		0	61,304	95,748	(15,330)	37,649	88,607	114,802	123,549	110,866	82,990	63,363	592,451
Present Value of:
	Forecast Period	763,549
	Terminal Value	592,451
	Unadjusted Value	1,356,000
		1,356,000	=(VAN(C$41,D$13:M$13))+VAN(C$41,E18:N18)

Agensys Software in Canada
Discretionary Cash Flow Projections
Low Value Range
												Schedule
												3A
	1992	1993	1994	1995	1996	1997	1998	1999	2000	2001	2002	Thereafter
Op. profit per Pritchard Projections	0	(364,955)	(157,247)	17,160	516,834	1,265,070	1,920,381	2,848,313	3,062,101	3,224,692	3,463,183	3,463,183
Schedule 4
Income taxes
Recoverable (payable) on op. profit	0	164,230	70,761	(7,722)	(232,575)	(569,282)	(864,172)	(1,281,741)	(1,377,945)	(1,451,111)	(1,558,432)	(1,558,432)
Tax shield on CCA from Software		179,663	179,663	0	0	0	0	0	0	0	0	0
	0	343,892	250,424	(7,722)	(232,575)	(569,282)	(864,172)	(1,281,741)	(1,377,945)	(1,451,111)	(1,558,432)	(1,558,432)
After-tax cash flow	0	(21,063)	93,177	9,438	284,259	695,789	1,056,210	1,566,572	1,684,156	1,773,581	1,904,751	1,904,751
Deduct: working capital requirements	0	(18,546)	(30,935)	(51,507)	(139,608)	(219,159)	(191,626)	(263,893)	(47,557)	(58,387)	(71,337)
Discretionary cash flow	0	(39,609)	62,242	(42,069)	144,651	476,630	864,584	1,302,679	1,636,598	1,715,194	1,833,413	1,904,751

Agensys Software in Canada
Discretionary Cash Flow Projections
High Value Range
												Schedule
												3B
		1993	1994	1995	1996	1997	1998	1999	2000	2001	2002	Thereafter
Op. profit/Pritchard Project.		(364,955)	(157,247)	17,160	516,834	1,265,070	1,920,381	2,848,313	3,062,101	3,224,692	3,463,183	3,463,183
Schedule 4
Income taxes
Recov. (pay) on op. profit		164,230	70,761	(7,722)	(232,575)	(569,282)	(864,172)	(1,281,741)	(1,377,945)	(1,451,111)	(1,558,432)	(1,558,432)
Tax shield: CCA on Sw		305,100	305,100	0	0	0	0	0	0	0	0	0
		469,330	375,861	(7,722)	(232,575)	(569,282)	(864,172)	(1,281,741)	(1,377,945)	(1,451,111)	(1,558,432)	(1,558,432)
After-tax cash flow		104,375	218,614	9,438	284,259	695,789	1,056,210	1,566,572	1,684,156	1,773,581	1,904,751	1,904,751
Deduct: work. cap. Requir.		(18,546)	(30,935)	(51,507)	(139,608)	(219,159)	(191,626)	(263,893)	(47,557)	(58,387)	(71,337)
Discretionary cash flow		85,829	187,679	(42,069)	144,651	476,630	864,584	1,302,679	1,636,598	1,715,194	1,833,413	1,904,751

Agensys Software in Canada
Development Cost Adjustments
Low Value Range
													Schedule
													5A
		1992	1993	1994	1995	1996	1997	1998	1999	2000	2001	2002	Thereafter
Initial development costs
	Estimated at
Ongoing development costs				5,641	15,050	30,717	73,181	139,842	198,128	278,396	292,861	310,620	332,319
	5% of sales		11,282	30,101	61,434	146,362	279,684	396,256	556,791	585,722	621,241	664,637	664,637
			(5,641)	(15,050)	(30,717)	(73,181)	(139,842)	(198,128)	(278,396)	(292,861)	(310,620)	(332,319)	(332,319)
Less: income taxes		0	(2,538)	(9,311)	(20,595)	(46,754)	(95,860)	(152,087)	(214,436)	(257,065)	(271,567)	(289,323)	(299,087)
Net development costs		0	3,103	11,380	25,172	57,144	117,163	185,884	262,088	314,191	331,915	353,616	365,551
	Terminal Value multiple												7 X
	Terminal Value adjust.												2,558,854
CCA adjustment in respect of
	development costs		56,453	56,453
Net cash outflow		0	59,555	67,833	25,172	57,144	117,163	185,884	262,088	314,191	331,915	353,616	2,558,854
45%	Present value	0	41,072	32,262	8,256	12,926	18,277	19,998	19,445	16,076	11,712	8,605	62,270
	Net Present Value	250,900

Agensys Software in Canada
Development Cost Adjustments
High Value Range
													Schedule
													5B
		1992	1993	1994	1995	1996	1997	1998	1999	2000	2001	2002	Thereafter
Initial development costs
	Estimated at
Ongoing development costs				3,385	9,030	18,430	43,909	83,905	118,877	167,037	175,717	186,372	199,391
	3% of sales		6,769	18,060	36,860	87,817	167,810	237,754	334,075	351,433	372,744	398,782	398,782
			(3,385)	(9,030)	(18,430)	(43,909)	(83,905)	(118,877)	(167,037)	(175,717)	(186,372)	(199,391)	(199,391)
Less: income taxes		0	(1,523)	(5,587)	(12,357)	(28,053)	(57,516)	(91,252)	(128,661)	(154,239)	(162,940)	(173,594)	(179,452)
Net development costs		0	1,862	6,828	15,103	34,286	70,298	111,530	157,253	188,515	199,149	212,170	219,330
	Terminal Value multiple												9 X
	Terminal Value adjustment												1,973,973
CCA adjustment in respect of
	development costs		49,703	49,703
Net cash outflow		0	51,564	56,531	15,103	34,286	70,298	111,530	157,253	188,515	199,149	212,170	1,973,973
40%	Present value	0	36,832	28,842	5,504	8,925	13,071	14,813	14,918	12,774	9,639	7,335	68,246
	Net Present Value	220,900

CITATION:

2004TCC280

COURT FILE NO.:

2000-3716(IT)G

STYLE OF CAUSE:

David Morley and Her Majesty the Queen

PLACE OF HEARING:

Toronto, Ontario

DATES OF HEARING:

September 15, 16, 17, 18, 19, 22, 23,24, 25, 26, 29 and 30 and October 2 and 3, 2003

REASONS FOR JUDGMENT BY:

The Hon. Justice Pierre Archambault

DATE OF JUDGMENT:

April 13, 2004

APPEARANCES:

Counsel for the Appellant:

Sheldon Silver and David Poore

Counsel for the Respondent:

Elizabeth Chasson Joel Oliphant and Eric Noble

COUNSEL OF RECORD:

For the Appellant:

Name:	Sheldon Silver
Firm:	Goodmans, LLP, Barristers and Solicitors Toronto, Ontario

For the Respondent:

Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada

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