Groupmark Canada Ltd. v. The Queen, 93 DTC 5179, [1993] 1 CTC 234 (FCTD)

Walsh, D.J.:— This action concerns a deduction sought by plaintiff in its 1984 tax year of a tax credit in the amount of $60,000 pursuant to the scientific research and experimental development tax credit program, for advances made by it to a company N.D.R. Technologies Inc. (N.D.R.) in that year. There is little dispute as to the facts, the issues depending on the interpretation to be given to subsection 194(4) and section 127(3) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the"Act").

By agreement dated May 18, 1984 between plaintiff and N.D.R., it was agreed that N.D.R. would issue a non-interest bearing promissory note to Groupmark in the amount of $120,000 which Groupmark would purchase and pay for. N.D.R. would designate pursuant to subsection 194(4) of the Income Tax Act this full amount and file the appropriate documentation. The note was issued and plaintiff became the registered holder thereof.

The plaintiff contends that as of May 18, 1984 it had already advanced to N.D.R. amounts in excess of $30,000 and thereafter advanced funds to N.D.R. or on behalf of N.D.R. in excess of the agreed $120,000. N.D.R. filed a designation under section 194 of the Act dated June 29, 1984 designating the amount of $120,000 in respect of the promissory note in plaintiff's name as a result of which plaintiff claimed a tax credit of $60,000 pursuant to subsection 127.3(1) of the Act.

The defendant contends that no amount was paid to N.D.R. by plaintiff at the time the purchase of the note took place. Defendant only admits that between March 15 and September 30, 1984 plaintiff from time to time advanced moneys to N.D.R. or issued cheques to third parties on behalf of N.D.R. without being legally obligated to do so. Defendant admits the designation of $120,000 by N.D.R. but states that as this exceeds the consideration for which the note was issued, the designation was invalid and plaintiff was not entitled to the scientific research and experimental tax credit claimed by it.

It is not disputed that both plaintiff and N.D.R. Technologies Inc. were corporations controlled by Edwin Cathcart and not dealing at arm's length. Plaintiff's business activity was that of an automobile driver's club, the business being described by Mr. Cathcart in testifying as a member services business. N.D.R. was purportedly engaged in scientific research, building an eight metre racing sail boat. At about this period, according to Mr. Cathcart's evidence, the idea of a winged keel for a racing sail boat had come to public attention as a result of the America's Cup races, and it was this sort of a keel which N.D.R. was experimenting with. The cost would be over $100,000 which N.D.R. did not have, and Croupmark provided the financing.

Subsection 194(4) of the Income Tax Act reads as follows: (deleting portions not pertinent in this case)

Every taxable Canadian corporation may, by filing a prescribed form with the Minister at any time on or before the last day of the month immediately following a month in which it issued . . . or debt obligation or granted a right under a scientific research and experimental development financing contract designate for the purposes of this Part and Part I an amount in respect of that . . . or debt obligation . . . not exceeding the amount by which

(a) the amount of the consideration for which it was issued or granted, as the case may be.

Subsection 127.3(1) reads:

There may be deducted from the tax otherwise payable under this Part by a taxpayer for a tax year an amount not exceeding the aggregate of

(a) his scientific research and experimental development tax credit for the year;

and

(b) his unused scientific research and experimental development tax credit for the taxation year immediately following the year.

The relevant parts of subsection 127.3(2) read:

Scientific research and experimental development tax credits of a taxpayer for a taxation year means the aggregate of all amounts each of which is an amount equal to

(i) where a taxpayer is a corporation 50 per cent of an amount designated by a corporation under subsection 194(4) of

(iv) a bond, debenture, bill, note, mortgage, hypothec or similar obligation (in this section and in Part VIII referred to as a "debt obligation”) acquired by the taxpayer in the year.

As the basis for alternative arguments, during the questioning of the witness Cathcart, reference was made to certain figures in Exhibit produced by plaintiff being extract from the cash ledger of N.D.R. from which could be calculated totals of amounts advanced by Groupmark to N.D.R. or accounts of N.D.R. paid on it as of May 18, 1984: the date of the agreement, totalling $33,350 and as of June 29, 1984 the date of the subsection 194(4) designation totalling $53,197.20. These figures calculated by counsel do not appear to exactly correspond with the totals of the amounts shown in the Exhibit, but it is not the actual amounts which are significant but the fact that plaintiff had made substantial advances to N.D.R. before the said two dates. Another column of the said cash ledger of N.D.R. for the periods in question indicates that it had spent these amounts and more on boat development by the said dates, and eventually considerably more to a total of $163,364.53 of which $142,103.18 was due to Groupmark. Another investor by the name of Yale had provided $25,000. There is no issue as to whether investments for scientific research and experimental development have to be made in cash to the developer, or whether payments can be made on behalf of the developer to its creditors for goods and services furnished for the development, as was frequently done in this case by Groupmark after June 11, 1984, nor is there any suggestion that N.D.R. did not receive amounts in excess of the $120,000 covered by the promissory note from Groupmark.

In a situation such as the present where both companies were under the control of Mr. Cathcart, who in fact signed the agreement of May 18, 1984 on behalf of both companies, the promissory note given by N.D.R. to Groupmark, and the designation under section 194 on June 29, 1984 as President of N.D.R. there is an ever present possibility of fraud, but there is no suggestion that that was the case here, nor has defendant pleaded that subsection 194(5) dealing with tax evasion in these circumstances can be applied. It is not a case where the debt obligation was fraudulently issued for amounts never received by N.D.R. or whether the amounts were not in fact used for scientific research and experimental development by it. It is not the tax return of N.D.R. Technologies Inc. which is being considered, and a corporation such as Groupmark making advances for such purposes is under no obligation once the section 194 designation is made to oversee how the funds are used by the recipient.

The defendant's position is more technical, seeking a strict interpretation of the word "consideration" in subsection 194(4), supra, contending that at the time the note was issued no $120,000 consideration was given for it, as amounts given by plaintiff to N.D.R. before this, whether by way of loans, gifts, or whatever, cannot be found to be consideration for the issue of the note, nor can amounts paid subsequently. The note in the usual form “for value received" constitutes a promise to pay, but at the time of its issue on May 29, N.D.R. had not received the $120,000 but only what amounts to a promise to provide this amount pursuant to the agreement made the same date. In the event of failure to make payments totalling this amount, N.D.R. might have a recourse against plaintiff by virtue of the agreement but defendant argues that Groupmark could not benefit by virtue of the designation to claim tax credits resulting from amounts not advanced. Furthermore, a promissory note is a negotiable instrument which can be disposed of by the holder, notwithstanding the statement in the agreement that the purchase of the note is for investment only and not with a view to its resale or distribution.

It is of some interest to note that the agreement states in paragraph 1: "The corporation hereby agrees to issue and sell and the purchaser hereby agrees to purchase, take up and pay for, as of the date hereof, a registered promissory note in the principal amount of $120,000.” The wording is somewhat ambiguous in that it might be argued that Groupmark (the purchaser) agreed to pay for the note "as of the date hereof". Plaintiff argues, however, that the words "as of the date hereof" relate to the word” purchase", which was its intent, as it was not paying $120,000 at that time, although the witness Cathcart testified it could have but was advised it was not necessary. The decision in this case cannot depend on the wording of the agreement, however, but on the interpretation to be given to the Income Tax Act applied to the undisputed facts of this case.

Neither can this decision depend on the treatment given to this amount in the tax returns of N.D.R. Technologies. In its tax return as of February 29, 1985, the balance sheet shows a current liability of $120,000 due on a promissory note to Groupmark as well as $22,103.18 as amounts payable to Groupmark, whereas in its return for the following year the balance sheet shows a current liability of $60,000 on a promissory note due to Groupmark as well as $22,034.43 due to it on accounts payable. Counsel explained that the reduction to $60,000 on account payable reflected the anticipated tax credit of $60,000 which Groupmark had claimed under the scientific research and experimental development provisions of the Act.

The plaintiff cited some jurisprudence although none directly deals with the question in issue here. On the meaning of consideration” reference was made to the Tax Review Board case of Mauger Estate v. M.N.R., [1972] C.T.C. 2264, 72 D.T.C. 1234, in which an attempt to assess gift tax was made on property transferred by a father to his daughter who had cared for him during a long illness. It was found that there was no evidence of a gift or of fraud. Definition of consideration from Black's Law Dictionary, 4th ed., page 279 was referred to at page 2268 (D.T.C. 1237) as follows:

The inducement to a contract. The cause, motive, price, or impelling influence which induces a contracting party to enter into a contract.

On the question of interpretation of a tax statute, reference was made to the statement of Estey, J. in the Supreme Court in the case of Johns-Manville Canada Inc. v. The Queen, [1985] 2 S.C.R. 46, [1985] 2 C.T.C. 111, 85 D.T.C. 5373 at page 126 C.T.C. (D.T.C. 5384) in which he refers to a "basic concept in tax law that where the taxing statute is not explicit, reasonable uncertainty or factual ambiguity resulting from lack of explicitness in the statute should be resolved in favour of the taxpayer."

This question was also dealt with by the Court of Appeal in Canterra Energy v. The Queen, [1987] 1 C.T.C. 89, 87 D.T.C. 5019. After referring at page 93 (D.T.C. 5022) to Stubart Investments Ltd. v. The Queen, [1984] 1 S.C.R. 536, [1984] C.T.C. 294, 84 D.T.C. 6305 at page 316 (D.T.C. 6323) where reference was made by Estey, J. to E.A. Driedger, Construction of Statutes, 2nd ed. (1983) at page 87, the judgment states at page 95 (D.T.C. 5023), in referring to a Regulation:

If the regulation was not aptly worded to carry out his original intention it does not mean that this Court should preclude the taxpayer from taking advantage of the benefits of the provision as worded.

and later,

lf the regulation in issue is insufficiently explicit to carry out what may have been the intention of the Governor in Council, the taxpayer should not be deprived of benefits arising from that lack of explicitness.

At page 96 (D.T.C. 5024) reference is again made to the judgment of Estey, J. in Stubart where he said at page 315 (D.T.C. 6322):

Thus, the statute (the Income Tax Act) is a mix of fiscal and economic policy. The economic policy element of the Act sometimes takes the form of an inducement to the taxpayer to undertake or redirect a specific activity.

Counsel argues that the policy to give tax incentives to direct funds to scientific research and experimental development does not require that the funds be advanced in a lump sum at one time, when, as in the case of a single research project such as that in the present case it is convenient to advance the funds from time to time as required, and nothing in section 127.3 or subsection 194(4) requires this.

On the question of there being no obligation on the part of the investing corporation to oversee the use of the funds by the research corporation for that purpose once the subsection 194(4) designation has been received, reference was made to the case of United Equities Ltd. v. M.N.R., [1992] 2 C.T.C. 213, 92 D.T.C. 6572 (F.C.T.D.), in which MacKay, J. dealing with a late designation, stated at page 223 (D.T.C. 6579):

If the designation form T2113 were filed in time in accord with subsection 194(4) the investor's position was protected, regardless of whether the designating corporation met its tax liability by paying the refundable tax within the prescribed time and whether or not it did any research. The only exception, under subsection 195(5), is where the investor knew or ought to have known at the time of the transaction, that the designating corporation would wilfully evade or attempt to evade the tax, in which event the S.R.T.C. would not be recognized.

As already stated, that is not the case here.

Paragraph 127.3(2)(a) defines “scientific research and experimental tax credit” and refers to subsection 194(4) the designation section. It refers to the “aggregate of all amounts” each of which is so designated. I do not conclude that this can mean that when funds are advanced from time to time as in the present case, a separate designation must be made each time, rather than an amount representing the total advanced during the taxation year in question. Plaintiff's counsel points out that in paragraph 127.3(2)(a) it is the word "amount" which is used. It is only in subsection 194(4) that the word "consideration" is used in the clause "the amount of the consideration for which it was issued or granted". There is no qualification of the word "consideration" such as "cash" or “monetary” consideration. Certainly "consideration" is not limited to cash, but if it included non-monetary items such as research equipment, these would have to be evaluated. It is the responsibility of the research corporation in issuing the designation however to comply with this. The investor merely accepts and acts on the designation.

Reference was also made to subsection 194(6) dealing with scientific research and experimental development financing contracts which uses the words "an amount is paid" not “will be paid" as an analogy, it being pointed out that similar words could have been used in subsection 194(4) instead of the more ambiguous words amount of the consideration for which it was issued”, it being suggested that this distinction was deliberate and that the fact the words" is paid" do not appear in subsection 194(4) indicate that payment does not have to be made simultaneously with the issuance of the debt obligation, but can be made before or after provided the amount so designated is received.

The defendant argues, however, that the choice of a promissory note as the form of debt obligation was that of plaintiff, and consideration for it cannot be a promise to pay the balance in future.

In the case of Bank of Nova Scotia v. The Queen, [1980] C.T.C. 57, 80 D.T.C. 6009, dealing with exchange rates, Addy, J. stated at pages 59-60 (D.T.C. 6011):

The word “ payable” does not normally mean “paid”. Kohler's Dictionary for Accountants, 5th edition, defines "payable" as follows: Unpaid, whether or not due. A liability; a debt owing to another; an account or note payable. Normally, for an amount to be payable there must be a clear legal though not necessarily immediate obligation to pay it. (Refer M.N.R. v. John Colford Contracting Co., [1960] C.T.C. 178, 60 D.T.C. 1131, as to the similar comment relating to the word "receivable.") It seems self-evident that ordinarily an amount which is payable is not yet paid and conversely an amount which is paid is no longer payable.

At page 60 (D.T.C. 6012) reference is made to the British case of Greig (Inspector of Taxes) v. Ashton, [1956] 3 All E.R. 123 where at page 125 Harman, J. stated :

It is agreed that "payable" in one sense must mean“ "paid"; in other words credit cannot be given in England for tax which has not yet been paid in the United States.

In the case of Blais v. M.N.R., [1990] 2 C.T.C. 2005, 90 D.T.C. 1499 in the Tax Court dealing with monthly alimentary payments to be made by the husband to the wife to be set off against $20,000 which she owed him for his interest in the matrimonial home which monthly payments he sought to deduct from his income and were added to hers, the agreement having been ratified in Court, it was held that this did not constitute payment within the meaning of the Income Tax Act. It was held that they were not paid because payment means the handing over of funds. At page 2008 (D.T.C. 1502) the comment is made:

Parliament does not say in paragraph 60(b) “any amount paid or deemed to have been paid”. Similarly in paragraph 56(1)(b) there is no attempt to expand the meaning of the concept" received" by including operations that resemble it.

The defendant argues that while a promise to pay may be“ "consideration" under the Common Law it is not within the meaning of the Income Tax Act, as there must be an "amount" which has been received before the credit can be claimed.

With respect to plaintiff's alternative argument that even if payments made to N.D.R. after the issue of the debt obligation (the promissory note) cannot be considered as payments on account of it, those made before May 18, or alternatively before June 29, should be so considered, being payments to N.D.R. for the scientific research for which it was issued, defendant points out that this contention is not set out in the statement of claim nor prayer for relief thereon. Plaintiff claims deductibility for the full $60,000 based on an advance of $120,000. Furthermore, defendant is not prepared to abandon the argument that any such payments were made by plaintiff voluntarily before any agreement was entered into with N.D.R. that they were for scientific research, and the note was issued by virtue of this agreement, so that they cannot be claimed as advance payments on account of the note. All payments before and after were made in fulfilment of the agreement, which defendant does not deny, but they were not made "for value received" nor constitute the "consideration" for which the note was issued within the meaning of subsection 194(4) of the Act, and defendant insists on a strict interpretation of the terms of the Income Tax Act.

I conclude that while these sections of the Act can easily lead to fraud when both the investing and research corporations are under the same control, as here, once it has been concluded that no fraud took place, as has been concluded in this case, it would be unrealistic and contrary to the intent of the Act to apply defendant's construction of the meaning of "consideration" in subsection 194(4) so as to deprive plaintiff of the benefit of the deduction of $60,000 resulting from its advances to N.D.R. of over $120,000, some before the agreement of May 18, continuing during the period between that date and the date of the designation on June 29, and again thereafter until more than the $120,000 provided for in the agreement had been advanced, or that because of the choice of the debt instrument (the promissory note) instead of some other form of recognition of the debt, the real purpose of these advances was defeated.

The plaintiff's appeal is therefore allowed and the reassessment disallowing the tax credit of $60,000 for 1984 is vacated; with costs.

Appeal allowed.