First Fund Genesis Corp. v. The Queen, 91 DTC 5361, [1991] 2 CTC 14 (FCTD)

Joyal, J.: —For some time in the period relevant to this appeal, the workings of the Scientific Research Tax Credit System ("SRTC") under the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act") had been a source of concern to Revenue Canada. One of these concerns was what was known as the "quick flip” transaction whereby an issuer of debentures or other instrument for which a scientific research programme had been designated would immediately redeem the debenture at a discount price while at the same time providing the investors in these debentures with a tax credit based on their full face value with limited risk to investors.

On October 10, 1984, the Minister of Finance issued a press release announcing an end to this kind of transaction. The Minister stated that pending the adoption of the necessary legislation, such transactions would no longer qualify for tax credits. The Minister, however, provided for a grandfather clause to protect pending transactions and stated that such transactions would still qualify if there were evidence in writing that arrangements for the issue of any such security were substantially advanced before October 10, 1984.

Early in 1986, the necessary legislation was adopted. It not only put and end to the quick flip transaction, it put an end to the whole SRTC programme as it then existed. The grandfather clause, however, which had been announced on October 10, 1984, was preserved. Specifically, paragraph 194(4.2)(b) of the amended statute, in disallowing any further designations in respect of securities issued after October 10, 1984, exempted those transactions where written agreements had already been concluded prior to October 10, 1984 or “where arrangements, evidenced in writing for the issue of the share or debt obligation or the granting of a right were substantially advanced before October 10, 1984”.

It was on May 2, 1985 and on May 23, 1985, that an Edmonton company, Dell Chemical Corporation Ltd. ("Dell") issued debentures to the plaintiff for a total consideration of $7,500,000. Dell proceeded to designate 50 per cent of that amount, i.e., $3,750,000, as a scientific tax credit pursuant to subsection 194(4) of the Act. In its return for the 1985 taxation year, the plaintiff used this credit as a set-off to its tax liability arising under Part VIII of the Act.

On November 18, 1987, the Minister of National Revenue issued a notice of assessment to the plaintiff disallowing the credit it had claimed pursuant to the purchase of the debentures from Dell in May 1985. As a result, the plaintiff was said to owe the defendant a total of $4 715 822.01 in unpaid Part VIII taxes and interest. The Minister assessed the plaintiff on the ground that the issue of the debentures by Dell did not comply with the requirements of paragraph 194(4.2)(b) of the amended Income Tax Act. In effect, the Minister's position was that the arrangements for the issue of the debentures had not been substantially advanced before October 10, 1984.

The plaintiff filed a notice of objection on December 8, 1987, but the Minister confirmed the assessment on March 4, 1988. As a result, the plaintiff is now appealing the assessment before this Court.

Background

In 1973, Mr. Hubert Delisle began a research and development program which led to the discovery of a chemical formula having several potential applications. Mr. Delisle later sold the rights to the formula to Dell, a research and development company incorporated under the laws of the Province of Alberta.

In 1976, Dell sold the marketing rights to this formula, which became known as "Valu 100”, to Nortek Energy Corporation. The following year, Mr. Charles Robert Beesley bought Dell and moved the principal office of the company to Edmonton. Over the next few years, research into various possible applications of Valu 100 continued, as is shown in a letter from D.R. Shaw, Chief Chemist for the Energy Resources Conservation Board, dated August 17, 1983. The letter summarizes the results of testing on Valu 100 for purposes of use on oil spills. A second letter from Mr. Shaw, dated January 19, 1984, refers to the results of Valu 100 testing carried out in July-August 1983.

Mr. Beesley remained very interested in the development of Valu 100 and in 1984, he approached Nortek Energy Corporation with a view to reobtaining the rights to the formula. As a result, on June 19, 1984, Nortek agreed to retransfer all rights to the product, including the trade name Valu 100”, to Dell.

Ten days later, on June 29, 1984, the shareholders of Dell passed a special resolution in which they authorized the continuance of the company. One month later, that is on July 26, 1984, Mr. Beesley, president, secretary and presumably sole director or Dell at that time, authorized the issuance of fifty Class A" common voting shares to Mr. Ross Thomas Merrick, who was identified at the hearing as a professional engineer with expertise in the exploitation of petroleum and chemical products. Mr. Beesley testified that the shares were issued to Mr. Merrick to induce him to become Director of Research for the company.

A series of meetings of Dell's directors took place on August 6, 1984, at which time it was resolved that the officers and directors of the company would be authorized to negotiate Government Grants and/or SRTC Sales to permit the Company to continue with its research and development” of five specific projects. One of those projects was the development of a chemical to treat coal for purposes of transport.

It was also resolved on this date that Dell would enter into an agreement with R.J. Merrick & Associates whereby the latter would provide all research, engineering and consulting services for those same five projects. Mr. Beesley testified that Mr. Merrick was paid $90,000 for these services.

Finally, the directors passed a resolution that Dell be “authorized to proceed with a SRTC sale and to approach Mr. W.B. Kerntopf to assist the Company with the SRTC funding, application for Federal R & D Grants and to make a formal application to the Canadian Imperial Bank for interim project financing." Mr. Beesley testified that he was introduced to Mr. Kerntopf by a former partner of his, Mr. Zirp.

On August 8, 1984, the company's directors passed another resolution authorizing Dell to make an application to Rayjac Industrial Urethanes for SRTC funding. Mr. Kerntopf, who had experience in raising SRTC funds, testified that Rayjac and its president, David Raymer, were known to have participated in several SRTC financial arrangements.

Rayjac subsequently wrote to Dell on August 14, 1984, confirming that it had clients who would be interested in making SRTC purchases. Rayjac indicated that the funds would be secured by the issuance of a debenture or a promissory note subject to such conditions as would bring the transaction within the purview of s. 194 and s. 127.3 of the Income Tax Act. Rayjac also listed various types of information and documentation that it would need in order to arrange the financing. Finally, it indicated that it would charge a placement fee of 1-2 per cent of the issue price and that Dell would have to grant it the exclusive right to arrange for SRTC funding. This agreement was accepted by Dell.

On the same date, i.e., August 14, Mr. Kerntopf wrote a letter to Mr. Merrick outlining the steps which he had taken to secure financing for Dell. First, he indicated that he had spoken to Mac Alston of the Canadian Imperial Bank of Commerce in Calgary about PIP Grant interim funding and about SRTC funding, but that bank financing was refused in both cases. Secondly, Mr. Kerntopf wrote that he had contacted Anwar Khan, an international financial consultant, who advised Mr. Kerntopf that he was not able to recommend a source for SRTC transitional flip funding. Finally, Mr. Kerntopf stated that he would continue to make inquiries on Dell’s behalf. Mr. Kerntopf reaffirmed his willingness to continue to pursue SRTC financing for Dell in subsequent letters dated August 20, 1984 and September 20, 1984.

In the meantime, testing of the Valu 100 product was ongoing. Included in the plaintiff's various exhibits are two pages of handwritten notes outlining formulations for XP-100, a derivative of Valu 100, in relation to a mosquito insecticide application for the product. According to Mr. Beesley, these notes emanated from a company called Raylo Chemicals. They are dated August 11, 1984.

Another research report was sent to Dell on August 23, 1984 by Mr. Shaw at the Energy Resources Conservation Board. On September 21, Mr. Shaw again wrote to Ross Merrick at Dell outlining additional test results of a Valu 100 derivative, designed for oil disbursement application.

Meanwhile, sometime during the month of August 1984, Mr. Kerntopf was able to put together a few pages of handwritten notes providing information about Dell and some of its research projects. These notes then formed the basis of the company's typewritten Executive Summary", which was to be shown to potential investors. Attached to this summary was a research budget listing projected expenditures and receipts for a 12 month period. Total disbursements were projected at $8,387,000. SRTC sales were listed as one principal source of funding and were projected to total $3,187,000. This budget was also put together by Mr. Kerntopf, with Mr. Merrick's assistance, again sometime in August 1984.

Counsel for the plaintiff also produced Mr. Merrick's handwritten notes, which preceded the preparation of the executive summary and which provide a breakdown of certain projected expenditures with respect to a pilot plant research project.

Additional typewritten notes dealing specifically with the coal dust suppressant application of Valu 100 were produced as well. These notes were included in the closing documents when Dell issued the first debenture to the plaintiff on May 2, 1985. Mr. Beesley testified that these notes were also prepared in August 1984. Furthermore, Mr. Beesley testified that from July until midOctober 1984, he was in constant contact with Mr. Merrick, as the latter conducted research into various possible applications of the Valu 100 product.

Further proof of continuing research into applications of Valu 100 included a report dated September 13, 1984, in which Syncrude Canada Ltd. notified Mr. Merrick of test results concerning use of the XPSOOS derivative to extract oil from oil sands. Counsel for the plaintiff also produced a letter dated November 2, 1984 from OBED Mountain Coal Company Ltd. to Mr. Merrick, referring to previous moisture testing of the product for purposes of dust suppression and expressing an interest in the examination of such new products.

Finally, counsel produced a letter from the Coal Mining Research Centre dated March 7, 1985 and addressed to Mr. Beesley. The Centre refers in the letter to the extensive testwork it has performed on Dell’s coal treatment products and indicates its intention to continue the research.

Fewer details, however, are known concerning the issue of the debentures to the plaintiff in May 1985. Mr. Kerntopf testified that throughout the fall of 1984 he pursued funding for Dell and that sometime in November or December, he spoke to Peter Bradshaw, the manager of First Fund, who asked him for documentation. Mr. Kerntopf indicated that his next contact with the plaintiff occurred somewhere at the end of 1984 or at the beginning of 1985, when he met Brian Shaw, an agent for the plaintiff. Discussions between the two concerning Dell's various research projects eventually led to the issue of the debentures to the plaintiff in May 1985.

Mr. Kerntopf also testified that his involvement as intermediary between Dell and the plaintiff ended sometime in March 1985 after Mr. Shaw requested that he back off". He said that he was told about a proposed deal with Sasktel, but that he was not committed to additional projects and that he eventually decided to walk away from any further deals.

Mr. Beesley testified that he first learned of the plaintiff in the early part of 1985 through Mr. Kerntopf. He said that the parties decided in April 1985 that two debentures would be issued to the plaintiff. Although it had originally been anticipated that $7,500,000 would be devoted towards research and development of the coal dust suppressant application of Valu 100, Mr. Beesley testified that the company decided by the end of April 1985 that only $4 million would be used for this purpose and that the remaining $3.5 million would be directed to telecommunications research. According to Mr. Beesley, coal prices were down and he could not be positively assured of securing a contract for the sale of his product. Thus, plans were made to enter into the two telecommunications research and development projects, which appear in Dell’s "Business Development Summary". This summary formed part of the closing documentation prepared for the issue of the first debenture to the plaintiff on May 2, 1985.

That debenture was issued to the plaintiff in consideration for a purchase price of $3,871,600. On the same date, Dell redeemed the demand debenture in the amount of $2,322,960 in favour of the plaintiff. The remaining $1,548,640, minus $20,500 in legal fees, was placed in escrow with Guaranty Trust Co. It was agreed that the trustee would only release the escrowed funds upon compliance by Dellwith certain specified conditions, including, for example, the presentation of project certificates.

As part of the escrow agreement, Dell also designated the $3,871,600 purchase price pursuant to subsection 194(4) of the Income Tax Act in order to enable the plaintiff to claim a credit for that amount. As a result of this designation, Dell became liable for Part VIII taxes in the amount of $1,935,800 (i.e., 50 per cent of the purchase price). Later on, as Dell proceeded to expend funds on the specified research projects, this Part VIII tax would be accordingly reduced by 50 per cent.

As indicated above, on October 10, 1984, the Minister of Finance had announced that a moratorium would be placed on quick-flip" SRTC transactions. On November 23, 1984, Revenue Canada had released a set of guidelines to enable investors to determine whether proposed transactions would qualify under the new rules. The plaintiff therefore instructed Dell to obtain an independent opinion as to whether the issue of the debenture on May 2, 1985 would fall within the transitional provisions announced by Revenue Canada. Accordingly, Dell obtained a letter of opinion from Ernst & Whinney, dated April 30, 1985, to the effect that the proposed SRTC transaction complied with these guidelines.

On May 3, 985, the day after the debenture was issued to the plaintiff, Mr. Beesley testified that he sold his shares in Dell to Mr. James F. Armstrong. Thereafter he was involved in the second closing only to the extent necessary to finalize documents. Mr. Armstrong was in control of Dell by the time the second debenture was issued to the plaintiff and it is his name that appears on the closing documentation prepared in connection with the May 23, 1985 transaction.

This second debenture was issued in much the same way as the first. The purchase price of the debenture was $3,628,400. On the same date that the debenture was issued, Dell redeemed the debenture in the amount of $2,249,608, leaving an outstanding balance of $1,378,792. This balance was reduced by $5,000 in professional and administrative fees. Dell designated $3,628,400, representing the purchase price of the debenture, pursuant to subsection 194(4) of the Income Tax Act. This enabled the plaintiff to claim a corresponding amount as a credit and rendered Dell liable for Part VIII taxes in the amount of $1,814,200, subject to subsequent reductions as scientific research expenditures were incurred.

Once again, due to the pending moratorium on quick-flip SRTC transactions, Dell was required to obtain an independent opinion as to whether the proposed issue complied with the Revenue Canada guidelines. On June 27, 1985, Ernst & Whinney indicated to Touche Ross & Co. that as of May 22, 1985, Dell had continued to qualify under the grandfathering provisions.

Two years later, the Minister of Revenue assessed the plaintiff and disallowed these tax credits. This assessment eventually led to the institution of the present action, as has already been explained.

Pleadings

Plaintiff

Counsel for the plaintiff advanced three separate arguments. First of all, he submitted that despite the defendant's intentions, subsection 194(4.2) of the Income Tax Act, which came into force on February 13, 1986, did not have any retroactive effect. As a result, that subsection did not apply to the debentures issued and designated by Dell in May, 1985.

Secondly, counsel argued that even if subsection 194(4.2) were found to apply retroactively, then his client had complied with the requirements of that subsection. That is, arrangements for the issue of the two debentures were evidenced in writing and were substantially advanced before October 10, 1984.

Finally, counsel for the plaintiff noted that similar to other provisions in the statute where an assessment against a taxpayer may be made by ricochet, as it were, there is a specific provision in subsection 195(5) of the Act where in the case of wilful evasion or attempt thereat by an issuer of a debt obligation and of which the investor has or ought to have knowledge, that debt obligation is deemed not to have been acquired. There is, counsel continued, no similar or express provision in the Act which would allow the Minister to assess the purchaser of a debt obligation once that debt obligation has been designated pursuant to subsection 194(4) of the Act.

Counsel noted that should this Court uphold the Minister's assessment, then not only would the plaintiff lose a $3,750,000 tax credit but the issuer, Dell, would benefit from a reduction of its Part VIII taxes by the same amount. This result, according to counsel, would be both inequitable and contrary to the whole legislative scheme.

Defendant

Counsel for the Crown essentially attempted to refute each of the plaintiff's three arguments. First, he argued that subsection 194(4.2) of the Act does have retroactive effect so as to encompass the transactions which occurred between the plaintiff and Dell back in May 1985.

Secondly, he submitted that arrangements for the issue of the two debentures were not substantially advanced within the meaning of that subsection.

Finally, Crown counsel argued that the provisions in the Income Tax Act relating to SRTC transactions did in fact make it clear that the purchaser of an improperly designated debt obligation could be deprived of the corresponding tax benefit.

Findings

Does subsection 194(4.2) of the Income Tax Act have retroactive effect?

In order to fully understand and appreciate the plaintiff's first argument, it is necessary to examine the relevant legislation. Section 194 of the Income Tax Act reads in part as follows:

194. (1) Every corporation shall pay a tax under this Part for a taxation year equal to 50% of the aggregate of all amounts each of which is an amount designated under subsection (4) in respect of a share or debt obligation issued by it in the year or a right granted by it in the year.

(4) 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 a share or debt obligation or granted a right under a scientific research and experimental development financing contract (other than a share or debt obligation issued or a right granted before October 1983, or a share in respect of which the corporation has, on or before that day, designated an amount under subsection 192(4)) designate, for the purposes of this Part and Part I, an amount in respect of that share, debt obligation or right not exceeding the amount by which

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

(7) Where a taxable Canadian corporation that issued a share or debt obligation or granted a right under a scientific research and experimental development financing contract does not designate an amount under subsection (4) in respect of the share, debt obligation or right on or before the day on or before which such designation was required by that subsection, the corporation shall be deemed to have made the designation on that day if

(a) the corporation has filed with the Minister a prescribed information return relating to the scientific research and experimental development tax credit in respect of the share, debt obligation or right within the time that it would have been so required to file the return had the designation been filed on that day,

and

(b) within 3 years after that day, the corporation has

(i) designated an amount in respect of the share, debt obligation or right by filing a prescribed form with the Minister, and

(ii) paid to the Receiver General, at the time the prescribed form referred to in subparagraph (i) is filed, an amount that is a reasonable estimate of the penalty payable by the corporation for the late designation in respect of the share, debt obligation or right;

except that where the Minister has mailed a notice to the corporation that a designation has not been made in respect of the share, debt obligation or right under subsection (4), the designation and payment described in paragraph (b) must be made by the corporation on or before the day that is 90 days after the day of such mailing.

(8) Where, pursuant to subsection (7), a corporation made a late designation in respect of a share or debt obligation issued, or a right granted, in a month, the corporation shall pay, for each month or part of a month that elapsed during the period commencing on the last day on or before which an amount could have been designated by the corporation under subsection (4) in respect of the share, debt obligation or right and ending on the day that the late designation is made, a penalty for the late designation in respect of the share, debt obligation or right in an amount equal to one per cent of the amount designated i in respect of the share, debt obligation or right, except that the maximum penalty payable pa under this subsection by the corporation for a month shall not exceed 500

However, it is section 127.3 of the Act which actually creates the tax credit:

127.3 (1) There may be deducted from the tax otherwise payable under this Part by a taxpayer for a taxation 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.

(2)(a) "scientific research and experimental development tax credit"—. . . means the aggregate of all amounts each of which is an amount equal to

(i) where the taxpayer is a corporation, 50%, or

of an amount designated by a corporation under subsection 194(4) in respect of

(iv) a bond, debenture, bill, note, mortgage, hypothec or similar obligation . . . acquired by the taxpayer in the year where the taxpayer is the first person, other than a broker or dealer in securities, to be a registered holder thereof, or

(10) For greater certainty,

(a) for the purposes of this section and Part VIII, the amount of consideration for which a share, debt obligation or right was acquired and issued or granted includes the amount of any consideration for the designation under subsection 194(4) in respect of the share, debt obligation or right, and

(b) the amount received by a corporation as consideration for a designation under subsection 194(4) in respect of a share, debt obligation or right issued or granted by it shall not be included in computing its income.

Section 194 was amended by S.C. 1986, c. 6, section 103, which came into force on February 13, 1986. That subsection reads as follows:

103. (1) Section 194 of the Act is amended by adding thereto, immediately after subsection (4) thereof, the following subsections:

(4.1) Where a corporation has designated an amount under subsection (4) in respect of shares issued after May 23, 1985, in computing, at any particular time after that time, the paid-up capital in respect of the class of shares of the capital stock of the corporation that includes those shares

(4.2) —Notwithstanding subsection (4), no amount may be designated by a corporation in respect of

(b) a share or debt obligation issued or a right granted by the corporation after October 10, 1984, other than a share or debt obligation issued or a right granted before 1986

(i) under the terms of an agreement in writing entered into by the corporation before October 11, 1984, other than pursuant to an option to acquire the share, debt obligation or right if the option was not exercised before October 11, 1984, or

(ii) where arrangements, evidenced in writing, for the issue of the share or debt obligation or the granting of the right were substantially advanced before October 10, 1984; or

(2) Subsection 194(4.1) of the said Act, as enacted by subsection (1), is applicable after May 23, 1985.

[Emphasis added.]

Thus, subsection 103(2) of the amending Act specifically states that subsection 194(4.1) of the Income Tax Act would become applicable after May 23, 1985. (Subsection 194(4.1) deals with the computation of the paid-up capital of shares issued after May 23, 1985.) However, no corresponding provision exists specifically making subsection 194(4.2) of the Income Tax Act applicable retroactively. Therefore, counsel for the plaintiff argued that subsection 194(4.2) only applies to designations made on or after February 13, 1986, the date on which the amending legislation came into force. To support his argument, counsel invoked subsection 5(4) of the Interpretation Act, R.S.C. 1985, c. 1-21, which states that:

Where an Act provides that certain provisions thereof are to come or are deemed to have come into force on a day other than the date of assent to the Act, the remaining provisions of the Act are deemed to have come into force on the date of assent to the Act.

Counsel for the Crown, on the other hand, suggested that subsection 194(4.2) must be given retroactive effect by necessary implication in the same manner as subsection 194(4.1). Although there is no provision expressly stating that the former subsection applies retroactively to October 10, 1984, such an effect can be implied from the reference in that subsection to this and other specific transaction dates. Counsel argued that the amending legislation was simply a codification of what everyone knew was going to happen as a result of the press release by the Minister of Finance on October 10, 1984 and as a result of the budget announced on May 23, 1985.

I must admit that initially the argument of counsel for the plaintiff was somewhat alluring. The absence of a specific provision in the amending legislation directing that subsection 194(4.2) would apply as of a particular date raised doubts in my mind as to its retroactivity, especially in light of the existence of such a provision directing that subsection 194(4.1) would apply back to May 23, 1985. However, upon a thorough reading of all of the relevant sections of Part VIII of the Act, I find that I am in substantial agreement with Crown counsel that subsection 194(4.2) must also by necessary implication apply retroactively.

First of all, subsection 194(4) makes it clear that a corporation can only designate an amount under Part VIII of the Act in respect of issued shares or debt obligations within a specific time. The corporation must file with the Minister a prescribed form before the last day of the month immediately following the month in which it issued the share or debt obligation. Pursuant to subsection 195(2), the corporation must also on or before the same date pay the Bart VIII taxes that result from this designation. Subsection 195(3) provides for the payment of interest when these taxes are not paid within the prescribed time.

Pursuant to subsection 194(7), however, late designations are possibly provided: (1) the corporation files with the Minister a prescribed information return relating to the SRTC within the time that it would have been required to file the return had the designation been filed on time; and (2) within three years after the date on which the designation is required, the corporation has designated the amount by filing the prescribed form with the Minister and has paid a reasonable estimate of the penalty owed to the Receiver General. However, if the Minister mails a notice to the corporation that a designation has not been made in respect of issued shares or debt obligations, then the designation and payment must be made by the corporation within 90 days after the date of mailing of such notice.

Subsection 194(8) of the Act provides that the penalty for late designations is equal to one per cent of the designated amount for each month the designation is late, subject to a maximum monthly penalty of $500.

If the argument of counsel for the plaintiff is sound, then subsection 194(4.2) would only prevent corporations from making /ate designations with respect to shares or debt obligations issued after October 10, 1984. This is because by virtue of subsection 194(4), designations must ordinarily be made at the latest by the end of the month following the month in which the shares or debt obligations are issued. Thus, for example, if a share or debt obligation was issued on October 10, 1984, the corporation would have until November 31, 1984 to make a designation. If a corporation issued a share or debt obliga- tionon December 31, 1985, it would have until the end of January 1986 to designate an amount in respect of that issue.

If counsel for the plaintiff is correct in submitting that subsection 194(4.2) only applies to designations made on or after February 13, 1986, then the references in that subsection to specific transaction dates are totally useless. By February 13, 1986, it would be impossible for a corporation to designate an amount pursuant to subsection 194(4) in respect of shares or debt obligations issued before 1986.

In order to designate an amount in respect of shares or debt obligations issued before 1986, a corporation would have to avail itself of subsection 194(7) and not 194(4). It is subsection 194(7) that enables a corporation to make a late designation provided it meets certain requirements and pays a penalty.

Note, however, that subsection 194(4.2) begins as follows:

Notwithstanding subsection (4), no amount may be designated by a corporation in respect of

If counsel for the plaintiff were correct, then subsection 194(4.2) would instead read as follows:

As of February 13, 1986, and notwithstanding subsection (7), no amount may be designated by a corporation in respect of

Thus, if the provisions of subsection 194(4.2) are to have any meaningful impact, then the only logical interpretation is that suggested by counsel for the Crown. That subsection is by necessary inference of retroactive effect and in the case of paragraph (4.2)(b), applies to designations made on or after October 10, 1984. Thus, paragraph 194(4.2)(b) does apply to the designations made by Dell in respect of the debentures issued to the plaintiff on May 2 and May 23, 1985.

Furthermore, as counsel for the Crown pointed out at the hearing, the legislative amendments which came into force in 1986 should not have come as any great surprise to those in the industry. The Minister of Finance had made the government's intentions in this regard clear in his press release issued on October 10, 1984. This press release was followed by the distribution of a series of guidelines on November 23, 1984, the purpose of which was to enable prospective investors to determine whether a particular issue of shares or debt obligations would qualify under the anticipated legislative changes.

Indeed, these guidelines were used by the professional accountants hired by Dell to give an opinion as to whether the issue of its debentures to the plaintiff in May 1985 would qualify under the new rules. This professional opinion had been requested from Dell by the plaintiff, which was well aware of the impending moratorium. The plaintiff therefore was clearly aware of the risk it was running if it were to buy the debentures and then to find out that the designations did not qualify under the new SRTC regime. In these circumstances, the imposition of a retroactive effect upon subsection 194(4.2) should not shock the plaintiff.

Counsel for the plaintiff and for the Crown cited numerous cases dealing with the issue of whether retroactive or retrospective effect should be given to various statutory provisions, but I do not intend to review each of those cases. Suffice it to say that although there may be a presumption that statutes are not intended to be retrospective or retroactive in their application, such a presumption must give way when the language of the statute and the context in which the statute was enacted dictate that a retroactive effect be given to it.

Were arrangements for the issue of the debentures by Dell sufficiently advanced before October 10, 1984?

Pursuant to paragraph 194(4.2)(b), the fact that the debentures were issued to the plaintiff after October 10, 1984 is not necessarily fatal to the plaintiff's ability to benefit from a scientific research tax credit. The plaintiff can still claim the credit provided it shows that arrangements for the issue of the debentures were “substantially advanced" before that date.

Counsel for the plaintiff submitted that the term “substantially advanced" should be interpreted as referring to the moving forward of something by more than a nominal or insubstantial degree. As long as there has been some measurable progress, the parties have satisfied the test. In contrast, Crown counsel argued that the term "substantially advanced" refers to arrangements considerably or largely advanced and to something more than de minimis progress.

Authorities were cited by both parties dealing with the proper interpretation of the word “substantial” in various contexts. However, those decisions seemed to rest upon the specific facts of each case. As Mr. Justice Deane of the Federal Court of Australia wrote in Tillmanns Butcheries Pty. Ltd. v. Australasian Meat Industry Employees' Union (1979), 42 F.L.R. 331 at 348:

The word “substantial” is not only susceptible of ambiguity: it is a word calculated to conceal a lack of precision. In the phrase "substantial loss or damage”, it can, in an appropriate context, mean real or of substance as distinct from ephemeral or nominal. It can also mean large, weighty or big. It can be used in a relative sense or can indicate an absolute significance, quantity or size. The difficulties and uncertainties which the use of the word is liable to cause are well illustrated by the guidance given by Viscount Simon in Palser v. Grinling (21) where, after holding that, in the context there under consideration, the meaning of the word was equivalent to “considerable, solid or big", he said: “Applying the word in this sense, it must be left to the discretion of the judge of fact to decide as best he can according to the circumstances of each case.. . .

Mr. Justice Deane then went on to conclude that whether the term is used to mean "large or weighty", or “real or of substance as distinct from ephemeral or nominal” , "it would be necessary to know something of the nature and scope of the relevant business before one could say that particular, actual or potential loss or damage was substantial.” (Ibid, at 348.)

Likewise, in the present case, I believe that the term “substantially advanced" cannot be interpreted in a vacuum. Rather its interpretation must reflect the nature and the scope of the subject matter with which subsection 194(4.2) is dealing, i.e., the issue of shares and debt obligations to finance scientific research.

While 1 do not find it strictly necessary to decide for the purposes of the present judgment, I am inclined to accept the plaintiff's argument that the term “substantially”, as it appears in paragraph 194(4.2)(b), has a relative rather than an absolute connotation. To my mind, the issue of whether arrangements were “substantially advanced" calls for a determination by this Court of whether the arrangements had been advanced or had progressed to a sufficiently measurable degree. In other words, there must have been more than just nominal or insignificant progress made by the parties towards securing an SRTC transaction. In coming to this conclusion, I have considered not only the various dictionary and jurisprudential meanings of the word "substantial", but also the retroactive nature of subsection 194(4.2).

It is also relevant to examine how Revenue Canada itself interpreted the transitory provisions. While such an interpretation cannot bind this Court or operate to change the clear wording of a statute, it does provide guidance as to the interpretation which ought to be given to ambiguous terms, especially when the administrative interpretation favours the taxpayer. [1]

The guidelines released by the Department on November 23, 1984 explain that:

Arrangements, evidenced in writing and substantially advanced before October 10, are intended to encompass those situations where there is a clear intent to issue an SRTC instrument and, the procedures for the issue thereof, are in process but the final agreement stage has not been reached.

The guidelines then list several criteria, which are not intended to be all inclusive, but are designed to indicate the type of existing documentation that the Department will look for in deciding whether the transaction falls within the grandfathering provisions.

Counsel for the plaintiff admitted that his client did not have a prospectus, offering memorandum, letters of intent or general correspondence to and from professionals, brokers and prospective purchasers. These criteria, counsel submitted, related to SRTC instruments which constituted public distributions. This was not the case with respect to the debentures issued to the plaintiff by Dell. Thus, the absence of such documentation was not surprising.

However, as counsel for the plaintiff pointed out, the Department also mentions that evidence of substantially advanced arrangements may be gathered from directors' resolutions and internal memoranda setting out the transaction in progress. Such documentation on its own, according to the Department, would not normally be conclusive, however.

Counsel for the plaintiff nevertheless drew great strength from the succeeding paragraph:

The above documentation, which pertains to the issuer, must indicate the likely or maximum amount of the designation, the type of security and the issue price and should indicate for example, the redemption amount, proposed closing date (normally prior to December 31, 1984) and details of the scientific research program.

The final paragraph in the guidelines then specifies that:

Arrangements may qualify for grandfathering in circumstances where the issuer had a strategy for issuing the SRTC instrument which would meet the above criteria, but did not have a specific purchaser identified prior to October 10, 1984.

Going through the evidence then, I accept the plaintiff's argument that it had indeed complied with the guidelines released by Revenue Canada and with the more abstract provisions of subsection 194(4.2) of the Act. When the totality of the written and oral evidence put before this Court is considered, it indicates that arrangements for the issue of the debentures in question were “substantially advanced" before October 10, 1984.

First of all, the maximum amount of the designation was known by the end of August 1984. This was the month in which Mr. Kerntopf and Mr. Merrick put together the Executive Summary in order to find potential investors. That summary contained a budget, which listed projected expenditures and receipts for a 12 month period. Disbursements were expected to total $8,387,000. SRTC sales are then clearly identified as one principal source of funding and are projected to amount to $3,187,000.

The total amount of the two designations made by Dell in May 1985 came to $7,500,000. After redemption of the demand debentures and payment of legal and administrative fees, $2,901,932 remained in escrow. These sums are slightly lower than those indicated in the Executive Summary, but nevertheless, it is clear that the scale of the research program to be carried out had been determined by the plaintiff well before the October 10, 1984 deadline.

Secondly, the type of security which would be provided to investors was also known well before the October 10th deadline. The contract with Rayjac Industrial Urethanes, dated August 14, 1984, indicated that the funds would be secured by the issue of a debenture or a promissory note. Mr. Kerntopf also indicated in his testimony that he was pursuing a debenture form of security on behalf of Dell. Demand debentures were eventually issued to the plaintiff by Dell and thus, the type of security which had been anticipated as early as August 1984 coincided with that finally issued.

Next, the approximate issue price was also known by the end of August 1984. As mentioned above, SRTC sales were projected to generate roughly $3,187,000. This equals 38 per cent of the projected $8,387,000 in expenditures, which would constitute the maximum designation amount.

The remaining 62 per cent of the designation amount would be refunded to the investor by the immediate redemption of the debentures or notes to be issued. Thus, as counsel for the plaintiff submitted, although the redemption amount is not specified in the Executive Summary, it can very easily be inferred from the given designation amount and issue price.

The proposed closing date was clearly not known prior to October 10, 1984. However, as counsel for the plaintiff pointed out, the guidelines state in the last paragraph that a specific purchaser need not have been identified as of that date. It is hard to conceive how Dell could have selected a proposed closing date before October 10, 1984 without knowing the identity of the SRTC investor.

Furthermore, there is no reason why the proposed closing would be "normally prior to December 31, 1984”. This particular date is not mentioned anywhere else in the guidelines and does not appear in the legislation itself. Subsection 194(4.2) simply requires that the debt obligation have been issued before 1986.

Finally, I am satisfied that as of October 10, 1984, the details of Dell's proposed scientific research program were sufficiently known to make it qualify for purposes of subsection 194(4.2). Although the telecommunications aspect of the research program only came to life sometime in April 1985, the principal portion of the research program related to the development of a coal treatment application for Valu 100. Dell had intended to carry out research in

this area for quite some time prior to October 10, 1984, as is evidenced by: (1) the production of various research reports from 1983 onwards describing the results of testing carried out on Valu 100; (2) the specific reference in the directors' resolutions dated August 6, 1984 to Dell's intention to research a coal treatment application for its Valu 100 formula; (3) the specific reference to this particular research project in the Executive Summary which was prepared in August 1984; and (4) Mr. Beesley's testimony to the effect that research into this ana other applications of Valu 100 was ongoing from July to mid-October 1984.

As a result, I believe that the most important segment of the research program eventually adopted had been planned well before the October 10, 1984 deadline ana the decision to conduct research into a coal treatment application for Valu 100 was a natural choice given the company's previously expressed intentions of doing research in this area. The subsequent decision to graft on subsidiary telecommunications research projects is not fatal to the plaintiff's appeal. These projects did not affect the overall scale of operations projected in August 1984. Rather, the parties simply decided to diversify the research to cope with changing market conditions. Some flexibility must be retained by an issuer in these matters if it is to ultimately find an investor and to secure a deal.

Thus, if we examine the various criteria set out by Revenue Canada in its guidelines, it is clear that the SRTC transactions which occurred between Dell and the plaintiff on May 2 and May 23, 1985 satisfy all but one of those criteria— no closing date had been selected by October 10, 1984. However, as explained above, the defendant could not reasonably expect the issuer to have chosen a closing date before October 10, 1984, if it did not require the issuer to have identified a specific purchaser by that date. There is an obvious anomaly in the guidelines in this respect and in my view, it should be resolved in the plaintiff's favour.

In any event, when the evidence is considered as a whole, I am satisfied that arrangements for the issue of the debentures by Dell did exist in writing and were “substantially advanced" before October 10, 1984. By that date, Dell had already established a general but concrete framework within which it would proceed with SRTC financing for its research projects. All that remained to work out were the finer details of exactly how much money would go where, who the SRTC investor would actually oe and which aspects of its research program would be emphasized.

Revenue Canada itself recognized in its guidelines of November 23, 1984 that such details might not be known before October 10, 1984 without thereby invalidating subsequent SRTC designations. Furthermore, Parliament envisioned in subsection 194(4.2) of the Act that shares and debt obligations which continued to be issued as late as December 1985 might qualify for a Part VIII tax credit. As I understand the transitory provisions in Part VIII, their purpose was not to invalidate all SRTC designations which occurred on or after October 10, 1984. Rather they were designed to phase out the existing SRTC regime while providing an appropriate grace period for those transactions which had already commenced and were “substantially advanced" by October 10, 1984, but which might not be complete for up to a year thereafter. I believe that the SRTC transactions entered into by the plaintiff with Dell in May 1985 fall into that category.

What are the consequences for an investor with respect to improperly designated debt obligations?

Given my finding that the issue of the debentures to the plaintiff in May 1985 fell within the scope of those transactions saved by subsection 194(4.2), there is no need to address the issue of whether an invalid designation should operate to the prejudice of the investor, as opposed to the issuer. Therefore, I will not make any comments with respect to this last issue except to repeat the plea of plaintiff's counsel that it appears somewhat inequitable to impose all of the risks of an improper designation upon the investor. This is especially true, says counsel, when that investor has done everything in its power to ensure that the designations are valid pursuant to the provisions of the Income Tax Act and when the result of the denial of a credit to the investor is not only a gratuitous receipt of a large sum of money in the hands of the issuer but a corresponding reduction in the issuer's tax liability as well. I am relieved that by reason of my disposition of the case under the grandfather clause, I need not deal further With that issue.

The plaintiff's appeal is allowed, with costs.

Appeal allowed.