Citation: 2009 TCC 348
Date: 20090717
Docket: 2007-3534(IT)G
BETWEEN:
RAYMOND PAYETTE,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Rip, C.J.
[1]
Raymond Payette appeals
from an income tax assessment for 2005 in which the Minister of National
Revenue ("Minister") denied a business loss of $64,785 in accordance
with paragraph 18(1)(a) of the Income Tax Act and a
Scientific Research and Experimental Development ("SR&ED") tax
credit of $13,757 pursuant to subparagraph 37(1)(a)(i) and
subsection 127(9) of the Act claimed by him in filing his income tax
return for 2005. The Minister's principal reason for denying the claims was his
view that Mr. Payette was not carrying on a business in 2005.
[2]
At the time of trial,
Mr. Payette was retired from the Quebec Ministry of Finance where he
worked for "30 odd years". He is a chartered accountant and also
received a Master's Degree in Public Administration. He has no scientific
background. Mr. Payette develops software programs which he intends to
sell.
[3]
The appellant says that
he was carrying on a business during the year under appeal. His business was
research and development. In 2003 he applied for a United States and international patents for a propulsion system he
developed to be used by spacecraft without having to interact with the
environment. (The applications were included in the appellant's Book of
documents, Exhibit A‑1.) The propulsion mechanism was designed to
thrust a space vehicle without using fuel; electrical energy would emanate from
photoelectric cells. After three years of "trying and amending my
application", the application was still refused. Mr. Payette
testified that the application was refused by the U.S. Patent Office
"because there was a moratorium on this kind of invention, which I was not
aware of". Mr. Payette's goal was to earn money by selling or
licensing the patent. He never intended to manufacture the device. Without the
patent, he said, he had "nothing to sell".
[4]
The following are the expenses
Mr. Payette seeks to deduct and on which he is claiming a SR&ED tax
credit and were incurred in 2003, 2004 and 2005, years during which the
appellant says he was carrying on a business:
|
|
|
2003
|
|
2004
|
|
2005
|
|
|
|
Taxes
|
$
|
110.00
|
$
|
65.00
|
$
|
85.00
|
$
|
260.00
|
|
Intérêts
|
$
|
423.36
|
$
|
723.69
|
$
|
2,122.53
|
$
|
3,269.58
|
|
Frais de
bureau
|
$
|
734.07
|
$
|
1,365.45
|
$
|
2,375.86
|
$
|
4,475.38
|
|
Fournitures
|
$
|
1,129.23
|
$
|
501.65
|
$
|
1,267.38
|
$
|
2,898.26
|
|
Frais
juridiques
|
$
|
4,011.37
|
$
|
25,040.48
|
$
|
15,927.71
|
$
|
54,979.56
|
|
Frais de
voyages
|
$
|
|
$
|
|
$
|
876.36
|
$
|
876.36
|
|
Ingénierie
|
$
|
793.65
|
|
|
$
|
1,232.22
|
$
|
2,025.87
|
|
|
$
|
17,201.68
|
$
|
27,696.27
|
$
|
23,887.06
|
$
|
68,785.01
|
[5]
The legal expenses were
laid out for the purpose of obtaining the patent.
[6]
Mr. Payette did
not deduct from his income any of the expenses he incurred in 2003 and 2004. If
I understand his evidence, the appellant did not deduct the expenses incurred
in the year they were incurred because he was carrying on a business and
therefore accrued the expenses. Then, in 2005, he realized he could no longer
carry on a business because he could not obtain a patent. He therefore
capitalized the expenses from 2003 and 2004 and, together with the expenses
incurred in 2005, he "wrote off" in 2005 the expenses for the three
years. He deducted $68,785 in computing his income for 2005. Similarly, the
appellant claimed the SR&ED tax credit for 2005 on expenses incurred in
2003, 2004 and 2005.
[7]
In the years 2003, 2004
and 2005, Mr. Payette states he was carrying on a business. His notice of
appeal declares that he commenced carrying on a business, insisting that his
creation of a propulsion system device resulted from scientific work and
experimental development. He claims he did "everything that could be
expected" to obtain such a patent but failed to do so.
[8]
His invention,
Mr. Payette testified, was the answer to what the United States National
Aeronautics and Space Administration ("NASA") required for human
interstellar exploration. NASA had set goals necessary for interstellar
exploration. These included propulsion methods that eliminate or radically
reduce the need for propellant and new energy methods to power the propulsion
devices.
[9]
The evidence of
Mr. Payette related to his efforts in obtaining a patent and securing
financial assistance to fund his activities, all of which ended in failure.
Other than his own testimony that the reason he did not obtain a U.S. patent was because the U.S. Patent Office took a
moratorium on inventions similar to his, there was no evidence or suggestion
corroborating his view.
[10]
In March 2003, Mr. Payette
incorporated Space Crab Corporation, the name of which was later changed to
"Spacecraft Corporation". The company was inactive: no meeting of
directors or shareholders was held, and except for corporate organization purposes,
there was no resolution of directors or shareholders and no shares were issued.
The company was authorized to open a bank account but did not. The evidence
suggests – it is not clear and I do not make any finding – that
Mr. Payette intended to transfer the right of ownership of the patent to
Spacecraft.
[11]
The evidence was not at
all clear as to whether Mr. Payette or Space Crab was carrying on the
purported business. In correspondence with the CRA, he advised that he paid all
the expenses for the corporation. I assume these expenses are those in issue.
As far as Mr. Payette carrying on a business as a sole proprietorship, he
acknowledged, for example, that the business had no bank account. However,
Mr. Payette filed his appeal on claiming that he carried on the business,
not the corporation. The respondent led evidence to answer the basis of his
claim, that is to prove that he did not carry on a business. In preparing these
reasons I have considered whether or not a business was carried on,
irrespective of whether it was carried on by Mr. Payette personally or by
a corporation.
[12]
Mr. Payette
described his business as a "research business". He did not, nor did
he intend to, manufacture any product. At time of trial, he had other patents
that, he said, were pending in other fields. He described himself as an
"inventor" rather than an engineer.
[13]
The only potential
client in Canada that Mr. Payette identified was the
Canada Space Agency ("CSA"). One of the reasons he renamed his
company Spacecraft Corporation was that he thought that the CSA would give a
corporate entity a contract or grant to prove his invention. He also sought
financial aid from other government agencies and a private placement in Vancouver.
[14]
Mr. Payette identified
other countries active in launching satellites and space exploration as other
potential clients. In his business plan he also referred to communication
forums and spacecraft manufacturers. Mr. Payette wanted to prove his
invention, "if I could prove to the patent office that it worked and from
well known sources, then I would have had no problem patenting it and then I
would have had no problem either licensing or selling it".
[15]
Mr. Payette was
able to prove the concept worked "to my satisfaction but not to anyone
else's". He complained no engineer wanted to look at his concept because
he did not make models, although he said he did make a hovercraft with radio
control.
[16]
Apparently, the CSA had
a program to sponsor innovative technology and Mr. Payette made a request
for a proposal with CSA's Space Technology Development Program –
Innovative Technologies. The CSA did award contracts to ten successful builders
under the Innovative Technologies Program, but not to Mr. Payette or
Spacecraft. Indeed, Mr. Payette's application did not receive the minimum
score requirement for technical criteria, management criteria and overall score
in CSA's evaluation process.
[17]
In its evaluation
summary of Mr. Payette's application with respect to technical criteria,
the CSA found, for example, that his engineering concepts and principles were
incorrect in describing the proposed technology, that the proposal did not
demonstrate an understanding of the technology or the skills needed to apply
the basic engineering concepts and principles and that while the proposed
methodology would likely resolve the challenges, the technology is fundamentally
flawed and cannot be successfully developed. Building a hovercraft to prove the
concept is not cost effective nor is it practical according to the CSA
evaluation.
[18]
A business plan was
included in Spacecraft's original proposal to CSA in December 2003. The
proposal proposed three methods of financing, one on a cost reimbursement
basis, one financed by private placements and one a partnership.
Mr. Payette's preferred "evolution" was to obtain "quick
backing from a government agency" and that is the reason he approached the
CSA.
[19]
Mr. Payette
recognized that the technology involved high costs, high margins and low
volume. The aimed business was to produce standardized spaceship drives for
spacecrafts that can be produced in high quality at high margin. He also
realized that "high level employees" were required. Mr. Payette
saw himself as the Chief Executive Officer. There would also be a Chief
Technology Executive, a Chief Financial Executive, a Chief Marketing Sales
Executive and an Executive Vice‑President. His business plan included a
job description for each.
[20]
As far as management
criteria was concerned, the CSA was of the view that the proposed management
personnel had no experience or track record of successfully completing projects
of similar technology to that required for Mr. Payette's proposal; there
was no one with experience to manage R&D projects. Also, according to the
CSA, the technical team has no formal training in physics, despite
Mr. Payette's three years of engineering education. There was no
collaborator with experience in closely related technology or space related
experience. The CSA also criticized the management plan of Mr. Payette. In
the CSA's view, lack of experience with similar projects exposed the team to
schedule risks where income and management estimates are made. There was also a
lack of collaboration. Finally, the CSA's evaluation concluded that "the
proposal indicates limited business opportunity and limited overall impact. The
proposal is not likely to improve the company's overall space market scheme
since all potential partners have either declined or not answered the company's
request for partnership."
[21]
No appeal from an
assessment based on the Minister's view that no business pertaining to
scientific research and experimental development was carried on should be
dismissed solely because the taxpayer was overly optimistic as to a possible
invention leading to a venture's success or that the venture was doomed to
failure at inception. In enacting subsection 37(1) of the Act,
Parliament wanted to encourage scientific discovery and invention through
research and development and thus one ought not give a narrow interpretation to
the expression "carried on business" or "carrying on
business": Bowie J. in Synchrosat Limited v. The Queen. The Federal
Court of Appeal cautioned against being too quick to second guess the wisdom of
a business judgment based on hindsight: The Queen v. Tonn.
[22]
The appellant's claim
is that in the year in appeal he carried on a business and is thus entitled to
deduct expenses and a SR&ED tax credit. I have no doubt he started work on
his project in good faith and in the belief he could accomplish his goal. However,
on the evidence before me, I cannot find that he carried on a business. His
activity in 2005, as well as in 2003 and 2004, was essentially twofold, to
obtain financing, primarily by government grant, and to obtain a patent. In and
by themselves, these activities are not the carrying on of a business; they
suggest preparation in anticipation of starting a business.
[23]
Mr. Payette's
activity did not have the ingredients of commerciality to make it a business. He
had insufficient capital for a project of such dimensions, thus he had to
secure financing. He did not have capital to construct a prototype or a model,
for example. His business records, if any – I have to conclude - were
not maintained in a businesslike manner.
No such records were produced. I have already commented on the problem of whether
he or his corporation was seeking the patent and grants.
[24]
In Mr. Payette's
view all he required for success was a patent. He remains convinced that if he
had been awarded a patent by the U.S. Patent Office, potential clients would
flock to his door. He ignores the fact that no organization gave credence to
his design; there is absolutely no evidence that his work was scientific
research or experimental development. The CSA concluded that his proposal did
"not demonstrate an understanding of the technology or the skills to apply
the basic engineering concepts and principles … [T]he technology is
fundamentally flawed …" These are views of third parties given before and
during 2005, and are not based on hindsight. While Mr. Payette's work may
have impressed Mr. Payette, it impressed no one else, he admitted.
[25]
No business was carried
on by Mr. Payette in 2005. He thought that obtaining a patent would solve
his problems. According to the CSA the invention was flawed. But even if he had
obtained a patent, there is absolutely no independent evidence that anyone
would want to obtain a licence for the patent or purchase it from
Mr. Payette. In seeking financing and a patent Mr. Payette was not
carrying on a business but taking steps to start a business. In the year of
appeal and earlier he did not have the necessary financing or assets to
undertake a business he envisaged, a business in which research and
experimental development would be costly, way beyond his means. Again, at best,
he was preparing to start a business. None of the activities undertaken by Mr. Payette
in 2005 or earlier was capable of generating income.
[26]
There are two other
matters that were brought to my attention by Mr. Payette. The first is
that if he had been carrying on a business, whether he would be permitted to
deduct in computing income in 2005, current expenses he incurred in 2003 and
2004 but he did not deduct in computing income for those years, but
capitalized. The answer to Mr. Payette's claim to deduct these capitalized
expenses is found in paragraphs 18(1)(a) and (b) of the Act:
|
18(1) In computing the
income of a taxpayer from a business or property no
deduction shall be made in respect of
|
18(1) Dans le calcul du revenu du contribuable tiré d'une entreprise ou d'un bien, les éléments suivants ne sont pas déductibles :
|
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(a) an outlay or expense
except to the extent that it was made or incurred by the taxpayer for the
purpose of gaining or producing income from the business or property;
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a) les dépenses, sauf dans la mesure où elles ont été engagées ou
effectuées par le contribuable en vue de tirer un revenu de l'entreprise ou du bien;
|
|
(b) an outlay, loss or
replacement of capital, a payment on account of capital or an allowance in
respect of depreciation, obsolescence or depletion except as expressly
permitted by this Part;
|
b) une dépense en capital, une perte en capital ou un remplacement
de capital, un paiement à titre de capital ou une provision pour
amortissement, désuétude ou épuisement, sauf ce qui est expressément permis
par la présente partie;
|
[27]
The second matter concerns
Mr. Payette's claim for a SR&ED tax credit in 2005. Included among the
expenses he claims for the credit are legal expenses and interest which,
according to section 2902 of the Income Tax Act Regulations, are
not included in the definition of "qualified expenditure" in
subsection 127(9) of the Act. It is qualified expenditures that qualify
for the SR&ED credit. Also, Mr. Payette's claim for a SR&ED tax
credit may have been filed late.
[28]
Since I have found
Mr. Payette did not carry on a business in 2005, there is no need to
consider these matters at this time.
[29]
The appeal is dismissed
with costs, if demanded by the respondent.
Signed at Ottawa, Canada, this 17th
day of July 2009.
"Gerald J. Rip"
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