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Citation: 2006TCC406
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Date: 20060823
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Dockets: 98-3187(IT)I and 2005-1685(IT)I
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BETWEEN:
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JACQUELINE RABY,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent,
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Dockets: 98-3371(IT)I and 2004-1989(IT)I
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BETWEEN:
RAYMOND BALTAZAR,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent,
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Dockets: 98-3373(IT)I and 2004-2600(IT)I
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BETWEEN:
JOCELYN BLANCHET,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent,
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Dockets: 98-3382(IT)I and 2004-2043(IT)I
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BETWEEN:
JACQUES ELIE,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent,
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Dockets: 98-3383(IT)I and 2004-2046(IT)I
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BETWEEN:
NORMAND ELIE,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
Respondent,
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Dockets: 98-3393(IT)I and 2005-1686(IT)I
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AND BETWEEN:
SERGE LE GUERRIER,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
[OFFICIAL ENGLISH TRANSLATION]
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REASONS FOR JUDGMENT
Dussault J.
[1] These appeals were heard, partly on common evidence, under the informal procedure of the Tax Court of Canada.
[2] The appeals in question pertain to assessments for the 1989 and 1990 taxation years under the Income Tax Act ("the Act"). Jacques Elie was the only Appellant who did not appeal from the assessment for 1990. As we shall see, some of the Appellants carried forward or carried back a part of the investment tax credit to which they believed they were entitled for 1989, and that is why the assessments disallowing carry-forwards or carry-backs to other years are also under appeal.
[3] The Appellant Jacqueline Raby and the other five Appellants (hereinafter collectively called "the Appellants") purchased shares in the C.I.D. SYSTEMS partnership ("C.I.D.") in the fall of 1989. C.I.D. proposed to conduct scientific research and experimental development. All the Appellants claimed the deduction of a business loss roughly equal to the amount of their investment, as well as an investment tax credit, for 1989 taxation year. The Minister of National Revenue ("the Minister") disallowed the business loss deduction, but permitted each of the Appellants to deduct their share of the losses incurred by the partnership of which they were a specified member - specifically, a "limited partner" within the meaning of paragraph (b) of the definition of "specified member" in subsection 248(1) of the Act. This business loss was therefore considered an "investment expense" within the meaning of subparagraph (c)(ii) of the definition assigned to that term in subsection 110.6(1) of the Act. The consequence of this characterization is that the "investment expense" was considered part of the "cumulative net investment loss" as defined in subsection 110.6(1) of the Act, which reduced the "cumulative gains limit" defined in the same subsection, and thereby limited the capital gains deduction that was available to the Appellants under subsection 110.6(3) of the Act upon the disposition of their C.I.D. shares in 1990.
[4] The investment tax credit claimed by each of the Appellants in 1989 was disallowed because they were specified members of a partnership within the meaning of subsection 248(1)(b) of the Act, and because, in computing the investment tax credit of such a "specified member", paragraph 127(8)(b) of the Act excludes a qualified expenditure (i.e. an expenditure in respect of scientific research and experimental development).
[5] The assessments of each of the Appellants for the 1989 taxation year were appealed.
[6] In early 1990, all the Appellants disposed of their shares in C.I.D. for an amount equal to 50% of their investment. Since the adjusted cost base of their shares was, in accordance with subparagraph 53(2)(c)(i) of the Act, reduced by the amount of the loss for which the deduction was granted for 1989, the Appellants realized a capital gain on this disposition. The taxable portion of the capital gain was added to the income of each Appellant who did not do so on their tax return, and the Minister disallowed the capital gains deduction because it had been limited as explained above. In addition, the Quebec tax credit was added to each of the Appellants' incomes under paragraph 12(1)(x) of the Act. As stated, Jacques Elie was the only one who did not appeal from the 1990 assessment.
[7] In computing their tax for other years, some of the Appellants deducted the investment tax credit to which they believed they were entitled for 1989. Since the investment tax credit was disallowed for 1989, assessments were made disallowing the carry-forwards or carry-backs of the credit to those other years. Those assessments were also appealed. Hence, Jacques Elie also appealed from the assessments for 1986 and 1992; Jacqueline Raby also appealed from the assessment for 1986; and Serge Le Guerrier also appealed from the assessment for the year 1987.
[8] The assumptions of fact relied upon in assessing each Appellant for the 1989 year are essentially the same, though each Appellant invested a different amount in C.I.D., which is why the losses for which a deduction was claimed, and the investment tax credits claimed, also vary. These facts are set out in the Reply to the Notice of Appeal ("Reply") for each Appellant. To illustrate, I refer to subparagraphs 29 (a) through (l) of the Reply in the matter of Appellant Jacqueline Raby (docket 98-3187(IT)I). Those subparagraphs read as follows:
[TRANSLATION]
(a) The C.I.D. SYSTEMS partnership ("the Partnership") was formed on August 25, 1989.
(b) Even before the Appellant Raby joined the Partnership, the latter entered into an agreement with Zuniq Corp. ("Zuniq") on November 24, 1989 entitled [TRANSLATION] "Service Contract", which stated that Zuniq would do work described as scientific research and experimental development work related to the "CASA" project.
(c) On the same day (November 24, 1989) Zuniq signed a [TRANSLATION] "Service Contract" with each of the following corporations: Dias Informatique Inc. ("Dias"), Data Age Corp. ("Data Age"), Zuniq Data Corp. ("Zuniq Data") and Système Inar Inc., ("Inar"). These agreements stated that Dias, Data Age, Zuniq Data and Inar would do work described as scientific research and experimental development work related to the "CASA" project.
(d) Zuniq was incorporated on March 25, 1985, purportedly to do research and development work. Zuniq was to perform different jobs for which various partnerships were created.
(e) These various partnerships entered into contracts with corporations that allocated certain costs according to percentages that were based on the investments received from these different partnerships.
(f) The proponent and organizer of the Partnership was Mr. Hien Vohoang ("Vohoang"), the directing mind of Zuniq.
(g) For its fiscal year ended December 31, 1989, the Partnership showed a loss of $1,599,572, of which $1.6 million was presented as a research expenditure under subparagraph 37(1)(a)(i) of the Income Tax Act.
(h) Toward the end of 1989, Diasware Inc. ("Diasware") "financed" 50% of the members' Partnership interests.
(i) Based on the documents submitted to the Minister of National Revenue, the loan, which bore an interest rate of 13.5%, was repayable in 120 monthly payments over 10 years, commencing one year after the investment date, that is to say, in late 1990.
(j) In early 1990, the members of the Partnership assigned their partnership interests to Glenrock Investments Ltd. ("Glenrock").
(k) The members of the Partnership did not know each other and did not actively work within the Partnership.
(l) The Appellant Raby is a member of the partnership other than a member who is actively engaged in those activities of the partnership business, or is carrying on a similar business as that carried on by the Partnership in its taxation year, on a regular, continuous and substantial basis throughout the year during which the business of the Partnership is claimed to have been ordinarily carried on.
[9] Paragraphs 30 to 42 were added to the Reply. They read as follows:
[TRANSLATION]
30. According to the purchase plan offered by the purported Partnership, when the partners' interests were sold, the Quebec investors would pay a cash amount representing 50% of their partnership interest, and the Ontario investors would pay a cash amount representing approximately 46% of their partnership interest. The difference was "financed" by the Diasware corporation.
31. The Appellant Raby had no obligations to anyone in respect of the amount purportedly "financed".
32. The Appellant Raby knew that, in accordance with the package presented during the solicitation, her equity would be redeemed in the short term for an amount that would purportedly be "financed".
33. All payments were in the form of a release from debt in an amount equal to the "financing" granted by Diasware. The amounts in question exceeded the fair market value of the partnership shares upon disposition.
34. For the proponents and members of the purported Partnership, the use of the redemption and financing strategy described above was an essential characteristic of the "tax shelter" of which they were reciprocally sellers and purchasers.
35. The Appellant Raby was entitled to receive an amount granted for the purpose of reducing the impact, in whole or in part, of a loss sustained in connection with her Partnership interest.
36. The Appellant Raby benefited from a mechanism providing for the disposition of her interest in the purported Partnership, and it is reasonable to believe that one of the principal objectives of that mechanism was to attempt to remove her from the scope of subsection 96(2.4) of the Income Tax Act.
37. The only reason that the Appellant Raby became a member of the Partnership was to obtain a reduction in her tax payable under the Income Tax Act.
38. The Partnership, Dias, Data Age, Zuniq Data, Inar, Diasware, Glenrock and Zuniq ("the Zuniq group corporations") are not at arm's length from each other or from Vohoang.
39. Zuniq, Dias, Data Age, Zuniq Data and Inar all have the same postal address.
40. The purported Partnership had no reason for being, except to serve as a tax-refund vehicle and a financing tool for the Zuniq group corporations.
41. The Appellant Raby had no intention to form a partnership contract; she and the co-contractors had no intention to work together to generate profits for the purported business.
42. Under the circumstances, the business of the purported Partnership had no reasonable expectation of profit, and so the Partnership was not, in this regard, carrying on a business.
[10] In order to clarify the factual allegations contained in the Reply, counsel for the Respondent filed an appendix to the Reply in each matter. The appendix concerning Jacqueline Raby reads:
[TRANSLATION]
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GENERAL INFORMATION CONCERNING THE INVESTMENT
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Tax shelter name: C.I.D. Systems
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Taxation year(s) under appeal: 1986, 1989 and 1990
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Date shares obtained: Unknown (1989)
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Number of shares obtained: 16
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Value of subscription $16,000
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Date shares assigned: February 1990 (approx.)
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Proceeds of disposition: $8,000
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INFORMATION REGARDING TAX TREATMENT OF INVESTMENT
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Business loss
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Limited partner loss
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ITC
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Claimed
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1 $16,086
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$0
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3 $3,159
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Disallowed
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$16,086
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N/A
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$3,159
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Allowed
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$0
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2 $15,996
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$0
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INFORMATION REGARDING CAPITAL GAIN IN 1990
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Capital gain
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Taxable capital gain
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Capital gains deduction
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Reported/claimed
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$0
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$0
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$0
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Revised
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$8,000
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$6,000
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$0
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__________________________
1 This amount includes a $15,996 operating loss and a $90 interest expense.
2 An additional financial expense of $90 was allowed as well.
3 This credit was attributed as follows:
- $2,286.79 in 1989
- $68.60 in 1989 (supplementary credit, surtax reduction)
- $803.61 carried back to 1986.
[11] At paragraph 43 of the Reply, the issues are stated in the following terms:
[TRANSLATION]
43. The issues are as follows:
- Is there a true partnership, and, if so, is it carrying on a business?
- If so, was the Appellant Raby a member of the alleged partnership who is a limited partner within the meaning assigned by subsection 96(2.4) of the Income Tax Act at any time of the year relevant to the instant appeal?
- If so, was the Appellant a member of the partnership other than a member who is actively engaged in the activities of the alleged partnership business or who is carrying on a similar business as that purported to be carried on by the alleged partnership in the year in issue?
[12] Lastly, the provisions and grounds relied upon by the Respondent, and the relief sought by the Respondent, are set out in paragraphs 44 to 48 of the Reply, which read as follows:
44. The Deputy Attorney General of Canada relies, inter alia, on the versions of sections 3, 9, 18(1)(a), 37, 96, 127 and 248(1) of the Income Tax Act, R.S.C. 1985 (5th Supp.). c. 1, which apply to this matter. The Deputy Attorney General of Canada also relies on section 2900 of the Income Tax Regulations, C.R.C., 1978, c. 945, as amended.
45. He submits that, given the circumstances as a whole, there is no genuine partnership carrying on a business, which means that its expenses or losses, if any, are not deductible.
46. He submits that, in that case, the Appellant Raby is a limited partner within the meaning assigned by subsection 96(2.4) of the Income Tax Act and is, consequently, a specified member within the meaning of paragraph (a) of the definition of this term contained in subsection 248(1) of the Act.
47. He further submits that the Appellant Raby is also a specified member within the meaning of paragraph (b) of the definition of this term contained in subsection 248(1) of the Income Tax Act.
48. Moreover, the Deputy Attorney General of Canada respectfully submits that, based on the above facts as a whole, the Court can find
(1) that the "tax shelter" in question is a sham that does not qualify for any of the deductions claimed; and
(2) that the Appellant was not a member of a partnership on December 31, 1989.
FOR THESE REASONS, he [the Deputy Attorney General] requests that this Court dismiss the appeal.
[13] All the Appellants testified. The following persons testified for the Respondent:
- Mr. Pierre Beaupré, a C.I.D. investor.
- Mr. Michel Beaudry, an auditor with Revenue Canada at the relevant time.
- Ms. Han Nguyen, an employee of Mr. Vohoang or of the corporations that he controlled.
- Ms. Hélène Deshaies, an appeals officer at the relevant time.
- Mr. Serge Huppé, an appeals officer at Revenue Canada headquarters in Ottawa at the relevant time.
- Mr. Claude Papion, the Respondent's scientific expert.
[14] The C.I.D. partnership agreement was initially between Tom Nguyen and Ms. Chau H. Nguyen, both of whom signed it on August 25, 1989, and stated that they lived in Modesto, California. According to section 15, the agreement is governed by the laws of the province of Ontario. However, section 3 states that C.I.D.'s address is in Rosemead, California. According to section 9.1 of the agreement, Tom Nguyen is appointed secretary of C.I.D. (Exhibit I-2, tab 3). The same two individuals signed a partnership declaration in Calgary, Alberta, in which Calgary addresses were given (Exhibit I-2, tab 2).
[15] C.I.D. is one of the 13 partnerships formed by Hien Vohoang and his group ("the proponents"), which, inter alia, comprises members of his family, to solicit investors for scientific research and experimental development (R & D) projects in the field of computer science from 1989 to 1992. In addition, several corporations were formed to carry out subcontracted research projects (Exhibits I-5 and I-8). These corporations include Zuniq Corp. ("Zuniq"), to which C.I.D. subcontracted its CASA project in 1989; Diasware Inc. ("Diasware"), which served to finance a part of the partners' investment in C.I.D. in 1989; and Glenrock Investments Ltd. ("Glenrock"), which redeemed the partnership interests that the C.I.D. partners had purchased in 1989.
[16] From September to December 1989, C.I.D. recruited 105 partners, including the six Appellants, who invested a total of $1,600,000 (Exhibit I-2, tab 6). Each investor became member of the C.I.D. partnership after signing an offer of participation under which they agreed to subscribe for a certain number of shares for $1,000 each in accordance with the terms and conditions of the partnership agreement. The offer of participation included the following clause: [TRANSLATION] "In addition, the undersigned agrees to engage, on a regular, continuous and substantial basis, in accordance with his or her skills, in the activities of the Partnership, and declares that he or she is available for the aforesaid purposes." (Exhibit I-2, tab 5).
[17] The proponents offered the investors the opportunity to double their investment in C.I.D. by offering to finance 50% of it. Diasware made the loans, which were secured by the C.I.D. shares (Exhibit I-2, tab 9). All the Appellants testified that they accepted this offer, under which they had to disburse only 50% of the amount of their investment. Some of the Appellants allegedly took out a second loan to cover their 50% outlay (see the transcript of Serge Le Guerrier's testimony, at page 226, and the transcript of Jacqueline Raby's testimony, at pages 242 to 244). It certainly appears that the amount which the investors borrowed from Diasware was paid directly by that corporation to C.I.D. on behalf of the investors (Exhibit I-2, tab 8, and the transcript of the testimony of auditor Michel Beaudry, at page 84, and Jacques Elie, at page 85).
[18] The proponents had arranged for Glenrock to redeem the investors' shares for an amount equal to 50% of their investment shortly after December 31, 1989, the date on which C.I.D.'s first fiscal year ended. The testimony of investor Pierre Beaupré, Appellants Raymond Baltazar, Jacques Elie and Jocelyn Blanchet, and Han Nguyen, are very clear in this regard. According to Ms. Nguyen, Marjorie Lauger, Mr. Vohoang's secretary, was the one who signed the assignment forms on behalf of Glenrock. The redemptions were mainly done during the early months of 1990 (Exhibit I-2, tab 32). Only Mr. Le Guerrier claimed that he was unaware, upon investing in C.I.D., that a share redemption was planned. However, he said that he might have missed a part of the meeting in which the redemption mechanism was explained (see the transcript of Serge Le Guerrier's testimony at pages 213 and 214). To complete the financial cycle of the investment in C.I.D., the redemption price of the investors' shares served to repay the loan granted by Diasware, and this was apparently done directly. Thus, the investors needed only pay Diasware the interest for a few months.
[19] I should point out that none of the Appellants were familiar with Diasware and Glenrock or their ties to Mr. Vohoang, his relatives, or his employees, such as his wife Huyen Anh Nguyen or his secretary Marjorie Lauger, who signed documents on behalf of those corporations. Diasware's address was in Calgary, Alberta, though its postal address was 2035 Côte-de-Liesse Road in Ville Saint-Laurent (Exhibits I-3 and I-4). In addition, Glenrock was incorporated in Dublin, Ireland in 1988 (Exhibit I-2, tab 67) and Huyen Anh Nguyen, in her capacity as a director, signed a change of head office, albeit to another Dublin address, in 1990. Aston Corporate Management Ltd. had a Manx address and its name is given as the "presenter" of the address change (Exhibit I-2, tab 68). In a fax addressed to auditor Michel Beaudry on February 16, 1993, Hien Vohoang told Mr. Beaudry that Glenrock's address was in Rosemead, California (Exhibit I-2, tab 44). For the purposes of certain banking transactions, the address on record was in Calgary, Alberta or was 2035 Côte-de-Liesse Road in Ville Saint-Laurent (Exhibit I-2, tabs 57 and 59). The number of business corporations that were utilized to look after different aspects of the investments in C.I.D. -whether it be for research, to offer the investors financing, or to redeem their shares - and the numerous and often foreign addresses given for these corporations, were certainly not intended to promote the transparency of the transactions.
[20] C.I.D.'s research project was called "CASA". Claude Papion, the scientific expert that the Respondent retained to analyze the project, said that its objective was to [TRANSLATION] "perfect a methodology as well as software engineering workbench software for object-oriented analysis" intended for use by computer specialists to build applications in [TRANSLATION] "so-called object-oriented language". According to the expert, this was a very large-scale project which fulfilled the conditions of section 2900 of the Income Tax Regulations and was therefore an eligible project.
[21] During his visit at 2035 Côte-de-Liesse Road with auditor Michel Beaudry in 1992, Mr. Papion met with Mr. Vohoang and certain scientists, including Sylvain Giroux and François Cloutier. The CASA project continued until 1991, and ended in an admission of failure. Mr. Papion said that he was surprised that only seven people worked on it, and that they only worked part-time for a total of three person-years. According to his estimate, this would have required a total research budget of $150,000, not the $1.6 million stated in C.I.D.'s operating statement for the four-month fiscal year ended December 31, 1989, which each of the Appellants submitted with their income tax return for the year 1989 (Exhibits I-11, I-15, I-18, I-20, I-22 and I-23). Mr. Papion testified that he would have expected roughly 30 people to work on a project that had a $1.6-million budget.
[22] The $1.6-million research expense reported by C.I.D. is related to a service contract with Zuniq dated November 24, 1989, for the same amount. Under this contract, C.I.D. assigned scientific research and experimental development work related to the CASA project to Zuniq, and the amount of the contract, $1.6 million, was equal to the total subscriptions by C.I.D. partners as of December 31, 1989 (Exhibit I-2, tab 13). In fact, the payments to Zuniq began on October 17, 1989, before the contract was even signed (Exhibit I-2, tab 14).
[23] Also on November 24, 1989, Zuniq entered into subcontracts with Data Age Corp., Zuniq Data, Dias Informatique Inc. and Système Inar for scientific research and experimental development work related to the CASA project (Exhibit I-2, tabs 15 to 18). All these corporations were controlled by Mr. Vohoang and members of his family. Since other partnerships also gave research contracts to the same business corporations, and since those corporations had different fiscal years and gave each other contracts, auditor Michel Beaudry claimed that it was not possible to verify which funds had been allocated to research work on a specific project, and that there was no way to know what really happened.
[24] There is no evidence that the Appellants or other investors participated in any manner in the decisions leading to the granting of the CASA research contracts. This is despite the wording of paragraph 8.1 of the partnership agreement (Exhibit I-2, tab 3), which reads:
[TRANSLATION]
The affairs and operations of the Partnership shall be managed and administered by the partners by a majority vote according to the number of outstanding shares, with the exception of such matters which, from time to time, are expressly entrusted to one or more of them. Any partner may occasionally mandate another partner by special proxy to act in his place to cover an absence or incapacity.
[25] While C.I.D. gave Zuniq the $1.6-million research work contract on November 24, 1989, and Zuniq awarded subcontracts to the other corporations discussed above, C.I.D.'s proponents asked the investors - or at least some of them - to sign a resolution appointing Sue Truong as manager of the CASA project until December 31, 1992. At least three of the Appellants signed this resolution. Serge Le Guerrier signed it on September 22, 1989 (Exhibit A-1, tab 5) and Normand Elie signed it on October 30, 1989 (Exhibit I-13). Apparently, Jacqueline Raby signed it as well, but her name, her signature and the date are illegible on the copy tendered in evidence (Exhibit A-2, tab 5). In any event, none of the Appellants testified that they knew Ms. Truong. Although Normand Elie and Serge Le Guerrier said that they did not know her, they claim that they signed the document simply because they were asked to do so.
[26] In addition, the documents tendered in evidence by Mr. Le Guerrier and Ms. Raby include a document dated February 26, 1990, entitled [TRANSLATION] "Software Engineering Method for the Open-Ended Development of Large-Scale Object-Oriented Applications: Scientific Research and Experimental Development Report in accordance with Revenue Canada Form T661 by C.I.D. Systems and Zuniq Corp." (Exhibit A-1, tab 2 and Exhibit A-2, tab 2). At page 5 of the document, under the heading [TRANSLATION] "Managerial and Operating Staff", there are five names, including Hien Vohoang, project director; Jean-François Cloutier, coordinator, and Sylvain Giroux, "senior" researcher. Messrs. Vohoang, Cloutier and Giroux are among the people that Mr. Papion (the Respondent's scientific expert) and auditor Michel Beaudry met in August 1992. Strangely, Sue Trong's name is nowhere to be found, even though she was appointed project manager under the terms of the resolution referred to above.
[27] All the Appellants testified about the circumstances surrounding their investment in C.I.D. and their participation in the partnership's project. Beyond the financial and tax-related aspects, which have already been discussed in detail, the Appellants mentioned several other reasons for their interest in the project. First of all, it is important to mention that Mr. Vohoang's software engineering research and his prestigious reputation in the field were known to several of the Appellants whose experience and professional endeavours pertained to computer science to varying degrees. Those Appellants, namely Jacques Elie, Normand Elie and Serge Le Guerrier, were therefore in a "privileged" position to participate actively in the CASA project proposed by C.I.D. Jacques and Normand Elie hoped that Mr. Vohoang's work would enable them to solve certain problems related to the transfer of software developed by Jacques Elie over several years on a Hewlett Packard 80 computer to open-architecture computers such as IBM PCs, with the help of a new graphics card that Mr. Vohoang was trying to develop. Mr. Le Guerrier himself was trained and had several years of experience in computer science, including software design and programming. As for Mr. Baltazar, he believed that the project was related to his experience and that it complemented his professional activities in the electronics field.
[28] Investor Pierre Beaupré and the Appellants learned of the existence of C.I.D.'s scientific research and experimental development project from various sources. Apparently, they went to a first information session at Hôtel Roussillon in Longueuil, on Montréal's south shore, where Mr. Vohoang and his cohorts explained it to them. Apart from a few relatives, friends or co-workers of the Appellants, the people there did not know each other, and did not forge personal or business ties thereafter.
[29] Following their decision to invest in C.I.D., Mr. Beaupré, the Appellants, and presumably all the other investors, received certain basic software tutorial diskettes such as J'apprends MS-DOS, Getting Started Sperry Personal Computer, WordPerfect Tutor, and Lotus 1-2-3. Two articles, "Niveau de connaissance d'un système informatique and perception des incohérences de son interface" [Level of knowledge of a computer system and perception of inconsistencies in its interface] by J.M. Robert, W. Blach and D. Goupil; and "Apprentissage des systèmes informatiques par exploration" [Learning computer systems through exploration] by Jean-Marc Robert, were also sent to the investors, who were asked to analyze the interfaces of one of the programs and fill out a questionnaire entitled [TRANSLATION] "Participation Sheet" (Exhibit I-2, tab 50, Exhibits I-10, I-14, I-17 and I-19, Exhibit A-1, tab 6, and Exhibit A-2, tab 6).
[30] In early 1992, auditor Michel Beaudry asked Claude Papion to examine the documentation obtained from C.I.D. (Exhibit I-9) for the purpose of auditing the partners' involvement in its project. In addition, he allegedly gave Mr. Papion the same mandate with respect to GET Systems and ECT Systems, which were formed by the same proponents.
[31] On May 21, 1992, Mr. Papion reported his findings in a [TRANSLATION] "Memo to Auditor" (Respondent's expert report, Exhibit I-25, Schedule A, tab 1). The memo reads as follows:
[TRANSLATION]
1. PREAMBLE
When a research partnership is formed in order to finance scientific research and experimental development projects using a tax shelter, the partners must participate suitably in the work.
I was asked to examine the nature of the partners' participation in the following partnerships:
· CID systems (CID)
· GET systems (GET)
· ECT systems. (ECT)
2. NATURE OF THE PROJECTS
CID undertook the CASA project. The aim of the project is to develop a prototype methodology for the open-ended development of large-scale object-oriented applications. Thus, it is a software engineering project.
GET, for its part, was formed to undertake the SEAGEPT project. The aim of that project is to develop a personal time-management support expert system that draws on artificial intelligence principles.
Lastly, ECT was to undertake the development of an expert system called DAMDES, which would simplify the maintenance of avionics systems while reducing maintenance and operation costs.
3. NATURE OF THE PARTNERS' PARTICIPATION
The abundant documentation supplied in connection with the partners' participation has the following characteristics:
· Although each of the projects deals with a fundamentally different subject, the documentation supplied is, in all three cases, identical in every way and not in the least bit relevant to the subject of the project in which the partners invested funds.
· Each file contains an annual report of the partners' participation activities for the year 1989
Yet, it was only in 1990 that the partners were first asked to review the documentation prepared for them, as evidenced by the work sheets of several partners, which date back to 1990 and correspond to the period in which they subscribed.
· Lastly, the questionnaires that the partners were asked to fill out are identical in all three cases and make no reference to the research project to which the partners were supposed to contribute.
Thus, the purpose of this documentation remains a mystery.
[32] Mr. Papion testified that this was all that he could say after reading the documents that he was given (transcript of Claude Papion's testimony, August 3, 2005, at page 27).
[33] In December 1993, Mr. Beaudry asked Mr. Papion to reconsider the activities of the C.I.D. partners based on the documentation that Dominique Boisvert, one of the investors, had sent him (Exhibit I-2, tab 50). On December 4, 1993, Mr. Papion sent his assessment to Mr. Beaudry (Respondent's expert report, Exhibit I-25, Schedule A, tab 2). The document reads as follows:
[TRANSLATION]
Based on the documentation submitted by Dominique Boisvert, his activities in relation to the CASA project undertaken by CID Systems Inc. do not correspond to the objectives of the project.
Indeed, the objectives of the CASA project were to design and develop the prototype of a methodology for the open-ended development of large-scale object-oriented applications.
The software technology on which the project was based began with the building of a methodological framework for the development of complex software "that cannot be wholly specified from the outset." Such a framework would be particularly attractive as fundamental research undertaken for the advancement of science without any foreseeable practical application, and would ultimately be of interest in the area of applied research. Thus, this was an attempt to develop a software engineering workbench program for object-oriented analysis.
The CASA project, which began in September 1988,[1] ended with an admission of failure in December 1991.
The activities in which Dominique Boisvert was involved pertain to the manipulation of elementary software which junior colleges use to teach the basics of computing: J'apprends MS-DOS (basic elements), WordPerfect (a popular word-processing application, and Teach Yourself Lotus 1-2-3 (the most popular spreadsheet application.)
Similarly, the two articles sent to Mr. Boisvert for analysis (M. Robert, W. Blach & D. Goupil, "Niveau de connaissance d'un système informatique et perception des incohérences de son interface"; and J.M. Robert, "Apprentissage des systèmes informatiques par exploration") are entirely unrelated to the topic and objectives of the CASA project.
Such activities are absolutely unrelated to the subject of the CASA project and do not contribute in any way to the work of several academics recruited for the project - academics who are very familiar with the technology behind the software examined during the feasibility study. Such software also requires a complete mastery of computer technology - something that is far more demanding than the "beginner" computing that CID Systems Inc. saw fit to invite Mr. Boisvert to do.
The interface analysis sheet has nothing to do with the exploration of object-oriented representation that the research team was involved in.
The sheet discloses no genuine participation in the building of the announced software engineering prototype in collaboration with the assigned researchers in order to select software technology likely to be used as a starting point for the CASA project research, or in order ultimately to steer the project away from the path that led to its failure.
[34] When Mr. Le Guerrier questioned Mr. Papion about the possible connection between the investors' software analysis (using the questionnaire that the promoters had invited them to fill out) and the CASA project, Mr. Papion reiterated his finding that there was no such connection, because the CASA project was a software engineering project. Mr. Papion began with a reference to the concept of "software engineering", found in paragraph 6.10(6) of Information Circular 86-4R2, "Scientific Research and Experimental Development", dated August 29, 1988:
Software engineering involves the study, in terms of basic or applied research, of the methodology for the design, implementation, testing, and performance evaluation of software systems; that is, advances in the methodology required to construct computer programs with greater flexibility, efficiency, reliability, and ease of maintenance.
[35] Mr. Papion continued as follows at pages 45 and 46 of the transcript of his testimony:
[TRANSLATION]
I would like the emphasize that in my mandate to assess the eligibility of the CASA project, I had to rely on the fact that software engineering is, for the members of the team, and in particular Sylvain Giroux, a Université de Montréal doctoral candidate in computer science . . . well, he was indeed qualified to undertake study in the sense of pure or applied research of work methods. That was the purpose of the CASA project. So it has nothing to do with the interface. On the contrary, we wanted the people who were supposed to contribute to the project . . . well, to contribute to the project regarding the analysis of the meaning of an object-oriented application, on the construction of an object-oriented application, and ultimately on programming if they were able to. Those are the three elements that I expected the participants to be able to work on. It did not happen.
[36] Later on, Mr. Papion completely rejected Mr. Le Guerrier's suggestion that the investors' interface analysis could constitute the preliminary phase of the CASA project and was akin to an advisability or feasibility study related to the project. The following can be found at pages 48 and 49 of the transcript of his testimony:
[TRANSLATION]
No. I cannot accept that. To put it simply, they were already miles ahead. The weaknesses of the existing technologies had already been identified. Mr. Giroux is another researcher working for Zuniq. He was working on other partnerships' projects as well. And he went a long way toward implementing his research on object-oriented languages when he prepared his doctorate in computer science. Thus, this was his field from the outset, so he was well beyond the preliminary study phase.
[37] Certain Appellants, namely Serge Le Guerrier, Jacques Elie and Normand Elie, testified that they attended a second meeting in Laval. Few details were provided, except that the discussion included interfaces (transcript of the testimony of Jacques Elie, pages 105 to 107).
[38] Several Appellants said that they were available to participate in the C.I.D. project. However, despite the fact that some of them, after filling out the questionnaire that they were sent in connection with the interface of one of the basic applications, made telephone calls to find out about the next stages that would require their participation, absolutely nothing concrete was proposed to them, and, as we know, they all transferred their C.I.D. shares to Glenrock in the early months of 1990.
[39] Moreover, apart from the aforementioned approval of Sue Truong's appointment as project manager, none of the partners participated in C.I.D.'s management or in any decision-making related to the partnership's activities. In fact, they were clearly unable to show that they were familiar with any aspect of the partnership's management and the decisions made in this regard. The answers that they provided on cross-examination are particularly telling on this point.
[40] It is important to add a comment about a particular consideration that Mr. Le Guerrier raised in connection with the management of the partnership. He noted that he revised and approved C.I.D.'s financial statements for the year ended December 31, 1989 (Exhibit A-1, tab 5, last page). In fact, he signed the declaration approving the financial statements on April 12, 1990. However, he had already disposed of his C.I.D. shares on January 24, 1990, following the offer received from Glenrock (Exhibit A-1, Schedule A entitled [TRANSLATION] "Summary History of Actions and Interventions.") Thus, two and a half months after ceasing to be a partner of C.I.D., Mr. Le Guerrier signed the document submitted to him, approving C.I.D.'s financial statements at December 31, 1989.
[41] In summary, the preponderance of the evidence tends to establish the following facts:
- The Appellants did not participate in the C.I.D. research project as partners. Their analysis of the interface of well-known software, at the proponents' request, was not shown to be connected with the CASA project in any way. In fact, as Claude Papion, the Respondent's scientific expert, noted, this beginner-level exercise, which was apparently also done in connection with three different research projects, was entirely unrelated to the work done by the researchers assigned to the CASA project, who were well beyond that stage. My finding on this subject is that the only activity that the C.I.D. partners were asked to engage in was designed to create the illusion of active involvement in the activities of the partnership - activities which were, in fact, very limited, given the CASA research project subcontract granted to Zuniq and the project-related research contracts that Zuniq simultaneously awarded to related corporations. None of the Appellants participated in the decisions that led to the granting of these contracts. Given this context, the resolution appointing Sue Truong as CASA project manager appears to be a sham intended to create the illusion that the partners were involved in the management of C.I.D. In all the documents adduced in evidence, nothing establishes that Ms. Truong took any part in the CASA project.
- Research-related aspects aside, none of the Appellants were engaged in the management of C.I.D. either, whether financially or otherwise. In fact, on cross-examination, all the Appellants had to admit that they had no knowledge of the administrative aspects of C.I.D.'s activities or its management. In this regard, the approval of the financial statements by certain partners, after they had transferred their shares, certainly cannot be considered an indicia of active engagement in the activities of the partnership.
- All the Appellants sold their shares in C.I.D. to Glenrock during the early months of 1990 using a mechanism which the promoters had planned in advance, and the terms of which the Appellants had no part in negotiating. The purchase price, fixed at 50% of the amount of each person's investment, was intended, and was used, to repay an equivalent loan granted by Diasware, which had the effect of doubling the expected tax advantages.
[42] The assessments for 1989 are premised on the assumptions that C.I.D. was validly formed, that it operated a business, but that the appellants were specified members of the partnership within the meaning of paragraph (b) of the definition of "specified member" in subsection 248(1) of the Act. At that time, the definition read as follows:
"specified member" of a partnership in a fiscal period or taxation year of the partnership, as the case may be, means
(a) any member of the partnership who is a limited partner (within the meaning assigned by subsection 96(2.4)) of the partnership at any time in the period or year and
(b) any member of the partnership, other than a member who is
(i) actively engaged in those activities of the partnership business that are other than the financing of the partnership business, or
(ii) carrying on a similar business as that carried on by the partnership in its taxation year, other than as a member of a partnership,
on a regular, continuous and substantial basis throughout that part of the period or year during which the business of the partnership is ordinarily carried on and during which the member is a member of the partnership;
[43] In light of my conclusion that the Appellants did not participate in the CASA research project or the administration or management of C.I.D., I have no option but to find that they were not actively engaged in the activities of C.I.D. on a regular, continuous and substantial basis throughout the four months of its fiscal year ended December 31, 1989. The consequences of this finding are consistent with the assessments, the details of which are set out in paragraphs 3 to 7 of these Reasons for Judgment.
[44] In the alternative, the Respondent submits that each of the Appellants was a specified member within the meaning of paragraph (a) of the definition of "specified member" in subsection 248(1) of the Act -that is to say, any member of the partnership who is a "limited partner."
[45] The definition of "limited partner" is found in subsection 96(2.4) of the Act. Paragraph 96(2.4)(b) of the Act provides that a taxpayer will be considered a "limited partner" at a particular time if, at that time or within three years of that time, the taxpayer or a person with whom the taxpayer does not deal at arm's length is entitled to receive an amount or obtain a benefit that would be described in paragraph 96(2.2)(d) of the Act, other than the stated exceptions. According to the terms of that paragraph, the entitlement to receive the amount or obtain the benefit can be immediate, future, absolute or contingent, and can be by way of reimbursement, compensation, revenue guarantee or proceeds of disposition, granted for the purpose of reducing the impact of any loss that the taxpayer may sustain by virtue of being a member of the partnership or by virtue of the taxpayer's disposing of the taxpayer's partnership interest.
[46] The mechanism put in place for the short-term redemption of the partners' (including the Appellants') C.I.D. shares by Glenrock for an amount equal to 50% of their investment was amply demonstrated, as was the fact that each of the Appellants obtained took advantage of this mechanism as early as the first months of 1990. In my opinion, given the right to obtain this benefit, each of them could have been considered "limited partners", and, as a result, the deduction of the loss would simply have been disallowed by operation of paragraph 96(1)(g) of the Act. The investment tax credit would also have been disallowed by operation of the restriction contained in paragraph (a) of subsection 127(8) of the Act. However, since the assessment was not made on the basis that each of the Appellants was a "limited partner", there is no point continuing on this basis, except to emphasize that they likely obtained more than they were entitled to.
[47] In the further alternative, the Respondent submits that there was no true partnership because, inter alia, there was no intention to operate a business jointly for the purpose of deriving profit -elements that are essential to the existence of a partnership under article 1830 of the Civil Code of Lower Canada.
[48] The Respondent also submits that the objective of the "financing package" orchestrated by the proponents was not to permit the operation of a business, but simply to give all the participants the opportunity to make money.
[49] Obviously, these findings are based on factual assumptions that are entirely contrary to the assumptions on which the assessments in issue are based. I must determine whether those assessments are well-founded having regard to the factual assumptions on which they are based and the applicable law. Having done so, I find it unnecessary to answer the question whether C.I.D. was a genuine partnership or whether it operated a true business; at the same time, I would note that I find it somewhat incongruous for the Respondent to argue one thing as well as its opposite. I am not convinced that subsection 152(9) allows one to go so far. In any event, I find that the assessments, as made, are well founded.
[50] In closing, I should point out that the Appellants criticized Revenue Canada's treatment of their file on several accounts and even with regard to the management of R & D files in general. One of the most significant critiques pertained to delays, which some of the Appellants considered excessive and unacceptable under the circumstances. Thus, the Appellants request that this Court cancel the interest in the event that their appeals are dismissed.
[51] As I stated at the hearing, the cancellation of interest comes within the discretion granted to the Minister under subsection 220(3.1) of the Act. The Tax Court of Canada has no power in this regard because its jurisdiction is limited to determining whether an assessment is well founded. If a taxpayer who has asked the Minister to cancel his interest is dissatisfied with the Minister's decision, the taxpayer may file an application for judicial review in the Federal Court.
[52] In light of the foregoing, the appeals are dismissed.
Signed at Ottawa, Canada, this 23rd day of August 2006.
Dussault J.
Translation certified true
on this 13th day of October 2006.
Monica F. Chamberlain, Reviser
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