Citation: 2005TCC660
Date : 20051026
Dockets: 98-3616(IT)I and 98-3721(IT)I
BETWEEN:
PAUL BOUDREAULT,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
REASONS FOR JUDGMENT
Lamarre J.
Preliminary remarks
[1] These appeals were heard at the same time as the appeal in Lucette Carpentier v. The Queen (docket 98-3791(IT)I). At the request of these two appellants, their appeals were not heard on common evidence. However, a portion of the respondent's evidence that was adduced in the appeals of Paul Boudreault was submitted in the case of Lucette Carpentier, by consent of the parties. Exhibit I-1 filed in Mr. Boudreault's appeals comprises Tab A only, Tab B being part of the evidence in Ms. Carpentier's appeal. Exhibits I-2 to I-10 inclusive filed in Mr. Boudreault's appeals will also be part of the evidence in Ms. Carpentier's appeal. Tabs A and B of Exhibit I-13 are part of the record for Mr. Boudreault's case and Tab C of Exhibit I-13 is included in the record for Ms. Carpentier.
[2] The appellant is appealing from the assessments made for the 1986 and 1988 taxation years by the Minister of National Revenue ("Minister"). The Minister has disallowed a $3,000 investment tax credit for a $15,000 investment the appellant made in 1986 in the limited partnership "PC-DOS utilitaires" ("PC-DOS") and a $4,000 credit for a $20,000 investment he made in 1988 in Société de Recherche système SED enr. ("SED") (a general partnership). The investment tax credit was disallowed under section 37 of the Income Tax Act ("Act") and section 2900 of the Income Tax Regulations ("Regulations"). The appellant was reassessed on December 17, 1991 for the 1986 taxation year and on June 18, 1992 for the 1988 taxation year. On April 26, 1990, he signed a notice of waiver regarding the application of the three-year time limit, allowing the Minister to reassess the tax, penalties and interest for the 1986 taxation year after the time limit set out in subsection 152(4) of the Act in respect of the [TRANSLATION] "business loss and investment tax credit from the limited partnership for research and development of software utilities running on PC-DOS as well as financing charges arising from amounts borrowed to finance the subscription in that partnership" (Exhibit I-1, Tab 3). The Minister had made the reassessment within the prescribed time for the 1988 taxation year. It should be noted that the Minister allowed the deduction of a $15,000 business loss in 1986 and a $20,000 business loss in 1988.
[3] On December 14, 1990, the appellant directed accountant Yves Renaud to represent him in dealing with Revenue Canada (now the Canada Customs and Revenue Agency, or "CCRA") with a view to reaching a settlement regarding the proposed assessment and PC-DOS's research and development expenditures in 1986 (Exhibit I-11).
[4] On January 31, 1992, Mr. Renaud filed for and on behalf of the appellant a notice of objection against the December 17, 1991 assessment made for the 1986 taxation year (Exhibit I-11), which disallowed a $3,000 investment tax credit.
[5] On July 6, 1992, the appellant authorized Lise Gauthier of Zuniq Corp. ("Zuniq") to sign on his behalf a notice of objection against the assessment of June 18, 1992 (Exhibit I-12), which disallowed a $4,000 investment tax credit. The notice was filed on August 25, 1992.
[6] On September 28, 1992, the appellant sent to then-Minister of Revenue the Honourable Otto Jelinek a form letter prepared for of all members of partnerships related to the Zuniq group. The letter explained the investment project and asked the Minister to intervene and to vary Revenue Canada's decision in the PC-DOS project (see Exhibit A-1, Tab P).
[7] Revenue Canada, Audit Division, acknowledged receipt on January 22, 1993 of the complaint with respect to the treatment of the research and development claims sent to the Honourable Otto Jelinek. It notified the accountant Mr. Renaud that the letter to Mr. Jelinek was considered to be a notice of objection (even though the appellant had already filed a notice of objection through Mr. Renaud) and asked him to inform his clients (including the appellant) to that effect (see Exhibit I-9). The appellant nonetheless testified that he could no longer recall Mr. Renaud's intervention in his case.
[8] The Minister not having confirmed the assessments, the appellant then filed notices of appeal with this Court through his counsel, Bonhomme, Castonguay et associés, on November 24 and 26, 1998 for the 1986 and 1988 taxation years respectively. The appeals were stayed pending the outcome of a similar test case being heard before this Court, McKeown v. Canada, [2001] T.C.J. No. 36 (Q.L.), which dealt with investments similar to those made by the appellant. All of them involved research contracts allegedly awarded to Zuniq (more than 500 taxpayers were reportedly involved).
[9] On October 22, 2002, after this Court ruled against the investors in McKeown, counsel for the appellant ceased representing him. Since the appellant wished to pursue his appeals, a hearing was called for September 2005. Given that the appellant has not paid the amount required under the assessment being appealed, he will need to pay a considerable amount in interest if his appeals are dismissed. I understand that he has already applied to the Minister under subsection 220(3.1) of the Act for a waiver of interest in the event the appeals are dismissed. Such a decision falls within the Minister's discretion, and I do not have the authority to decide whether the interest should be cancelled in these circumstances.
Facts
[10] During the 1986 taxation year, the appellant was director of professional services at the Centre d'accueil Sénécal in Montreal. He left that employment on July 1, 1988 to accept a position as a full-time professor and researcher at l'Université du Québec à Hull. During that time the appellant completed his doctoral studies, his dissertation dealing with the services offered at institutions within the health and social services network.
[11] On the recommendation of Guy Massé, the accountant and director of administrative services at the Centre d'accueil Sénécal, the appellant invested in the PC-DOS project. In connection with his work at the Centre d'accueil and his doctoral studies, the appellant felt the need to better coordinate inter-institutional services within the health and social services network. According to the appellant, the PC-DOS project was presented to him as intended to develop research expertise on the use of informatics, or more specifically, research and development regarding a software program that could be used to standardize the files of a number of rehabilitation centres. He said that in the context of his work he was looking for a product that would run using a single language that could be used by different institutions. According to the appellant, this PC-DOS project was in line with his work as director of professional services at the Centre d'accueil Sénécal (although the centre was not directly involved in the PC-DOS project) and with his research concerns, which were focussed on the need to develop data management tools. Although he acknowledged that he had not invested any real time in PC-DOS, he considered himself the champion or the promoter of this project at the Centre d'accueil Sénécal. The appellant acknowledged that there were tax benefits associated with his financial participation in such a research project but considered those benefits to be secondary to the professional advantages and those related to his doctoral studies that he would derive from it.
[12] On this subject, it is important to note that the appellant purchased two shares of PC-DOS on December 16, 1986 for $15,000 ($7,500 per share). The PC-DOS limited partnership had been formed according to the Quebec legislation shortly before that date, on November 4, 1986, by Gestion Gessica Inc. (a corporation whose president was Hien VoHoang) as general partner and Anh Nguyen (Hien VoHoang's wife) as limited partner (Exhibit I-2, Tabs 31 and 32). According to the contract issued on November 4, 1986 to Zuniq (a corporation of which Hien VoHoang was also president) for the experimental development and production of the prototype for the PC-DOS software utilities, all of the design, construction and testing work was to be completed within a 12-month period (Exhibit I-2, Tab 33). The project description signed by Hien VoHoang on Zuniq's behalf on December 30, 1986 (found in the appellant's tax return for the 1986 taxation year at Exhibit I-1, Tab 1, page 23) indicates that the research work began in early July 1986 and that most of the work was completed by December 30, 1986 (Exhibit I-1, Tab 1, page 27). As for the appellant, his shares were bought out by Data Age Corp. Inc. ("Data Age"), whose president was also Hien VoHoang, on January 7, 1987 (just three weeks after he invested) for $9,000 ($4,500 per share), or 60 percent of the purchase price (without his first having obtained an appraisal). On his 1986 tax return he claimed a business loss for the full amount of the investment, that is, $15,000 minus the $3,000 investment tax credit claimed (thus a claimed loss of $12,000), $9,000 having already been refunded to him. Since the appellant had a high enough income in 1986 to be in a 50 percent tax bracket (federal and provincial combined), he recovered almost all of his investment through a tax refund of approximately $6,000 (50 percent of the claimed loss of $12,000) plus the $9,000 that had been refunded to him within a very short time. If we add to this the $3,000 investment tax credit that he received (but that is now being contested by the Minister), he was anticipating a profit of at least $3,000 in tax benefits. The $9,000 amount refunded in 1987 was not taxable under the rules applicable at that time with regard to the tax exemption on capital gains. PC-DOS was dissolved on October 26, 1987 (Exhibit I-2, Tab 51).
[13] On May 28, 1987 the appellant invested in another limited partnership, Société en commandite LI-STAT ("LI-STAT"), whose general partner was DIAS Informatique Inc., a corporation whose president was Hien VoHoang (see form T661, Claim for SR & ED Expenditures, in the appellant's 1987 tax return, Exhibit I-1, Tab 5, at page 30). The appellant invested $15,000, again according to the same scenario. The partnership in question also stated that it performed scientific research and experimental development, not in informatics but in an entirely different field, that of oil and gas. The partnership had only one fiscal year lasting two months, and the appellant's shares were bought out for $9,000, or 60 percent of his investment. He also obtained a $3,000 investment tax credit, which this time the Minister did not contest, and claimed a business loss for the full amount of the investment ($15,000), which exceeded the $3,000 investment tax credit (claimed loss of $12,000). The appellant claimed an exemption on the capital gain arising from the buyout of his shares in 1987. The appellant said at the hearing that he could not remember having invested in LI-STAT in 1987.
[14] On January 27, 1988, the appellant purchased $20,000 worth of shares in SED, another general partnership formed in accordance with the Quebec legislation. The latter was established on November 17, 1987 by Michel Picotte and Stéphane Gagnon (Exhibit I-2, Tab 64), two key people named on the offering memorandum issued in connection with the PC-DOS project (Exhibit I-2, Tab 34, page 7). The address of SED's head office was the same as that of PC-DOS, and the contact person indicated on the T661 form is Hien VoHoang. On November 17, 1987 SED subcontracted to perform research for Gestion DAC Inc., a corporation represented by Hien VoHoang (Exhibit I-2, Tab 67). SED was allegedly established to conduct scientific research and experimental development in the informatics field as well, specifically on a prototype for an expert medical diagnosis system. It had only one fiscal year lasting 75 days that ended on January 31, 1988, the date on which the research was to have been completed (Exhibit I-2, Tab 67, page 2, paragraph 4). The appellant, who had invested $20,000 three days earlier, sold his shares back to the partnership during the 1989 taxation year for $10,000 and claimed a business loss for the full amount of the investment, $20,000. He claimed a $4,000 investment tax (which is now being disallowed). He claimed a capital gains exemption on the redemption of his shares in 1989.
[15] The evidence thus shows that those three investments were all associated with the same group of persons and that the appellant saw in them a tax benefit that was much more advantageous (the respondent calculated a rate of return of approximately 24 percent taking into account the tax refund and the investment tax credit, both federal and provincial) than that from his previous investments in Canada Savings Bonds and his shares in large companies like Bell Canada. The appellant acknowledged that, although the research projects were in areas of informatics in which he was involved (except in the case of LI-STAT), he did not invest any actual time in them. Moreover, he did not know the vast majority of the other members of the partnerships in which he had invested. He never realized that there were more than 40 investors in each of those partnerships, thinking always that there were only five or six. He acknowledged that he had no interest in going into business with them and did not attend any of the partners' meetings. Furthermore, he was not aware at the time when he purchased shares in those partnerships that he could become jointly and severally liable with the other members for the partnership's debts. Had he know this, he never would have invested in them.
[16] The appellant did not know whether any market research or testing had been done on the research software. Although the offering memorandum for the PC-DOS project referred to a selling price of $1,500 per unit for the software, the appellant was under the impression that the unit price would be around $50,000. He acknowledged that, at $1,500 per unit, it was far from profitable. Furthermore, when the prospectus was issued it was anticipated that investors would be able to claim the full amount of their investment as a loss as of the first year. The appellant acknowledged that, although the partnership's project did not appear profitable, he was not worried and was sure of making a profit on the basis of the professional opinion his accountant had given him. He said he did not know at the time when he invested in those partnerships that his profit would be in the form of tax benefits. He acknowledged that no research had been done as to the profitability of the various projects. He did not participate in any discussions to find out whether the products were marketable.
[17] Richard Bernier, Large File Case Manager at CCRA, explained that he had reviewed all of the limited partnerships and general partnerships that had proposed scientific research projects and that had subcontracted with Zuniq or corporations related to it to carry out such projects. In June 1989, at a time when there was a proliferation of partnerships applying for investment tax credits for scientific research and experimental development, the tax avoidance section of Revenue Canada began scrutinizing such research projects more closely. Mr. Bernier identified 12 partnerships that had been established between 1986 and 1988 and that had subcontracted research contracts to Zuniq (including PC-DOS, LI-STAT and SED) (see Exhibit I-3).
[18] In checking the use of the funds associated with these various projects, Mr. Bernier noted in the case of PC-DOS that this partnership had collected $375,000 from 41 limited partners between December 15 and 19, 1986. PC-DOS had previously subcontracted with Zuniq in November 1986 for the full amount of the investment collected from the limited partners (see Exhibit I-2, Tab 33). Zuniq invoiced PC-DOS on December 26, 1986 for an amount of $375,000 (Exhibit I-2, Tab 38). Zuniq itself had previously subcontracted the same research contract to Data Age for an amount equivalent to 60% of the investors' total subscription amount, or $225,000 (60% x $375,000) (see invoice dated December 23, 1986 from Data Age to Zuniq for the amount of $225,000 at Exhibit I-2, Tab 39). On January 5, 1987, Data Age remitted $225,000 to PC-DOS (see bank statements of PC-DOS and Data Age, Exhibit I-2, Tabs 43 and 44), which in turn refunded to each limited partner that had invested 60 percent of the initial investment, or $4,500 per share, for a total of $225,000 (see PC-DOS bank statements showing a number of $4,500 disbursements between January 6, 1987 and February 3, 1987, Exhibit I-2, Tab 43).
[19] Mr. Bernier noted that 60 percent of the amount of the investments had not been used for scientific research in any way, since those amounts had been returned to the investors within three to eight weeks. He was able to check this against the personal case of each investor. Moreover, all of them had apparently signed a special resolution authorizing the general partner to sell their interest in the software to Data Age and to dissolve the partnership, thereby acknowledging receipt of a cheque for an amount representing 60 percent of the initial investment, identified as the share of PC-DOS's assets vested in them further to the dissolution of the partnership. Mr. Bernier calculated that this scheme enabled investors to make a 24 percent profit on their investment through the tax implications alone and that, even with the investment tax credit being disallowed, all of the investors made a profit of 10 percent over and above their initial investment given that they were allowed a business loss for the full amount of the investment (thus, for the appellant, a loss of $15,000 rather than the $12,000 initially claimed was allowed in connection with his investment in PC-DOS at the time of the reassessment of December 17, 1991). PC-DOS was the only partnership for which Mr. Bernier carried out a full audit. All of the other partnerships related to the Zuniq group (Exhibit I-3) were referred to Revenue Canada's scientific research department.
[20] Claude Papion, an informatics expert, was directed by Revenue Canadaon May 23, 1991 to evaluate the applications relating to the scientific research and software (PC-DOS) development activities of the PC-DOS partnership for the year ended December 31, 1986. Mr. Papion was to have completed his report by June 21, 1991. Under his mandate, Mr. Papion was to report to Revenue Canada's regional scientific advisor on the eligibility of the work performed by PC-DOS pursuant to subsection 2900(1) of the Regulations.
[21] To determine the eligibility of that work, Mr. Papion relied on three criteria identified by Revenue Canadaand set out in Information Circular 86-4R2, namely:
- scientific or technological advancement;
- scientific or technological uncertainty;
- scientific or technical content, the first criterion being what resources were used and whether they were reasonable, and the second whether the resources were used to conduct scientific or technical research.
[22] To that end, the expert verified whether the documentation had been retained. The onus is on the taxpayer to show that it managed its research project properly.
[23] According to the documentation that was provided, the goal of the PC-DOS project was to create a set of software tools for programmers for the development of application systems to be run on the DOS operating system on PCs. At the end of the 1986 fiscal year, the PC-DOS limited partnership submitted a Claim for SR & ED Expenditures(Form T661), along with a description of the project that Zuniq was entrusted with completing. In 1986 the project was entrusted to a team of two specialists, to which a third was apparently added in 1987 and two others in 1988.
[24] In September 1989, a new description of the project was submitted, indicating that a new approach was being adopted as of that time. The project seemed to be divided into two phases. The first was apparently dedicated to creating a utility program for the development of management applications under PC-DOS, while the second was described as a new approach leading to the creation of a tool for the development of interdependent management applications in Smalltalk language. Given that the new approach was introduced in September 1989, it would seem that the work for Phase 1 had to be attributed to the period from 1986 to 1988.
[25] The project was initially evaluated by Dr. Miguel Marin, an external scientific advisor engaged by Revenue Canadaon November 14, 1989. In his report Dr. Marin evaluated the PC-DOS project according to these two phases. The first (for the years 1986 to 1988) was entirely dedicated to the application of traditional data processing methods, while the second (for the years 1989 to 1993) was based on object-oriented languages. According to this expert, only the second phase was deemed eligible within the meaning of section 2900 of the Regulations.
[26] In response to a request by the Zuniq representative to Revenue Canada to reconsider this position, Mr. Papion was thus directed to re-examine Phase 1 of the project and to see whether, in light of the file submitted by PC-DOS and the reports pertaining to the development of the PC-DOS project during the years 1986-87-88 provided by Zuniq, this phase was essential in order for Phase 2 to be carried out.
[27] According to Mr. Papion's report, the project under Phase 1 did not qualify as scientific research and experimental development under section 2900 of the Regulations. That section defines scientific research and experimental development as "systematic investigation or search carried out in a field of science or technology by means of experiment or analysis." According to Mr. Papion, the documentation produced by PC-DOS describes software tools that were already available, and not the results of systematic investigation or search within the meaning of the Regulations. Mr. Papion summarized the requirements of section 2900 as follows: [TRANSLATION] "development, that is, use of the results of pure or applied research with a view to creating new materials, devices, products or procedures or to improving existing ones" (see Rapport d'expert, PC-DOS, Exhibit I-14, page 7). According to Mr. Papion, the documents filed refer to neither the creation of new software tools nor the improvement of those selected, which were already available on the market. According to him, there was no transition between Phase 1 of the project, which was entirely devoted to the application of traditional data processing methods, and Phase 2, which was based on object-oriented languages. The results of Phase 1 did not point to or prepare in any way the work under Phase 2.
[28] Mr. Papion thus concludes that the work performed under Phase 1 of the project involving software utilities running on PC-DOS and dedicated to the development of management applications on PC-DOS: [TRANSLATION] a) "relies on the routine application of known technologies and products"; and b) "in no way constitute activities aimed at the examination of existing or emerging technologies with a view to establishing the technological objectives of Phase 2" (see Rapport d'expert de l'intimée, société PC-DOS, Exhibit I-14, Tab 2, page 10).
[29] He concluded that the project under Phase 1 did not address a technological uncertainty or a possible advancement of the existing technology. Accordingly, the project under Phase 1 does not meet the eligibility requirements for the scientific research and experimental development tax credit as set out in section 2900 of the Regulations.
[30] Mr. Papion testified in court that the expenditures that were claimed as having been made in 1986 in connection with the PC-DOS project were clearly unreasonable. In fact, PC-DOS claimed to have spent $375,000 in 1986, which in Mr. Papion's opinion would have entailed the involvement of at least eight to ten person-years in this case. However, as his report indicates, there were only two scientists who were named in the documentation and who allegedly participated in this project in 1986. Mr. Papion further noted that those same two people had also been assigned to other projects in which Zuniq was involved. Mr. Papion had been asked in 1990 to analyze another project with which Zuniq was still associated, the Micromondix project. He realized that the submission in the PC-DOS project was exactly the same as the one for the Micromondix project, although they were completely different projects. According to Mr. Papion, this situation did not seem normal.
[31] He also realized that Zuniq appeared among a dozen projects in several different fields (as varied as oil and gas development and informatics) and that starting in 1989 it was always the same team that, in theory, was working on all of the projects at the same time.
[32] He further noted that the same expenditure could be claimed for a number of different projects. For example, a trip to San Francisco and Calgaryundertaken for a seismographic study project in Calgaryhad been claimed under the PC-DOS project when it had nothing to do with it.
[33] Concerning the project submitted by SED, Mr. Papion was directed by Revenue Canadaon March 19, 1990 to evaluate applications pertaining to SED's scientific research and experimental development activities for the period from November 17, 1987 to January 31, 1988, as indicated on form T661. His report was to have been completed by March 31, 1991.
[34] This partnership was created on November 17, 1987 in order to perform scientific research and experimental development in the field of computers and electronics and to market the products that might result from this work. SED claimed that it had incurred $733,300 in expenses during the period from November 17, 1987 to January 31, 1988.
[35] A contract that SED signed on November 17, 1987 to engage DAC Inc. indicated that the project's initial objective was to develop a prototype for an expert medical diagnosis system, which had nothing to do with the initial objective. DAC Inc. was to complete the design, construction and testing before January 31, 1988, the date on which its work was to end. It would appear that DAC Inc. in turn was to entrust Zuniq with performing that same work.
[36] According to Mr. Papion's report (Exhibit I-15), as of March 14, 1988 only one preliminary analysis of a few bugs in the expert systems had been initiated. There was no objective of contributing to the advancement of the software technology; rather, the work entailed using commercial tools to develop a prototype. A December 14, 1990 letter from Zuniq president Hien VoHoang to Revenue Canadain response to a request by Mr. Papion to visit the premises to assess the scientific research and experimental development work indicated that the status of the work at that time did not yet attest to any kind of technological advancement. In fact, in that letter Hien VoHoang suggested that the final scientific report on the project would not be available until the fourth quarter of 1991. Hien VoHoang indicated at that time that he did not wish to receive a visit from Revenue Canada's scientific team before the end of the fourth quarter of 1991.
[37] In such circumstances, Mr. Papion concluded that, as of the date of his report, the project that SED had submitted on December 31, 1987 did not show any technological advancement and that this would not be possible before December 31, 1991. He further concluded that no technological uncertainty had actually been addressed and that none of the documents submitted attested to a systematic program of experimental development activities that was planned, implemented and monitored. He thus concluded that the expenditures claimed were not eligible for the investment tax credit.
[38] Mr. Papion added at the hearing that SED could not possibly have spent $733,000 on this project on the basis of the information submitted.
[39] Mr. Papion noted that no accomplishments were established for either the PC-DOS project or the SED project. He was unable to identify any work that had been performed. Nor was he given the opportunity to witness firsthand any genuine activity on those projects. PC-DOS never indicated to him that they wanted to link three languages to produce a software utility, as the appellant claims. All that was submitted to him were proposals; he was never given any kind of report on how the research (if in fact there was any) was progressing.
[40] Sonia Borin, a human resources advisor at CCRA, acted as objection officer. From 1992 to 1995 she coordinated all of the notices of objection filed by the limited partners of nine partnerships in the Zuniq group. She realized that the 12 partnerships in the Zuniq group (Exhibit I-3) were managed by the same group of people under Hien VoHoang. For each of those partnerships there was only one fiscal year lasting a minimum of 52 days to a maximum of 11 months for the very brief period in which each partnership was in existence. In every case, the end of the fiscal year corresponded to the time given to Zuniq or to another corporation related to it to complete the research work. In every case, the investors purchased shares in the partnerships shortly before the end of the fiscal year. The shares of each of those investors were bought back by a partnership affiliated with Zuniq for amounts ranging from 50 percent to 60 percent of their initial investment. Each investor held the shares for a very brief time, from a few weeks to three or four months. Each partnership claimed a loss that corresponded in every case to the amount of the total subscription and the research contract awarded to Zuniq or a related corporation.
[41] She concluded from this that none of the investors intended to work together on a scientific research project and thus doubted that the partnerships in question actually existed. She also concluded that the latter were not in fact carrying on business but had been created instead as a smokescreen to enable Zuniq to take 40 to 50 percent of the monies invested by the investors while ensuring that the latter did not lose anything and even gained a tax benefit from their investment. She thus concurred that the investment tax credit that had been previously been disallowed on the ground that there was no scientific research that would qualify under section 2900 of the Regulations was ineligible in light of the fact that the partnerships had no existence in law and were not carrying on any kind of business. Given that the Minster had already allowed the losses, she did not address the question of whether those losses were justified.
Issue
[42] The Minister initially disallowed the investment tax credit on the ground that the projects were not eligible under section 2900 of the Regulations. The respondent is now raising further arguments for not allowing the credit, the first being the absence of true partnerships and the second the absence of a true business. The respondent is raising these alternative arguments despite the fact that the Minister agreed to consider that the disposition of the appellant's shares in the partnerships had given rise to a taxable capital gain for which the appellant requested a tax exemption under section 110.6 of the Act. In accepting the existence of a capital gain arising from the disposition of the shares in the partnerships, the Minister thus initially recognized that the partnerships actually existed. The Minister also recognized a business loss for the full amount of the investment. In recognizing such a loss, the Minister thus admitted the existence of a business. The Minister is now arguing the opposite in support of his contention that the appellant is not actually entitled to the investment tax credit.
[43] According to the respondent's counsel, this does not constitute a new basis for the assessment but simply an alternative argument. The respondent is not attempting to increase the amount of the assessment through these alternative arguments. The respondent is not questioning the fact that the business loss was allowed or the capital gains exemption in connection with the disposition of the shares in the partnerships.
[44] What the respondent is now arguing is that the Minister did not doubt the actual existence of those partnerships at the time of the assessment. It was not until the objection stage that the Minister became aware of the proliferation of partnerships related to the Zuniq group and the fictional nature of those partnerships. The Minister thus questioned their existence and the respondent is now raising this alternative argument to contest the claim that an investment tax credit should be allowed.
[45] For his part, the appellant maintains that he made an investment in good faith and should not be penalized because of what may have been concocted by those running the partnerships in which he invested. In his opinion, the research and development projects were real, and if his investment is considered from a strictly personal point of view, without putting Zuniq on trial, it could be concluded that he truly invested in these projects. He thus maintains that he is entitled to the investment tax credit in both of the cases at issue.
Analysis
[46] It seems clear to me that, since the addition of subsection 152(9) of the Act, which applies to appeals disposed of after June 17, 1999, the Minister is entitled to raise an alternative argument, even after the time limit normally established for making a reassessment, subject only to paragraphs 152(9)(a) and (b) (see Canada v. Loewen (F.C.A.), [2004] F.C.J. No. 638 (Q.L.) and Gould v. Canada, [2005] T.C.J. No. 403 (Q.L.)). Indeed, it seems that subsection 152(9) allows the Minister, subject to the restrictions set out therein, to present any alternative argument to defend the amount assessed, as long as he does not endeavour to increase the amount in question.
[47] Subsection 152(9) reads as follows:
Alternative basis for assessment
(9)The Minister may advance an alternative argument in support of an assessment at any time after the normal reassessment period unless, on an appeal under this Act:
(a) there is relevant evidence that the taxpayer is no longer able to adduce without the leave of the court; and
(b) it is not appropriate in the circumstances for the court to order that the evidence be adduced.
[48] Paragraphs 152(9)(a) and (b) refer to the harm a taxpayer could suffer if Her Majesty were permitted to make new factual allegations many years after the fact.
[49] In this case, the appellant must have been aware of the factual allegations raised by the respondent for quite some time, since he directed Zuniq's accountant (Mr. Renaud) to represent him in dealing with Revenue Canadain 1990 with a view to reaching a settlement regarding the proposed assessment in the PC-DOS project. He also directed a Zuniq representative to represent him in 1992 in the objection filed with Revenue Canadain the SED project. If the appellant failed to ask his representatives about the discussions held with Revenue Canadaover the years, he cannot say several years later that he was not aware of the factual situation in effect at the time and cast the blame on CCRA.
[50] The respondent is not trying here to take into account transactions different from those that served as the basis for the reassessments made during the reassessment period (a practice that was not approved by the Federal Court of Appeal in Pedwell v. The Queen, 2000 DTC 6405). Nor is the respondent trying to increase the amount of tax to be paid. The respondent now considers that the Minister made an error in recognizing the existence of a partnership, and it cannot be bound by an error in law (see Ludmer v. Canada, [1995] 2 F.C. 3, [1994] F.C.J. No. 2007 (Q.L.) at paragraph 12). Furthermore, that same court cannot be bound by an admission which the evidence shows is contrary to the facts (see Hammill v. Canada, [2005] F.C.J. No. 1197 (F.C.A.) (Q.L.)).
[51] Furthermore, in circumstances that were similar to those in this case, Chief Judge Garon of this Court (as he then was) ruled in Blanchette v. Canada, [2001] T.C.J. No. 900 (Q.L.) that the Minister was entitled to argue that the partnerships in question were non-existent, even though there was no doubt as to their existence at the time when the assessments under appeal were made.
[52] I thus consider that the respondent is justified in raising this alternative argument in support of the assessments being appealed. I am of the opinion that the Minister has more than adequately demonstrated that the partnerships in question were non-existent and that no business was being carried on in this case.
[53] It is a matter of ordinary law, at both civil law and common law, that the essential element for the creation of a partnership is the intention of each partner to establish such an entity, which is expressed through each partner's intention to carry on business in common with a view to profit (see Bourboin v. Savard, [1926] 40 B.R. 68, in Quebec civil law; and see Continental Bank Leasing Corp. v. Canada, [1998] 2 S.C.R. 298, paragraph 22, regarding partnerships regulated by the Province of Ontario).
[54] In Backman v. Canada, [2001] 1 S.C.R. 367, the Supreme Court of Canada stated that "[...] to ascertain the existence of a partnership the courts must inquire into whether the objective, documentary evidence and the surrounding facts, including what the parties actually did, are consistent with a subjective intention to carry on business in common with a view to profit."(page 382, paragraph 25).
[55] Accordingly, the documentary evidence is not the only criterion for determining the existence of a partnership. It is necessary to determine whether the parties' concrete actions are consistent with such a subjective intention of carrying on business in common with a view to profit (see Witkin v. Canada, [2002] F.C.J. No. 703 (Q.L.), at paragraph 12, which reiterates Backman, supra).
[56] Moreover, when it has been established that the only reason a partnership has been started is to confer the benefit of a tax loss on a partner, and when the parties do not anticipate deriving any profit from carrying on business in common, the partnership cannot truly be considered as having been created with a view to profit (see Continental Bank, supra, at paragraph 43).
[57] In this case, although on the face of it the documentation submitted could seem to establish that the partnerships in question truly existed during the years in issue, I find that the evidence does not suggest that the appellant's actions are consistent with a true subjective intention to carry on business in common with the other partners with a view to profit. The appellant did not know the majority of the other members of the two partnerships in which he invested, did not attend any meetings, and was not aware of any marketing or profitability plans for the projects those partnerships were supposedly putting forward. Neither of the partnerships in question lasted more than one very short fiscal year (less than 12 months).
[58] I find as well that the documentary evidence tends instead to show that the two partnerships had no intention of carrying on real business with the money the alleged partners invested. Indeed, when the appellant invested in PC-DOS he knew from the offering memorandum that he would be able to claim a tax loss as of the first year (Exhibit I-2, Tab 34, page 15, section on maximum risk). In the case of SED, he invested in that partnership only a few days before the end of the fiscal year-end of January 31, 1988. Shortly afterward he received a notice from SED that indicated he would be able to claim a tax loss for the full amount of his investment for the 1988 taxation year (Exhibit A-2, Tab 70). The appellant knew from the beginning that he would not lose money, since he was refunded 60 percent and 50 percent of his investment in PC-DOS and SED respectively very soon after the time when he had invested. He was also told that he was not incurring any risk, since those investments would bring tax benefits that would offset his actual investment. Reduction of tax cannot by itself be a business for the purpose of the Act (see Moloney v. Canada, [1992] F.C.J. No. 905 (Q.L.)). Furthermore, although the appellant claims that he always acted in good faith, being in no way a party to the scheme orchestrated by the Zuniq group, this cannot give rise to a real source of income from the victim's point of view, and therefore it cannot be concluded that he was carrying on a genuine business through the partnerships in which he had invested. The mere fact that the evidence establishes the existence of a scheme which was orchestrated by the Zuniq group and in which the appellant participated unwittingly is sufficient to find that no business whatsoever existed (see Hammill, supra).
[59] In my opinion, this is sufficient to establish that the appellant had no intention of becoming a partner in PC-DOS or SED and that he never carried on business through those partnerships. I thus find that, if he decided to invest in them, his primary purpose was to invest in a tax shelter that his accountant had recommended to him.
[60] The respondent's evidence also established that all of the partnerships related to the Zuniq group were managed by the same group of people and that the purpose behind the creation of those partnerships was to solicit funds by dangling in front of investors a tax refund so substantial that they would recover their investment within a very short time by incurring tax losses that would reduce their personal tax, in addition to receiving a tax credit. The investors made a profit based on the tax benefits they were seeking by investing in those supposed partnerships.
[61] In my opinion, the respondent showed on a balance of probabilities that the partnerships related to the Zuniq group were not real partnerships. More specifically, it satisfied me that PC-DOS and SED had no real existence and were not carrying on any business.
[62] That said, to be entitled to an investment tax credit under subsection 127(8) of the Act, the appellant had to be a taxpayer who was a member of a partnership that filed eligible expenditures under section 37 of the Act. Expenditures for scientific research and experimental development are eligible if the partnership carried on business during the year. In light of my conclusion that no real partnerships carrying on business existed, the appellant cannot be entitled to the investment tax credit on that basis.
[63] This conclusion is sufficient for the appeals to be dismissed. However, even if I focus solely on the initial argument raised by the Minister for disallowing the investment tax credit, which relates to the eligibility of the research projects as such under section 37 of the Act and section 2900 of the Regulations, the appellant has not convinced me that the Minister made an error in deeming those projects ineligible. It seems that the courts have accepted the approach set out in Information Circular 86-4R3 for establishing the criteria to be considered in determining whether a scientific research project is eligible. (I note that, contrary to the appellant's claims, those criteria do not differ from those set out in the previous Information Circular 86-4 as retranscribed in the offering memorandum issued by SED at the time when the appellant invested in it (see Exhibit I-2, Tab 66, page 9).). Five criteria were set out in Northwest Hydraulic Consultants Ltd. v. Canada, [1998] T.C.J. No. 340 (Q.L.) at paragraphs 14, 15 and 16 and were cited with approval by the Federal Court of Appeal in C.W. Agencies Inc. v. Canada, [2001] F.C.J. no 1886 (Q.L.) at paragraph 17.
[64] Those criteria are as follows:
1. Was there a technological risk or uncertainty which could not be removed by routine engineering or standard procedures?
2. Did the person claiming to be doing SRED formulate hypotheses specifically aimed at reducing or eliminating that technological uncertainty?
3. Did the procedure adopted accord with the total discipline of the scientific method including the formulation, testing and modification of hypotheses?
4. Did the process result in a technological advancement?
5. Was a detailed record of the hypotheses tested and the results kept as the work progressed?
[65] Mr. Papion, the respondent's expert witness, identified the following criteria as those on which he relied in his analysis of the ineligibility of the projects in question:
a) scientific or technological advancement;
b) scientific or technological uncertainty;
c) scientific or technical content, which entailed examining: 1) how the resources were used, 2) whether the resources were reasonable, and 3) whether there is adequate documentation establishing how the work was carried out.
[66] According to counsel for the respondent, Mr. Papion's analysis consisted in determining:
a) the project's objectives;
b) the status of the existing technology;
c) whether there were any weaknesses in the existing technologies that prevented the project's objectives from being met.
[67] Mr. Papion concluded that there was no evidence in any of the documentation submitted that any scientific research or experimental development had been performed. In response to the appellant's argument that he had not consulted the scientific experts concerned before making his decision, Mr. Papion stated that he had been unsuccessful in his attempts to meet with the people in question and was therefore unable to observe personally whether the projects existed or how they were progressing. Furthermore, those scientific experts never provided him with any written proof as to the progress of the work or gave him a concrete and real description of what was taking place. They simply submitted proposals to him without establishing that anything had been done to implement them.
[68] He did not observe in any of the projects any kind of difficulty that would indicate that there was a technological uncertainty to be resolved or serious technological advancement that was being contemplated. According to him, the documentation submitted in no way supported the existence of a program of systematic investigation.
[69] Furthermore, the expenses submitted in support of the scientific research and experimental development appeared to him to be grossly exaggerated in light of the staff on site. He further noted that this staff had to work on a number of projects in different fields at the same time.
[70] Mr. Papion thus concluded that there was no serious evidence that eligible work had actually been carried out.
[71] I agree with the respondent's counsel that the appellant failed to provide positive proof of the uncertainties or advancement associated with the various projects. He simply criticized Mr. Papion's approach without providing any further clarification and without satisfying me that Mr. Papion had made a mistake. For example, the appellant asserts at paragraph 72 of this argument that, [TRANSLATION] "[...] the fact that research and development were carried out to allow three different languages to communicate together so as to generate a new software program facilitating the processing of several files together in a single database should be considered eligible in light of the criteria of both uncertainty and technological development." The appellant nonetheless does not provide any kind of expert analysis that could prove his point. Furthermore, at paragraph 83 of his argument, the appellant questions Mr. Papion's second assessment with regard to SED. According to the evidence, that second assessment was carried out in response to new information provided by Zuniq. The purpose was not to request a second assessment but rather to verify whether the additional arguments that Zuniq raised might alter Mr. Papion's initial assessment in any way. I believe the appellant is going too far in stating that the addendum that Mr. Papion added to his assessment of the SED project was a [TRANSLATION] "pretext for attempting to put a little more meat on the bones" (see paragraph 84 of the appellant's argument). All of the evidence adduced by the respondent with regard to the scheme concocted by those running the Zuniq group established that the partnerships in question, if they actually existed, could have operated with only 40 to 50 percent of the total amount of the investments. This undermines the seriousness of the undertaking and casts strong doubt on the true amount of the expenditures put into these projects.
[72] In my opinion, the appellant has failed to establish that scientific research and experimental development were actually taking place in the projects in which he invested. This being an essential requirement for an investment tax credit, the appellant cannot be entitled to such a credit.
[73] These conclusions mean that I am not required to analyze the respondent's alternative argument regarding the at-risk amount of the limited partner under subsections 127(8.1), (8.2) and (8.5) of the Act with regard to the calculation of the investment tax credit.
[74] The fact that the appellant was not reassessed until 1991 for the 1986 taxation year and until 1992 for the 1988 taxation year is not relevant in this case. The appellant waived the limitation period for the 1986 taxation year; for the 1988 taxation year, he was reassessed within the normal reassessment period. Furthermore, the fact that the Minister had not confirmed the assessment before the appellant finally filed notices of appeal in 1998 (six years having passed between the filing of the notices of objection and the filing of the notices of appeal) is another element that I need not take into account in determining the merits of the assessments under appeal. Under paragraph 169(1)(b) of the Act, the appellant was entitled to file notices of appeal before our Court after 90 days had elapsed after service of the notices of objection, without the Minister having notified him of his decision. Accordingly, the appellant could have filed appeals as early as 1992 instead of waiting until 1998. The decision to wait for the outcome in McKeown, supra, before proceeding with the hearing of the appellant's appeals was accepted by his counsel at the time, which suggests that the appellant had also given his approval.
[75] The appellant is thus responsible today for the length of time that has elapsed. To avoid further interest, it was open to him from the beginning to have the amount of the assessments exempted pending the outcome of his appeals. Finally, our Court does not have jurisdiction to vacate an assessment solely on the basis of the Minister's actions (see Main Rehabilitation Co. v. Canada, [2004] F.C.J. No. 2030, 2004 FCA 403 (Q.L.); Hardtke v. Canada, [2005] T.C.J. No. 188, 2005TCC263 (Q.L.)).
[76] For all these reasons, the appeals are dismissed.
Signed at Ottawa, Canada, 26th day of October 2005.
"Lucie Lamarre"
Translation certified true
on this 30th day of January 2006
Kathleen McHugh, Translator
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