Date: 19990305
Docket: 96-4343-IT-G
BETWEEN:
COM DEV LTD.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for judgment
Hamlyn, J.T.C.C.
[1] The Appellant, Com Dev Ltd. ("Com Dev") is a
Canadian controlled private corporation and is involved in the
manufacturing of components for spacecraft. The design and
manufacture of the components involved extensive research and
development activities. The parties agree that the Appellant
incurred expenditures that qualify as scientific research and
experimental development ("SRED") within the meaning of
section 37 of the Income Tax Act (the
"Act"). The parties also agree that these
expenditures are "qualified expenditures" within the
meaning of subsection 127(9) of the Act.[1] Com Dev claimed
investment tax credits ("ITCs") on the qualified
expenditures.
[2] These appeals are under the General Procedure and concern
the Appellant's 1989, 1990, 1991 and 1992 taxation years. The
Minister of National Revenue (the "Minister")
reassessed Com Dev for the taxation years in question by
concurrent Notices of Reassessment dated December 16, 1994.
In reassessing Com Dev, the Minister denied the ITCs that were
claimed by the Appellant.
FACTS
[3] At the beginning of trial, the parties filed a Partial
Agreed Statement of Facts. The relevant agreed upon facts are as
follows:
3. At all relevant times, the Appellant was a corporation duly
incorporated under the laws of Canada and was a
Canadian-controlled private corporation within the meaning of the
Income Tax Act (Canada) (the "Act").
4. The Appellant carries on active business as a designer and
manufacturer of satellite components.
5. Spar Aerospace Limited ("Spar") was awarded a
contract by the Canadian government to design and manufacture a
satellite ("Radarsat") which was scheduled to be
launched in 1994. The contract between the two parties was signed
on January 26, 1990.
...
6. Spar issued a Request for Proposal to various
subcontractors in respect of the design and manufacture of the
calibration system, receiver system, the low power transmitter
and the phase shifters for the spacecraft (collectively the
"Components").
...
7. In 1989, the Appellant was selected as the subcontractor
for the design and manufacture of the components subject to the
conditions indicated in a letter of intent and the contract with
Spar dated July 6, 1990 the "Spar-Com Dev
Contract".
...
8. The Spar-Com Dev Contract was amended 6 times in writing.
There were no other written amendments to that contract.
...
9. The Appellant delivered the last components required under
the contract in September 1994.
10. In total, the Appellant had received a total amount of
$28,350,000 (collectively the Spar Payments) arising from the
Spar-Com Dev Contract.
EVIDENCE AT TRIAL
[4] The Appellant called four witnesses. Those witnesses gave
their evidence in a straightforward credible manner and through
their evidence identified and commented upon the documents filed
as exhibits.
[5] The first witness was Ms. Anita Carol Davis, a Vice
President of Com Dev, who, for the period in question, was the
contract administrator for the Appellant responsible for the
contract that developed between Spar Aerospace Limited
("Spar") and Com Dev.
[6] She outlined the events leading to the involvement of Com
Dev with Spar. Spar entered into a contract with Her Majesty The
Queen ("Her Majesty") in January of 1990 to build a
Radarsat Satellite to allow an enhanced monitoring of changes in
the environment by way of radar images of the earth's
surface. Towards this end, after preliminary proposals, Spar
asked Com Dev to manufacture and deliver four components for the
satellite. The contract between Spar and Com Dev was on a firm
fixed price basis that provided for risk management, a
performance guarantee and payment on a milestone result oriented
basis. The witness distinguished this contract from one that was
structured on a cost plus basis, where risk was borne by the
contractor not the subcontractor, payments were not based on
results and profits were protected within a cost plus structure.
She further explained a cost plus contract was usually the
vehicle applied in a research and development retainer as opposed
to the contract before the Court being that of manufacturing and
supplying a product.
[7] From Com Dev's point of view what they were asked to
do was to research and develop their heritage technology[2] to complete a
commercial product contract. Spar bought a product with
sufficient accompanying information supplied by Com Dev to use
the product and to provide a historical outline to track the
product from design to flight model, that is, the information
that was transferred was to ensure the functionality and
reliability of the components.
[8] The second witness, Mr. Bill Chisholm, was the
hardware programmer for Radarsat employed by Spar. This
individual was directly involved with the development of the
contract with Com Dev on behalf of Spar. His evidence indicated
that Spar believed that Com Dev had sufficient heritage
technology, intellectual property and knowledge acquired prior to
the contract to allow Spar to conclude the Appellant had the
capability to perform the contract in its entirety. He confirmed
the relationship between Spar and Com Dev was at arm's length
and at times was not always cordial as the cost controls imposed
by the Government of Canada on Spar affected the relationship
that Spar had with Com Dev.
[9] Both witnesses described and discussed their respective
focus and conduct in relation to the two contracts: the first
between Her Majesty and Spar and the second between Spar and Com
Dev. There was no direct contractual relationship between Her
Majesty and Com Dev. The ultimate or originating funding of the
project as between Her Majesty and Spar was from the Government
of Canada. As between Spar and Com Dev payments on the contract
came from Spar. The project was phased by Spar to Com Dev to meet
Her Majesty's requirements with Spar, that is, to protect the
integrity of the project against risk failure.
[10] The Government of Canada in its contractual arrangement
with Spar insisted that the following inclusion be in contracts
between subcontractors and Spar:
12.3 All Technical Information and Inventions conceived or
developed or first actually reduced to practice in performing the
Work under this Contract shall be the property of Her Majesty,
and the Contractor shall have no rights in and to the same except
as may be provided by Her Majesty. The Contractor shall not,
without the express written permission of Her Majesty, divulge or
use such Technical Information and Inventions, other than in
performing the Work under this Contract, and shall not sell other
than to SPAR under this Contract, any articles or things
embodying such Technical Information and Inventions.[3]
[11] Spar included the foregoing clause in its contract with
Com Dev, but also included the following diminution modification
clause:
12.7 The information detailed in the Contractor's letter
dated April 19, 1990 is considered proprietary to the Contractor
or its Subcontractors as the case may be.[4]
[12] The letter referred to in clause 12.7 and filed as
an exhibit in this proceeding reads as follows:
April 19, 1990
File: 5050
Ref.: JB-1578
SPAR Aerospace
Satellite and Communications System Division
21025 Trans Canada Highway
Ste. Anne de Bellevue, Quebec
H9X 3R2
Attention: Mr. Terry Littlewood
Subcontracts Manager
Subject: Letter to be referenced in Contract S-700014
Article 12.7
Dear Mr. Littlewood:
The following Statement of Proprietary Information is to be
referenced as per the above subject.
Statement of Proprietary Information
In accordance with the conditions of the RADARSAT Contract
between SPAR Aerospace and COM DEV, S-700014, Article 12
– Intellectual Properties – this will certify that
all equipments, associated Technical Information and Technical
Documentation to be generated in performance of the Work and
considered deliverable under the contract will utilize computer
software, processes, methods, techniques and know-how in
existence or residence with COM DEV prior to effective date of
the Contract. Consequently, the intellectual property for any
deliverable computer software, processes, methods, techniques and
know-how in existence or residence within COM DEV prior to
effective date of the Contract is proprietary to COM DEV and can
solely be used for the purposes of the RADARSAT programme.
Yours truly
[signature]
JOHN BERRY
Contract Administrator[5]
[13] The witness from Spar indicated Spar's full approval
of this modification inclusion in the contract between Spar and
Com Dev and indeed the witness was the one who recommended its
inclusion.
[14] This witness stated from his point of view what Com Dev
did in the production of the components was to take the known
technologies of Com Dev that were part of its internal heritage
and rearrange them into the contractual product components for
Spar. He stated at no time through the rearrangement process did
Com Dev deliver research and development results to Spar nor were
any research or development results expected.
[15] The next witness was Dr. Bertram Blevis,
qualified as an expert in the space industry including expertise
in aerospace and telecommunications. His evidence was confined to
what were normal contractual practices in the space industry and
how these practices related to the activities of Com Dev.
Further, his evidence was tendered to assist in the understanding
of the Appellant's voluminous documentation.
[16] He stated the component products provided by the
Appellant under the contract were unique and had to be developed
from the Appellant's technology to meet specifications not
previously achieved, to interface with other equipment whose own
specifications were changing and to serve applications not
previously addressed and to be space qualified.
[17] The witness distinguished within the industry two types
of contracts, one for the sale of goods and the other for
research and development.
[18] The expert witness reviewed in detail several
distinguishing contractual factors including firm fixed pricing,
payment schedules, performance guarantees and technology
protection. Dr. Blevis found in this case the components
delivered and the accompanying supporting documentation supplied
were consistent in the space industry with a contract for the
sale of a product.
[19] He further commented that the information supplied (the
supporting documents) to Spar by Com Dev were not consistent with
the reporting of results normally expected in a research and
development contract.
[20] The last witness was the Chief Financial Officer of Com
Dev, Mr. David Belbeck, who advised the Court that Com Dev
suffered a $4,283,000 loss on the contract. He also identified
documentation that demonstrated after the expiration of the
contract that Spar proposed to buy the technology from Com Dev to
allow Spar to build Radarsat II, that is, to perform the
precise function that Com Dev performed for Spar in
Radarsat I. The witness also confirmed the Appellant's
attempt to seek other means to reduce its losses by claiming
compensation from the Government of Canada but was unable to do
so because there was no contractual relationship between Com Dev
and the Government of Canada.
THE APPELLANT'S POSITION
[21] Com Dev states that the Spar-Com Dev contract was for the
delivery of a product, namely the components. Com Dev did not
perform SRED for Spar nor did they deliver any SRED information
to Spar. The Component Information that was delivered to Spar
would not be sufficient for Spar or anyone retained by Spar to
duplicate the components. The delivery of the Component
Information is typically required by a purchaser of components in
the aerospace industry and is not the delivery of SRED.
[22] The Appellant further states that any clauses in the
contract that appear to vest a proprietary interest in research
or development to Her Majesty were modified and diminished by
other clauses.
[23] The contract payments made to Com Dev by Spar were not
contract payments made by a Canadian government and were not
amounts paid to Com Dev for SRED.
[24] The Appellant concludes the amounts paid by Spar under
the subcontract with Com Dev did not constitute contract payments
within the meaning of subsection 127(9) of the Act
and the Appellant is entitled to an ITC claim for the years in
question in the full amount of the qualified expenditures without
deduction.
THE RESPONDENT'S POSITION
[25] The Respondent pleads that with respect to the Spar-Com
Dev contract, the contract speaks for itself. The Respondent also
asserts that under the Spar-Com Dev contract, the Appellant
became a subcontractor of Spar for the research, design,
development, analysis, testing, verification and delivery of
subsystems that were to be integrated to Radarsat and that
pursuant to the Spar-Com Dev contract, the Appellant was required
to perform SRED in order to design, development, analyse, test,
verify and deliver subsystems to Spar. The intention was to
transfer to the Government of Canada the intellectual property
arising from the entire performance of the Spar-Com Dev contract.
In accordance with the agreement, the Appellant received payments
from Spar in the aggregate amount of $28,350,000 in respect of
the expenditures incurred for the research, design, development,
analysis, testing, verification and delivery of the subsystems to
Spar. The Respondent further submits that the Appellant's
qualified expenditures incurred pursuant to the Spar-Com Dev
contract were properly reduced by the aggregate amount received
from Spar as the overall project was funded by the Government of
Canada. The reduction of the qualified expenditures had the
effect of reducing the ITCs claimed by the Appellant.
[26] The Respondent also asserts the project was fully funded
by the Government of Canada and this funding was directly related
to Com Dev through Spar.
ISSUE
[27] The issue is whether the amounts received by the
Appellant from Spar under the Spar-Com Dev contract represent
contract payments within the meaning of paragraph (b)
of the definition of "contract payment" in
subsection 127(9) of the Act.
ANALYSIS
[28] Section 37 of the Act is designed to
encourage scientific research in Canada (Consoltex Inc. v. The
Queen, 97 DTC 724, T.C.C.). The tax incentive of
performing SRED in Canada is twofold. First, SRED expenditures
are given preferential treatment under section 37.
Expenditures that qualify under section 37 are fully
deductible in the year they are incurred or can be pooled and
deducted in later years. Secondly, an ITC is available under
subsection 127(5) of the Act.
[29] Subsection 127(5) of the Act allows a
taxpayer to claim a deduction for an amount that is based on the
taxpayer's ITC for the year. The ITC for the year is defined
under subsection 127(9) of the Act. The definition of
an ITC under subsection 127(9) of the Act includes,
among others, a percentage of a taxpayer's "qualified
expenditures" made in the year. The term "qualified
expenditure" is also defined under subsection 127(9) of
the Act. The Respondent admits that the amounts in
question are "qualified expenditures" of the Appellant
within the meaning of subsection 127(9) and would qualify
for the ITC under subsection 127(9) if that definition was
read without reference to subsection 127(11.1)(c) of
the Act.
[30] With respect to the definition of ITC in
subsection 127(9) of the Act,
paragraph 127(11.1)(c) reads as follows:
(11.1) For the purposes of the definition "investment tax
credit" in subsection (9),
...
(c) the amount of a qualified expenditure made by a
taxpayer shall be deemed to be the amount of the qualified
expenditure, determined without reference to subsections 13(7.1)
and (7.4), less the amount of any government assistance,
non-government assistance or contract payment in respect
of the expenditure that, at the time of the filing of the return
of income for the taxation year in which the expenditure was
made, the taxpayer has received, is entitled to receive or can
reasonably be expected to receive.
(emphasis added)
[31] "Contract payment" is defined in
subsection 127(9) of the Act. For amounts that became
payable on or before December 20, 1991, the definition of
"contract payment" reads as follows:[6]
"contract payment" means
(a) an amount payable by a person resident in Canada
for scientific research and experimental development related to
the business of that person,
(b) an amount, other than a prescribed amount, payable
by a Canadian government, municipality or other Canadian public
authority or by a person exempt from tax under Part I by virtue
of section 149 for scientific research and experimental
development to be performed for it or on its behalf, or
(c) an amount payable by a person not resident in
Canada if he is entitled to a deduction under clause
37(1)(a)(ii)(D) in respect of the amount.
[32] In the Partial Agreed Statement of Facts, the parties
agreed that paragraph (c) of the definition of
contract payment in subsection 127(9) did not apply. At the
submission stage of the trial, the Respondent stated that he
would not make an argument under paragraph (a) of the
definition of contract payment in subsection 127(9). As a
consequence, the Appellant's and the Respondent's
submissions were based upon paragraph (b) of the
definition of contract payment. The difference between the
wording of paragraph (b) for amounts payable after
December 20, 1991 and the wording of
paragraph (b) for amounts that became payable on or
before December 20, 1991, is minimal and does not affect the
determination to be made in this case.
[33] To qualify as a contract payment under
paragraph (b) in subsection 127(9), an amount
must:
1) be payable by a Canadian government, municipality or other
Canadian public authority or by a person exempt from tax under
Part I by virtue of section 149; and
2) be payable for SRED be performed for it or on its
behalf.
WAS THERE A CONTRACT PAYMENT PAYABLE BY
A CANADIAN GOVERNMENT, MUNICIPALITY OR
OTHER CANADIAN PUBLIC AUTHORITY
[34] The Respondent submits that the $28,350,000 was paid by
the Government of Canada. The Respondent claims that Spar was
merely a general contractor and that all payments flowed through
Spar and the Respondent also places emphasis on the fact that Her
Majesty is mentioned in numerous provisions of the Spar-Com Dev
contract.
[35] The Appellant takes the position that Her Majesty and
Spar entered into a particular contract while Spar engaged Com
Dev by way of a separate contract. The Appellant further claims
that Her Majesty was not a party to the Spar-Com Dev contract and
that Spar paid Com Dev all of the amounts owing to the Appellant
under the Spar-Com Dev contract. The Appellant states that the
definition of contract payment as set out in paragraph (b)
in subsection 127(9) of the Act should be given its
plain and ordinary meaning and should not be expanded to deal
with indirect arrangements.
[36] While the Radarsat project was ultimately funded by the
Government of Canada the Appellant did not have any direct
contractual relationship with the Government of Canada. The
Appellant's contractual arrangements were with Spar. The
evidence establishes that Spar bought components that were
designed, manufactured and delivered by the Appellant. The
contract was a firm fixed price contract, with milestone payments
linked to production results. At all times risk was in the hands
of the Appellant.
[37] Although Her Majesty was mentioned in the contract, this
does not change the commercial reality of the relationship
between the parties. Her Majesty had the right to monitor the
progress of the components but the evidence has shown that this
arrangement is common in the aerospace industry when the ultimate
success of the overall project is dependant in part on products
produced by subcontractors. The right of Her Majesty to monitor
the progress of the components does not change the fact that
there was no direct contractual relationship between Com Dev and
Her Majesty. Moreover, there was no evidence that Spar, in
engaging Com Dev under the Spar-Com Dev Contract, acted merely as
Her Majesty's agent. Spar had a contract with Her Majesty to
act as the general contractor for the Radarsat project. It was
Spar, not Her Majesty, who paid all of the amounts owing to Com
Dev under the Spar-Com Dev contract.
[38] When Com Dev realized it was going to incur a loss on the
Spar contract, Com Dev attempted to claim compensation from the
Government of Canada in order to minimize its losses. Com Dev
however, was unable to do so because there was no contractual
relationship between Com Dev and the Government of Canada. Any
request for financial compensation would have to be presented to
Spar who had the option of submitting the request to the
Government of Canada. Spar chose not to submit the request for
financial compensation. It is the Court's conclusion that the
payments received by Com Dev from Spar arose from the rights and
obligations established under the Spar-Com Dev contract and were
not contract payments from Her Majesty.
[39] The Respondent also makes the argument that with respect
to paragraph 127(11.1)(c) of the Act, the
words "in respect of" are to be read in their widest
possible scope.[7]
[40] As a matter of legislative interpretation, the plain and
ordinary meaning of words should be applied to the definition of
a "contract payment". The words "in respect
of" are used to link the terms government assistance,
non-government assistance and contract payments to the qualified
expenditures. The expansive language of
paragraph 127(11.1)(c) was not used in
paragraph (b) in the definition of contract payment
in subsection 127(9) and that such expansive language cannot
be read into the provision.
WAS THERE A CONTRACT PAYMENT PAYABLE FOR SRED
ON BEHALF OF A CANADIAN GOVERNMENT
[41] Although the Court has found that the payments received
by Com Dev were not payable by a Canadian government, the Court
shall also consider whether the payments received by Com Dev were
payable for SRED.
[42] The evidence indicates that the clause that related to
the rights Her Majesty received as to "Technical Information
and Inventions conceived or developed or first actually reduced
to practice in performing the Work" (clause 12.3) was
modified by clause 12.7. The effect of this clause at a minimum
severely restricted Her Majesty's right to a proprietary
interest in technical information and inventions under the
contract. It is these potentially conflicting clauses that do not
allow the Spar-Com Dev contract to simply speak for itself.
Therefore, the Court is not constrained by the parol evidence
rule and may look beyond the contract and examine the collateral
evidence surrounding the contract.
[43] Under the contract between Spar and Com Dev, Com Dev
retained rights to technology that Com Dev had at the inception
of the contract. The work done in this retained technology was as
previously reviewed a rearrangement of the proprietary interests
of the Appellant to meet the component demands of Spar. The
actions of the parties under the contract supports the stated
intention of the parties given in evidence, that is, Spar showed
no interest in the technology and indeed did attempt later to buy
the technology from Com Dev for the Radarsat II project.
There was no evidence that Her Majesty asserted or attempted to
obtain any of the intellectual property that the Respondent now
maintains is the property of Her Majesty. In support of the
argument that the intellectual property in question belonged to
Her Majesty, the Respondent produced an annotation on some
technical documentation (see Exhibit A-1, tabs 28 to 34), an
acknowledgement at the end of a paper presented by Com Dev to a
space conference (Exhibit A-1 Supplemental, tab 9, page 130), and
an internal correspondence from Com Dev warning Com Dev employees
about using information that rightfully belongs to other
companies in documents submitted to Spar (Exhibit A-1,
tab 37). It is the Court's finding that this evidence
does not change this Court's review of the evidence in
relation to the contractual relationship and intention of the
parties.
[44] Clearly, the evidence indicates that there were no
patentable results from the work performed by the Appellant in
the production of the components. Com Dev retained all rights to
the technology previously developed. Com Dev had the heritage and
ability to further rearrange, research and develop their existing
technology to meet the contractual component purchase of Spar.
All the witnesses confirmed the position that Spar did not intend
to buy nor did it buy on behalf of the Government of Canada the
research and development with respect to the purchased
components. I conclude, in this case, the contractual
relationship based on a fixed firm price for the purchase of the
components did not include the purchase of SRED.
CONCLUSION
[45] The amounts in question are "qualified
expenditures" within the meaning of
subsection 127(9).
[46] The amounts paid by Spar to Com Dev do not constitute
contract payments within the meaning of paragraph (b)
in subsection 127(9) of the Act.
[47] The Appellant is entitled to claim a deduction for ITCs
for the years in question as calculated in accordance with
subsection 127(5) without reduction pursuant to
paragraph 127(11.1)(c) of the Act.
DECISION
[48] The appeals are allowed and the assessments are referred
back to the Minister of National Revenue for reconsideration and
reassessment on the basis that the Appellant is entitled to
investment tax credits without a reduction pursuant to
paragraph 127(11.1)(c) of the Act.
[49] The Appellant is entitled to its costs.
Signed at Ottawa, Canada, this 5th day of March 1999.
"D. Hamlyn"
J.T.C.C.
Email this Content