Date: 20000927
Docket: 2000-1378-IT-I
BETWEEN:
SYNCHROSAT LIMITED,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Agent for the Appellant: Asim K. Sen
Counsel for the Respondent: J. Michelle Farrell
___________________________________________________________________
Reasons for Judgment
(Delivered orally from the Bench at Ottawa, Ontario, on
September 1, 2000)
Bowie J.T.C.C.
[1]
The Appellant company is, for practical purposes, the alter
ego of Dr. Asim K. Sen. Dr. Sen is the principal
shareholder and the only employee of the corporation. His is the
corporation's directing mind.
[2]
Since 1984, the company has been engaged, through the efforts of
Dr. Sen, in the development of something called a "Momentum
Turbine". In each of the years since 1991, perhaps longer,
the Appellant has claimed to be entitled to receive a refundable
investment tax credit (ITC) under section 127.1 of the Income
Tax Act (the Act). The present appeal is brought from
an assessment under the Act for the 1998 taxation year,
whereby the Minister of National Revenue (the Minister) refused
the Appellant the claimed ITC. The basis of that refusal, as
pleaded by the Deputy Attorney General of Canada, was:
...that it [the company] had no qualified expenditures
for the SR & ED as the Appellant was not carrying on a
business.
It is now common ground that the Appellant company, through
the efforts of Dr. Sen has for a number of years carried on
scientific research and experimental development. This was at one
time disputed by the Minister, but this Court decided that issue
in respect of the taxation years 1991 and 1992 in the
Appellant's favour.[1] That issue has not been raised by the Minister in
relation to the 1998 taxation year.
[3]
The legislative scheme by which a taxpayer becomes eligible to
receive ITCs, is a complex one. Entitlement to the credits arises
under section 127.1 of the Act, but it depends on the
taxpayer first establishing that it has the right to a deduction
from income under subsection 37(1) of an amount expended on
scientific research and experimental development.
[4]
Happily, it is not necessary in the present appeal to delve into
the complexities of the computation called for by those
provisions of the Act. The Respondent takes issue only
with the Appellant's ability to meet the requirement of the
opening words of subsection 37(1) which are:
Where a taxpayer carried on a business in Canada in a taxation
year there may be deducted ...
The position of the Respondent is simply that the Appellant
did not carry on business in 1998, because it had no reasonable
expectation of profit.
[5]
The basis of this conclusion is set out in paragraph 8 of the
Reply to the Notice of Appeal, filed by the Deputy Attorney
General of Canada. In the Reply it is said that, in assessing the
Appellant's income tax return for the 1998 taxation year, the
Minister relied on 14 assumptions of fact.
[6]
The first assumption is that the Appellant is a research and
development company. The second is that Dr. Sen is the majority
shareholder and the only employee and he performs all of the work
in the company, administrative and scientific research. The third
assumption recites the history of the gross income, salaries,
other expenses and losses of the company from 1991 to 1998. The
next assumption sets out the computation of the loss claimed for
the 1998 taxation year. The next one, that the Appellant's
business, since 1984, has been working on -- which I take to mean
developing a project called "The Momentum Turbine".
Next, it is pleaded that the Appellant's gross revenues
throughout the years, have been derived entirely from federal
ITCs and from Ontario Innovation Tax Credit Refunds. None of this
is disputed by the Appellant. At this point, the Minister's
assumptions turn from fact to argument. The next one is:
... that, 25 years after the start of the Project,
research and development is still being performed with no
commercial activity, indicates that the profit motivation is not
the main reason for the Project.
Quite apart from the obvious arithmetic error, the leap in
logic is startling!
[7]
The next assumption is that the deduction the company claims, his
salary expense, is a paper transaction only. This is not disputed
by the Appellant in the sense that, as Dr. Sen explained it in
his evidence, the company does not have revenues sufficient to
pay him a salary at the level at which he, as a
well-qualified scientist, might expect to be paid if he
worked for an arms-length employer. In fact, the only revenues of
the company, he agrees, are the tax credit refunds referred to
earlier, and to the extent that his salary exceeds those amounts,
he takes it in the form of indebtedness from the company, which
is subsequently transferred to shareholdings. To the extent that
the company is able to pay him part of his salary in cash, it is
used to set aside his personal income tax obligations and the
company remits it for that purpose.
[8]
Again, the Minister turns to argument in assumption 8(i), which
reads:
The extent of the losses indicates a non-commercial
intention.
The next assumption, (g), is that the Appellant has no
relevant plans to increase gross revenues in order to make the
project profitable. This assumption was disputed, and refuted, by
Dr. Sen in his evidence. Dr. Sen's plan for the company is
quite clear. It is to develop the "Momentum Turbine" to
the point where he has a patentable, indeed a patented, invention
which has great commercial value, at which point he will sell the
patent to a venture capitalist, or to an established concern,
which will manufacture and produce it. That is, certainly, a plan
to increase the gross revenues of the corporation and to make the
project profitable. Dr. Sen expressed the opinion that, when the
project is completed and the patent ultimately sold, it will be
sold for a great deal of money. Why the Minister says there are
no relevant plans is not clear to me. I should have thought that
any plan intended to turn the losses into profit would be a
relevant plan.
[9]
It is, next, pleaded in paragraph 8(k) that:
The Appellant was given a reasonable number of years to
demonstrate that the Project was viable.
This appears to be a reference to the fact that the company
had been permitted ITCs in prior years and, presumably that the
Minister, looking at one more year, added to a succession of
years with no revenues and some expenditures, had concluded that
the project, in his words, was not viable. This conclusion, of
course, ignores the fact that any project, which consists of the
application of inventive genius, with a view to selling the end
product after years of development of the invention, will produce
revenues only at the end of the project. Similarly, paragraph
8(l) reads:
The Project, as operated in the 1998 taxation year, was
incapable of yielding a profit.
Clearly, it is intended to suggest that no profit could be
made in the 1998 taxation year, and again, this assumption
ignores the nature of the project. The same may be said of
subparagraph 8(m), which reads:
The Appellant had no reasonable expectation of profit from the
Project, during the 1998 taxation year.
[10] In
subparagraph 8(n), the Deputy Attorney General of Canada turns,
as usual, to a statement which is a conclusion of law and the
ultimate issue before this Court, which is whether or not the
expenses incurred were expenses from a business or property or,
in other words, whether or not the Appellant was carrying on a
business during the taxation year 1998.
[11] In short,
the Minister's sole basis for denying the Appellant the
claimed ITCs, is that the Appellant has had no revenues over the
years that he has spent developing his "Momentum
Turbine", other than the federal and provincial tax credits
and it has, therefore, incurred successive losses in each
year.
[12] Dr.
Sen's evidence revealed that he has worked systematically and
continuously for many years on the development of the
"Momentum Turbine". He has obtained a patent for it,
and made improvements to the original invention. His conception
is that this invention has the potential to provide an alternate
energy source which, given the world's diminishing supply of
energy resources and constantly increasing state of pollution,
will be of great value in the 21st century. His intention is
clear. It is to develop this invention to the stage of practical
application, at which time he intends to sell the patent to a
venture capitalist or to an established concern that will
manufacture and market it.
[13] I am not
called upon in this appeal to decide whether the "Momentum
Turbine" will, in the end, be a commercial success. The
Minister has concluded that the Appellant did not carry on a
business in 1998, simply on the basis that I have outlined above,
that is to say, that the lengthy and unbroken string of annual
losses leads to the conclusion that this project has no
reasonable expectation of profit and, therefore, does not qualify
as a business, and the company, therefore, does not qualify as
carrying on a business. It has never been alleged, in respect of
this appeal, that the turbine is incapable of being a commercial
success. Hence, the Appellant was not put to disproving this.
[14] I should
perhaps mention at this point that Dr. Sen in giving his
evidence, stated that he had, at some time past, written two
monographs of a scientific nature, which sold -- although not in
large numbers -- to libraries, scientists and others interested
in the subject matter of them. The company maintains stocks of
these monographs available to be purchased and it advertises
their availability. Dr. Sen, I understood, relied heavily on
these facts to support the proposition that the company is a
company carrying on business. However, the sales of the
monographs at best, it seems, were sparse, and even those few
sales were in the early 1990s. None have been sold since 1994. I
do not consider this to be evidence of a commercial activity and,
certainly not of one having a reasonable expectation of profit,
or otherwise satisfying the requirements of carrying on a
business. If this company ever makes any money, it will not be
from these monographs but from the "Momentum
Turbine".
[15] The
Respondent relied in argument on the decision of this Court in
Knight v. M.N.R., 93 DTC 1255. In that case, the Appellant
spent a great deal of time and energy, and incurred losses
aggregating somewhat more than $120,000, over three taxation
years in developing a computer controlled machine tool which he
hoped to manufacture and sell. He sought to deduct these losses
in the computation of his income. His appeal to this Court from
the disallowance of these losses was unsuccessful on the basis
that, in the period between 1986 and 1988, he did not have a
business, but was simply developing a product which he would
later manufacture. He would have a business only after he had
succeeded in creating the product. His outlays, it was held, were
to develop a capital asset.
[16] This
case, on the other hand, is not one in which the Appellant
proposes to become a manufacturer or a seller of "Momentum
Turbines". It is a case in which the Appellant is developing
and refining a concept which will ultimately lead, it is hoped,
to a marketable patent of invention which will be sold.
[17] In
M.N.R. v. H.J. Freud [1968] C.T.C. 438, the taxpayer
expended funds to develop the concept of a small personal sports
car, and he built a prototype of it. He endeavoured to interest
potential manufacturers in purchasing the concept from him so
that they could manufacture it themselves. The enterprise did not
succeed, and the Appellant claimed to have business losses to set
off against his professional earnings as a lawyer. On appeal to
the Supreme Court of Canada, that Court, unanimously,
characterized the project as an adventure in the nature of trade
and held that it was, therefore, within the definition of a
business as it then appeared in section 139 of the Act. In
giving the reasons of the Court, Pigeon J. said, at pages
440-41:
It must also be noted that the Income Tax Act defines
business so as to include "an adventure or concern in the
nature of trade". (Section 139 (1)(e)). By virtue of
this definition, a single operation is to be considered as a
business although it is an isolated venture entirely unconnected
with the taxpayer's profession or occupation. This
consequence of the definition has been recognized and given
effect to in many cases but I will refer only to one of them
namely McIntosh v M.N.R, [1958] S.C.R. 119; [1958] C.T.C.
18, in which it was held that a single venture of speculation in
land gave rise to taxable income when profit was obtained as a
result of an acquisition made with a view to a profit on the
resale.
After quoting from Kerwin C.J. in McIntosh, Pigeon J.
then went on:
Such being the principles to be applied in cases when a profit is
obtained, the same rules must be followed when a loss is
suffered. Fairness to the taxpayers requires us to be very
careful to avoid allowing profits to be taxed as income but
losses treated as on account of capital and therefore not
deductible from income when the situation is essentially the
same.
In the present case, appellant does not deny that the venture in
itself was an adventure in the nature of trade so that if
respondent and his friends had embarked upon it in their own
names, the loss would be deductible.
[18] In my
view the Appellant in this case, like Freud, is engaged in
an adventure in the nature of trade. The definition of
"business", as it now appears in subsection 248(1) of
the Act is:
"Business" includes a profession, calling, trade,
manufacture or undertaking of any kind whatever and, except for
the purposes of paragraph 18(2(c), section 54.2,
subsection 95(1) and paragraph 110.6(14)(f), an
adventure or concern in the nature of trade but does not include
an office or employment;
[19] I see no
principled distinction between the development of the
"Momentum Turbine" by this Appellant and the
development of the concept of a small personal sports car by Mr.
Freud. In both cases it is an adventure in the nature of trade,
and in both cases it is therefore within the definition of the
word "business" in the Act. This conclusion, in
my view, is reinforced by the decision of the Supreme Court of
Canada in J. Friesen v. Canada [1995] 2 C.T.C. 369 and, in
particular, in the reasons for judgment of Major J., at pages 374
to 376.
[20] This
conclusion does not, however, fully answer the question whether
the Appellant, in 1998, was "carrying on a business".
Not every person who engages in an adventure in the nature of
trade can be said to be carrying on a business. It was held by
President Jackett, as he then was, of the Exchequer Court, in
Tara Exploration and Development Company Limited v.
M.N.R., [1970] C.T.C. 557, that a purchase and the subsequent
resale of mining shares in Canada by a company incorporated in
Canada, but carrying on all of its other business in Ireland, did
not have the result that the Appellant was carrying on business
in Canada. In reaching this conclusion, President Jackett said at
page 567:
With great doubt as to the correctness of my conclusion, I am of
opinion that Section 139(1)(e) does not operate to make a
non-resident person subject to Canadian income tax in respect of
a profit from an adventure that otherwise does not amount to, and
is not part of, a "business". With considerable
hesitation, I have concluded that the better view is that the
words "carried on" are not words that can aptly be used
with the word "adventure". To carry on something
involves continuity of time or operations such as is involved in
the ordinary sense of a "business". An adventure is an
isolated happening. One has an adventure as opposed to
carrying on a business.
[21] It is
clear that the adventure in the nature of trade in which
Tara was engaged was a far different one from that of
Freud or of the Appellant before me. President
Jackett's self-expressed great doubt and hesitation may,
perhaps, result from the obvious fact that there are adventures
in the nature of trade that may have widely different
characteristics. I have no doubt that he was correct in his
conclusion in respect of an adventure of the type before him,
which is to say the sale and resale of a commodity, be it shares,
land or any other speculative commodity, with no activity in
between.
[22] In
contradistinction to that, the adventures carried on in
Freud and in this case have the degree of continuity which
President Jackett found to be lacking in the Tara case.
They have continuity of both time and operations.
[23] In my
view, the adventure in the nature of trade which I am called on
to consider here does amount to the carrying on of a business. I
am reinforced in this conclusion by several additional
considerations. First, the proceeds of sale of the patent,
assuming that the development of it is a success and it is sold
as Dr. Sen anticipates for a large sum of money, will fall
to be taxed as income from an adventure in the nature of trade.
That seems to me to be unavoidable, in the light of the Supreme
Court's decision in Freud. Secondly, Parliament, in
the most recent manifestation of the definition of
"business" in subsection 248(1) of the Act, has
been at some pains to exclude adventures in the nature of trade
from the definition of "business" in respect of certain
specified provisions of the Act, none of which are
relevant to the present case. If it had been Parliament's
intention to deny inventors access to deductions for scientific
research and experimental development and ITCs, it could easily
have added subsection 37(1) to that short list of exclusions.
[24] Finally,
to conclude that this company, which the Minister admits is
engaged in research and development, and whose enterprise I have
found to be an adventure in the nature of trade, is foreclosed
from any access to scientific research and experimental
development deductions and ITCs on this narrow basis, would be
contrary to the often repeated instructions of the Supreme Court
of Canada that statutory ambiguity must be resolved in a way that
will achieve the purpose of the enactment. The purpose of the
enactment is clearly to encourage scientific discovery, and
invention through research and development. A narrow
interpretation of the expression "carrying on business"
would certainly not promote the desired effect.
[25] In my
view, the Minister in this case was mesmerized by the many years
during which this company has expended money for research and
development with no revenues to show for it, and has concluded
that this string of unbroken losses spelled no reasonable
expectation of profit.
[26] There
are, of course, scores of cases binding upon me which hold that
the existence of a business requires that there be a reasonable
expectation of profit. In many cases a long series of losses has
been determinative of the absence of a reasonable expectation of
profit. I know of no case, however, where this doctrine has been
applied to a business which consists of an adventure in the
nature of trade. I do not exclude the possibility that what might
otherwise be an adventure in the nature of trade, and so a
business, may someday, be held not to be because it is so forlorn
that no reasonable expectation of it succeeding could be
harboured.
[27]
Adventures in the nature of trade, however, are speculative by
their nature. They often involve great risk, with the prospect of
enormous reward. This has been seen over and over again
throughout history, and in spectacular numbers in recent years.
We are told by the Federal Court of Appeal in The Queen v.
Tonn,[2] that
the Court should not be quick to second guess the wisdom of
business judgment with the knowledge of hindsight. Even more so,
it seems to me the Court cannot, absent the most compelling
evidence, foretell the failure of invention. Certainly, it would
take more than an absence of revenues during the developmental
phase in a case such as this, where revenues can only be realized
at the end of the adventure, to reach that conclusion.
[28] In the
result, therefore, I conclude that the Appellant was carrying on
a business in the taxation year 1998. The appeal is allowed with
costs and the assessment referred back to the Minister for
reconsideration and reassessment on the basis that the Appellant
is entitled to the ITC claimed.
Signed at Ottawa, Canada, this 27th day of September,
2000.
"E.A. Bowie"
J.T.C.C.
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