Satellite Earth Station Technology Inc. v. Minister of National Revenue, [1991] 1 CTC 2416, 91 DTC 337

Bonner, T.C.J.:—The appellant appeals from reassessments of income tax for the taxation years ending April 30, 1934, 1985 and 1986. In making the reassessments the respondent:

(a) treated outlays related to two aircraft, video equipment and musical instruments as the cost of leasing property within the meaning of subsection 1100(17) of the Income Tax Regulations;

(b) disallowed claims which had been made by the appellant on the basis that activities constituted scientific research;

(c) disallowed expenditures (including the costs of a Caribbean cruise and the Visa bills of a shareholder) which he found had not been made for the purpose of gaining or producing income with the consequence that paragraph 18(1)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72,

c. 63) (the"Act") applied.

I have in a general way described the assessing actions which I gather are in dispute. More precise details of those assessing actions may be found in the reply to the notice of appeal and in Exhibit R-1 tabs 8 and 15. However, it should be noted that this case proceeded to hearing without any clear definition of the issues. The allegations of fact contained in the notice of appeal were so irrelevant and incomplete that, if established, they would not have entitled the appellant to any relief. The relief sought in the notice of appeal was the following:

The Plaintiff claims that the expenses it undertook during it’s 1984, 1985 and 1986 taxation years were legitimate business expenses, the costs of which were properly deductible in computing it’s (sic) income, pursuant to section 9 of the Income Tax Act.

The Plaintiff claims that the Minister used extreme prejudice in denying it’s claims made under the provisions of the Income Tax Act, particularly with respect to an aircraft obtained for its business activity, certain research and development undertakings, and other expenses properly undertaken by the Plaintiff.

The Plaintiff makes claim that the Minister did not properly undertake his review of the Plaintiff's claims to legitimate deductions as provided by the Income Tax Act.

The appellant filed a document entitled ” Reply to Respondent's Reply”. In it the appellant:

(a) denied that the aircraft and other property were purchased for “ film making purposes”; it alleged facts which, generally speaking, tended to show acquisition for use in connection with the business of manufacturing and selling satellite television antenna systems; it pleaded that shortly after the purchase of the aircraft the market for such systems suffered a set back and that film making was then taken up as a stop gap to make use of an asset that would otherwise have been unused;

(b) in relation to scientific research activities asserted that it had "provided sufficient documentation to qualify its activities to be bona fide undertakings";

(c) asserted that it maintained an office and storage facility at a country home known as the Hillsburgh property and used the property as a site for scientific research and development, a site for making industrial films to be used for the purpose of demonstrating the appellant's products and as the main business location of its president and owner;

(d) claimed that snowmobiles and a piano were acquired for use by business guests at the Hillsburgh property and that a shelf unit had been acquired for use at trade shows;

(e) claimed that the expenses of the Caribbean cruise taken by its owner and president related to the satellite business;

(f) claimed that Visa charges in question were "made in bona fide company business pursuits".

The evidence given in support of the appeal can best be described as vague, and unfocused. I found the testimony of the two principal witnesses called on behalf of the appellant, Ms. Joni Manchee and Mr. David Brough, of dubious value. Their attempts to justify and explain disputed corporate expenditures might in any single case have been regarded as somewhat unlikely ut conceivably true. The cumulative effect of all of their testimony leads me to conclude that the business purpose explanations offered by them were rationalizations for expenditures made primarily to satisfy their personal desires.

The appellant was incorporated in 1981. Initially at least it carried on the business of manufacturing satellite antenna dishes and other components of systems designed to receive television signals. David Brough described himself as the founding shareholder of the company. Mr. Brough was president. Throughout the period under review, he owned two shares. The principal shareholder was Ms. Manchee. She owned two thousand shares and was secretary-treasurer. Mr. Brough appears to have played a dominant role in the operation of the company. He testified that Ms. Manchee played a valuable role but said "you could describe her as being a gofer".

On April 25, 1985 the appellant purchased an amphibious aircraft known as a Lake Buccaneer at a cost of $48,150. Mr. Brough testified that when he purchased the aircraft he was not a licensed pilot. He bought it with the intent of learning to fly in an amphibian. He said that if he learned to fly in a conventional aircraft it would be necessary to turn around and learn to fly all over again in an amphibian. As it turned out, having discovered after purchasing the Buccaneer that it was not certified for spinning, Mr. Brough proceeded at corporate expense to take about two thirds of his training in a conventional rented Cessna aircraft. Later in his evidence Mr. Brough said that the company purchased the aircraft so that it could use it in conducting its business. He stated that the company taught him how to fly so that he could travel in the aircraft for purpose of visiting dealers engaged in selling the appellant's antenna systems. It was never so used. Mr. Brough explained that after he became familiar with the airplane he discovered that it was old and underpowered and did not have a cargo area sufficient for corporate purposes. Then, he said, the company decided to trade it in on a second aircraft offering greater capability, more power, and electronics when would permit him to travel to remote areas such as Wawa and Chapleau in order to visit the appellant's dealers.

The Buccaneer aircraft was traded-in on a Lake Renegade aircraft. The transaction took place on or about August 2, 1985. The cost of the Renegade was approximately $224,000. It was registered not in the name of the appellant, but in the name of Mr. Brough's mother. Mr. Brough explained that no insurance company in Canada would insure it. The only insurer willing to provide coverage was prepared to do so only if the aircraft were registered in the U.S. Mrs. Brough was a U.S. resident. Mr. Brough testified that the second aircraft was used exclusively for business purposes. He said that it was used in September and October of 1985 to go to visit the appellant's dealers and distributors in places such as Rochester, New York, the Catskills Mounts and Arkansas. He stated that he was unable to produce the aircraft trip log. It had, he said, been lost.

Mr. Brough stated that the satellite antenna business took a serious downturn after the purchase of the Renegade. That downturn arose when broadcasters of satellite signals started to scramble the signals. That happened, he said, in January of 1986. Devices designed to unscramble the signals were not available to consumers for some time and in consequence the market for the appellant's antenna systems declined precipitously. It was then, and only then, according to Mr. Brough that the company found it necessary to devise new uses for the aircraft. One such use was the filming of documentaries.

No independent evidence was tendered as to the time when the scrambling of television signals commenced and as to the timing of the consequent downturn in the antenna business. Ms. Manchee stated that it happened in the Spring of 1985 but later changed her mind. Mr. Brough said it happened in January 1986. On the evidence I am unable to find that either aircraft was bought for use in connection with the appellant's satellite receiver business. It is useful in testing evidence of subjective purpose and intent to examine what actually happened. The first aircraft was used for training Mr. Brough and then sold. The second was used at most for one or two business trips and then for filming a documentary named Hinterland. In the face of actual use and in the absence of corroboration, I am not inclined to accept the testimony of Mr. Brough as to alleged business purpose and use.

In 1985, the appellant acquired musical instruments and video equipment which the respondent found to be unrelated to the satellite antenna business. The assessor concluded on the basis of statements made by Ms. Manchee in 1986 when facts were fresher in her mind that at the time of the hearing that those purchases had been made by the appellant with a view to the filming of documentary productions for rental purposes. According to her explanation the appellant took up film production because the satellite industry had entered a very slow period. One such production entitled "Hinterland" was shown to the assessor. The respondent assessed on the basis that the costs in question were the costs of the leasing property, that is to say the cost of property which was:

. . . used by the taxpayer. . . principally for the purpose of gaining or producing gross revenues that is rent, royalty or leasing revenue, .. . .

within the meaning of subsection 17 of section 1100 of the Income Tax Regulations.

The respondent's assessing action was founded not only on the absence of any apparent rational connection between the satellite antenna business and expenditures for airplanes, a piano, flute, video camera, bagpipes and so forth, not only on answers given to the assessor by Ms. Manchee in 1986 but also on a statement made by Mr. Brough to the assessor on January 4, 1986 that the company had branched into a new field, documentary production, and that the aircraft was used to travel to different areas for purposes of filming. On the evidence of use actually made I cannot find that the respondent erred in treating the costs in issue as the costs of leasing property namely the Hinterland production.

The evidence with respect to activities alleged to constitute scientific research or scientific research and experimental development as defined by section 2900 of the Income Tax Regulations was unpersuasive. It should be noted that the issue is not whether the appellant provided the respondent with sufficient documentation relating to the activities said to constitute scientific research but rather whether the activities fell within the relevant statutory language. All witnesses agreed that it was Mr. Brough who was responsible for the conduct or supervision of the conduct of the activities in question. He stated that:

Our Research effort wasn't what you would characterize as being high technology by any means. We were working initially out of a converted pig barn and other buildings on a farm, a chicken coop. Much of our work was actually done by taking bits of paper and drawing out, sketching out various components. We did not use a methodology that might be followed by the Spar Aerospaces or the big firms. Often it was a case of going to the blackboard or taking the chalk and writing on the shop floor, sketching out different ideas and hypotheses. You actually had to try them.

Ms. Manchee gave evidence on this topic as well. She said:

At that time we were such a small little hokey company that nobody ever told us that we should be keeping huge records and diagrams of what we were doing. We had a graveyard out behind the barn of our. . . mistakes. We had a huge pile that we'd just cart out to the back if it didn't work. We tried a sandbox . . . we were trying all sorts of different things to get new designs, so it was never even considered that we would need to have blueprints for the things that we were working on . . . Nobody told us we should be saving these things. And when they were done on paper napkins nobody told us to save our paper napkins or our extra pieces because it just wasn't in our minds or thoughts to have to do that. We just went out and built them. When it worked we saved it, when it didn't we'd cart it out behind the barn.

I cannot find in the evidence of the activities described in the passages quoted or in any of the other testimony or in Exhibits A-10 and A-11 any indication of". . . systematic investigation or search carried out in a field of science or technology by means of experiment or analysis. . .” within the meaning of section 2900 of the Income Tax Regulations.

The disallowed expenses include the cost of a Caribbean cruise taken in February of 1985 by Mr. Brough and Ms. Manchee, the cost of a snowmobile and various personal expenses charged on Ms. Manchee's Visa account which account was paid by the appellant. Some of the Visa charges related, I gather, to the costs of furnishing the Hillsburgh property rented by the appellant. The snowmobile was said to have been bought for the entertainment of guests at Hillsburgh. Hillsburgh was a rural property at which Mr. Brough and Ms. Manchee lived. There was evidence that some business guests were housed at Hillsburgh and that some corporate activities took place there. There was however no clear and persuasive evidence that the snowmobile was bought to meet any genuine corporate need to entertain anyone other than Mr. Brough and Ms. Manchee. It seems rather unlikely that Hillsburgh was used very much as a place to entertain customers and distributors of the appellant. There was evidence that the house on the property could not be properly heated in winter and that the water supply was polluted.

Mr. Brough claimed that by taking a Caribbean cruise he was able to visit in the most economical way a number of islands and there investigate what was required for satellite signal reception and observe the effects of rusting of satellite dishes caused by salt in the air. He said that he bought a portable television receiver for purposes of the trip. He was unable to explain how the television receiver assisted in the accomplishment of the stated objectives. He did not say what data was garnered or where or how. It appears from Ms. Manchee's testimony that following the cruise the possibility of sale of the appellant's antenna dishes in the Caribbean area was rejected. Mr. Brough did not produce any notes, letters, correspondence made in preparation for or in the course of carrying out the supposed business purposes of the trip. I reject this explanation as improbable in the absence of any sort of corroboration from persons other than those who received the direct and obvious benefits derived by anyone who takes a Caribbean cruise in February.

For the foregoing reasons the appeals will be dismissed.

Appeals dismissed.