Donat Flamand Inc. Et Al. v. Minister of National Revenue, [1995] 2 CTC 2590

Lamarre Proulx J.T.C.C.:-This appeal was heard on common evidence with the following appeals: Wing Hon Ng, 89-1970; Jean Lambert, 89-2932; Marcelle Thériault, 89-2933; André Gagnon, 89-2934; André Godin, 89-2936; René Brochu, 89-2938; Raymond Laflamme, 89-2941; Laurien Gagnon, 89-2942; Louis E. Beaudet, 89-2943; Roger Simard, 89-2944; Jean-Guy Emond, 89-2946; Gilles Falardeau, 89-2947; Alain Rousseau, 89-2948; Donald Béliveau, 89-2950; Jean-Louis Malouin, 89-2951; Lindsay Lemoine, 89-295; Jean-Marie Grenier, 90-414; André Imbeau, 90-415; Serge Godin, 90-1002; René Drouin, 90-1338; Jean-Pierre Delwasse, 90-1833.

This appeal relates to the 1984 taxation year. [1] The issue concerns the application of subparagraph 194(4.2)(b)(ii), section 127.3 and, more specifically, paragraph 127.3(2)(a) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act”).

Essentially, the issue is whether a designation of an amount made under subsection 194(4) of the Act is valid, and thus whether the appellants are entitled to a scientific research tax credit under section 127.3 of the Act.

Subsection 127.3(1) of the Act read as follows in 1984: [2]

127.3(1) There may be deducted from the tax otherwise payable under this Part by a taxpayer for a taxation year an amount not exceeding the aggregate of

(a) his scientific research tax credit for the year; and

(b) his unused scientific research tax credit for the taxation year immediately following the year.

The relevant portion of paragraph 127.3(2)(a) read as follows in 1984 [0] 3127.3(2)(a) "scientific research tax credit" of a taxpayer for a taxation year means the aggregate of all amounts each of which is an amount equal to:

(i) where the taxpayer is a corporation, 50%, or

(ii) where the taxpayer is an individual other than a trust, 34%

of an amount designated by a corporation under subsection 194(4) in respect of

(iv) a bond, debenture, bill, note, mortgage, hypothec or similar obligation (in this section and in Part VIII referred to as a "debt obligation") acquired by the taxpayer in the year where the taxpayer is the first person, other than a broker or dealer in securities, to be a registered holder thereof, or

The relevant portion of subsection 194(4.2) reads as follows:

194(4.2) Where amount may not be designated.-Notwithstanding subsection (4), no amount may be designated by a corporation in respect of

(b) a share or debt obligation issued or a right granted by the corporation after October 10, 1984, other than a share or debt obligation issued or a right granted before 1986

(i) …

(ii) where arrangements, evidenced in writing, for the issue of the share or debt obligation or the granting of the right were substantially advanced before October 10, 1984; or

[Emphasis added.]

Retrospective operation of subsection 194(4.2) of the Act

It will be noted that subsection 194(4.2) of the Act was added by chapter 6 of the Statutes of Canada 1986, section 103, and applies as of the date it was assented to, that is, February 13, 1986, since no commencement date was specifically provided. [4] It seems strange that Parliament did not state a specific retroactive commencement date in 1984, while on the other hand, in the same chapter, it stated specific commencement dates for several provisions, including those referred to in footnotes, supra.

When counsel for the appellants and for the respondents were asked to comment on the absence of any indication that subsection 194(4.2) came into force retroactively, they were of the same opinion and did not suggest that subsection 194(4.2) of the Act was not retroactive to the 1984 taxation year.

They referred to the comments of Joyal J. in First Fund Genesis Corp. v. The Queen, [1991] 2 C.T.C. 14, 91 D.T.C. 5361, at 22 (D.T.C. 5367):

However, upon a thorough reading of all of the relevant sections of Part VIII of the Act, I find that I am in substantial agreement with Crown counsel that subsection 194(4.2) must also by necessary implication apply retroactively.

[Emphasis added.]

This concept of the retroactive effect of a statutory provision by necessary implication was expressed by Dickson J. in Gustavson Drilling (1964) Ltd. v. M.N.R., [1977] 1 S.C.R. 271, [1976] C.T.C. 1, 75 D.T.C. 5451, at page 279 (C.T.C. 6-7; D.T.C. 5454):

First, retrospectivity. The general rule is that statutes are not to be construed as having retrospective operation unless such a construction is expressly or by necessary implication required by the language of the Act. An amending enactment may provide that it shall be deemed to have come into force on a date prior to its enactment or it may provide that it is to be operative with respect to transactions occurring prior to its enactment. In those instances the statute operates retrospectively.

Also, at page 281 (C.T.C. 7-8, D.T.C. 5455), he stated:

The Income Tax Act contains a series of very complicated rules which change frequently, for the annual computation of world income. The statute in force in the particular taxation year must be applied to determine the taxpayer’s taxable income for that year.

Normally, Parliament expresses its intention with respect to the date when a taxing provision comes into force specifically and not by necessary implication. However, given that, after a detailed analysis of the provision, Joyal J. came down in favour of subsection 194(4.2) of the Act having retrospective operation, and given also that this point was not disputed by counsel for the appellants, I accept this subsection as having been in force beginning in 1984.

Historical context

In Schedule A of the document entitled ’’Research and Development Tax Policies", published by the Minister of Finance in April 1983, we find an explanation of the financing modalities of the financing mechanism set out in the sections at issue in this case:

Appendix A

Details of Tax-Assisted Financing Mechanism

The purpose of the financing mechanism proposed in the paper for consultation is to allow a company (the researcher) which is undertaking a program of R&D to renounce some or all of the tax benefits associated with its R&D expenditures and allow a special tax credit to another taxpayer (the investor) who invests in the researcher. The mechanism allows the investor to claim a tax credit of one-half of the amount provided to the researcher. The researcher, in turn, will renounce its rights to the tax deductions and credits ordinarily arising from the expenditures.

The investor may enter into contractual arrangements with the researcher under which funds will be advanced to the researcher. The investor will receive a security instrument from the researcher together with the right to claim an R&D financing tax credit. The type of security which may be issued by the researcher will be defined broadly and unrestricted and, for example, could consist of a debt instrument, a common share, a preferred share or a royalty interest or a package containing a combination of various securities. The cost base of the security for tax purposes will be reduced by an amount equal to the R&D tax credit.

The R&D tax credit will be equal to 50 per cent of the value of the consideration for which the security was issued. The consideration must be paid by the investor within 60 days from the date of the contract. The financing tax credit may be claimed by the investor against his tax otherwise payable for the year in which the security is issued. The tax credit, therefore, will be available to the investor whether or not the researcher spends the funds received for research and development in that year. If the investor is a trust or partnership, the tax credit can be passed through to the beneficiaries of the trust or to the partners. Where the investor is a corporation, the R&D tax credit may be used either to reduce its tax otherwise payable or to claim a refund of the refundable tax described below. The mechanism will ensure that persons who purchase newly-issued securities through underwriters will be able to claim the R&D financing credit even though the underwriter may have first owned the security, as underwriter.

The researcher will become liable to pay a refundable tax within 30 days after the month in which the security has been issued. As explained below, the liability for payment of this tax may be reduced or eliminated. The refundable tax will be equal to the R&D financing tax credits arising from the issue of the security.

The liability for the refundable tax will be reduced by one-half of the qualified R&D expenditures incurred in the year by the researcher, but for which the researcher renounces the right to claim R&D tax deductions or credits. The refundable tax also may be reduced by any R&D financing tax credits earned by the researcher for investments made in qualifying securities of other companies.

To the extent that the researcher has not eliminated its liability for payment of the refundable tax by the end of the year, interest will be charged on the balance owing from the month that the liability first arose. The precise means for determining the required interest payment will parallel closely that used in the share-purchase tax credit mechanism proposal in the budget of April 19, 1983. Any refundable tax which is not eliminated in the year may be refunded in a subsequent year if the researcher renounces tax incentives as described above.

Having read the document referred to, supra, I see that the government wanted to have investors participate in the research efforts of businesses, but I have found nothing specific to protect the right of an investor who has acted diligently and in good faith to claim the tax credit.

At page 17 of the ’’Budget Papers" tabled in the House of Commons by the Minister of Finance on May 23, 1985, we read that the effectiveness of this program was doubtful and that a moratorium had been imposed on October 10, 1984 in a press release:

Scientific Research Tax Credit

An examination of this incentive, following the moratorium announced on October 10, 1984 on certain "quick flip" SRTC investments, has revealed problems in ensuring the effectiveness of the program.

The facts

On December 28, 1984, the appellant acquired a debenture in the amount of $250,000, which was issued under a scientific research and experimental development financing contract by Agri-Can Research Corp. ("Agri-Can"). The agreement was produced as Exhibit A-1. The first "whereas" reads as follows:

WHEREAS the company proposes to issue and sell 1984 scientific research tax credit debentures ("SRTC debentures") as set out in the summary term sheet attached hereto (as Schedule "B")

Schedule B is short, and I believe that it is of interest to quote it in full:

SCHEDULE B

SUMMARY TERM SHEET

1. Gross Debenture Issue: $2,000,000

2. Redemption to Purchasers: $1,140,000

3. Retention by Company: $860,000

Total Research and Development Expenditures $2,000,000

To be completed by December 27, 1985

The second "whereas" reads as follows:

AND WHEREAS each purchaser wishes to buy one SRTC debenture in the principal amount and having a redemption price as set forth opposite the name of each purchaser listed in Schedule "A" hereto;

Schedule A sets out the list of investors, the purchase price and the redemption price. The details concerning the appellant are as follows:

SCHEDULE "A"

PURCHASE PRICE REDEMPTION AMOUNT

Donat Flamand Inc. $250,000 $142,500 90, Industriel St-Apolinaire GOS 2E0

Clause 2.02 of the agreement explains the effect of the redemption of a debenture:

2.02 The company shall pay to each purchaser an amount equal to the full redemption price of the debenture, on demand, in accordance with the terms and provisions of such debenture, against the surrender of each debenture for cancellation, without any notice or other action on the part of the purchaser.

The following undertaking was made by the issuer of the debentures, as it is described in clauses 2.03 and 2.04(b) of the agreement:

2.03 The company shall designate for the benefit of each purchaser an amount in respect of each debenture equal to the full amount of the purchase price under subsection 194(4) of the Income Tax Act, and for the purposes of Part I and Part VIII of the ITA, in order to ensure that each purchaser will obtain a scientific research tax credit of 50 per cent of such purchase price for corporate purchasers and 53.4 per cent for individual purchasers. In this connection, the company shall table at the closing the form prescribed under said subsection 194(4), being Form T2113, and an information return, being Form T2114 and all corresponding Province of Quebec, Department of Revenue Forms, all duly completed for filing with the Minister of National Revenue and shall immediately forward such forms to such Minister by registered mail, return receipt requested. The company shall not make any other designation pursuant to subsection 194(4) or any other provisions of the ITA in respect of each debenture or file any other form in respect thereof other than the forms referred to in this agreement.

2.04(b) The company will satisfy its liability under Part VIII of the ITA in respect of the issue of the debentures by:

(i) making expenditures of at least $2,000,000 on scientific research qualifying under the ITA on or before the last day of the company’s current fiscal year,

(ii) making payments pursuant to Part VIII of the ITA to the Receiver General for Canada of $1,000,000 56 days following the end of the company’s current fiscal year, altogether with prescribed interest thereon or

(iii) any combination of the above.

There was also an investor’s indemnification clause in this agreement, clause 2.06:

2.06 The company shall indemnify and save harmless each purchaser from and against any Canadian federal taxes, interest and/or penalties levied or required to be paid under the ITA ("amount assessed") which such purchaser is required to pay (i) as a result of the failure of the company to comply with its obligations to make the designation pursuant to section 2.03 hereof or to file the prescribed forms referred to in this agreement, or (ii) as a result of any representation or warranty of the company being untrue or incorrect or any breach of any other covenant of the company contained in this agreement, or

(iii) as a result of the company not being permitted under the ITA to designate for the benefit of each purchaser the full amount of the purchase price as an amount in respect of each debenture under subsection 194(4) of the ITA and for the purpose of Part I and Part VIII of the ITA.

Clause 2.07 even added:

2.07 In the event of a claim by a purchaser under the indemnity provided for in section 2.06 hereof, the company shall pay an amount equal to the amount assessed to such purchaser within 30 days after notification by such purchaser of such claim. If a purchaser pays the amount assessed to the Receiver General of Canada prior to receipt of payment from the company, the company shall pay interest on such amount at a rate per annum which is equal to the rate charged by the Toronto-Dominion Bank at its main branch, Toronto, to its preferred customers plus I per cent. Such interest shall accrue from and including the later of the day of payment of the amount assessed by such purchaser or the 30th day following the date that such purchaser notifies the company of its claim against the company under the said indemnity and shall be payable together with the amount paid to such purchaser under the said indemnity.

Clause 6 of the agreement stated:

Intervention

Steve Parent and Ron Fletcher hereby intervene to the present agreement to be jointly and severally bound with the company to all its obligations and covenants contained in the present agreement, the trust agreement and the debentures. Furthermore, Steve Parent and Ron Fletcher, hereby certify that all representations and warranties contained in section 2 of this agreement are true, complete and correct.

On December 28, 1984, a trust fund was established by Agri-Can in the amount of $1,000,000 to secure payment of taxes to be assessed under Part VIII of the Act. The trustee was a lawyer. The trustee was authorized to remit monies to Agri-Can upon the certificate of Agri-Can that equivalent amounts had been expended for research purposes. An opinion from an accounting firm had to accompany the certificate. Everything had to be spent before the end of Agri-Can’s financial year ending on December 27, 1985.

As we saw, the agreement signed by Agri-Can and the appellants (Exhibit A-l) contained the best indemnification clauses, except that, according to what was stated in evidence, Agri-Can was dissolved on March 3, 1989 (Exhibit A-7). One of the two directors no longer resides in Canada and the other has declared bankruptcy.

Agri-Can designated the total amount of the contract, $2,000,000, for the purposes of Parts I and VIII of the Act, as required by subsection 194(4) of the Act. The Minister of National Revenue (the "Minister”) assessed Agri-Can on February 28, 1985 for $1,000,000 under the provi- sions of Part VIII of the Act (Exhibit I-1, tab 20). On May 16, 1988, by notice of reassessment (Exhibit 1-2), the Minister vacated the assessment of February 1985 and entered the amount of tax owing under Part VIII as ’’nil". The reason stated in the notice of assessment was as follows:

Your designation as assessed under notice of assessment number 591748 dated February 28, 1985 has been invalidated as the designation does not meet the provisions of subsection 194(4.2) of the Income Tax Act.

This reassessment was the result of an investigation which had determined that no written arrangements were substantially advanced before October 10, 1984, and that the alleged written arrangements had been backdated. The amounts designated under these arrangements could therefore not be designated. Accordingly, Agri-Can had no tax payable under Part VIII. As a result of this reassessment, the purchasers of the debentures issued by Agri-Can were reassessed. The tax credit granted in the first assessment under section 127.3 of the Act was vacated and the appellants were allowed a business loss, except those who had made an election under subsection 39(4) of the Act. In the latter cases, the Minister allowed a deduction for a business investment loss.

The facts set out in the reply to the notice of appeal (the "reply") are always important, but in this case they are particularly so, since they indicate precisely what evidence the appellants had to provide to counter the Minister’s allegations. What the Minister was clearly alleging was that the documents had been backdated. He stated these facts, and also the facts recounted by certain persons whom he named:

(a) on October 10, 1984, Mr. James Beadles, a Vancouver lawyer, incorporated 283571 B.C. Ltd.; to all appearances, this was a charter obtained for future use in the event that a client so requested;

(b) presumably, it was not until after October 10, 1984 that Mr. Steve Parent of Multitech Industries Inc. (hereinafter referred to as "Multitech") approached Mr. Beadles to obtain a charter for "Agri-Can";

(c) on October 23, 1984, 283571 B.C. Ltd. filled out an application and/or a certificate for the purpose of obtaining a change of name to "Agri-Can" retroactively to October 10, 1984; in fact, notwithstanding the application and/or certificate referring to a resolution of October 10, 1984 for the change of name, it was not until after October 10, 1984 that the decision was made to change the name of 283571 B.C. Ltd. to Agri-Can;

(d) 51 per cent of the shares of Agri-Can are held by Multitech Industries Inc. and 49 per cent are held by R. Fletcher and Associates (1982) Limited;

(e) on October 23, 1984, Mr. Derek Darling (of the firm Healy & Darling), an accountant acting for Agri-Can at the request of Mr. Steve Parent of Multitech, submitted an application to the Minister of National Revenue asking whether the debt obligations that Agri- Can wished to issue qualified for the application of subsection 194(4.2) of the Income Tax Act;

(f) in support of that application, Mr. Darling submitted four documents,

among others, these being:

(i) a letter allegedly dated September 4, 1984, signed by Mr. Gregory M. Pek, accountant (acting on behalf of R. Fletcher), addressed to a Mr. Grant McDonald of Multitech;

(ii) another letter allegedly dated September 12, 1984 from Mr. Pek, accountant, to Mr. Steve Parent of Multitech;

(iii) a letter allegedly dated September 13, 1984 from Mr. Darling to Mr. Parent of Multitech, supposedly to confirm that he had been hired as an accountant;

(iv) a letter allegedly dated September 24, 1984 from Mr. Darling to Mr. Parent, supposedly to confirm in writing the proposal of a scientific research project to be financed in the manner described in that opinion;

(g) after discussions and various correspondence between Mr. Darling and officials of the Minister of National Revenue, the Minister provided a favourable response to the request of October 23, 1984, not suspecting the false representations made by Mr. Darling on behalf of Agri-Can;

(h) with respect to the two documents from Mr. Gregory M. Pek referred to in subparagraphs (f)(i) and (f)(ii) of this reply, the officials of the Minister of National Revenue were never able to obtain corroboration as to the truth of the content of or the dates appearing on those documents;

(i) with respect to the two documents from Mr. Darling, referred in to subparagraphs (f)(iii) and (f)(iv) of this reply, these two documents are backdated: the dates appearing on the said documents, September 13 and 14, 1984, respectively, are false, the documents not having been prepared before October 22, 1984;

(j) In fact, the secretary who typed these documents from Mr. Darling, Mrs. Denni Cheng, did not work for the firm Healy & Darling before October 22, 1984;

[Translation.]

Evidence

The appellant’s evidence consisted of showing that all care had been taken by the appellants to ensure that the designation was valid, to produce the documents relating to the designation and to indicate that the dates appearing therein were prior to October 10, 1984. Counsel for the appellants also produced the investigation reports of the Minister’s officials for the purpose of proving that the main actors in relation to the designation of the amount had no interest in asserting the validity of that designation since they have been informed that the tax assessment would be reduced to nil.

None of the participants in the development of the research plan and the establishment of its budget and its method of financing was called to testify. Counsel for the appellants produced a letter from a law firm in Vancouver dated March 18, 1994 (Exhibit A-7). This letter was produced in order to show the Court that the main actors in relation to the designation of the amount could not be reached. It seems, simply from reading this letter, that the person who allegedly developed the research plan, Mr. Fletcher, is still present in Canada.

The letter makes no reference to Mr. Pek, whose letters are mentioned in subparagraphs (f)(ii) and (f)(iii) of the reply and were produced as Exhibit I-1, tabs 4 and 5. According to counsel for the appellants, some attempts were made to find him, but they were fruitless. Nor did the appellants call Mrs. Cheng to testify; according to paragraph (j) of the reply, she stated that the documents signed by Mr. Healey were backdated and that she had not started to work for the accountant before October 22, 1984.

The only persons who testified for the appellants were their legal and financial advisers.

Counsel for the respondent stated that the Minister was not doubting the investors’ good faith and diligence, but contended that since the Minister had determined that the designation was invalid, he was entitled to reassess the investors within the three-year period provided in paragraph 152(4)(c) of the Act, as he did.

Analysis

I asked myself whether the Court had jurisdiction to decide whether the designation of an amount was valid or not, given that the designation had been made by a person other than the person who appealed.

I have discussed a subject which to some extent was similar in an earlier case, Stewart, S. v. M.N.R., [1990] 1 C.T.C. 2231, 90 D.T.C. 1110, at 2233 (D.T.C. 1112). Counsel for one party had argued that the Court was entitled only to interpret an agreement and not to rule as to the validity of a clause. I concluded that this Court had the requisite jurisdiction to decide questions that are necessary and useful in making its decisions. In that case, however, the appellant was a party to the agreement containing the disputed clause. In the case at bar, the designation of the amount at issue was done solely by third parties.

Counsel for the parties referred to the decisions of the Federal Court-Trial Division in First Fund Genesis Corp. v. Canada, supra, and Mort, C.L. v. The Queen, [1993] 1 C.T.C 99, 93 D.T.C. 5058 (F.C.T.D.). They pointed out that in those cases the situation was the same. They contended that it was possible for this Court to decide, as did the Federal Court-Trial Division, whether the designation was valid, although that designation was made by another taxpayer. They argued that this Court therefore had jurisdiction to determine whether the designation of the amount by Agri-Can was valid and that the Court should see no difference in the situation based on the fact that, in the cases heard by the Federal Court, the principal shareholder of the corporation which had made the designation had testified.

Counsel for the appellants also referred to the decisions in Nova Ban-Corp. v. Tottrup et al., [1989] 2 C.T.C. 304, 89 D.T.C. 5489 (F.C.T.D.) and Hart, R. et al. v. M.N.R., [1986] 2 C.T.C. 63, 86 D.T.C. 6335 (F.C.T.D.).

Those decisions hold that only the assessed taxpayer may appeal his or her assessment, and that another person who feels aggrieved by the amount of tax owing may not appeal it on behalf of the taxpayer. Here, however, as counsel for the appellants pointed out, we do not have an appeal of a third party’s assessment, but a request for a decision as to the affairs of a third party which affect the assessment of another person. The issue is not the determination of the amount of an assessment, but of whether or not a designation is valid.

In the two cases cited, supra, First Fund Genesis Corp, and Mort, C.L., the appellants were in fact the investors and the shareholders of the corporations participated merely as witnesses. Accordingly, following these precedents of the Federal Court-Trial Division, and also because this point was not contested by either of the parties, I find that this Court has jurisdiction to determine the validity of the designation of the amount by AgriCan in this appeal. The only effect of the failure of the principal shareholders to participate in the proceedings will be in terms of the preponderance of evidence.

Was the designation of the amount valid? On the evidence adduced by the appellants, I cannot vary the Minister’s decision that the designation was not valid. There was no evidence to counter the Minister’s presumptions of fact, to the effect that on October 10, 1984 no written arrangements were substantially advanced with respect to the issuance of the debt obligations acquired by the appellants. The mere presentation of documents signed on a date prior to October 10, 1984 is not sufficient to reverse the Minister’s presumptions of fact. Those presumptions of fact were made following a long investigation by the Minister, the reports of which were produced by counsel for the appellants. In addition, the failure of important witnesses to attend also allows me to draw a negative inference that those witnesses would not have been able to prove the contrary. [5] The argument that the main actors in relation to the designation had no interest in defending themselves to the Minister’s investigators, this being the argument in support of which the reports were produced, cannot be accepted. At the outset, I cited the clauses guaranteeing liability which the directors signed. In addition, the amount of tax supposedly owing under Part VIII had been paid into a trust account and the research expenditures had supposedly been made. Accordingly, to my mind, this is a neutral point.

Was the Minister entitled to reassess the appellants for something done by third persons, as he did, despite the fact that they exercised due diligence? No cases were cited to me which prevent him from doing so, and I am not aware of any such cases. The first assessment was based on something done by third persons. This leads me to believe that the second may also be. The designation was void ab initio because it violated the requirements of subparagraph 194(2)(b) of the Act. Accordingly, the first assessment was not correct. The second is.

The appellants also argued that the Minister had not acted with due dispatch as required by the Act and that he acted without making them aware of what was happening in the investigation. With respect to the investigation, the Minister believed that he was obliged to maintain confidentiality, under the requirements of section 241 of the Act, and no legal argument has been made that he did not have to do so. When the investors obtained a power of attorney from one of the directors of Agri-Can permitting access to Agri-Can’s records, the appellants had access to those records. The requirement to act with due dispatch exists only in relation to the first assessment, since there is no other limitation under the Act. In the case of a reassessment, when there is no fraud or misrepresentation of the facts that is attributable to neglect, carelessness or willful default by the taxpayer, the limitation is three years, under subsection 152(4) of the Act.

Accordingly, the appeals are dismissed.

Appeals dismissed.