Orenstein & Partners Inc. In Its Capacity as Court-Appointed Receiver of the Part Viii Tax Refund of Scannar Industries Inc. And Scannar Industries Inc. v. Her Majesty the Queen, [1994] 1 CTC 215

Denault, J.:— This is an appeal pursuant to Rule 336(5) of the Federal Court Rules by the defendant from the order of the Associate Senior Prothonotary Giles dated April 19, 1993, granting leave to the plaintiffs to file an amended statement of claim. The grounds for appeal are that the decision was wrong and that the decision involves a question vital to the final issue of the case. The defendant is seeking to have the decision set aside and requesting that I exercise discretion de novo in determining whether leave to amend the statement of claim should be granted.

The main action involves an appeal by the plaintiffs of notices of assessment for the 1984 and 1985 taxation years. The principal issue in the original statement of claim was whether the plaintiffs are entitled to a Part VIII refund on the basis that a number of expenditures constituted scientific research and experimental development expenditures within the meaning of subsection 37(1) and subsection 194(2) of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). The decision of the Associate Senior Prothonotary granted leave to the plaintiffs to amend the original statement of claim to raise the issue of the validity of a number of designations made by the plaintiffs during the 1985 taxation year pursuant to subsection 194(4) of the Act. The Minister’s principal objections to these amendments are that they effectively withdraw admissions made in the original statement of claim and reply, that they raise a completely new cause of action and that they will prejudice the defendant in a manner not compensable in costs.

Facts

The following is a summary of the facts in relation to the 1985 taxation year only. Counsel for both parties agreed at the hearing to the proposed amendment adding a preliminary paragraph to the statement of claim limiting the action to an appeal of the assessment for the 1985 taxation year. Therefore, it is not necessary to examine here the details of the 1984 taxation year.

The plaintiff, Orenstein & Partners Inc. (Orenstein), is the Court-appointed receiver of the Part VIII tax refund allegedly owing to the other plaintiff, Scannar Industries Inc. (Scannar). Scannar's 1985 taxation year began on December 1, 1984 and ended on November 30, 1985.

On November 15 1984, counsel for Scannar wrote to the Minister of National Revenue (Minister) requesting an opinion on whether a proposed transaction with Combustion Engineering Superheater Ltd. would fulfil the requirements of Part VIII of the Income Tax Act, in particular whether a designation made pursuant to subsection 194(4) of an investment by Combustion Engineering Superheater Ltd. would meet the criteria in subsection 194(4.2) regarding designations made after October 10, 1984.

Part VIII of the Income Tax Act provides the structure for a deduction from business income for scientific research and experimental development expendi tures when third parties have invested in the corporation and are going to claim the scientific research and experimental development credit in section 127.3. When a corporation has designated the investors and amounts received under subsection 194(4), the corporation incurs tax liability pursuant to subsection 194(1) for 50 per cent of the total amount designated. Subsection 194(4.2) was enacted to limit the application of subsection 194(4) to designations made prior to October 10, 1984. However, paragraph 194(4.2)(b) allows certain designations made after October 10, 1984 to be “grandfathered” into the application of Part VIII if they meet specific criteria. Subsection 194(2) permits a reduction of the corporation's tax liability incurred by the designations in the amount of 50 per cent of the total scientific research and experimental development expenditures of the corporation in the taxation year which meet the criteria in paragraphs 37(1 )(a) and (b). That portion of the latter amount which exceeds the tax liability incurred by the designations is refundable pursuant to subsection 194(3).

On December 3, 1984, the Minister responded that the proposed transaction with Combustion Engineering Superheater Ltd. would satisfy the necessary requirements of paragraph 194(4.2)(b).

On December 31, 1984, Scanner filed three designations pursuant to subsection 194(4) of the Act: $19,000,00 for Hayes-Dana Inc., $5,000,000 for Chieftain Products Inc., and $1,000,000 for Atelco Inc. On January 11, 1985, a designation was filed in respect of shares issued to employees in the amount of $101,000. Finally, on January 25, 1985, $5,000,000 was designated in respect of the above- mentioned transaction with Combustion Engineering Superheater Ltd. The total of these designations was $30,101,000.

On December 2, 1985, Scannar filed its Part VIII tax return and reported that 50 per cent of the designated amounts was $15,055,500 (the amount should have been $15,050,500). This represents Scannar’s Part VIII tax liability pursuant to subsection 194(1). The third parties to whom the shares or debt obligations subject to the designations were issued were entitled to claim tax credits equal to 50 per cent of the amount (these credits were claimed by Hayes-Dana Inc., Combustion Engineering Superheater Ltd. and Chieftain Products in their returns). In its return, Scannar also indicated that it paid to the Receiver General $8,700,000 on account of the tax liability arising from the designations. Finally, Scannar indicated that it incurred a total of $27,869,383 in scientific research expenditures pursuant to subsection 37(1) of the Act. This amount includes $25,000,000 resulting from a contract dated November 27, 1985 with Proteus Bio-Research Corporation to provide research and development services in connection with the production of certain products. As a result, Scannar claimed a Part VIII refund of $8,837,761.

By notice of assessment dated June 8, 1987, the Minister disallowed $26,579,013 of the expenditures, including the Proteus expenditure. Taking into consideration the $8,700,000 payment and the error in reporting the liability for the designated amounts, the assessment resulted in a total Part VIII tax liability on the part of Scannar for the 1985 taxation year in the amount of $4,405,316.50. On September 1, 1987 Scannar filed a Notice of Objection. The assessment was confirmed by the Minister on 14 December 1988.

The plaintiffs filed a statement of claim appealing this assessment on March 13, 1989. The principal issue in the original statement of claim was whether the plaintiffs are entitled to a Part VIII refund on the basis that a number of expenditures constituted scientific research and experimental development expenditures under subsection 37(1). There is no mention of the designations, though the statement of claim states at paragraph 9 that "Scannar paid certain amounts in respect of Part VIII Tax [sic] for the 1984 and 1985 fiscal years.”

This statement of claim was met by a statement of defence in which, at paragraph 12(c), the defendant states: “in February of 1985 Scannar paid Part VIII tax in the amount of $8,700,000.” In paragraph 12(d) the defendant states:

. . . in its 1985 taxation year, Scannar designated an amount pursuant to subsection 194(4) of the Income Tax Act of $30,101,000 thus creating Part VIII tax payable of $15,050,000. The designation followed a "quick flip" transaction whereby securities given by Scannar to investors were contemporaneously redeemed by Scannar at an amount of approximately 60 per cent of the face amount of the securities, leaving Scannar with cash of approximately 40 per cent of the amount of the designation;

In paragraph 6 of its reply, "[T]he plaintiff denies the allegations in subparagraph 12(d), but states that the amount designated pursuant to subsection 194(4) of the Income Tax Act in 1985 was $30,111,000, thus creating Part VIII tax payable of $15,055,500.” In paragraph 7, "[T]he plaintiff admits the allegations of fact in paragraphs 4 and 12(c), but in addition the fact is that the plaintiff acquired scientific research tax credits in the amount of $1,300,000, for 1985.”

By notice of motion dated April 8, 1993, the plaintiffs applied for leave to amend the statement of claim. The principal amendments raise the issue regarding the validity of the designations made pursuant to subsection 194(4) of the Act. On April 19, 1993, the Associate Senior Prothonotary allowed the application without reasons and the Minister filed a notice of motion on May 3, 1993 to appeal this decision. The motion was heard by me on September 27, 1993.

Issues

As mentioned above, during the hearing on the motion the Minister consented to proposed amendments limiting the action to an appeal of the assessment for the 1985 taxation year. Other amendments consented to included those which limited the action to an appeal of the disallowance of the $25,000,000 expenditure resulting from the Proteus contract and those which “cleaned up the other points" to be dealt with. As such, I will limit my review of the Associate Senior Prothonotary's decision to the proposed amendments relating to the validity of the designations made pursuant to subsection 194(4).

In my opinion, the first determination to be made is whether this is an instance where I should intervene in a discretionary decision of a prothonotary and exercise my own discretion de novo. The second issue involves a determination of whether the proposed amendments should be allowed.

Standard of review

The standard of review of a prothonotary's order was set out by Justice Mac- Guigan in Aqua-Gem Investments Ltd. v. M.N.R., [1993] 1 C.T.C. 186, 93 D.T.C. 5080, at pages 207-08 (D.T.C. 5094), representing the majority of the Federal Court of Appeal sitting on a bench of five judges, when he stated that:

. . .discretionary orders of prothonotaries ought not to be disturbed on appeal to a judge unless:

(a) they are clearly wrong in the sense that the exercise of discretion by the prothonotary was based upon the wrong principle or upon a misapprehension of the facts, or

(b) they raise questions vital to the final issue of the case.

Where such discretionary orders are clearly wrong in that the prothonotary has fallen into error of law (a concept in which I include a discretion based upon a wrong principle or upon a misapprehension of the facts), or where they raise questions vital to the final issue of the case, a judge ought to exercise his own discretion de novo.

On this issue, the plaintiffs maintain that the defendant cannot establish that the order allowing the amendment was based on the application of a wrong principle or a misapprehension of the facts. They also submit that the order does not determine any issue vital to the final decision in the case, "but rather is allowing the trial judge to decide the action on the basis of all the facts of the case" (Plaintiffs’ Outline of Argument on the Motion to Appeal, at paragraph 14). Counsel for the defendant argues the opposite.

Because Associate Senior Prothonotary Giles did not provide any reasons for his decision it is difficult to determine whether he erred by applying a wrong principle or misapprehending the facts of the case. However, such a determination is not necessary since I am of the opinion that the order raises a question “vital to the final issue of the case”. In my opinion, this is a case where the Court ought to intervene and exercise its discretion de novo because the amendments, if allowed, would create a whole new cause of action. Implicit in many of the plaintiffs arguments in support of the necessity for the amendment is the view that the amendments are necessary because they put into issue the validity of the designation and a negative finding on this question will relieve Scannar from any liability for the payment of any Part VIII tax for the 1985 taxation year (Plaintiffs’ Outline, supra, paragraph 7). Clearly, the issues raised by the amendments are vital to the final resolution of the case. However, this does not mean that the amendments should or should not be allowed, merely that I ought to examine the amendments and exercise my own discretion.

The amendments

Plaintiffs' submissions

As stated above, the plaintiffs argued that the amendments are necessary to put in issue the validity of the designations made pursuant to subsection 194(4) of the Act in order to enable the Court to determine the validity of the assessment on the basis of all of the relevant facts. They submit that they were previously unaware that the designations may not be valid and could not have intended to concede this point. The plaintiffs maintain that the Minister is not prejudiced by the amendments because, notwithstanding the expiration of the limitation period in subsection 152(4), the third party investors could be pursued to repay the scientific research and experimental development tax credit they received as a result of the designations on the basis of misrepresentation. Also, they maintain that the amendments cause no additional prejudice to the Minister in that the limitation period had already expired for some of the third party investors when the original statement of claim was filed. If it is shown that the amendments may cause prejudice to the defendant, it seems that the plaintiffs submit that this prejudice is compensable by costs and that this prejudice is in part the result of the Minister's failure to discharge its duty to verify the designations when they were made.

On the issue of whether the amendments constitute a withdrawal of an admission, it is the plaintiffs’ opinion that paragraph 7 of the statement of claim and paragraphs 6 and 7 of the reply do not constitute admissions as to the validity of the designations. In their view, paragraph 6 is an express denial of the validity of all of the allegations in paragraph 12(d) of the defence, including the remarks about the designations. However, if the amendments are considered to be a withdrawal of an admission, the plaintiffs submit that the same principles of law as those governing any other amendment apply. In particular and in addition to the above arguments regarding the amendments generally, they maintain that the alleged admission was made inadvertently and that they acted promptly to remedy the error.

Finally, the plaintiffs argue that the decision of the Associate Senior Prothonotary was based on the view that the defendant's objections are based on the notion of estoppel — that is that the plaintiffs are estopped from relying on the application of subsection 194(4.2) — and that this is an argument that should more properly be considered by the trial judge (Plaintiffs’ Outline, supra, paragraphs 10 and 23). There is no evidence before me other than the Plaintiffs’ Outline as to what the reasons were for the Associate Senior Prothonotary's decision. However, it is not necessary to consider the issue of estoppel to determine this appeal.

Defendant's submissions

The defendant's submissions are based on the view that the amendments constitute a withdrawal of an admission. The Minister maintains that the amend- ments result in severe prejudice and that this prejudice cannot be compensated by costs. In support of this submission, the defendant argues that the designations were acted on in good faith by the Minister and that it allowed, as a result of these designations, scientific research and experimental development tax credits to be claimed by the third party investors pursuant to section 127.3 in the total amount of $14,500,000. The Minister submits that the operation of subsection 152(4) prevents it from reassessing these companies unless there is evidence of misrepresentation attributable to neglect, carelessness or wilful default or evidence of fraud. No such evidence was presented by the plaintiffs in support of the motion. As such, if the plaintiffs are permitted to change their position and succeed at trial, the Minister is left in the position of having lost the tax payable by the third party investors which was offset by the tax credits and, at the same time, of having lost the Part VIII tax payable by the plaintiffs as a result of the designations.

On the issue of the timeliness of the motion, the defendant submits that there is no reasonable explanation for the withdrawal of the admission and change in position. It is submitted that the explanations that the admission was inadvertent, that the plaintiffs acted promptly to correct the error, and that the plaintiff Orenstein was not advised by its solicitor that the designations might not be valid are insufficient. The defendant maintains that the plaintiffs were aware of the possible issue regarding the validity of the designation as early as 14 November 1984 when counsel for the plaintiffs wrote to the Minister for an opinion about the proposed Combustion Engineering Superheater Ltd. transaction. The same firm filed the original statement of claim and reply.

Finally, the defendant submits that there is insufficient evidence of a triable issue to support the amendment. The only evidence of the timing of the transactions giving rise to the designations is the aforementioned opinion letter and the reply by the Minister, evidence which supports the validity of the designations. It is submitted that the allegation that Revenue Canada officials accepted the designations without verifying or confirming them is not sufficient evidence raising a triable issue.

Analysis

The rule governing the amendment of pleadings is set out in Rule 420(1) of the Federal Court Rules:

420.(1) The Court may, on such terms, if any, as seems ust, at any stage of an action, allow a party to amend his pleadings, and all such amendments shall be made as may be necessary for the purpose of determining the real question or questions in controversy between the parties.

In Francoeur v. Canada, [1992] 2 F.C. 333, 140 N.R. 389, the Federal Court of Appeal considered similar amendments and stated at page 337 (N.R. 391-92):

. . . the general rule is that an amendment should be allowed 'Tor the purpose of determining the real questions in controversy between the parties” provided that the allowance would not result in an injustice to the other party not capable of being compensated by an award of costs.

(See also Canderel Ltd. v. Canada, [1993] 2 C.T.C. 213, 93 D.T.C. 5357 (F.C.A.) at page 217 (D.T.C. 5360), and Continental Bank Leasing Corp. v. Canada, [1993] 1 C.T.C. 2306, 93 D.T.C. 298 (T.C.C.) at page 2309 (D.T.C. 301).) The Tax Court, in Continental Bank, applies the same rule as set out in Francoeur, supra, (adding the test for a "triable issue”) to the specific situation where the effect of the amendment is a withdrawal of an admission and held (page 2310 (D.T.C. 302)) that the question of whether an amendment or a withdrawal of an admission should be allowed should be put on a broad basis: is the amendment in the interests of justice? The Court states further that:

. . . other factors should also be emphasized, including the timeliness of the motion to amend or withdraw, the extent to which the proposed amendments would delay the expeditious trial of the matter, the extent to which a position taken originally by one party has led another party to follow a course of action in the litigation which it would be difficult or impossible to alter and whether the amendments sought will facilitate the court's consideration of the true substance of the dispute on its merits. No single factor predominates nor is its presence or absence necessarily determinative. All must be assigned their proper weight in the context of the particular case. Ultimately it boils down to a consideration of simple fairness, common sense and the interest that the courts have that justice be done.

On the basis of the above, it would appear that the considerations are the same whether the amendments are considered to be a withdrawal of an admission or not, though in my opinion the proposed amendments do constitute a withdrawal of the admission that the designations were considered by the plaintiffs to be valid.

These amendments would cause prejudice to the defendant because the Minister is now precluded from reassessing the third party investors. The potential prejudice caused, in the amount of $14,500,000 representing the total amount of credits claimed and allowed on the basis of the designations and not including interest, is clearly not compensable by costs. While it could be argued that this prejudice is dependent upon the final resolution of the case and is not relevant to the determination here, I am persuaded that when you weigh the potential prejudice along with some of the other factors to be considered against the scarcity of the evidence presented with respect to the merits of the issue to be raised, the proposed amendments do not aid in "determining the real questions in controversy between the parties” nor do they raise a "triable issue".

In addition, I am of the opinion that counsel for the plaintiffs had plenty of previous opportunities for raising the issue of the validity of the designations and that this motion is by no means "timely". The failure of the plaintiffs to raise the issue beforehand has caused the Minister to take a course of action which is impossible to alter. Specifically, since the reply to the opinion letter was provided and the 1985 return filed, the Minister has acted on the basis that the validity of the designations and these actions cannot be changed retroactively.

Conclusion

All of these considerations lead me to conclude that the proposed amendments regarding the designations would cause an irremediable injustice that could not be compensated by an award of costs. Accordingly, the appeal must be allowed and the order of the Associate Senior Prothonotary dated April 19, 1993 granting leave to the plaintiffs to file an amended statement of claim is set aside. The Court reserves to the plaintiffs the right to file a revised amended statement of claim not incompatible with this order.

Costs in the cause.

Appeal allowed.