Citation: 2007TCC260
Date: 20070502
Docket: 2005-4039(IT)I
BETWEEN:
ARMADA EQUIPMENT CORPORATION,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Mogan D.J.
[1] When computing
income for the 1994 taxation year, the Appellant reported Scientific Research
and Experimental Development (SR&ED) expenditures in the amount of $134,235
and claimed an Investment Tax Credit (“ITC”) at the rate of 35% in the amount
of $46,982. By Notice of Reassessment dated June 13, 1996, the Minister of
National Revenue (the “Minister”) disallowed a portion ($34,909) of the amount
($134,235) which the Appellant had reported as SR&ED expenditures, but the
Minister allowed the remaining portion ($99,326). The Minister also disallowed (at
the 35% rate) a portion ($12,218) of the ITC claimed by the Appellant.
[2] In September 1996,
the Appellant filed a Notice of Objection to the reassessment described above
and, after a delay of almost nine years, the Minister confirmed the reassessment.
The Appellant has appealed from the 1994 reassessment and has elected the
informal procedure.
[3] The amount of
$34,909 which the Minister disallowed as an SR&ED expenditure has two
components of $18,618 and $16,291. The issue in this appeal concerns only the
$18,618 component. The question is whether the $18,618 is a “qualified
expenditure” within the meaning of subsection 127(9) of the Income Tax Act (the
“Act”).
The Facts
[4] The Appellant’s first
witness was William J. Heaps who incorporated the Appellant company many years
ago. He has always had a love of equipment and all of his work experience dealt
with vehicles. In 1994 (the year under appeal), the Appellant built heavy
specialty equipment like drilling rigs, underground waste disposal units and
vehicles to launch satellites. The Appellant would take a project from concept
to design to manufacture to delivery. There were only a few workers in the
office (engineers, draftsmen, secretaries, etc.) and about a dozen in the plant
(welders, fabricators, etc.). The Appellant did not build or make engines,
transmissions or tires. Those products had to be sourced from outside suppliers.
[5] Mr. Heaps retired
two years ago but, before he retired, he was president of the Appellant
company. He referred to the firm of James A. Deacur & Associates Ltd. as
“our accountants”. I will refer to that firm as “Deacur & Co.”. Exhibit A-1
is a copy of the Appellant’s unaudited final statements for the year ended
March 31, 1995 as prepared by Deacur & Co. Exhibit A-2 is a copy of
an invoice dated August 10, 1995 from Deacur & Co. to the Appellant in the
amount of $2,343.30 for the preparation of the 1995 financial statements, 1995 corporate
tax returns, and GST returns. Exhibit A-3 is a copy of a different invoice
dated November 16, 1994 from Deacur & Co. to the Appellant in the amount of
$30,621.26 for services in connection with documenting the 1994 SR&ED
expenditures and claiming the corresponding ITCs.
[6] Allan J. Gordon (the
Appellant’s second witness) is a chartered accountant who was in 1994 and still
is associated with Deacur & Co. In the early 1990s, he started to
specialize in SR&ED claims so that he could help small Canadian companies
acquire the available investment tax credits. He became an expert in the
preparation and submission of SR&ED claims under the Act. He
recognized Exhibits A-1, A-2 and A-3. He helped prepare the financial
statements in Exhibit A-1. He produced Exhibit A-4, a printout from the
records of Deacur & Co. showing invoices sent to the Appellant. Within
Exhibit A-4, he identified Exhibit A-3 which appears as an entry for
November 16, 1994. He also identified Exhibit A-2 as an entry for August
10, 1995; and a similar invoice of $2,247 dated October 31, 1994 for preparing
1994 financial statement and tax returns.
[7] Mr. Gordon
described the detail required to support a taxpayer’s claim for an ITC based
upon SR&ED expenditures. In order to provide that detail, Deacur & Co.
hired Gerry Loban, a retired engineer. Mr. Loban would visit the clients of
Deacur & Co. to obtain a precise description of the research and
development being done, and then assist in the writing of a technical report.
According to Mr. Gordon, Gerry Loban did extensive work on the Appellant’s
SR&ED claim for 1994. Mr. Loban would invoice Deacur & Co. for the work
he did; and Deacur & Co. would pass the cost on to its client if the ITC
claim was successful.
[8] Mr. Gordon reviewed
with care Exhibit A-3 which showed professional fees of $28,618 plus a GST
charge of $2,003.26. Within the professional fees of $28,618, he determined
that an amount of $10,000 could be reasonably allocated to “non-qualifying
activity”, and so should be deducted from the total fees for purposes of the
ITC claim. He stated that, by deducting the $10,000, he was being extremely
conservative in claiming only the amount $18,618 as a professional fee for the
preparation of the ITC claim based upon SR&ED. Mr. Loban would not
have been retained by Deacur & Co. if they had not been preparing ITC
claims for SR&ED. Also, the Exhibit A-3 invoice would not have been sent if
Deacur & Co. had not prepared the Appellant’s 1994 claim for an ITC based
upon its SR&ED expenditures.
[9] This appeal will
depend upon the interpretation of certain provisions of the Act and
the Income Tax Regulations (the “Regulations”). In 1994,
subsection 127(5) permitted the deduction of an investment tax credit with
respect to a taxpayer’s qualified expenditures on SR&ED. The following
definition of “qualified expenditure” appeared in subsection 127(10.1):
127(10.1) For the purposes of subsection (9) and (10),
(a) …
(c) “qualified expenditure” means an
expenditure in respect of scientific research made by a taxpayer after March
31, 1977 that qualified as an expenditure described in paragraph 37(1)(a)
or subparagraph 37(1)(b)(i), but does not include
(i)
a prescribed expenditure, and
(ii)
in the case of a taxpayer that is a corporation,
an expenditure specified by the taxpayer for the purposes of clause 194(2)(a)(ii)(A);
[10] The Appellant and
Respondent rely on different provisions of the Regulations to come
within or fall outside the required terms of a “qualified expenditure”. The
Appellant relies on Regulation 2900(2)(c):
2900(2) For the
purposes of clauses 37(7)(c)(i)(B) and (ii)(B) of the Act, the
following expenditures are directly attributable to the prosecution of
scientific research and experimental development:
(a) the cost
of materials consumed in such prosecution;
(b) where an
employee directly undertakes, supervises or supports such prosecution, the
portion of the salaries or wages and related benefits paid to or for that
employee that can reasonably be considered to related thereto; and
(c) other
expenditures that are directly related to such prosecution and that would not
have been incurred if such prosecution had not occurred.
The Respondent relies on the
definition of “prescribed expenditure” in Regulation 2902:
2902 For the purposes of the definition “qualified
expenditure” in subsection 127(9) of the Act, a prescribed expenditure
is
(a) an expenditure of a current nature
incurred by a taxpayer in respect of
(i) the general administration or management
of a business, including
(A) administrative salary or wages and related
benefits in respect of a person whose duties are not all or substantially all
directed to the prosecution of scientific research and experimental
development, except to the extent that such expenditure is described in
subsection 2900(2) or (3)
(B) a legal or accounting fee ,
(C) an amount described in any
of paragraphs 20(1)(c) to (g) of the Act,
(D) an
entertainment expense,
(E) an
advertising or selling expense,
(F) a
conference or convention expense,
(G) a due or fee in respect of
membership in a scientific or technical society or organization, and
(H) a
fine or penalty, or
(ii) the maintenance and
upkeep of premises, facilities or equipment to the extent that such expenditure
is not attributable to the prosecution of scientific research;
[11] Counsel for the Appellant
argued that the amount $18,618 paid to Deacur & Co. was directly
attributable to the Appellant’s prosecution of SR&ED within Regulation 2900(2)(c)
because that payment would not have been incurred if such prosecution had not
occurred. The Respondent acknowledges that the Appellant had significant
SR&ED expenditures ($99,326) in its 1994 taxation year. The uncontradicted evidence of Mr. Gordon
was that the invoice (Exhibit A-3) for $28,618 (which includes the amount
$18,618 in issue) would not have been sent to the Appellant
and paid by the Appellant if Deacur & Co had not been preparing claims for ITCs based
upon SR&ED expenditures.
[12] Counsel for the
Respondent argued that the amount $18,618 was excluded from being a “qualified
expenditure” under subsection 127(10.1) because it is “a legal or accounting
fee” and, therefore, a “prescribed expenditure” within Regulation 2902(a)(i)(B).
[13] In my opinion, the
amount in dispute ($18,618) was a “legal or accounting fee” within the meaning
of Regulation 2900(a)(i)(B). That amount was paid to Deacur &
Co. who Mr. Heaps referred to as “our accountants”. Deacur & Co. prepared
the Appellant’s financial statements and tax returns. Those services are within
the scope of what an accountant ordinarily does for a fee. Filing a claim for
an investment tax credit is part of filing an income tax return if the taxpayer
is engaged in SR&ED. Why wouldn’t the outside professional (Deacur &
Co.), retained to prepare financial statements and income tax returns, be the
same person who would prepare and file a claim for investment tax credits which
are deducted as a credit against tax otherwise payable in accordance with the tax
returns? The outside professional who prepares financial statements and tax
returns is the logical person to write the required report on SR&ED, to
complete the prescribed form claiming investment tax credits based upon
SR&ED, and to file such form as an integral part of filing an income tax
return.
[14] The Appellant has a
more difficult task identifying the amount in dispute ($18,618) as an
expenditure directly attributable to the prosecution of scientific research
and experimental development within the meaning of Regulation 2900(2)(c).
Subparagraph 2(a) describes the cost of materials consumed in “such
prosecution”. Subparagraph 2(b) describes the cost of salaries or wages
paid to an employee who directly supports “such prosecution”. And subparagraph
2(c) describes:
(c) other
expenditures that are directly related to such prosecution and that would not
have been incurred if such prosecution had not occurred.
[15] I cannot conclude that
the amount ($18,618) paid to Deacur & Co. was an expenditure “directly
related to such prosecution”. In order to be “directly related”, an expenditure
must be incurred in the research itself or in the development itself. The
amount paid to Deacur & Co. was a consequence of research and development
which had already taken place. It was an accounting fee paid to the accounting
firm which prepared the Appellant’s income tax returns to see if certain
expenditures already incurred with respect to research and development could
qualify for a specific investment tax credit.
[16] Both counsel
referred to the decision of this Court in Val-Harmon Enterprises v. Her
Majesty the Queen, [1995] T.C.J. No. 1762. In the Val-Harmon case,
Bowman J. (as he then was) was faced with a question similar to the issue in this appeal. Val-Harmon
had engaged in SR&ED, and retained Gessat Inc. to prepare its claim for
ITCs based upon SR&ED. Gessat Inc. was not an accounting firm or legal firm
but a company which helped taxpayers making claims for credits based upon
SR&ED. In 1993, Gessat Inc. charged a fee of $20,638 to Val-Harmon
who then claimed an ITC of $7,223 based on that fee.
[17] At the hearing
before Bowman J., the Respondent attempted to amend its pleading to argue that
the fee paid to Gessat Inc. was “an expenditure of a current nature incurred by
a taxpayer in respect of (i) the general administration or management of a
business including (B) a legal or accounting fee” within the meaning of Regulation
2902(a)(i). When denying the proposed amendment to the Respondent’s
pleading, Bowman J. in his oral reasons for judgment stated:
8 The
point is well taken, I think. It raises a serious question as to
whether such expenses should be allowed or should be treated as
prescribed. I did not allow the amendment because it came at a
rather late stage of the proceedings and I felt it would be unfair to the
taxpayer who came prepared to argue only the one point, and that is whether
these are accounting fees.
9 I'm
reluctant to deny amendments, but at this stage of the game I think it would be
quite unfair because the appellant might have put in different evidence, might
have come prepared with different arguments. I think that argument
has to be saved for another day. The amount of money involved in
this case is not substantial and I don't think it would be fair to permit an
amendment and we would have to adjourn the case, I think we'll leave that for
some other, for some other cases. It also raises of course the
rather serious question whether what one does in preparing reports and making
submissions to the Department of National Revenue falls under the general
definition of scientific research expenses. It's a very good
question and I think some day should be addressed but not in this case.
[18] In Val-Harmon,
Bowman J. held that 75% of the fee paid to Gessat Inc. was a “qualified
expenditure” but the Respondent in that case had failed to plead that the fee
was a “prescribed expenditure” within Regulation 2902. In this appeal by
Armada Equipment Corporation, the Respondent rests its case on Regulation 2902.
[19] In Val Harmon,
it is important to note that Justice Bowman (as he then was) delivered oral
reasons from the bench; and there is no indication that Regulation 2900(2)
was brought to his attention or relied on by the taxpayer. In this appeal by
Armada, the Appellant rests its case on Regulation 2900(2). In paragraph
14 above, I have attempted to explain why I do not bring the amount in dispute
($18,618) within Regulation 2900(2). In my opinion, the following words
and phrases from Regulation 2900(2) operate strongly against the
Appellant:
“directly attributable
to the prosecution of scientific research and experimental development”;
“such prosecution” in
paragraphs (a) and (b); and
“directly related to
such prosecution” in paragraph (c).
[20] When considering
SR&ED, the nouns are “research” and “development”. The words “scientific”
and “experimental” are only adjectives. I conclude that a “qualified expenditure”
must be incurred in connection with ongoing research and development, and not
incurred after-the-fact because research and development have already taken
place. I do not have any doubt that the $18,618 is a current expense of the
Appellant for profit and loss computation but I hold that it is not a
“qualified expenditure” for the purposes of an investment tax credit. The
appeal is dismissed.
Signed at Ottawa, Canada, this 2nd
day of May, 2007.
“M.A. Mogan”
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