Citation: 2009 TCC 632
Date: 20091216
Docket: 2007-2422(IT)G
BETWEEN:
TRI-O-CYCLES CONCEPT INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
[OFFICIAL ENGLISH TRANSLATION]
REASONS FOR JUDGMENT
Paris J.
[1] The issue in these appeals is whether the Appellant
is entitled to business loss deductions and investment tax credits (ITCs) with
respect to scientific research and experimental development (SR&ED) for its
2002 and 2003 taxation years.
[2] The Minister of National Revenue denied the
Appellant’s claims for business losses of $7,018 in 2002 and $9,567 in 2003 and
for ITCs of $13,322 in 2002 and $19,321 in 2003 on the basis that the Appellant
was not carrying on a business in those years. Before this Court, the
Respondent also argued that certain amounts claimed as business expenses were
unreasonable in the circumstances.
Facts
[3] The Appellant was incorporated in 1997. Its
sole shareholder and director is Mr. Yves Brisson. Mr. Brisson has a background
in business and industrial design.
[4] The Appellant began operating in 1999, when
it started the development of an adult tricycle designed for urban use. Almost
all, if not all, the development work on the tricycle was carried out by Mr.
Brisson, who was paid a salary by the Appellant. Mr. Brisson’s efforts were
focused on designing two specific elements incorporating technological advances
vis-à-vis existing adult tricycles: a pedal system and a steering system.
[5] It was admitted by the Respondent that the work
carried out by Mr. Brisson for the Appellant qualified as SR&ED.
[6] Various prototypes of the pedal and
steering systems were produced between 1999 and 2001, and in 2002 Mr. Brisson
began work to integrate these components into a working tricycle. By 2003, he
had developed what he referred to as a [TRANSLATION] “prototype that was very
close to being marketable”. In 2004, he contacted a patent agent for the
purpose of having the agent carry out a study of the potential patentability of
the components. He said that, while the study was not conclusive, it appeared
that there were no existing patents which could block a patent application by
the Appellant.
[7] Mr. Brisson testified that the Appellant
intended to licence the technology once it obtained patent protection, and to
earn income from royalties rather than through its own production and sale of
tricycles. He explained that the cost of applying for patents in the
jurisdictions contemplated by the Appellant would have been as much as $500,000
and that the patent process, once started, needed to be completed within two to
three years. The Appellant’s plans were put on hold after it was denied the
ITCs in issue, and because of the illness and subsequent death of Mr. Brisson’s
parents. Mr. Brisson also indicated that he felt it would be difficult to
obtain the necessary financing for the Appellant given the Minister’s refusal
to allow the ITCs and business losses claimed.
[8] According to the evidence, Mr. Brisson
spent 1,000 hours per year working for the Appellant in 1999 and 2000, 500
hours in 2001, 700 hours in 2002 and 1,000 hours in 2003, and was paid $50 per
hour.
[9] The Appellant applied for and received ITCs
in relation to SR&ED expenditures made in its 1999, 2000 and 2001 taxation
years. In April 2004, it applied for ITCs in relation to SR&ED expenditures
of $35,000 for 2002 and $50,457 for 2003, which consisted of Mr. Brisson’s
salary (and the purchase of some materials in 2003). It also reported business
losses for those years. Those claims were denied by the Minister in assessments
dated April 15, 2005 because the Minister did not accept that the Appellant
had commenced carrying on a business.
[10] The key assumptions made by the Minister in
assessing are set out in subparagraph 6(k) of the Reply to the Notice of Appeal,
which reads as follows:
[TRANSLATION]
(k) During the years at issue, the Appellant had not begun
carrying on a business;
(i) the Appellant had not made any sales nor earned any revenue
since its incorporation in 1997, nor did it do so during the years at issue;
(ii)
the Appellant was not carrying on any real
commercial activity during the years at issue;
(iii)
the expenses, in particular those for equipment,
materials and subcontracting, are general in nature and have nothing to do with
carrying on a business;
(iv) no
organizational structure existed;
(v) no market analysis or feasibility analysis had been done,
and no structured business plan had been drawn up;
(vi) there was no documentation, in the form of correspondence,
a marketing agreement or anything else, establishing the existence of any
regular revenue-producing activity or of any preliminary activities essential
to the normal operation of a business;
(vii) the Appellant obtained no financing other than the funds advanced
by Mr. Brisson for the payment of his salary and certain provincial and federal
SR&ED credits.
Positions of the parties
[11] Counsel for the Respondent argued that in
2002 and 2003, the Appellant had not yet put into place a structure for the business
which it wished to carry on, and that its activities were merely preliminary to
setting up a business.
[12] Counsel submitted that the Appellant had
not carried out any studies to determine the potential demand for an adult
tricycle, or the costs associated with its production, that it had not met with
any manufacturers to discuss possible production of the tricycle, that it had neither
revenue nor an infrastructure that would enable it to earn revenue, and that it
had not taken steps to obtain financing. Overall, the Respondent suggested,
nothing concrete had been done by the Appellant to commercialize its product
and it had made little progress on the project since its inception in 1999. Counsel described the Appellant’s plans as [TRANSLATION]
“somewhat unrealistic”.
[13] Alternatively, the Respondent submitted
that the amounts paid by the Appellant to Mr. Brisson as salary were
unreasonable and that the deductions should therefore be disallowed. The Respondent argued that the Appellant did not have
the financial ability to pay those amounts to Mr. Brisson because it was not
earning any revenue. The Respondent also submitted that the Appellant paid the
salary out of advances made to it by Mr. Brisson, and suggested that the
advances by Mr. Brisson and the payments by the Appellant to him, and then
from him back to the Appellant, were repeated a number of times.
[14] The Respondent
also suggested that the Appellant only paid Mr. Brisson those amounts in order
to generate ITCs, since the salary payments qualified as SR&ED
expenditures. In these circumstances, the Respondent says, the salary expenses
were not reasonable within the meaning of section 67 of the Income Tax Act (the
Act).
[15] The Appellant
maintained that it had all the necessary elements in place to permit it to
carry on business in 2002 and 2003 and that the design and development work
preformed by Mr. Brisson was an integral part of its business activities. It
stated that its business plan was reasonable and it was working towards
obtaining a patent that would then put it in a position to approach bicycle
manufacturers. Counsel for the Appellant suggested that, by allowing it ITCs in
1999, 2000 and 2001, the Minister had accepted that the Appellant had already commenced
carrying on business. Counsel also pointed out that significant time and money
had been spent by the Appellant on the development of an adult tricycle.
[16] The Appellant
maintained that the salary payments were reasonable given the nature of the
work that was undertaken and the amount of time spent on it by Mr. Brisson.
Relevant Legislation
[17] According
to subsection 127(5) of the Act, a taxpayer must be carrying on a business in
order for that taxpayer to be entitled to claim SR&ED expenses that may be deducted
under subsection 37(1). The opening words of subsection 37(1) read as follows:
37(1) Where
a taxpayer carried on a business in Canada in a taxation year, there may be deducted
in computing the taxpayer’s income from the business for the year such amount
as the taxpayer claims not exceeding the amount, if any, by which the total of
. . . .
[18] Section 67 of the Act prohibits the deduction of any amount
except to the extent that the amount is reasonable in the circumstances. That
provision reads as follows:
67. In computing income, no deduction shall be made in
respect of an outlay or expense in respect of which any amount is
otherwise deductible under this Act, except to the extent that the outlay or
expense was reasonable in the circumstances.
Analysis
[19] The decisions in Gartry v. The Queen and Samson et Frères Ltée v. Canada provide
useful guidance on how to determine whether a taxpayer has commenced carrying on a business.
[20] In Gartry, the taxpayer had decided
to go into business as a commercial fisherman, and to that end he agreed to
purchase a boat, arranged to hire a crew, negotiated financing and obtained the
necessary operating licenses. However, the boat sank before title to it passed to
the taxpayer. His claim for business losses relating to the activities he had
carried on prior to the loss of the vessel was denied by the Minister, and it
was argued that the business had not commenced operating. Judge Bowman (as he
then was) noted that, while each case depends on its own facts,
. .
. where a taxpayer has taken significant and essential steps that are necessary
to the carrying on of the business it is fair to conclude that the business has
started.
[p. 1949]
In
that case, Judge Bowman held
that the business had commenced operating and was well under way when the taxpayer
incurred the expenses he sought to deduct.
[21] In Samson et Frères Ltée v. Canada, the
Minister had denied the deduction of business losses on the basis that the
taxpayer was not carrying on a business. The taxpayer had previously operated a
meat-processing business but its plant had been largely destroyed by a fire two
years before the first of the years in issue. After the fire, the taxpayer planned
to build a new, larger facility in a different location. It sought government
assistance in order to proceed with the project but was refused. The Court found
that the efforts made by the taxpayer to obtain equipment and new premises were
preliminary steps to commencing the business and that the plans to do so were
abandoned when the necessary financing could not be obtained. As a result, the
Court held that the taxpayer had not yet begun the new business during the
years at issue.
[22] At paragraph 22 of the decision in Samson
et Frères Ltée, the Court made the following observations:
22 It seems clear to me . . . that, for a business to exist
and to have commenced, one must have gone beyond the stage of merely intending
to commence it. A plan to do so, even a clearly-stated one, is in my view
merely the expression of that intention and must be taken further. The
essential elements relating to the very structure of the business, that is the
necessary financing, assets and labour, must have been sought out and brought
together before it can be stated that the business exists and that it has
commenced. I will add that the decision to commence the business, as it may be
detected from "significant" or "essential" steps taken by
the taxpayer with a view to operating the business, is an important indicator
that the business has commenced. That, in my view, is the meaning of the
decision by Judge Bowman of this Court in Gartry, supra. It is indeed fairly
difficult to conceive that a business has commenced before a firm decision has
been made to that effect and before the essential elements relating to the very
structure of such a business have been brought together.
[Emphasis added.]
[23] In the case before
me, it appears that, during the years in issue, the Appellant had created a
structure that incorporated all of the elements necessary for carrying on
business. It had Mr. Brisson’s initial capital investment of approximately
$130,000 (according to the Appellant’s 2002 and 2003 financial statements), as
well as premises from which to operate. It had a qualified employee, Mr.
Brisson, to perform the development and design work. It also had an operating
plan and was executing that plan in an organized and methodical manner that
involved significant expenditures of time and money. The Appellant had clearly
progressed beyond the stage of studying the possibility of starting up a
business, and beyond assembling the elements necessary to carry on the
undertaking. The infrastructure necessary to develop the adult tricycle was in
place and work had begun by 1999. This is in contrast to the situation in Samson
et Frères, where the Court found that the taxpayer had not yet made a firm
decision concerning the launch of the new business and that the project had
always remained conditional on obtaining the required financing.
[24] The fact that the Appellant
had no revenues in 2002 and 2003 is not determinative of whether a business had
begun operating. It must be kept in mind that by its very nature the Appellant’s
business, that is, the development of a new product, involves a longer start-up
time than is necessary for other kinds of businesses. As noted by Judge Bowman
in Gartry, each case turns on its own facts, and:
In determining when
a business has commenced, it is not realistic to fix the time either at the
moment when money starts being earned from the trading or manufacturing
operation or the provision of services or, at the other extreme, when the
intention to start the business is first formed.
[25] Nor is it fatal to
the Appellant’s position that its only financing was obtained from Mr. Brisson
and through tax credits received in 1999, 2000 and 2001. The intended purpose
of the tax credits obtained by the Appellant would seem to me to be to provide financial
assistance for research and development work, and such credits would appear to
be a legitimate source of working capital for a business that is developing a
new product, as in this case. Shareholder financing likewise is an accepted
means of providing start-up capital for small businesses.
[26] Many of the points
raised by the Respondent relate to a concern whether the Appellant was carrying
on its operations in a commercial manner, rather than having to do with whether
it had commenced carrying on business at all. A review of the commerciality of
the Appellant’s conduct is only appropriate, however, in circumstances where
there is a personal element to its operations (Stewart v. The Queen). The Respondent has
neither pleaded nor argued here that the Appellant’s predominant intention was
other than to make a profit, or that there was a personal element to its activities.
[27] Having found that
the Appellant was carrying on business in 2002 and 2003, I now turn to the Respondent’s
alternative argument that the amounts paid to Mr. Brisson as salary–$35,000
in 2002 and $50,000 in 2003–were unreasonable.
[28] The Courts have
taken section 67 as being intended to mean the reasonableness of an expenditure
in terms of its quantum or magnitude: Mohammad v. The Queen and Gabco Ltd. v. M.N.R. The Supreme Court of Canada
has also held, in Stewart, that the determination of reasonableness for
the purposes of section 67 can be based on consideration of the type of expense
claimed and its relation to the business of the taxpayer. (See also Hammill
v. The Queen.)
[29] The onus in this
case is on the Respondent to show that the salary expenses in issue are, either
by virtue of their amount or by their nature, unreasonable in the context of
the Appellant’s business.
[30] Mr. Brisson was
paid $50 per hour for his work. There was no evidence presented to show that
this rate of pay was unreasonable for the type of design work done by Mr.
Brisson. Mr. Brisson testified that he worked 700 hours in 2002 and 1,000 in
2003 for the Appellant. This testimony was unshaken in cross‑examination.
The Respondent did not call any witnesses to show that the amount of time spent
by Mr. Brisson on his work was inordinate or unreasonable in light of the
results he produced.
[31] Furthermore, I do
not accept that the fact that the salary was paid out of money advanced to the
Appellant by its shareholder or received as tax credits, rather than out of
revenues, should lead to an inference that the expense was unreasonable. If
such were the case, any salary paid for product development would arguably be
unreasonable. I also reject the notion that the manner in which Mr. Brisson
advanced the funds to the Appellant has a bearing on the issue of
reasonableness.
[32] Overall, I find
that the Respondent has failed to show that, in the words of the Exchequer Court in Gabco Ltd.,
“no reasonable business man would have contracted to pay such an amount having
only the business consideration of the appellant in mind.”
[33] For these reasons,
the appeals are allowed, with costs.
Signed at Vancouver, British Columbia, this 16th day
of December 2009.
“B. Paris”
Translation
certified true
on this 6th day
of March 2013.
Erich Klein,
Revisor
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