Date: 19980714
Docket: 96-4783(IT)I
BETWEEN:
HUGH VINCENT LUNN,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hamlyn, J.T.C.C.
[1] These appeals are in respect of
the Appellant's 1991, 1992, 1993 and 1994 taxation years.
THE PROJECT
[2] The project is the building of a
wood frame Spitfire replica.
[3] For the last several years, Mr.
Lunn has been building a full size wooden frame Spitfire
aeroplane. This project started in 1986 and is still ongoing.
During this period, Mr. Lunn claimed Scientific Research and
Experimental Development ("SR & ED") expenses for efforts
toward building a Spitfire and also for cost associated with
building in his successive houses an enclosure sufficiently large
to house the Spitfire. Also, he claimed for the purchase of
special tools and equipment to be used in building the aeroplane.
The construction is based on a set of plans that were designed by
Mr. Marcel Jurca. These plans were purchased by Mr. Lunn and are
the basis from which he is attempting to build the Spitfire.
[4] The special features of the full
size Spitfire being built are in addition to its wooden frame
different from the aluminium used in World Ward II, a fire wall
located forward in the cockpit leaving less engine room than what
was in the original World War II model. Also, other minor
modifications were made, the plan includes a tail wheel replacing
the tail drag assembly found in the World War II model.
[5] The type of wood consists mainly
of sitka spruce which is laminated and glued.
SIGNIFICANT EVIDENCE FROM THE APPELLANT
[6] The purpose of the project is to
reduce the weight of the plane, to increase the fuel economy and
to change the flight dynamics of the original aeroplane and
eventually to market this aeroplane to private licensed pilots to
give them a higher performance aeroplane. His evidence also
clarified several points.
[7] There was no organized testing of
the project.
[8] There was no business plans or
market surveys.
[9] No income was reported by the
alleged business.
[10] There was no product produced.
[11] No profit was expected for at least
twenty to thirty years.
[12] Many of the expenditures were to allow
for aeroplane parts and construction accommodation in his
residences, and as well, other expenditures, were for accounting
and legal matters with respect to problems with his employer.
FACTS
[13] The Appellant claimed business losses
for a business called Historic Aircraft Replication ("Historic")
for the 1991, 1992, 1993, and 1994 taxation years in the
following amounts:
Year
Business Losses
1991
$25,311
1992
$23,066
1993
$27,947
1994
$23,365
[14] The Respondent also noted in its
pleadings that in the six taxation years prior to 1991 the
Appellant reported a series of business losses.
[15] The assumptions of fact pleaded in the
Reply to the Notice of Appeal and presumably relied upon by the
Minister of National Revenue (the "Minister") at the time of
reassessment are that during the taxation years of 1991, 1992,
1993 and 1994 the Appellant:
a. did not report any
income from sales or from the provision of services;
b. did not have a product
for resale with respect to Historic;
c. did not engage in the
manufacture or processing of any product with respect to
Historic; and
d. did not create or
develop any new product with respect to Historic.
[16] Therefore, the Respondent submits
that:
a. the Appellant had no
reasonable expectation of profit from Historic for the 1991,
1992, 1993 and 1994 taxation years;
b. the Appellant's
expenses with respect to Historic for the years in question were
not made or incurred by the Appellant for the purpose of gaining
or producing income from business or property; and
c. the expenses claimed by
the Appellant for the years in question were in fact personal and
living expenses.
[17] The Minister disallowed the business
expenses claimed for 1991, 1992, 1993 and 1994 and reassessed the
Appellant accordingly.
[18] The Appellant also submitted a "Claim
for Scientific Research and Experimental Development
("SR & ED") Expenditures Carried on in Canada" (T661(E)) to
Revenue Canada for the years 1991, 1992, 1993 and 1994, claiming
deductions for SR & ED expenditures in the following
amounts:
Year
SR & ED Expenditures
1991
$13,650
1992
$14,076
1993
$54,191
1994
$39,459
[19] The Respondent's pleaded assumptions
with regards to these expenditure claims which are as
follows:
a. the expenditures for
the taxation years in question were not for work undertaken for
the purpose of achieving technological advancement for the
purposes of creating new, or improving existing, materials,
devices, products or processes including incremental improvements
thereto,
b. the expenditures for
the taxation years in question were not made on SR & ED carried
on in Canada.
[20] The Minister denied the Appellant's
claim that these expenditures were qualified SR & ED within the
meaning of paragraph 37(1)(a), paragraph 37(1)(b)
or Regulation 2900 of the Income Tax Act (the
"Act") and reassessed him accordingly.
ISSUES
[21] The issues in these appeals are:
a. Were the business
expenses claimed by the Appellant for the taxation years 1991,
1992, 1993 and 1994 allowable under subsection 18(1) of the
Act?
b. Were the expenditures
made by the Appellant for the 1991, 1992, 1993 and 1994 taxation
years qualified SR & ED expenditures allowable under subsection
37(1) of the Act?
ANALYSIS
[22] The Appellant claims an aeronautical
engineer on behalf of the Minister reviewed the project for the
taxation years and found the project to be scientific research
and experimental development as defined in Regulation
2900(1)(c). Thus the project was eligible for SR & ED
claim under the Act.
[23] No record of this report could be found
including a research under the Access to Information Act
and the Appellant maintains such records have been destroyed. As
a consequence he maintains this is a bar to further proceedings
and should be a bar to collection by Revenue Canada.
[24] Further, the Appellant argued the
Minister's prior SR & ED approval to his project stands as a
bar to this proceeding.
[25] The conclusion to this submission is
well tested. Each tax year stands on its own. The onus to prove
the Minister's assumptions are incorrect lies with the Appellant
and there is nothing before the Court to prevent the Minister
from assessing as he has.
ALLOWABLE BUSINESS LOSSES
[26] In order for Historic to claim business
expenses for the 1991, 1992, 1993 and 1994 taxation years it must
be a 'business' for the purposes of the Act. A 'business'
for tax law purposes is an enterprise that is carried on for
profit or with a reasonable expectation of profit.[1]
[27] In this case, based on the profit and
loss experience of the project, the lack of any business plan and
the SR & ED Science Report of Jean E. Tardy, it appears that
its preponderant purpose was not the making of profit. Rather, it
appears the project was in the nature of a hobby and the expenses
incurred were of a personal nature.
[28] Historic was not in fact a business for
the purposes of the Act and the expenses claimed in
relation to Historic's operations cannot be deducted as business
expenses because of the operation of subsection 9(2), paragraphs
18(1)(a) and 18(1)(h) of the Act.
SCIENTIFIC RESEARCH AND
EXPERIMENTAL DEVELOPMENT EXPENDITURES
[29] Subsection 37(1) of the Act
entitles a taxpayer to a full deduction for SR & ED
expenditures. As well, such expenditures are "qualified
expenditures" as defined in subsection 127(9) and entitle the
taxpayer to investment tax credits.
[30] In order to deduct such expenditures
under subsection 37(1) and to claim an investment tax credit
under section 127, a taxpayer must be carrying on a business and
must be able to demonstrate that the expenditures incurred were
for "scientific research and experimental development" as defined
in the Act.
[31] Subsection 248(1) states that the
phrase "scientific research and experimental development" has the
meaning given to it by Regulation 2900 which states, in part:
... "scientific research and experimental development" means
systematic investigation or search carried out in a field of
science or technology by means of experiment or analysis, that is
to say,
(a) basic
research, namely, work undertaken for the advancement of
scientific knowledge without a specific practical application in
view,
(b) applied
research, namely, work undertaken for the advancement of
scientific knowledge with a specific practical application in
view,
(c)
experimental development, namely, work undertaken for the
purposes of achieving technological advancement for the purposes
of achieving technological advancement for the purposes of
creating new, or improving existing, materials, devices, products
or processes, including incremental improvements thereto, or
(d) work with
respect to engineering, design, operations research, mathematical
analysis, computer programming, data collection, testing and
psychological research where that work is commensurate with the
needs, and directly in support, of the work described in
paragraphs (a), (b) or (c).[2]
[32] The Appellant has not presented
sufficient facts to support a claim that any kind of systematic
investigation or search by way of experiment or analysis
occurred, as required by Regulation 2900. There is no evidence of
controlled experiments, of accurate measurements or a testing of
theories against empirical evidence. The SR & ED report of Jean
E. Tardy clearly states that the Appellant's project was not one
that met the specified criteria for experimental development as
defined in Regulation 2900(1).[3]
[33] The evaluation of Jean E. Tardy,
qualified at the hearing as an expert in the analysis of
technology of aeronautics in terms of the criteria for scientific
research and experimental development, was as follows:
Technological advancement
This project is to build a full size Spitfire replica which is
built with a wooden frame rather than the original aluminium.
..., upon examination, we found that wooden frame aircraft of
that size and power were built routinely in the 1930s.
... there are no features of the Spitfire ... that makes
wooden frame construction uncertain or more advanced than the
original aluminium. ...
The proposed Spitfire has a fire wall which is located further
forward than in the original model. This is due to the fact that
modern aircraft engines are smaller and more efficient than World
War II engines. ... The use of a wheel, rather than a tail drag
has also been standard technology for many years.
Technological uncertainty
... the project does have uncertainty but it is linked to the
lack of knowledge or experience of the claimant and not to any
technical advancement that was attempted. ... the uncertainty is
linked to the specifics of this project rather than to the
technology attempted. ...
Technological content
The project has been ongoing for at least 10 years. The
duration of the project and the lack of project documentation
points to an absence of systematic effort in this construction.
The construction proceeded forward with techniques that are
common to a hobbyist or home aircraft builder rather than to a
systematic engineering project.
...
RECOMMENDATIONS
... the cost claimed by the taxpayer were not invested in the
Spitfire itself but in building enclosures in Mr. Lunn's various
homes that were large enough to contain the aircraft. ...
CONCLUSION
This project is an ongoing attempt at building a wood framed
Spitfire airplane. It is an attempt by a homebuilder to replicate
1930's technology and does not meet any of the three
criteria.
DECISION
[34] Based on the finding that there was no
business and the conclusion that the criteria for scientific
research and experimental development have not been met, the
appeals are dismissed.
Signed at Ottawa, Canada, this 14th day of July 1998.
J.T.C.C.
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