[OFFICIAL ENGLISH TRANSLATION]
Date: 20020108
Docket: 2000-3931(IT)I
BETWEEN:
CHRISTIANE AURAY-BLAIS,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
AND
Docket: 2000-3934(IT)I
JEAN-FRANÇOIS BLAIS,
Appellant
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Lamarre Proulx, J.T.C.C.
[1] These appeals were heard under the
informal procedure on common evidence.
[2] The points for determination for
1996 are:
(1) whether the acquisition of a
tractor was an expenditure on or in respect of scientific
research and experimental development ("SR & ED")
within the meaning of subclause 37(8)(a)(ii)(A) (III)
of the Income Tax Act (the "Act");
and
(2) whether the acquisition of a
tractor that had previously been used for two years but was sold
with a new tractor warranty is property qualified for the
investment tax credit within the meaning of
subsection 127(9) of the Act.
[3] The points for determination for
1997 are:
(1) whether an interest expense of
$5,410 was a prescribed expenditure under section 2902 of
the Income Tax Regulations (the
"Regulations") and, consequently, not qualified
for the investment tax credit (the "ITC");
(2) whether that interest expense was
an expenditure on or in respect of scientific research and
experimental development within the meaning of
paragraph 37(8)(a) of the Act; and
(3) whether the sharing of the
business's losses as amended by the Minister of National
Revenue (the "Minister"), that is on a 50/50 basis
between the partners, under the authority conferred on him by
subsection 103(1.1) of the Act, is reasonable in the
circumstances.
[4] In making his reassessment of the
appellant Auray-Blais dated May 8, 2000, the Minister relied
on the facts described in paragraph 8 of the Reply to the
Notice of Appeal (the "Reply") as follows:
[TRANSLATION]
(a) during the
period in issue, the appellant and
Jean-François Blais were partners in a business
engaged in SR & ED (hereinafter the "business");
(b) based on the
analysis of the SR & ED project, the Minister disallowed the
following expenditures within the business's SR & ED:
1996
(i) a certain
property was deemed to be not qualified for the investment tax
credit (hereinafter the "ITC") and not deductible as an
SR & ED expenditure; that was a tractor in respect of which an
amount of $36,000 was included in computing the SR & ED
expenditure account;
(ii) the appellant
agreed with the disallowance of the ITC on the tractor since it
was used;
1997
(iii) an interest expense
of $5,410, which the Minister:
· deemed not
deductible in respect of SR & ED;
· deemed not
qualified for the ITC since it was a prescribed expenditure under
section 2902 of the Income Tax Regulations
(hereinafter the "Regulations");
· considered
that expense as an operating expense;
(iv) the appellant agreed
with the disallowance of the ITC in respect of the interest
expense;
(v) the sharing of
the business' losses was amended so that the losses were
shared on an equal (50-50) basis between the partners;
(vi) at no time was the
appellant able to provide documents to prove the allocation of
work time between the partners;
(vii) consequently, the Minister
issued the notices of reassessment dated May 8, 2000, to the
appellant for the taxation years in issue.
[5] With respect to the appellant
Blais, the Reply gives an additional reason explaining the
Minister's refusal to consider the tractor as a capital
expenditure on or in respect of scientific research and
experimental development within the meaning of
paragraph 37(8)(a) of the Act.
Subparagraph (b)(iii) of the Reply reads as follows:
[TRANSLATION]
. . . the tractor's useful life is longer
than the duration of the SR & ED project.
[6] With respect to the sharing of the
business' losses for 1997, subparagraph (b)(vi) of the
appellant Blais' Reply states the following:
[TRANSLATION]
ten percent of the business's loss was allocated to the
appellant, as he reported it in his income tax return for the
1997 taxation year;
[7] On this point, counsel for the
respondent stated that, if the decision were to confirm the
Minister's equal sharing, 50 percent of the
business's loss would be allocated to the appellant Blais for
the 1997 taxation year.
[8] The Notices of Appeal are
identical:
[TRANSLATION]
. . .
Following is the statement of the dispute over the position of
the Revenue Canada staff concerning the Christiane and
Jean-François Blais research company: for the
notices of assessment for 1996, scientific expenditures
respecting certain instruments (used exclusively for research)
the useful life of which was deemed by Revenue Canada to be
longer than the life expectancy of the research project were
disallowed. Therefore, those instruments could not be included as
research expenditures. From the decision rendered concerning the
notice of objection, although confusing, we cannot conclude that
the instruments in question do not qualify as scientific research
expenditures. By that very fact, the calculation of the figures
provided does not give us information about the Department's
position.
We would therefore like the Court to render a decision on the
definition of useful life and its application (using the time for
project realization as useful life or other factors such as
depreciation, asset valuation (material value, technological
value, economic value), market value after a few years, etc.)
with respect to instruments used solely for scientific
research.
For the notices of assessment for 1997, we do not agree with
Revenue Canada's agents that they can do as they please with
respect to the partnership agreement for the sharing of profits
and losses as well as the allocation of salaries to partners.
Furthermore, we would like the Court to apply a single
borrowing rate for the taxation period for 1996 and 1997 for each
of the notices of assessment because it should be considered that
a partnership of individuals has a communicating vessel effect on
the amounts of the notices of assessment of each partner and that
the difference between the borrowing and lending rates
undoubtedly penalizes the partnership. We would also like to be
able to present our appeal jointly.
. . .
[9] The two appellants testified. Both
are biochemists.
[10] The appellant Blais worked for
Agriculture Canada from 1972 to 1983 and left to attempt a career
as a consultant. He is now in research. The appellant
Auray-Blais is currently working for the Centre Hospitalier
de l'Université de Sherbrooke ("CHUS").
[11] The appellant Blais explained that, in
1997, he was taking part in two research projects, that of the
Christiane and Jean-François Blais partnership
and that of Innovations et Intégrations Brassicoles Inc.
It is the first project that is in issue here.
[12] As to the second project, in 1997, a
$15,000 National Research Council grant was awarded to the
corporation, not to the appellant because, as he claimed, the
National Research Council gives grants only to corporate
entities. However, that corporate entity could pay the senior
researcher the amount of the grant as salary, and that was how
the appellant Blais had income of $15,000 for 1997.
[13] The appellants' research project
concerns the development of hops and barley plants capable of
resisting certain diseases and infections. The Minister did not
dispute the fact that this project was an SR & ED activity.
[14] With respect to the sharing of the
losses of the partnership's business, the appellant Blais
filed Exhibit A-1, which consisted of documents
prepared for the purposes of the hearing. Those documents
included the appellants' income tax returns showing the
difference in incomes. The appellant Auray-Blais'
income in 1997 was double the income of the appellant Blais. In
previous years, it had been even greater, as a result of which,
according to the appellant Blais' calculations, for the years
from 1994 to 1997, his salary had ranged from 88 percent to
12 percent of the salary of the appellant Auray-Blais.
The documents in that exhibit also included general descriptions
of the work performed and an overall compilation of hours worked.
The appellant Auray-Blais purportedly worked 508 hours
in 1997, whearas the appellant Blais worked 51 hours. The
appellant Blais stated that he had worked 2,300 hours for
Innovations et Intégrations Brassicoles Inc. in 1997 and
that he had devoted only 51 hours to the joint research
project. The documents do not include a description of the work
done on a day-to-day basis or indicate who performed the work.
Nor were there any tables showing the financial contributions of
each of the two appellants.
[15] The appellants stated that they had
purchased the tractor in order to do the cultivation work
required for the SR & ED activities in an experiment that might
last 10 to 15 years. The appellant Auray-Blais said
that she would not have acquired the tractor had it not been for
research and development projects.
[16] The appellant Auray-Blais
explained that they had previously purchased one tractor in 1997
and another in 1996, a tractor which had been reconditioned. She
admitted that the tractor could occasionally be used for the work
of the corporation for which her husband was the researcher. She
also admitted that it was her husband who had used the tractor
most often.
[17] She also mentioned that she and her
husband owned 195 acres of land, of which four acres were
devoted to the joint project. The appellants also carried on
farming activities.
[18] According to the appellant
Auray-Blais, the business's most active period was from
April to October, 30 weeks, during which she had purportedly
worked 10 hours a week.
[19] The interest expenses concerned two
loans, one for $33,000 to purchase the Landini tractor, and the
second for $60,000 for equipment supplies and installation
expenses. There was no detailed description of the $60,000
amount. The appellants testified that it had included computer
and other purchases made in previous years, but no document was
filed to explain that total of $60,000.
[20] The appellants explained that the loans
had been made jointly but that repayments had been made in
proportion to their incomes.
[21] Jean-Guy Paquet is a
regional scientific adviser for the Canada Customs and Revenue
Agency ("CCRA"). In his view, the purchase of a tractor
could not be considered as a capital expenditure on or in respect
of SR & ED activities because the tractor itself was not
subject to experimentation. It was not a prototype that was used
in the context of SR & ED activities. He also mentioned that
the purchase of the tractor was excessive. As an example, he
cited the purchase of a Boeing aircraft by a person experimenting
with the surfacing of airstrips.
[22] Gaétan Descheneaux, an
auditor, explained that he had inquired about the lifetime of the
project and that of the tractor. The project's lifetime was
10 years, and the tractor's lifetime was 20 to
25 years. It was on that basis that he had refused to
consider it as an expenditure on or in respect of SR & ED
activities. With respect to the investment tax credit, the
tractor was not qualified property since it was not new. As to
the interest expenses, they were not deductible under
section 37 if the purchase of the tractor was not an
SR & ED expenditure. As regards the ITC, interest is not a
qualified expenditure since, under section 2902 of the
Regulations, it is a prescribed expenditure.
[23] Furthermore, in computing the income
from the farming business, capital cost allowance was allowed for
the tractor for 1996 and 1997 as well as interest.
[24] Exhibit I-5 was filed at the
time of Mr. Descheneaux's testimony. This is the report
on objection, which reads as follows concerning the tractor
expenditure and the sharing of the profits and losses of the
partnership formed by the appellants:
[TRANSLATION]
1996 -
We confirm the assessment in that the tractor acquired in 1996
for $36,000 is not a qualified SR & ED expenditure. The auditor
inquired with the tractor dealer as to the selling price of a
10-year-old tractor of the same make and the dealer replied that
it was approximately $20,000. It is therefore clear that
90 percent of the tractor will not have been consumed after
the 10 years of SR & ED.
1997 -
We confirm the assessment resulting from the 50-50
sharing in the partnership, since the taxpayer has no document
that might prove to us that he worked 90 percent of the
time, whereas his partner worked only 10 percent.
. . .
[25] Bertrand Provencher, a technical
adviser, explained that, in 1997, the appellant Auray-Blais
had worked at CHUS on a full-time basis and the appellant Blais
had worked on his own research project. It is therefore
reasonable to believe that the two worked equally on the
partnership's project. The financial contributions of each
were not specifically revealed. There are no reasons why it would
not be a 50-50 sharing.
[26] Marcel Vaillancourt, a CCRA
appraiser, testified. He explained that the economic life of a
tractor is usually 15 to 20 years. A tractor does not lose
much value. Useful life means economic life.
Arguments
[27] The appellants referred to
Judge Hamlyn's decision in Com Dev Ltd. v.
Canada, [1999] T.C.J. No. 141 (Q.L.):
28 Section 37 of the
Act is designed to encourage scientific research in Canada
(Consoltex Inc. v. The Queen, 97 DTC
724, T.C.C.). The tax incentive of performing SRDE in Canada
is twofold. First, SRED expenditures are given preferential
treatment under section 37. Expenditures that qualify under
section 37 are fully deductible in the year they are incurred or
can be pooled and deducted in later years. Secondly, an ITC is
available under subsection 127(5) of the Act.
29 Subsection 127(5)
of the Act allows a taxpayer to claim a deduction for an amount
that is based on the taxpayer's ITC for the year. The ITC for
the year is defined under subsection 127(9) of the Act. The
definition of an ITC under subsection 127(9) of the Act includes,
among others, a percentage of a taxpayer's "qualified
expenditures" made in the year. The term "qualified
expenditure" is also defined under subsection 127(9) of the
Act. The Respondent admits that the amounts in question are
"qualified expenditures" of the Appellant within the
meaning of subsection 127(9) and would qualify for the ITC under
subsection 127(9) if that definition was read without reference
to subsection 127(11.1)(c) of the Act.
[28] The appellants stated that the
provisions of section 37 of the Act are measures to
encourage research and must be liberally interpreted. They said
that the tractor had been used 100 percent for SR & ED
activities and that its useful life will coincide with the
anticipated duration of their project, that is, 10 or
15 years. At the end of the research project, property used
100 percent for SR & ED activities will no longer be of
any use.
[29] Counsel for the respondent argued that
the tractor will have considerable residual value at the end of
the project and that the proportion in which the tractor was used
by the appellant's research project is vague: the appellant
has his own research project for which he also used the tractor
and there are also the appellants' farming activities. In
counsel's view, section 37 of the Act does not
apply in this case.
Conclusion
[30]
Subclause 37(8)(a)(ii)A(III) reads as follows:
37(8) Interpretation - In this
section,
(a)
references to expenditures on or in respect of scientific
research and experimental development
...
(ii) where the
references occur other than in subsection (2), include only
(A) expenditures incurred
by a taxpayer in a taxation year (other than a taxation year for
which the taxpayer has elected under clause (B), each of which
is
...
(III) an expenditure of a
capital nature that at the time it was incurred was for the
provision of premises, facilities or equipment, where at that
time it was intended
1. that it
would be used during all or substantially all of its operating
time in its expected useful life for, or
2. that all or
substantially all of its value would be consumed in, the
prosecution of scientific research and experimental development
in Canada, ...
[31] To determine the application of this
provision, one must consider the time at which the capital
expenditure is incurred. The equipment acquired must meet one of
the following two conditions. It must be used all or
substantially all of the time for SR & ED activities during all
or substantially all of the time it is in normal operation.
Second, all or substantially all of the equipment's value
must be consumed in SR & ED activities.
[32] The appellants spoke of a 10-year term
for their research project. They also said that their research
could extend over a period of 15 years. They further
mentioned that they believed the tractor would no longer have any
value or use at the end of the experimental period.
[33] The regional scientific adviser
appeared to give two reasons for disallowing the expenditure. The
first concerned the condition of section 37, that the useful
life of the property was greater than the duration of the
experiments or that the value of the property would not be
consumed by the experiment. Certain witnesses also expressed the
opinion that the tractor was not used during all or substantially
all of its operating time in SR & ED activities. The second
reason apparently given by the regional scientific adviser was
that he thought the purchase of the tractor was clearly excessive
for the research purposes pursued by the appellants. The second
reason, which may be a valid reason, is not the one that was
given to the appellants.
[34] I must note that the reason given to
the appellants was that the useful life of the tractor exceeded
that of the project. That is the only reason that I must
consider, and it is the one that is expressed in the Reply. The
difficulty in this appeal is the lack of details in the Reply to
the Notice of Appeal concerning what the Minister considered to
be the useful life and the residual value of the tractor after 10
or 15 years of SR & ED activities. Figures were stated by
the respondent's witnesses, who said that the tractor might
be worth $20,000 after its 10 or 15 years of use and could
still have some 10 years of normal operating life at the end
of the research activities. Those figures should have been stated
in the Reply. They are important facts on which the Minister
relied. They can be seen stated in the report filed as
Exhibit I-5. However, those figures do not appear to
have been transmitted to the appellants. No letters to the
appellants providing this information were filed in evidence.
They were simply told that the useful life of the tractor
exceeded the duration of the project. I believe that greater
clarity on this point was needed.
[35] It is not clear at first glance that
substantially all of the value of a tractor would not be consumed
in the context of SR & ED activities prosecuted in Canada at
the end of a 10- to 15-year project. Specific data must be
stated in the letters to the appellants and in the Reply so that
a valid and fair debate may be conducted in Court. The same is
true if the respondent wishes to argue that the equipment is
substantially used for activities other than the SR & ED
activities or that the expenditure is not reasonable in the
circumstances; these are allegations that must be stated in the
Reply. Since the appellants' proposal is not, on the face of
it, unreasonable as regards the useful life of the tractor, and
in view of the absence of allegations of any other arguments
raised by the respondent's witnesses at the hearing, I must
conclude that the acquisition of the tractor is a capital
expenditure on or in respect of SR & ED within the meaning of
paragraph 37(8)(a) of the Act.
[36] As to the investment tax credit,
subsection 127(9) of the Act defines "qualified
property" as follows:
In this section,
...
"qualified property" of a taxpayer means
property (other than an approved project property or a certified
property) that is
(a) a
prescribed building to the extent that it is acquired by the
taxpayer after June 23, 1975, or
(b)
prescribed machinery and equipment acquired by the taxpayer after
June 23, 1975,
that has not been used, or acquired for use or lease, for any
purpose whatever before it was acquired by the taxpayer and that
is
(c) ...
[37] The appellants admitted that the
tractor had previously been used for two years before it was
acquired by them. They stated that the warranty offered them on
the tractor was identical to the warranty offered on a new
tractor. However, I find that the text of the Act is quite
clear. The machinery or equipment must not have been used or
acquired for use or lease for any purpose whatever before
acquisition. The tractor therefore is not property qualified for
the investment tax credit within the meaning of those definitions
in subsection 127(9) of the Act.
[38] As to interest, counsel for the
respondent argued that the interest would be acceptable as a
research and development expenditure under subsection 37(8)
if the tractor expenditure were allowed. She made no distinction
with respect to the purpose of the interest payable, that is to
say, whether it was interest on the loan taken out for the
acquisition of the tractor or for the acquisition of computers in
the previous years. I shall make none. The interest must thus be
considered an expenditure of a current nature attributable to
SR & ED within the meaning of section 37 of the
Act.
[39] Counsel for the respondent stated,
however, that these were prescribed expenditures with respect to
the ITC. She referred to section 2902 of the
Regulations and paragraph 20(1)(c) of the
Act, which concerns interest. The relevant portion of
section 2902 of the Regulations reads as follows:
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
...
(C) an amount described in
any of paragraphs 20(1)(c) to (g) of the Act,
...
[40] I find that counsel's views are
consistent with the Act. The interest is a prescribed
expenditure. Consequently, it is not a qualified expenditure. I
refer to the decision by Judge Mogan of this Court in
Minicom Data Corp. v. Canada (Minister of National
Revenue - M.N.R.), [1992] T.C.J. No. 417 (Q.L.), at
pages 4 and 5:
In my view, there is no ambiguity in the provision which I am
required to construe because the language in Regulation 2902
(a)(i) is clear and unequivocal in its description of a
"prescribed expenditure"....
...
... A common sense reading of Regulation 2902(a)(i) indicates
that the items listed in clauses (A) to (H) are not merely
examples of a current expenditure "in respect of the general
administration or management of a business". The word
"including" directly following that phrase is expansive
in and of itself. In my opinion, it was the draftsman's
intention that each item in clauses (A) to (H) would be a
prescribed expenditure if it was of a current nature without
regard to whether it was in respect of the general administration
or management of a business.
[41] A similar decision was reached by
Judge Kempo of this Court in Spectron Computer
Corp. v. Canada (Minister of National Revenue - M.N.R.),
[1993] T.C.J. No. 700 (Q.L.).
[42] As to the sharing of the
partnership's income, subsection 103(1.1) of the
Act reads as follows:
103(1.1) Agreement to share income, etc., in unreasonable
proportions. Where two or more members of a
partnership who are not dealing with each other at arm's
length agree to share any income or loss of the partnership or
any other amount in respect of any activity of the partnership
that is relevant to the computation of the income or taxable
income of those members and the share of any such member of that
income, loss or other amount is not reasonable in the
circumstances having regard to the capital invested in or work
performed for the partnership by the members thereof or such
other factors as may be relevant, that share shall,
notwithstanding any agreement, be deemed to be the amount that is
reasonable in the circumstances.
[43] Although an employee of CHUS, the
appellant Auray-Blais devoted her free time and summer
vacation to research. The appellants stated that, during 1997,
since the appellant Blais had his own research project, the
appellant Auray-Blais devoted many more hours to the joint
research project than her husband. They also claimed that she
devoted more financial resources than her husband because they
had each contributed in accordance with their income. The
Minister's agents stated in their testimony that they had not
seen an itemized account of each partner's financial
contributions or the hours they worked. I do not have in evidence
letters to the appellants specifically requesting such
information from them. In their testimony, the appellants adduced
evidence of greatly differing individual incomes and explained
the difference in the number of hours worked. In the
circumstances, I find that, in view of the financial
contributions made and work performed by the partners, their
income sharing agreement for 1997 was reasonable in the
circumstances.
[44] The appeal is allowed, without costs,
on the basis of the conclusions described above.
Signed at Ottawa, Canada, this 8th day of January 2002.
J.T.C.C.
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