Citation: 2007TCC337
Date: 20070612
Docket: 2006-2206(IT)I
BETWEEN:
MICHEL CHICHKOV,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Rip, A.C.J.
[1] Michel Chichkov
appeals from income tax assessments for 2002 and 2003 in which the Minister of
National Revenue ("Minister") disallowed various expenses claimed by
Mr. Chichkov in computing income from a business on the grounds that he did not
carry on a business during 2002 and 2003.
[2] At the commencement
of the hearing the respondent amended her reply to the notice of appeal to
argue in the alternative that, if the appellant carried on a business during
2002 and 2003, the expenses claimed were not deductible a) because they were
not incurred for the purpose of earning income from a business, b) one Mlle
Sylvie Nobert was a partner of the appellant in a partnership which purported
to carry on the business, and c) the appellant did not derive all or
substantially all of his revenue from the prosecution of scientific research
and experimental development in the manner described in paragraph 37(8)(c)
of the Income Tax Act ("Act") and in any event the
expenditures were on account of capital and therefore not deductible in
computing income: paragraph 18(1)(b) of the Act.
[3] Mr. Chichkov
submits that he did carry on a business, a software business, in the years in
appeal and suggests that the Minister's officials did not understand steps
necessary in the carrying on of his software business, specifically, the
development of software application that becomes the business product.
[4] The purported
business was started on January 1, 2002, according to Mr. Chichkov, when
he started work on a project called "Infox". He contracted the work
for the project to a friend, Sylvie Nobert. In filing his income tax returns
for 2002 and 2003 Mr. Chichkov claimed scientific research and experimental
development ("SR&ED") expenditures and claimed a business loss of
$29,485.58 for 2002 and $30,893.71 for 2003.
[5] Mr. Chichkov also
claimed investment tax credits with respect to these expenditures for 2002 and
2003 as well as for subsequent years, 2004 and 2005.
[6] Of the $29,485.58
of expenses claimed in 2002, the $26,940 was paid to Mlle Nobert under the
subcontract. The balance of $2,545.58 included $331.98 for meals and
entertainment, $305.12 for motor vehicle and $1,807.41 as office expenses. For
2003, $29,310 was allegedly paid to Mlle Nobert, $197.43 as motor vehicle
expenses, $1,195.98 as office expenses and $190.30 for telephone and utilities.
In the form claiming SR&ED expenditures for each year, Mr. Chichkov
left blank any reference to non-arm's length transactions and in his attachment
of the form in his 2003 tax return, stated that he and the subcontractor, Mlle
Nobert, dealt with each other at arm's length.
[7] When the purported
business started in 2002 and at all relevant times Mr. Chichkov was
employed on a full-time basis: this is the reason why he subcontracted work to Mlle
Nobert, who, he said, was a computer programmer and knowledgeable, having done
development work.
[8] The development of
the product was completed in 2006 and, at time of trial, was being sold on the
internet by a corporation, the majority of the shares of which are owned by Mr.
Chichkov.
[9] Mr. Chichkov
described Infox as a data base with two distinctive characteristics: a)
personal information containing names of people, addresses and notes, and b) a
"huge corporation database for almost everything". He explained that
Infox "bridged the gap between the two extremes for small and medium
users", it is a suites application "that talks to the parties". The
product, he believed, was unique in the market place.
[10] For the past 18
years Mr. Chichkov has been a computer programmer. He received a Master's
degree in applied mathematics in 1985 from Moscow Physical and Technical
Institute. He immigrated to Canada in 1994. In Montreal, where he resides, he worked for three years in pure
software as a graphics programmer and seven years in hardware, with respect to
video cards for personal computers.
[11] Mr. Chichkov
declared he entered into a legitimate contract with Mlle Nobert. She was
not his business partner since it was his business. Also, he denied any common
law or conjugal relationship with Mlle Nobert.
[12] The relevant
programming agreements between Mlle Nobert and Mr. Chichkov are dated
January 1, 2002 and January 1, 2003. Programming tasks to be performed by Mlle
Nobert are described in the agreements. The projected schedule for completion
of Mlle Nobert's work was December 31, 2002 in the agreement dated January 1,
2002 and December 31, 2003 for the agreement of January 1, 2003. The fees,
$26,940 in 2002 and $29,310 in 2003 are set out in each agreement. The fee was
to be paid in "cash, certified cheque or equivalent" within 45 days
of invoice. The agreements provided for its termination by either party.
[13] At the beginning of
2002, Mlle Nobert was employed elsewhere and worked on the contract on weekends
and evenings. In July 2002 she left her job to work full-time on the contract
with Mr. Chichkov. According to Mr. Chichkov she then worked seven days a
week, probably eight hours a day. Mlle Nobert confirmed that she worked at
least 40 hours a week from July 2002. She said she worked five days a week and
frequently on weekends, probably six days a week, for a salary less than what
she was paid as an employee before July 2002. She agreed to lower pay because
there were less stress, interesting work and better working conditions.
[14] The appellant
produced several documents to confirm that he was carrying on a business. These
included a "to do" list of work to be done by Mlle Nobert. Thirty‑five
pages of work notes pertaining to the project were produced. Mr. Chichkov
did testify that on weekends and some evenings he also undertook research and
development. Copies of computer screenshots of the application of Infox with
search grids and detailed view windows as well as a copy of a detailed project
description submitted to the Canada Revenue Agency were also produced by
Mr. Chichkov.
[15] A market research
report describing potential competitors was prepared by the appellant and Mlle
Nobert, purportedly in 2002. Mr. Chichkov claimed SR&ED expenditures with
respect to the market research. The appellant did not log the hours worked on
the report.
[16] Respondent's counsel
queried Mr. Chichkov with respect to his and Mlle Nobert's living
arrangements. Starting in about 1998 they shared a common residence in an
apartment building because it was "convenient". Mr. Chichkov insisted
theirs was a work relationship only. If I understood him correctly, both intended
to start a business and used the time to "think it through". He
wanted to be sure she was capable of doing the work. In 2002 they together purchased
a single family dwelling for $280,000, each owning a one-half undivided
interest; each was also liable on the mortgage on their home. Mr. Chichkov said
they bought the most expensive home as an investment; neither could afford a
house "of this type".
[17] From about the time
Mr. Chichkov and Mlle Nobert obtained mortgage approval for their home, they shared
a bank account.
[18] Mr. Chichkov
testified in his cross-examination that he paid Mlle Nobert for her services
under the contract in cash and received no receipt. No invoice was sent by Mlle
Nobert to Mr. Chichkov. The reason for the lack of documentation,
according to Mr. Chichkov, was that "we were living close enough".
Each trusted the other. Mr. Chichkov did "transfer" some funds to
her, but "substantially" all was paid to Mlle Nobert in cash, he said.
[19] The appellant
explained that he paid Mlle Nobert the "equivalent in cash". He made
the mortgage payments on their home, including Mlle Nobert's share of the debt.
They considered that the portion of the mortgage payment that Mr. Chichkov
paid for her was payment on the contract. He said he "assumed" her
debt for the $27,000 each year under the contract.
[20] House expenses for
hydro, telephone and other services came out of the joint bank account of the
appellant and Mlle Nobert. The bulk of the money in the account came from Mr.
Chichkov.
[21] The amounts of
investment tax credits claimed by Mr. Chichkov for the years in appeal were
equal to the amounts of tax he would have had to pay in those years, after
deducting fees to Mlle Nobert, absent the credit. The appellant also calculated
his potential tax for 2003, 2004 and 2005 to determine how much investment tax
credit he should claim in those years. Similarly, the fees paid to Mlle Nobert
were a function of the tax he would have had to pay; the fees and the tax
credit would reduce his tax to nil. Mr. Chichkov acknowledged that he and Mlle
Nobert did not negotiate the contract fees except, he said, for the first year,
which was all he could afford. He did admit that the fees for other years were
tax motivated.
[22] Under
cross-examination Mr. Chichkov acknowledged that the contracts with Mlle Nobert
were not executed on the first day of January in 2002 and 2003, respectively;
they "could have been signed" in the following years, that is, 2003
and 2004, respectively, after he completed his tax returns for the year. Both
agreements were back dated. He could not have predicted on the first day of the
year what his income, and thus tax, would be for that year; therefore,
Mr. Chichkov could not have determined the fees to be paid to Mlle Nobert
for the year on January 1st.
[23] With respect to
expenses other than that paid to Mlle Nobert, Mr. Chichkov explained that
meals and entertainment expenses were for people who could advise him on the
market for the product and for potential clients.
[24] Mlle Nobert also
claimed business expenses. Since Mlle Nobert was working from their home, she
claimed 25 percent of house expenses were for her business. Later on, she
admitted that probably 10 percent of the housing expenses were for business,
not 25 percent. She calculated the 25 percent on the basis that she used two of
the eight rooms of the house, ignoring the actual area of the house and what
she used. She also claimed expenses for meals and entertainment but had no idea
who she entertained. She became quite agitated at this line of questioning from
crown counsel.
[25] Mr. Chichkov
insisted he and Mlle Nobert were in an arm's length relationship and therefore
he was entitled to SR&ED expenses, assuming he was carrying on a business.
[26] Respondent's counsel
cross-examined Mr. Chichkov concerning his relationship with Mlle Nobert. Mr.
Chichkov was a beneficiary under a medical insurance plan with his employer. He
claimed Mlle Nobert as his spouse when he made claims for her medical expenses
under this plan. He claimed her as his spouse, he explained, because she had no
medical insurance and he was told he could do so because they were living
together.
[27] Mlle Nobert
testified that she prepared her income tax returns for 2002 and subsequent
years. In her 2002 tax return she included 100 percent of the interest earned
in the joint bank account with Mr. Chichkov. In her 2003 tax return she claimed
the difference between what was paid for prescription drugs and the benefits
Mr. Chichkov received from his insurer as her medical expenses. She also
included Mr. Chichkov's dental expenses in her medical expenses in 2002.
[28] Alventis
Corporation, incorporated in 2006, is currently selling the software
purportedly developed by Mr. Chichkov. He owns 60 percent of the voting shares
of the corporation and Mlle Nobert owns 40 percent of such shares. Mr. Chichkov
stated that he offered her 40 percent of the shares and she agreed. The user's
guide for the software state that the "software" is based, in part,
on the work of Anders Malendar, Gustavo Hufferbackor, David and Jordan Russell.
Neither Mr. Chichkov nor Mlle Nobert's name is mentioned. Mr. Chichkov said it
is because it is "not common to mention programmers who developed the
project". In any event, he said, Alventis Corporation owns the trademarks;
he was not paid for the trademarks.
[29] At close of trial I
asked Mr. Chichkov if he would submit written arguments rather than make an
oral presentation. He agreed.
[30] Mr. Chichkov submits
that he carried on a business at all relevant times. He cites Bowman J. (as he
then was) in Gartry v. The Queen:
. . . 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. Each case turns on its own facts, but 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. . . .
[31] In Mr. Chichkov's
view, the most essential step necessary in the carrying on of a software
business is the development of the software application that is to become the
business product. Once he took the first step to create the product, he
declares, he started a business. He acknowledges that while the software was
not complete in 2002, the application had come into existence: it was
functional and usable. He states that he could have started selling the
software in 2002-2003 but he insisted that it meet all the specifications.
[32] Mr. Chichkov reviewed
Interpretation Bulletin IT-364, dated March 14, 1977, at paragraphs 1, 2,
3 and 5. He says that the expenses in issue were business expenses. His
activities in the years in appeal were essential preliminaries to a normal operation
of a software-development company. He contracted the development of the product
to a skilled programmer. Over 4,000 man-hours have been expended and over
50,000 lines of code have been developed. By the end of 2003, he said the
product was approximately 50 percent completed. The product was completed
in 2006 and is being sold. However, the appellant did not present any evidence
of sales.
[33] Extensive market
research was performed, according to Mr. Chichkov. Analyses were made of
user requirements in the domain of information management retrieval as well as
of competing technologies and products.
[34] Mr. Chichkov denied
that he and Mlle Nobert did not deal at arm's length or that they carried on a
business in partnership. He submits that in making such allegations the
Minister is attempting to vary the basis of the assessments, that he did not
carry on a business. He relies on Letourneau J.A. in The Queen v. Hollinger
Inc.:
[23] . . . Changing the amount of an
assessment in pleadings is tantamount to the Minister appealing his own
assessment, an avenue which has been clearly rejected by the Courts.
[35] In the appeals
before me, the Attorney General has not changed the amount of either
assessment; he has simply raised alternative arguments. In his original notice
of appeal, the respondent alleged that the appellant and Mlle Nobert did
not deal at arm's length. The Minister's assumptions leading to assessments
have not been altered.
[36] In his written
submission, Mr. Chichkov questions whether the Minister made certain
assumptions described in the reply to the notice of appeal. Any assumption
stated in a reply to have been made by the Minister is deemed to have been made
and is true, unless the appellant can prove that it was not made, or, if made,
is not true.
[37] The basic facts
assumed by the Minister in assessing were the following:
j) The decisions
conveyed to the Appellant by the audit division and the SR&ED section were
based upon that the representations of the Appellant that:
i) He is developing a computer
software program;
ii) He has not earned any profit
to date;
iii) The product is in a stage of
development;
iv) He has not yet developed his
market;
v) He has no clients;
vi) The program is not yet
available in the market place;
vii) He has not applied for a
licence or a product patent; and,
viii) That he has
not invested any funds into a business, has no suppliers, has no potential
clients, has no business address, has no bank account for his business, has no
business telephone, has no business card, has no business assets, and has no
balance sheet for a business,
he had not commenced a business;
k) For the decision
of the SR&ED expenditures for 2003 it was found that the Appellant did not
have an eligible claim as the expenditures were not incurred by a taxpayer that
carried on a business in Canada and that the expenditures were for subcontract
payments that were made to a non‑arm's length party, Sylvie Nobert the
common-law partner of the Appellant;
[38] The facts that were
set out in paragraph j)(i-viii) of the reply were not established to be false;
the Minister's conclusion of course, is what is in issue.
[39] I have great doubt
that Mr. Chichkov was carrying on a business during the years in appeal. I am
leery of his testimony; I fear his testimony was wanting in credibility, among
other things. If anything, the work was preliminary to a commencement of a business.
[40] Mr. Chichkov was not
consistent in his evidence. His background suggests that he is a very
intelligent person. However, his evidence and that of Mlle Nobert, show
that he will attempt to take advantage of any situation. For one purpose he claims
Mlle Nobert as his spouse, for another purpose — these appeals — he denies he
does not deal with her at arm's length. He claims her medical expenses from his
insurer on the basis that she was his spouse. As well, Mlle Nobert
includes his dental expenses in her medical expenses for the year.
[41] And in his written
submissions he is not consistent. For example, he first states that the
software came into existence during the years in appeal but later on writes
that at the end of 2003 the software development was "approximately 50
percent towards completion". He also contended that the "initial
software application existed as early as 2002" and suggested Mlle Nobert's
work constituted gradual additions and improvements to an existing product.
Nevertheless, he claimed investment tax credits for the "gradual additions
and improvements".
[42] I also am disturbed
that the contracts with Mlle Nobert were back dated and it appears, the
contract price, was wholly dependent on the appellant's tax liability for the
year. There was no negotiation between arm's length persons.
[43] The document
produced by Mr. Chichkov in support of the market research activity appears to
be simply a list of competitors; what the extensive research comprised I have
no idea. Also, it is not clear when this document was prepared.
[44] I also have
difficulty with the fact that Mr. Chichkov does not sell Infox, rather it is
sold by a corporation he incorporated in 2006 for that purpose. There is no
evidence as to what consideration the corporation pays to Mr. Chichkov for its
right to sell the product. The intellectual rights, I assume, are still owned
by Mr. Chichkov; there is no evidence that he transferred it to another person,
including the corporation, although he seemed to suggest that the corporation
owned these rights. He, himself, never sold Infox to the public.
[45] I have no evidence
before me to confirm that Mr. Chichkov carried on any business in the years
2002 and 2003. His testimony is suspect and is not convincing. He tended to
exaggerate what he did and often his evidence conflicted. Work was being
performed but not to the degree suggested by him. What Mr. Chichkov was doing,
as far as I can make out, was putting a structure in place for a future
business. I am not so concerned that during the years in appeal Mr. Chichkov
had no clients, no bank account, no business face, so to speak. What I am
concerned with is whether, in fact, he was carrying on a business and I
conclude that he did not. If
a business was being carried on, it began in 2006 and it was carried on by
another person, a corporation. He incurred no expenses in the carrying on of a
business during the years in appeal.
[46] I also find that Mr.
Chichkov did not deal at arm's length with Mlle Nobert. They lived
together, he claimed her as a spouse in making claims under a medical insurance
policy. She claimed him as a spouse in calculating her medical expenses. His
excuses for living together — but at arm's length — are lame, although
imaginative.
[47] Since no business
was carried on by Mr. Chichkov during the years in appeal and because he and
Mlle Nobert were not dealing at arm's length, he did not incur any SR&ED
expenditures that may be deducted in computing income.
[48] The appeals are
dismissed.
Signed at Ottawa, Canada, this 12th
day of June 2007.
"Gerald J. Rip"
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