Qix Facilities Corp, Canada V., [1992] 2 CTC 383

Craig, J:—On January 28, 1991, each of the accused elected to be tried in the Provincial Court and pled not guilty to 11 counts in information 12918C. Trial on all charges commenced January 28, 1991, and concluded February 27, 1991.

In count 1 QIX was charged with wilful evasion of taxes in the amount of $6,315,603 imposed under Part VIII of the Income Tax Act, R.S.C. 1952, c. 148 (am. S.C. 1970-71-72, c. 63) (the "Act"). Schmidt and Zink were charged as officers, directors or agents of QIX. The specific allegation is that between August 29, 1984 and May 21, 1986, the corporation's expenditures on scientific research within the meaning of subsection 194(2) of the Act were overstated, thereby resulting in an offence under paragraph 239(1)(d) of the Act.

In counts 2 and 3 QIX, and Schmidt as its officer, agent or director, are charged with mailing false or deceptive statements in 1985 corporate tax returns under Part VIII and Part I respectively. The accused are alleged to have falsely stated expenditures in the amount of $34,700,000 and $35,159,541 in these tax returns for the period August 29, 1984 to September 27, 1985, thereby committing an offence under paragraph 239(1)(a) of the Act. The returns are dated May 14, 1986.

Schmidt is charged alone in counts 4 and 5. Count 4 is an allegation of wilful evasion of taxes under paragraph 239(1)(d) in that between December 31, 1984 and April 15, 1986, Schmidt failed to report as income $1,200,000 appropriated from QIX. Count 5 is under paragraph 239(1)(a), alleging that Schmidt made false or deceptive entries in his 1985 tax return by failing to include $1,200,000 as income. Zink is charged in an identical fashion in Counts 6 and 7.

Counts 8, 9, 10 and 11 are identical allegations against QIX with Schmidt and Zink charged as its officers, directors or agents with making false or deceptive entries in the books and records of QIX contrary to paragraph 239(1)(c) of the Act. These counts involve the making of statutory declarations by Zink on January 11, 1985, May 27, 1985, July 11, 1985, and August 30, 1985, in which it was stated that QIX had made or planned to make within 60 days of each declaration a specific amount of expenditures on scientific research, and that this was an entry in the books and records of QIX which was falsely stated.

Schedule 1 to this judgment is a copy of Information 12918C. Schedule 2 is a copy of section 239 of the Income Tax Act.

I am satisfied that each of the witnesses gave truthful testimony, keeping in mind that their recollection of events is six years after the fact. John Young, an architect with Wright Engineers Ltd., gave extensive evidence of his company's work for QIX in the design and management of construction of a research and production building in Richmond, B.C. In his initial discussion in the fall of 1984 with Schmidt and Zink, Young learned of a proposed purchase of irradiation equipment from Emergent Technologies Inc. (ETI) and that A & A Refrigeration Contractors, Inc. (A&A) had already been engaged to design and install heating and refrigeration. Young testified that the role of Wright Engineers Ltd. was ultimately to cooperate with A&A in designing the building but that management of A&A and ETI was to be left to QIX. Patrick Hogan, a principal of A&A, recalled discussions with Schmidt and Zink in 1984 concerning ETI and that company's involvement in food irradiation. His evidence carried through the involvement of A&A in a project with QIX, and dealt extensively with work to be done by A&A and the pricing and invoicing of that work. Gerald Linton, another principal in A&A, gave an account of his dealings with QIX and Schmidt and Zink, in the main concerning the latter stages of A&A's involvement. Robert Irlam, a senior employee of The Royal Bank of Canada, identified various accounts and transactions involving QIX, A&A, Schmidt and Zink, and the instructions he received from Schmidt and Zink. Roger Cesvets, a professional engineer, explained his interest in food irradiation and his meetings with Schmidt and Zink leading to his employment as a consultant and project director in the construction of the QIX building. Cesvets was involved in the project from February 1985 to May or June, 1985. Bradley Sakich, a chartered accountant with Coopers & Lybrand in 1985, explained his work with Schmidt and Zink, and that his involvement was principally with Zink in connection with the release of funds held in escrow by The Canada Trust Company. Eleonore Christ, as a principal of the Denco Enterprises Ltd., verified that her company consented to the incorporation by QIX of Denco Engineering Ltd. Grant Cowan was presented by the Crown as the principal investigator in this case and as Certified General Accountant. Cowan has been employed by Revenue Canada for the past 15 years. He identified that QIX 1985 returns as well as those of Schmidt and Zink and said that he supervised the seizure of documents. Cowan testified to examining source documents concerning expenses claimed by QIX in its Part VIII and Part I corporate returns extrapolating into them expenditures alleged by the Crown to be founded on sham transactions or otherwise inflated. Finally there is the evidence of Rodney Johnston, a chartered accountant with Coopers & Lybrand, who testified at length concerning Part VIII of the Income Tax Act and Regulations 2900 and 2902 of the Act. Johnston prepared the QIX tax returns and the financial statements included in them and met with Schmidt on May 14, 1986, when the returns were signed.

A vast number of documents were received in evidence. Many establish relevant facts, while others form a part of the facts found in viva voce evidence.

Exhibit 35 is a series of facts stated by the Crown and admitted by counsel on behalf of each of the accused.

On September 28, 1984, QIX created and sold one “1984 Scientific Research Note" to the Consumers' Gas Company Ltd. (Consumers' Gas) for $34,700,000. Exhibit 2-05-01 pages 1 to 165 is a copy of all the documentation in that transaction and the securing of payment of the Note as carried out on September 28, 1984. As well it contains a record of the redemption of the Note on November 1, 1984. The exhibit also consists of copies of forms filed with Revenue Canada by QIX (Exhibit 1-01-02-1) in which a designation was made under section 194 of the Income Tax Act that it had issued a scientific research tax credit note for a consideration received of $34,700,000 and that Part VIII tax was payable by QIX in the amount of $17,350,000 (Exhibit 1-01-02-2). The filings with Revenue Canada were put in evidence again as Exhibits 36 and 37. Without doubt the accused Schmidt and Zink were in attendance on September 28, 1984, at the closing and as directors and officers of QIX they would be aware of all aspects of the transaction.

The scientific research note created a debt in the principal sum of $20,820,000 due November 1, 1984. On September 28, 1984, QIX delivered the note to Consumers' Gas and received $34,700,000. As required by the agreement with Consumers' Gas, QIX then paid $20,820,000 of the selling price to obtain a certificate of deposit, and by giving an irrevocable direction to the bank to deliver the certificate to Consumers' Gas, it secured payment of the note when it became due. On November 1, 1984, Consumers' Gas demanded payment and the amount of the certificate of deposit was used to pay the note. The note was cancelled and returned to QIX.

Of the selling price of $34,700,000 there remained $13,880,000 from which various costs were deducted leaving QIX with $12,200,000 which was paid on September 28, 1984, to The Canada Trust Company, as escrow agent. This was required by the terms of the agreement with Consumers' Gas to ensure that scientific research would be carried out by QIX. In a companion agreement with Canada Trust as trustee of the funds, QIX could obtain periodic releases of the funds by producing to the trustee a statutory declaration of one of its directors certifying the amount of expenditures in scientific research which would be underway in the ensuing 60 days and the amount of cash required for those expenditures. As well QIX was required to have its accountant, Coopers & Lybrand, provide a statement to Canada Trust to the effect that after reviewing the statutory declaration they were of the opinion that all such expenditures certified in the statutory declaration were expenditures which QIX would be entitled to specify as scientific research. The form of the statutory declaration is at page 101 of Exhibit 2-05-01 and the accountants letter is at page 103.

A significant requirement of Consumers' Gas was that QIX provide a letter on closing from Coopers & Lybrand. That letter is found at page 133 of Exhibit 2-05-01 and it begins by stating that as requested by QIX, Coopers & Lybrand will comment in respect of the nature of expenditures to be incurred by the company in order to designate $34,700,000 pursuant to subsection 194(4) of the Income Tax Act, in respect of scientific research tax credit debentures to be issued by the company. After outlining Coopers & Lybrand's understanding of the QIX venture in developing technology on food irradiation there is an explanation of the uncertainties and vagaries in establishing expenditures as scientific research as defined in section 37 and Regulation 2900 of the Act. The letter concludes with an understandably qualified opinion followed by a statement that:

The directors of the company have represented to us that the company is planning to carry out a $34,700,000 scientific research program in Canada to satisfy its liability for tax under Part VIII of the Income Tax Act (Canada) and in addition, have represented to us that in the event that a portion of the program is not expended, then the company's Part VIII tax liability would be paid from the proceeds of financing to be arranged.

Exhibit 35 is a series of facts stated by the Crown and admitted by counsel on behalf of QIX, Schmidt and Zink. Paragraphs 5, 6 and 7 are as follows:

5. The documents found at tab 5 in Exhibit 2 are agreements entered into by the parties on the dates stated.

6. Pursuant to the Agreement between QIX Facilities Corporation and the Consumers' Gas Company Ltd., starting at 05-01-63, and the Trust Agreement between QIX Facilities Corporation and Canada Trust starting at 05-01-106, the sum of $12,200,000 was held in escrow by Canada Trust.

7. Pursuant to Trust Agreement, Canada Trust released funds to QIX Facilities Corporation following delivery to it of statements from Coopers and Lybrand and statutory declarations by Wolfgang H. Zink, as follows:

(a) a statement dated January 22, 1985 (07-01) and statutory declaration dated January 11, 1985 (07-02) caused the release of $2,932,944.29 on February 5, 1985;

(b) a statement dated May 27, 1985 (07-07) and statutory declaration dated May 27, 1985 (07-09) caused the release of $3,871,131 on May 29, 1985;

(c) a statement dated July 29, 1985 (07-11) and statutory declaration dated July 11, 1985 (07-12) caused the release of $4,168,492 on August 2, 1985;

(d) a statement dated September 4, 1985 (07-17) and statutory declaration dated August 30, 1985 (07-18) caused the release of $2,155,191.25 on September 10, 1985.

On May 14, 1986, in his capacity as a director, Schmidt signed a Corporation Part VIII Tax Return for QIX for the taxation year August 29, 1984, to September 27, 1985. This return was received by Revenue Canada on May 20, 1986. Exhibit 1-01-03-1 is a copy of this Part VIII return. In similar fashion a Part I return was signed by Schmidt and delivered to Revenue Canada.

In its Corporation Part VIII Tax Return QIX reported a tax outstanding and payable (being 50 per cent of the amount designated under subsection 194(4) on September 28, 1984) of $17,350,000 and claimed scientific research expenditures of $34,700,000 in the tax year. This resulted in a claim in the return for a Part VIII tax refund for the year of $17,350,000. In this manner QIX asserted that all of its tax was deemed to have been paid.

Handwritten entries on the Part VIII return by employees of Revenue Canada calculate scientific research expenditures at $14,719,047 and a Part VIII refund of 50 per cent of that amount being $7,359,523.50 with a resulting balance of tax payable ($17,350,000 minus $7,359,523.50) of $9,990,476.50.

In its standard corporation tax return for the same period, QIX reported expenditures made on scientific research for tax purposes of $35,159,541 resulting in its determination that no amount of tax was payable.

The allegations against QIX, Schmidt and Zink require a determination whether between August 29, 1984, and September 27, 1985, the accused were doing what they were entitled to in organizing a legitimate business venture so that any tax would be less than it might otherwise be, or, as alleged by the Crown, they were engaged in wilfully evading payment of taxes by overstating expenditures made on scientific research.

The circumstances surrounding the scientific research project of QIX begin in the early 19805. Patrick Hogan recalled discussion with Schmidt, a long time family friend, who was then in the business of distributing food products in the Pacific Rim. Undoubtedly these discussions involved food spoilage and means to preserve food quality. In the course of these sporadic dealings, Schmidt was given the name of Niel Nielson the president of Emergent Technologies Inc. (ETI). ETI was involved in developing irradiation processes. In 1984, at Schmidt's request, Hogan arranged a meeting between Nielsen, Schmidt and Zink. This led to the possible use of an ETI linear accelerator in a research and development project being conceived by Schmidt and Zink. The project involved the construction of a production facility in Richmond, B.C. which would incorporate refrigeration and irradiation technology.

In August and September, 1984, ETI committed itself to supply QIX with specialized irradiation equipment and other machinery, to enable QIX to engage in research and development of commercially viable food processing facilities in Canada and elsewhere. The price was $10,300,000, payable by instalments, with the first being $400,000 on execution of a formal agreement, $600,000 within 30 days thereafter, and the remainder by instalments of $300,000 each over ten months followed by five annual instalments of $1,260,000 bearing interest at 13 per cent per annum. All of this was part of the scientific research tax credit transaction with Consumers' Gas and disclosed as part of it. QIX represented to Consumers' Gas that the entire amount due ETI would qualify as expenditures under Part VIII. In its agreement with Canada Trust QIX was precluded from using expenditures related to the contract with ETI as part of an application for release of funds.

What had been concepts and promotion became serious business on September 28, 1984, when the QIX scientific research note was sold to Consumers' Gas. The net proceeds due to QIX of $12,200,000 were paid to The Canada Trust Company as escrow agent. If QIX failed to draw on these funds, then, as provided in the trust agreement, the trustee would pay them at year end to satisfy or reduce the company's Part VIII tax liability. The QIX Part VIII tax liability at September 28, 1984, was $17,350,000.

There is some evidence of financial planning in the Coopers & Lybrand letter dated September 28, 1984, sent to Consumers' Gas at the request of QIX. At page two items seven and eight are as follows:

7. The Company plans to finance the $34,700,000 of scientific research expenditures as follows:

(a) scientific research Tax Credit Debenture	$13,880,000
(point 6 above)
(b) third party financing (point 8 below)	20,820,000
	$34,700,000

8. The Company proposes to repay its third party financing from: profits to be earned on the sale of subsequent irradiation facilities, the sale of technical knowledge obtained from the research undertaken; and from a planned public equity offering.

Hogan continued discussions with Schmidt and Zink with the result that A&A became committed by October 1984 to design and supply cooling and refrigeration equipment and other items within a budget of $2,500,000. Exhibit 3-10-01 is a letter dated October 18, 1984, prepared and signed by Hogan, from A&A to QIX, projecting cash requirements needed over the ensuing 12 months “for the design, equipment, installation and construction of the Vancouver International Airport Facility:

Hogan identified Exhibit 3-10-02-2 as written by Zink before the October 18, 1984, letter was prepared. In part Exhibit 3-10-02-2 contains the following:

Released at 40 per cent of billing

60 per cent in escrow

1. Forecast the expenditures over the next 12 month.

2. Bill 2.5 x the amount of cash you require

3. Bill at least 30 days before the cash is required

4. We will issue invoice to you to cover the 60 per cent

On November 5, 1984, Alpha Refrigeration Services Inc. (Alpha) was incorporated in B.C. as a subsidiary company of A&A to carry out the work in B.C. on the QIX project. On April 24, 1985, an agreement was entered into between QIX and Alpha dated October 5, 1984, (Exhibit 3-10-08). It called for QIX to pay Alpha $8,675,000. Hogan agreed that it was not a true amount and said it was 2.5 x $2,500,000 and an allowance for contingencies.

During discussions with Schmidt and Zink in San Jose, California, when the October 18, 1984, letter was prepared, Hogan testified that Zink explained that billing was to be at a factor of 2.5 and that this had to do with their unique method of financing. Hogan specifically stated in evidence that the true A&A budget was $2,500,000 as shown in the right hand column in the October 18, 1984, letter, and that he expected to be paid that amount. Hogan identified the following invoices from A&A to QIX:

He said these invoices were inflated by a factor of 2.5 to correspond to the column of inflated cash requirements in the October 18, 1984, letter. Specifically they relate to the following numbered items in that letter:

#1 October 10, 1984, $125,000

(invoice—October 19, 1984)

#2 January 10, 1984, $1,062,500

and

#3 February 11, 1984, $1,187,500

(invoice—December 14, 1984)

#4 March 11, 1984, $1,187,500

and

#5 April 10, 1984, $1,062,500

(invoice—February 14, 1984)

#6 June 10, 1984, $375,000

and

#7 July 10, 1984, $375,000

(invoice—April 17, 1984)

He said that the invoices were requested by Zink and their issuance had been discussed in the San Jose meeting; and that it was to meet the requirement of QIX financing.

Exhibit 3-10-12, an invoice dated May 12, 1985, for $4,000,000 was issued by A&A to QIX and stated, “supply refrigeration equipment as per contract”. Hogan stated that this invoice was false.

During the design phase of the project Hogan was asked by Roger Cesvets to reduce the A&A cost. This was done by taking certain items out of the A&A budget. On May 30, 1985, Hogan gave an extensive written quotation to Denco Engineering Ltd. (Denco) for refrigeration only, at a price of $1,369,000. Denco was incorporated by Schmidt and Zink on February 19, 1985.

In February, 1985, A&A opened a bank account in Vancouver at The Royal Bank of Canada. It was numbered 100-100-7. At the same time two more accounts were opened numbered 100-102-3 and 100-103-1. In the banking resolutions for these latter two accounts Schmidt was designated as the only person authorized to sign cheques drawn on account 100-102-3 (A&A Schmidt account) and Zink in similar fashion with respect to 100-103-1 (A&A Zink account). In his testimony Hogan gave the following explanation for this unusual and significant occurrence.

MR. REYNOLDS: Shortly after you opened this account at the Royal Bank of Canada, did you have a conversation with Mr. Schmidt or Mr. Zink or either of them with respect to banking matters?

MR. HOGAN: Yes, I was asked — or it was explained to me that —

MR. REYNOLDS: By whom?

MR. HOGAN: By Mr. Schmidt and Mr. Zink.

MR. REYNOLDS: All right.

MR. HOGAN: That —

MR. REYNOLDS: What did they explain?

MR. HOGAN: That the way the financing was done on this project and the money was being paid under our budgetary and contractual arrangements that this money had to be paid to A.&A. Refrigeration out of an escrow account, and because that we were not entitled to it because we had not proceeded any farther than we had on the job that this money had to be paid to A.&A. Refrigeration and they needed some accounts opened in A.&A. Refrigeration, so they had control of the money to pay other subs which were covered under the contingency arrangement. These accounts had to be opened and they had to be the signing authority because, “I might get hit by a truck,” and“ I'm a nice guy and I’m trustworthy but we don't know about those other guys.”

MR. REYNOLDS: Is this the nature of what they explained to you?

MR. HOGAN: That's correct.

MR. REYNOLDS: So, how many other accounts were opened in the name of A.&A. Refrigeration?

MR. HOGAN: Two other accounts were opened; one in the name Gunther Schmidt and one in the name of Wolfgang Zink.

MR. REYNOLDS: I see. Now, when you say in the name of —

MR. HOGAN: They were the sole signing authority.

MR. REYNOLDS: But the account was in the name of?

MR. HOGAN: A.&A. Refrigeration.

All QIX or Denco cheques made payable to A&A or Alpha were examined by Hogan. Those actually received by A&A and applied against QIX indebted* ness totalled $1,350,441.47. A&A did receive QIX cheques numbered 170 and 171 dated February 12, 1985, for $300,000 each, which were deposited in the A&A account. A&A then directed the bank to transfer $300,000 to the A&A Schmidt account and $300,000 to the A&A Zink account.

A QIX cheque numbered 283 and dated May 29, 1985, payable to A&A in the amount of $800,000 was never received by A&A, and is endorsed in a manner such that $400,000 was deposited to the A&A Schmidt account and $400,000 to the A&A Zink account. Two QIX cheques numbered 389 and 390 dated August 2,1985, each payable to A&A in the amount of $500,000 were never received by A&A but were deposited in the A&A Schmidt and A&A Zink accounts.

After the project was shut down in February 1986, Hogan met with Schmidt and Zink and asked for payment of money due A&A. The upshot of this was a transfer to A&A by Schmidt of the remaining balance in the A&A account 100-102-3 of $10,339.07 and by Zink from the A&A account 100-103-1 of $10,102.

Robert Irlam of The Royal Bank of Canada in Vancouver, was responsible for the various A&A accounts. From exhibits put to him he traced the QIX cheques numbered 170, 171, 283, 389 and 390, totalling $2,400,000 and it is readily apparent that of this sum, $1,200,000 was deposited to the A&A Schmidt account and $1,200,000 to the A&A Zink account.

On August 16, 1985, Schmidt caused Alpha Micro Research Corp to be incorporated and Zink incorporated RDM Research International. Shortly after incorporation, bank accounts were opened at The Royal Bank in Vancouver for Canadian and U.S. funds. Between August 27, 1985, and September 4, 1985, the entire amount in the A&A Schmidt account and the A&A Zink account with accumulated interest was transferred in two instalments to Barbados and returned without the accumulated interest to the accounts of the companies they had incorporated. Irlam identified and interpreted all of the exhibits put to him which included letters from Schmidt and Zink, internal bank memorandums, telex and telegraph transfer records. He testified that all of the transactions carried out by the bank were on the written or oral instructions of Schmidt and Zink.

Irlam did have discussions with Schmidt and Zink concerning the reason for the transfer of funds and recollected that it was in very general terms and to the effect that it was on their accountant's advice to minimize tax. In Exhibits 3-09-16 and 18, internal bank memorandum dated August 16, 1985, Irlam made a note that Alpha Micro Research Corp, and RDM Research International had been formed to receive royalty payments from QIX.

On February 19, 1985, Denco Engineering Corporation (Denco) was incorporated in B.C., Schmidt and Zink being its directors and officers. Exhibit 2-07-29 is an agreement dated October 5, 1984, between QIX and Denco. Ignoring the promotional text of this agreement it may be construed on its face as a contract in which Denco became committed to construct the QIX research

Of this amount, $7,000,000 was to be payable as follows:

The remaining $7,000,000 was to be paid with interest at 9 per cent per annum by ten annual instalments on the last day of each year commencing December 31, 1987. Handwritten notes of changes in the payment schedule appear on Exhibit 2-07-29. These are incorporated in an identical agreement dated October 5, 1984,between QIX and Denco. The contract price of $14,795,000 remained the same, and of this amount the initial instalments totalling $7,000,000 were increased to $10,795,000 payable as follows:

The remaining $4,000,000 was to be paid in ten annual instalments of $400,000 on the last day of each month commencing December 31, 1987. Exhibit 16-02-9 is a letter dated August 28, 1985, from Denco to QIX and purportedly signed by Zink on behalf of Denco, and Schmidt on behalf of QIX, in which payments were to be varied as follows:

As a result of the increased construction costs of approximately $2,000,000, we request that the November 30, 1985, payment of $1,590,000 be increased to $4,000,000.

As per our contract the remaining amount of $4,000,000 therefore would be decreased to $1,590,000 payable in ten equal instalments of $1,590,000. [sic]

Exhibit 02-7-27 is a copy of an invoice dated January 9, 1985, from Denco Enterprises Ltd. to QIX with reference to the construction of QIX refrigeration/ irradiation processing facility at 8460 River Road, Richmond, B.C.

This invoice, not in the name of Denco, was issued before Denco was incorporated on February 19, 1985.

Bradley Sakich, a chartered accountant with Coopers & Lybrand, worked with Zink on the QIX applications to Canada Trust for release of the net proceeds of the sale of the note to Consumers’ Gas. He clearly understood the terms of the agreement between QIX and Consumers' Gas and the escrowing of $12,200,000 with Canada Trust. In completing the accountants letter for each of the four releases of funds by Canada Trust he examined statutory declarations of Zink, and cheques, bank statements, invoices, agreements and lists of expenditures produced by Zink, or employees of QIX.

In connection with the first release Sakich completed Exhibit 2-07-01-1, the Coopers & Lybrand letter to Canada Trust dated January 22, 1985, in which he made a calculation based on Zink's Statutory Declaration, Exhibit 2-07-02 sworn January 11, 1985, that the sum of $2,932,944.29 be released to QIX. Zink had provided him with Exhibit 2-07-03-1 and 2, a list of invoices which included the Denco Enterprises invoice of January 9, 1985, for $3,000,000 and two A&A invoices for $125,000 and $2,250,000. Sakich agreed that he was not shown the October 18, 1984, letter from A&A to QIX with the inflated budget and the actual budget. When asked whether he would have issued the Coopers & Lybrand letter if he had seen it he said ”I don't think I would have, it seems there has been an inflation”.

In the second application to Canada Trust for release of funds Sakich completed the Coopers & Lybrand letter dated May 27, 1985, Exhibit 02-07-1, in which he made a calculation based on Zink's Statutory Declaration, Exhibit 02-07-09 sworn May 27, 1985, that the amount to be released was $3,871,131. Zink had given Sakich a list of expenditures, Exhibit 2-07-06, which is a list of cheques for payments made totalling $3,061,321.92 and other amounts yet to be paid, totalling $10,247,847.39. Sakich prepared Exhibit 2-07-08, being a summary of expenditures by QIX to May 16, 1985. He agreed that in the summary there is an error not attributable to Schmidt or Zink concerning amounts due A&A being overstated as $3,735,000 rather than $2,725,000. This latter amount he found in the QIX/Alpha contract dated October 5, 1984, and being the third or fourth instalments due to A&A according to the contract.

The amount of $3,205,000 shown on the summary as being due to Denco was derived by Sakich from the contract, Exhibit 2-07-29. Whereas Sakich used invoices in dealing with the first release he relied on contracts for the second release in determining amounts due to A&A and Denco.

In working on the third release Sakich was given Exhibit 3-07-16, a six-page list of cheques. He prepared a summary of expenditures to July 11, 1985, Exhibit 3-07-14. In the summary there is reference to 'A&A as per contract $2,000,000”, and Sakich included it as a payment due A&A in the agreement of October 5, 1984, between QIX and Alpha. The reference to "Denco as per contract” $6,000,000, he viewed as payments due of $3,000,000 each for July and August, 1985, in the October 5, 1984, agreement between QIX and Denco. Sakich did complete a letter for the third release and relied on Zink's Statutory Declaration of July 11, 1985, in which expenditures were planned of $8,621,812. Sakich testified that this amount included the A&A and Denco amounts.

Sakich agreed that part of his review involved a determination of cash actually paid. His attention was directed by the Crown to Exhibit 2-07-16 and the entry on the list of cheques to numbers 170 and 171 payable to A&A in the amount of $300,000 each. Sakich said that he treated these amounts as money paid to A&A for services or materials. He then said he would not have completed the Coopers & Lybrand letter had he known the amounts were paid to a different account and not to A&A on the contract. When asked similar questions about cheque #283 for $800,000 he agreed again that he would not have completed the letter to Canada Trust. The total of cheques 170, 171 and 283, being $1,400,000 was included in the Statutory Declaration.

On September 4, 1985, Sakich sent the fourth and final request for release of funds to Canada Trust (Exhibit 2-07-18). The amount called for was $2,463,121 being the remainder of funds held in escrow. Accompanying the Coopers & Lybrand letter was a statutory declaration of Zink sworn August 30, 1985, in which projected expenditures totalled $4,762,243 and the net cash outflow associated with cumulative expenditures totalled $18,074,065. The cumulative expenditures were stated to be $26,671,376. On examining a summary of expenditures, Exhibit 2-07-20, Sakich explained that no A&A expenditures were included since they had all been claimed in earlier releases and so far as the fourth release, A&A expenditures would be included in the stated cumulative expenditures of $26,671,376. He did identify a projected expenditure of $4,000,000 to Denco as being included in the release and was aware that there had been a re-scheduling of payments having received a copy of Exhibit 16-02-9, the Denco/QIX letter agreement dated August 28, 1985. In the list of cheques, Exhibit 7-07-23, are cheques numbered 389 and 390 payable to A&A in the amount of $500,000 each. Sakich agreed that they are in the net cash outflow total of $18,074,065.

In cross-examination Sakich agreed that his summaries and working papers would be used by Coopers & Lybrand when the time came for QIX to file tax returns. In that regard he said he had no difficulty getting information and documents from QIX.

In visits to the construction site on July 11,1985, and August 29, 1985, Sakich prepared handwritten records, Exhibits 24 and 25. Item #5 in Exhibit 24 stated ‘No anticipated budget overrun" and Sakich said this was a reference to the original budget Exhibit 2-07-13. He drew this conclusion from a conversation with the construction foreman. Item 4 in Exhibit 25 states "slight budget overrun estimated at $2,000,000—accept. (Denco)."

When it was suggested to him that there was nothing wrong with QIX paying Denco and then borrowing money back from Denco, Sakich said he would think that one arm's length loan wouldn't trigger anything under Part

VIII. However, when asked in re-examination what his view would be if he had known that cheques 391 and 394 each payable to Denco in the amount of $3,000,000 coincided with a loan by Denco to QIX on the same day for $3,000,000 he said, "you are pushing what you would view as an ordinary commercial transaction.”

It was put to Sakich that he never told Zink that any of the QIX/Denco contracts would be unacceptable to Revenue Canada and he answered equivocally, saying—"yes, but we never told him they would be accepted." In reexamination he was asked whether he was ever requested to give advice on falsely inflating contracts and replied "certainly not".

In notes made on Exhibit 2-07-03 the invoice list relating to the first release from Canada Trust Sakich had noted a comparison he made between emerging costs of construction and the refrigeration component with the original budget. He said he was applying a reasonableness test to see if they were within the original budget.

Coppers & Lybrand notes, entitled "'QIX escrow release July 1985”, Exhibit 32, make reference to a due diligence requirement—"required as accountants to perform certain due diligence requirements to satisfy ourselves that certain expenditures have been made or will be made." Sakich agreed that it was his function.

There is no specific evidence of the purpose of Denco in the QIX scientific research and development project. There is some evidence from Rodney Johnson, a chartered accountant with Coopers & Lybrand of tax planning in which QIX would be kept as a pure research and development company and all other activities would be through Denco. He viewed Exhibit 48, a copy of a report circulated by Arthur Anderson & Co., chartered accountants in May 1984, as being known in the business and consistent with his own views, provided, he said, amounts charged were based on fair market value and were reasonable in the circumstances. When asked if he gave such advice in the QIX project Johnson said he could have or Coopers & Lybrand could but he was not certain.

That part of Exhibit 48 which is pertinent to this case included a hypothetical fact pattern similar to the QIX/Consumers’ Gas transaction in which the issuing corporation retains the difference between the selling price of a debenture or note and its principal amount. Recognizing that the issuing company would be faced with a shortfall of funds to pay for sufficient expenditures to eliminate its tax liability the notion was advanced that the problem could be overcome without actually raising additional financing. It went on to give the example of the issuing company incorporating a subsidiary company to conduct research on its behalf charging the parent for its services at rates that would be charged non-related customers, with those charges including a significant profit element which would not be present if the research was done directly by the parent company.

Johnson said he knew that a profit factor was involved in the QIX/Denco agreement. He was then asked what he did to determine if it was appropriate for inclusion in the tax returns of QIX. The gist of his answer was “ primarily what was done, we were acting under an escrow with Canada Trust and the Consumers’ Gas arrangement and we were required to review expenditures and during that period we established for our view that, yes, there was a markup and in our view it was not necessarily unreasonable.” The only documentation Johnson relied on in his consideration of the reasonableness of the Denco mark-up was Exhibit 49 a working paper of Coopers & Lybrand of July 25, 1985, used in connection with the third request for funds to be released by Canada Trust. There is a portion, numbered 3, in handwriting:

Doug, presumably you are satisfied with the involvement of the related parties and this has been fully disclosed to all concerned — and what is being provided by the parties is at fair value. Particularly Denco.

A response appears in writing opposite the query:

Previously discussed. Also discussed with QIX — Revenue Canada has been in and Wilf has given him some of the earlier bids which were equal to or well in excess of what their current contract [sic].

Johnson was asked what conclusion he reached as to whether he could include with propriety the Denco mark-up and replied that the key item was whether the Denco contract represented a fair market billing; that it had been dealt with by the Coopers & Lybrand accounting division, and therefore he had no reason to presume it wasn't fair market value. He agreed that he did not advise the client to incorporate a subsidiary and simply flow money through it.

When the Crown put Exhibit 3-10-1 to Johnson in which the A&A budget was shown as inflated by a factor of 2.5, Johnson agreed that Coopers & Lybrand would not have sent its letter to Canada Trust and if he had known of this fact that his level of concern about Denco would have been raised.

It is abundantly clear that Johnson was not fully informed by QIX, that is by Schmidt and Zink and further that his review of information was cursory at best.

Grant Cowan, with Revenue Canada, and the principal investigator in this case produced documents filed by QIX in connection with the sale of its scientific research tax credit note to Consumers’ Gas. They are:

Exhibit 36 — Designation under S-194 (T 2113)

Exhibit 37 — Scientific Research Tax Credit Summary (T2114-Summary) Exhibit 38 — QIX—Corporate Part VIII Tax Return

Exhibit 39 — 1985 Tax Return—Schmidt

Exhibit 40 — 1985 Tax Return—Zink

On February 6, 1991, Cowan searched for a corporate return for 1985 of Denco and none has been filed. Filing is required whether or not there is any profit.

In connection with expenses claimed by QIX in its Part VIII and Part I returns, Cowan examined statements filed with the returns, accounting documents and then the source documents such as cancelled cheques and working papers. In his testimony he dealt with Exhibit 1-01-04-5, QIX statement of scientific research expenditures—September 27, 1985, which are stated on a net basis for income tax purposes at $35,159,541. With respect to the allocation of $34,700,000 to the QIX Part VIII return he testified that it included $8,675,000 attributed to A&A. He totalled cheques received by A&A at $2,705,000, which sum was included in project costs of $14,930,460 as entered in a working paper, Exhibit 2-06-01-9. In addition to A&A costs included in the project costs there were costs calculated at $5,970,000 in Exhibit 2-06-01-3, entitled” Journal Entries and Adjusting Journal Entries—September 27/85”. The entry refers to current and long term liabilities, its purpose is stated “To record costs incurred (not paid) re A&A Contract". The amount of $5,970,000 would then be added to the initial calculation of project costs of $14,930,000. Cowan simply added payments received by A&A of $2,705,000 — and the amount shown as an outstanding liability to A&A of $5,970,000 to arrive at a total of $8,675,000 which had been included in expenditures claimed by QIX in its Part VII return. Exhibit 3-10-08, the agreement executed by QIX and A&A on April 24, 1985, and back dated to October 5, 1984, called for payment to A&A of $8,675,000.

By reference to Exhibit 3-10-23-5 the statement of claim of A&A against QIX in which the amount owing to A&A is stated to be $2,923,946 and by deducting this from $8,675,000 Cowan calculated the“ inflation” in the A&A expenditures claimed by QIX to be $5,752,054.

Cowan testified that he analyzed the QIX/Denco agreement dated October 5, 1984, Exhibit 2-07-29, by the terms of which QIX was obligated to pay Denco $14,795,000. Using the same procedure as with the A&A agreement Cowan established that $9,530,000 had been paid by QIX to Denco. By deducting from $9,530,000 amounts involving ETI, A&A and payments back to QIX, Cowan calculated there had been a total of $7,155,607 in expenses relating to the building. He deducted $7,155,607 from $14,795,000 to arrive at an "inflation" in the QIX/Denco contract of $7,639,393.

Cowan calculated the total amount of tax avoided to be $6,465,453.

Cowan did examine the tax returns of Schmidt and Zink and found that none of the money paid into the A&A Schmidt and Zink accounts was included as income.

Exhibit 2-07-13, is a copy of an August 1984 construction budget totalling $34,760,000. It was prepared for the transaction with Consumers' Gas and used in each of the escrow releases. In all the circumstances it could not have escaped the attention of Schmidt and Zink. They knew that the only fixed amount in the budget was the ETI amount of $10,300,000 and that they would have to cause QIX to expend or commit itself to expend a further $24,460,000 in constructing and equipping the proposed research facility.

After closing the agreement with Consumers' Gas on September 8, 984, Schmidt and Zink would have been engaged in planning construction and would be well aware of projected costs. Young, of Wright Engineering Ltd. testified that in the fall of 1984 the initial discussion with Schmidt and Zink involved a figure of $14,000,000 including A&A, but not ETI. Young confirmed that the project was reduced in size with a projected end cost of $7,000,000, including A&A at $2,500,000. His evidence established that the cost rose through the spring of 1985 to approximately $8,100,000 and remained at that level through the remainder of 1985. Young identified monthly progress reports which included details of costs and projections within the framework of the targetted end cost.

In the month of February 1985, QIX employed Cesvets as the project director with virtually unlimited authority to oversee construction. At the outset Cesvets informed Schmidt and Zink that the original concept for the building would not work and it could not be completed for $7, to $8,000,000. Cesvets expedited planning and construction, placing it on a "fast-track" basis so that what would normally take 30 months would be done much sooner. Although this would normally increase the cost he testified that it did not have that effect, commenting that because of the business conditions at the time, there was astonishing response to tenders.

There can be no doubt whatsoever, that in April 1985 when the A&A agreement was signed and back-dated to October 5, 1984, that both Schmidt and Zink knew the projected cost of construction was approximately $8,100,000 including $2,500,000 for A&A. The same facts and circumstances apply to the QIX agreement with Denco. By these agreements Schmidt and Zink committed QIX to pay the following amounts:

and by adding to this the ETI amount of $10,300,000 they had achieved liabilities of $33,770,000. In large measure this would serve to meet their original budget of $34,760,000

Hogan testified that the amount of $8,675,000 which QIX committed itself to pay A&A, was not a true amount. Furthermore he testified to earlier events in October, 1984, and his complicity with Schmidt and Zink, in the formulation of a false budget which was to be the actual cost of $2,500,000 increased by a factor of 2.5. This was followed by A&A invoicing QIX on the false budget. The QIX/A&A agreement is not genuine and is false and misleading.

Schmidt and Zink acted in concert when they prevailed on Hogan and Linton of A&A to create the A&A Schmidt and A&A Zink accounts. QIX cheques made payable to A&A were transferred to or deposited in these accounts to a total of $2,400,000. There is no evidence to suggest that the money was ever used to pay any liabilities of QIX There is every reason to conclude that these funds, once in the A&A accounts were solely controlled by Schmidt and Zink and used for their purposes. In July or August of 1986, Linton, of A&A, met Schmidt and Zink in Vancouver, and confronted them over the money paid by QIX to the A&A Schmidt and Zink accounts. He accused them of stealing and claimed that Zink admitted they had taken the money and that Schmidt did not deny it when Zink made the admission.

The accountants, Sakich and Johnson, were not involved in the formulation of the A&A false budget, the QIX/A&A agreement with a false contract price, or the two A&A bank accounts controlled by Schmidt and Zink. All of this was kept from them while at the same time they were provided with a copy of the agreement as being genuine, and with invoices of A&A and cheques issued by QIX which Schmidt and Zink had to know were false. I am satisfied that all of this was done with the intention to deceive Sakich, Johnson and Coopers & Lybrand. It cannot reasonably be attributed to lack of knowledge, carelessness, or sloppy business practice, and it certainly cannot be viewed as a course of conduct based upon any advice given by Coopers & Lybrand in connection with Part VIII of the Income Tax Act, in particular, any advice that might have been given concerning what type of expenditures would qualify as scientific research.

In dealing with Denco and the QIX/Denco agreement, it is necessary to accept the proposition that Schmidt and Zink, as directors and officers of QIX, were entitled to incorporate a subsidiary company or companies in furthering the QIX research and development project. It would be appropriate and desirable to utilize Denco to carry out whatever part of the project they assigned to it and this could include charging back to QIX a reasonable profit. Its sole purpose could be to serve to reduce the amount of taxes ultimately payable by QIX. It matters not how clumsy, unsophisticated, or unbusinesslike the attempt might be. It would not equate to a wilful attempt to evade tax unless the element of deceit is present in the creation of a facade of reality quite different from the truth.

While recognizing the freedom of Schmidt and Zink to act in the legitimate interests of QIX, it is still necessary to decide whether the incorporation of Denco, the outstanding liabilities in the QIX/Denco agreement, payments made by QIX to Denco and the loan by Denco to QIX are in fact a sham transaction. The use of Denco is not to be judged in isolation from other circumstances in evidence. The actions of Schmidt and Zink when dealing with A&A, the creation of a false contract price, and an inflated projection of cash payments and invoices, are relevant to the issue. Moreover the immediate purpose for inflating A&A commitments is a factor.

On all the proven facts it must be inferred as a fact that Schmidt and Zink intended the inflation of A&A participation in the project so that QIX could supply its accountant and in turn the Canada Trust with sufficient expenditures to obtain releases from escrow. There is no other reasonable or rational inference. This was done by deceit in concealing true facts from Coopers & Lybrand while allowing them to rely on a sham transaction. The incorporation and use of Denco was done in tandem with the sham involving A&A and is itself a sham transaction. The choice of the Denco contract price $14,795,000 is one of convenience in achieving total expenditures of $34,760,000.

The functions of Wright Engineering Ltd. in designing the building and managing construction, as well as those of Cesvets as project director; all continued in spite of the emergence of Denco in February, 1985. There is no evidence to establish that Denco did anything other than nominally contract to build the research facility.

Having concluded that the A&A and Denco transactions were a sham and that the initial purpose of Schmidt and Zink in perpetrating these shams was to ensure the release of funds from Canada Trust, the question raised is whether the inclusion by Zink of false and inflated expenditures in the four statutory declarations is the making of false entries in the books and records of QIX, and whether Schmidt is a party to the offence. It is obvious that the statutory declarations are required only as part of the agreement with Consumers' Gas, but once sworn they become an integral part of the entries in the books and records required to be kept by QIX, in particular those specific entries and records on which they are based. The complicity of Schmidt with Zink in the A&A and Denco sham transactions, the initial purpose of which I have concluded was to secure a release of funds from Canada Trust, is a sufficient basis for the inference that he knew the declarations would include false statements of expenditures made or to be made on scientific research. On all of the facts I am satisfied beyond a reasonable doubt of the guilt of QIX, and Zink as a director of QIX, in Counts 8, 9, 10 and 11. Schmidt was a party to the offences and is therefore guilty in counts 8, 9, 10 and 11.

The deceit practised on Coopers & Lybrand in the securing of release of funds from the Canada Trust remained latent in the books, records and information which were ultimately relied upon by the accountants in preparing the Part I and Part VIII corporation tax returns. No action was ever taken by Schmidt or Zink to provide true information to the accountants. When Schmidt signed the tax returns on May 14, 1986, the only rational conclusion is that he knew that the Part I and Part VIII returns included stated expenditures of $35,159,541 and $34,700,000, made on scientific research and that these amounts included expenditures that were false. I find QIX, and Schmidt as a director, and Zink as a director, guilty of the offence in Count 1, the offence of willful evasion of payment of taxes imposed by Part VIII of the Income Tax Act. I find QIX, and Schmidt as its director, guilty of the offences in Counts 2 and 3, being the making of false statements in Part I and Part VIII corporate tax returns.

The charges against Schmidt and Zink of failing to report $1,200,000 of income in their 1985 tax returns and of failing to include that sum in their stated total income have been established beyond a reasonable doubt. I find Schmidt guilty of the offences in Counts 4 and 5 and Zinc guilty of the offences in Counts 6 & 7.

Dated at the City of Vancouver, Province of British Columbia, this 14th day of March, 1991.

Defendants found guilty.