Date: 19991103
Docket: 98-2697-IT-I
BETWEEN:
AYER'S CLIFF INVESTMENTS INTERNATIONAL INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
P.R. Dussault, J.T.C.C.
[1] This is an appeal from an assessment for the appellant's 1994 taxation year. The appeal was heard under the informal procedure of this Court and the appellant's representative, Mr. Ari Wloski, elected to limit the appeal to $12,000 pursuant to section 18.12 of the Tax Court of Canada Act even though the amount of federal tax in issue is greater than $12,000.
[2] In assessing the appellant, the Minister of National Revenue (the "Minister") refused the deduction of Scientific Research & Experimental Development ("SR & ED") expenditures as well as the claim of Investment Tax Credit ("ITC") and he made related adjustments on the basis of the assumptions of fact stated in paragraph 4. of the Reply to the Notice of Appeal (the "Reply"). This paragraph reads:
a) during the taxation year in litigation, the Appellant was a Canadian-controlled private corporation;
b) the Appellant's fiscal period was from May, the 1st to April the 30th;
c) for the taxation year 1994, the Appellant claimed the following amounts in the calculation of the SR & ED expenditures and of qualified expenditures for ITC:
Details Amounts
Material consumed $6,542
Sub-Contracting 63,248
TOTAL $69,790
d) the sub-contracting item included an amount of $60,000 being a remuneration payable to Ari Wloski, director and only shareholder of the Appellant;
e) the amount mentioned in the preceding paragraph has never been paid by the Appellant to Ari Wloski;
f) Ari Wloski never declared as revenue the amount mentioned in the paragraph d), in his Income Tax Returns (T-1);
g) after evaluation of the projects for which the Appellant claimed SR & ED and ITC, our scientist came to the conclusion that the projects do not qualify as SR & ED projects;
h) consequently, for the taxation year in litigation, the Minister refused the following amount as SR & ED expenditures:
Current Expenditures
Materials consumed $6,542
Sub-Contracting 63,248
Sub-Total $69,790
Less
Quebec Tax Credit (25,021)
Previous year's ITC ( 6,783)
Total SR & ED Expenditures refused $37,986
i) for the taxation year in litigation, the Minister also refused the following amount as qualified expenditures for ITC and refused the Appellant the ITC claimed, consequently:
Current Expenditures
Materials consumed $ 6,542
Sub-Contracting 63,248
Prescribed Proxy amount 65,680
Sub-Total $135,470
Less
Quebec Tax Credit (25,021)
Expenditures not qualified for ITC $110,449
Reduction in ITC allowable:
$110,449 X 35 % = $ 38,657
j) for the taxation year in litigation, the Minister refused the deduction in an amount of $60,000, claimed as SR & ED expenditures, this amount being a remuneration payable to Ari Wloski, director and only shareholder of the Appellant, as this amount has never been paid by the Appellant;
k) for the taxation year in litigation, the Minister transferred and applied the following expenses claimed as SR & ED expenditures, against the general business revenues:
Materials consumed $ 6,542
Sub-Contracting 3,248
l) moreover, for the taxation year in litigation, the Minister also added to the Appellant's revenues the amount of $6,783 as previous year's ITC received.
[3] As per paragraph 5. of the Reply the issues are whether, for the year in litigation:
a) the projects for which the Appellant claimed SR & ED expenditures and ITC, do qualify as SR & ED projects;
b) the Minister was justified to refuse the deduction in an amount of $60,000 claimed as SR & ED expenditures, this amount being a remuneration payable to Ari Wloski, director and only shareholder of the Appellant, as this amount has never been paid by the Appellant;
c) the Minister was justified to transfer and apply the expenses claimed as SR & ED expenditures, against the general business revenues;
d) the Minister was justified to add to the Appellant's revenues the amount of $6,783 as previous year's ITC received;
e) if this Honourable Court comes to the conclusion that the projects for which the Appellant claimed SR & ED expenditures and ITC do qualify as SR & ED projects, if the calculations of the SR & ED expenditures and of qualified expenditures for ITC have been correctly established.
[4] At the outset of the hearing, Mr. Wloski admitted that the amount of $60,000 claimed as remuneration payable to him had in fact never been paid. According to subsection 78(4) of the Income Tax Act (the "Act")it is thus deemed not to have been incurred as an expense in the appellant's 1994 taxation year.
[5] The remaining expenses forming the basis of the appellant's claim are thus $6,542 for material consumed and $3,248 for sub-contracting.
[6] Mr. Ari Wloski and his wife, Mrs. Jackie Wloski testified for the appellant. Mrs. Hanna Karczewska, Science Advisor for Revenue Canada and Mr. Christopher Bradley, Auditor, testified for the respondent.
[7] According to its claim for SR & ED expenditures carried on in Canada (Exhibit R-5, Tab 1.1), the appellant's company has been involved in "developing low cost, high efficiency building systems focusing primarily on structural and energy efficiency" since 1987. In the same document, the name indicated for the project for the appellant's 1994 taxation year is "The summation of Interlocking Box-beam Joinery experiments and an Automated Structural Components Assembler (Mobile Platform)."
[8] From the description of the project filed with form T661(E) Rev. 94, the goal for the 1994 taxation year seems to have been the development of a box beam interlocking joinery to form structural members of a house in addition to
walls, roof and floors as well as a robotic structural assembler.
[9] As a matter of fact, a test structure, a house, was built in Wentworth, Quebec in 1990-1991 using a system of interlocking plywood box beams. During the 1994 taxation year, the appellant would have been involved in a process of long term testing of the structural components "in a real time and real scale environment" in order to select the best jointry system and develop a robotic assembly system to produce box beams.
[10] Following the filing of its claim along with a six page report in which the project and its objective, the technological advancement sought, the technological uncertainties and the technological work actually done are all described in the most general terms, the appellant was asked to provide more technical information as required on form T661 (Exhibit R-5, Tab 1.2, Letter of November 8, 1995 and attachment by Hanna Karczewska).
[11] More specifically the appellant was required to provide technical information on the following points:
Technological uncertainties solved from 01-05-1993 till 30-04-1994.
Technical work done from 01-05-1993 till 30-04-1994.
Technical reports and documentation prepared between 01-05-1993 till 30-04-1994.
List of contractors and subcontractors performing SR & ED on your behalf working between 01-05-1993 till 30-04-1994.
[12] Following that request, Mr. Ari Wloski sent to Mrs. Karczewska a copy of the same report as the one mentioned in paragraph 10 above, along with an executive summary of the appellant's long-term project (Exhibit R-5, Tab 1.3).
[13] After a site visit by Mrs. Karczewska herself and a second visit by an outside consultant for Revenue Canada, Mrs. Karczewska prepared an eligibility report on January 9, 1996 (Exhibit R-5, Tab 1.4). In that report, her evaluation of the appellant's project was as follows:
Evaluation
This evaluation is based on the project description supplied for 1994, the site visit done by myself on Sept. 30 1994 and done by the Outside Consultant on Sept. 7, 1995, and the evaluation Reports prepared after each site visit.
The T/P claims that in 1994, the work on long term testing of the structural system was carried out.
From the information obtained by myself during the side visit and from the O.C. Reports, it appears that there are no new evidences of a systematic experimental development work being carried out by the taxpayer in 1994 (see the O.C. Report).
The taxpayer did not demonstrate that the testing was carried out through the planned approach, with a stated hypothesis which was confirmed by means of experimentation or analysis.
No specific data collected during the test period was presented to me during my site visit or to the O.C. during his site visit.
The samples of box beam, or jointry system, or the video recording of the house construction are not considered to be the evidences of systematic experimental development work.
The taxpayer claims that some work was done by McGill University. The taxpayer presented no evidences that the work carried out by McGill University was done on his behalf and that he has right to exploit the results of this work.
For the automated assembler system, it seems that only an evaluation of the best jointry system was accomplished in 1994. Such an evaluation does not constitute an experimental development process. No evidence of testing work was presented during each site visit.
Based on the above presented information, it is my conclusion that the work claimed by the T/P is not of experimental development nature.
In this respect, this project did not meet the requirements of the Reg. 2900(1) of the Income Tax Act.
[14] With respect to the work done at McGill University ("McGill"), the respondent has been recently provided with a research agreement between McGill and Mr. Wloski himself and not the appellant company. An invoice dated October 6, 1993 by McGill to Mr. Wloski for an amount of $8,200 has also been provided (Exhibit R-5, Tab 1.5). Mr. Wloski produced a cheque for the same amount made payable to McGill signed by him for another corporation called Planet Era Action Inc. ("Planet Era"). Those documents relate to "Experimental Testing of Wooden Box-Beam Assemblies". In his testimony, Mr. Wloski said that the work done at McGill has been paid for with a grant obtained by Planet Era from the Canadian Mortgage and Housing Corporation. The amount of $8,200 has never been claimed as an SR & ED expenditure by the appellant and is not in issue.
[15] In her testimony, Mrs. Karczewska said that she had actually seen two reports prepared at McGill.
[16] The first report is entitled "The long term durability of wood box beams", dated April 1994 is a review of existing technical literature with respect to the effects of moisture and fungus on the durability of wood. The second report is on the bending tests conducted at McGill on samples of wooden box beam assemblies. Although data was collected, Mrs. Karczewska stated that she could not ascertain the specific purpose for which such data was collected as no specific hypothesis is stated in the report. She said that she could not relate those tests with the appellant's own work supposedly done in the 1994 taxation year. As said in paragraph 14 above, the work done at McGill was paid for with a grant obtained by another corporation and is not part of the appellant's claim.
[17] Mrs. Karczewska said that a third report was sent to Revenue Canada by the appellant. It is a report prepared by Joe Deom Associates, dated February 20, 1997 and entitled "A semi-Automated Box-Beam and Panel assembly System – Technical Feasibility Assessment and Cost / Benefit Analysis of the Concept" (Exhibit R-5, Tab 1.6). Mrs. Karczewska said that this report could not substantiate the work done by the taxpayer during its 1994 taxation year and agreed with Mr. Wloski that in fact the report was not really provided for that specific purpose.
[18] Many other documents besides the ones already mentioned were sent on behalf of the appellant mainly by Mr. Wloski (see Exhibit R-5). The appellant's project for its 1994 taxation year was reviewed by different persons at the objection as well as the appeal stage and all the documents submitted were examined.
[19] In her final report dated September 15, 1999, Mrs. Karczewska states the following at page 6:
In my opinion, the Appellant was given many opportunities to present the required documents and required evidences to substantiate his work.
The Appellant did not show any documents which were created at the time the work was performed and which should include: a statement of hypothesis, an analysis of the problem, internal design documents and drawings of the test specimens, a test bench, test data and results, progress reports, laboratory books or records etc.
Since the Appellant can not substantiate his claim with such documents, his claim does not meet the requirements of the Reg. 2900(1) of the ITA.
And further:
Due to the lack of evidences required to support SR & ED type of project, I can conclude that the work carried out by the Appellant and claim for the ITC for the 1994 fiscal year is of a routine construction type.
The Appellant did not demonstrate that the work performed aimed:
to advance technological knowledge in a construction engineering field;
to resolved technological uncertainties by activities such as testing or analysis;
to conduct systematic investigation by a qualified personnel.
Since none of the three criteria were met the activities claimed by the Appellant are judged to be of the routine construction type. The routine construction work does not meet the requirement of the Reg. 2900(1) of the Income Tax Act Regulations.
[20] In her testimony, Mrs. Karczewska recognized that a lot of work had been conducted but again emphasized the lack of evidence as to any systematic investigation that would have been conducted during the appellant's 1994 taxation year.
[21] After a full day of hearing and after having examined all the documents submitted in evidence, I arrive at the same conclusion. Moreover, there is simply nothing to indicate what specific experiments were actually conducted by the appellant in 1994, besides the work done at McGill, which I repeat is not in issue. There is nothing either to connect the remaining expenses in the amount of 9 790 $ forming the basis of the appellant's claim to actual work performed during that year. I may add that invoices to substantiate those expenses and establish the connection to research that would have been carried on were never produced. Beside the cheque of $8,200 payable to McGill mentioned above, Mr. Wolski submitted only two other cheques: one for $65.00 payable to his wife and the other for $81.91 payable to Club Price. Both cheques are drawn on Planet Era's account.
[22] Subsection 2900(1) of the Income Tax Act Regulations basically defines SR & ED to mean "systematic investigation or search carried out in a field of science or technology by means of experiment or analysis...".
[23] In RIS-Christie Ltd. v. The Queen, 99 DTC 5087, a decision of the Federal Court of Appeal referred to by counsel for the respondent, the following is stated at paragraph 14:
[14] In addition to developing new products or processes, scientific research connotes the existence of controlled experiments involving the testing of models or prototypes. Thus, evidence of scientific research must be adduced by the taxpayer in order to demonstrate that such research (including testing) was undertaken and that it is eligible for favourable tax treatment: see, for example, Progressive Solutions Inc. v. R., 96 DTC 1232 (T.C.C.). Not only must taxpayers establish that tests were performed, they must also demonstrate that they were conducted in a systematic fashion. In my view, the requirement that research efforts be 'systematic' is a higher threshold than simply requiring that research, including testing, be conducted.
[24] From the foregoing, I must conclude that such evidence has not been provided by the appellant. Consequently, the Minister was justified in assessing the appellant for its 1994 taxation year the way he did.
[25] The appeal is dismissed.
Signed at Ottawa, Canada, this 3rd day of November 1999.
“P.R. Dussault”
J.T.C.C.