Date: 20000927
Docket: 2000-1378-IT-I
BETWEEN:
SYNCHROSAT LIMITED,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
____________________________________________________________________
Agent for the Appellant: Asim K. Sen
Counsel for the Respondent: J. Michelle Farrell
___________________________________________________________________
Reasons for Judgment
(Delivered orally from the Bench at Ottawa, Ontario, on September 1, 2000)
Bowie J.T.C.C.
[1] The Appellant company is, for practical purposes, the alter ego of Dr. Asim K. Sen. Dr. Sen is the principal shareholder and the only employee of the corporation. His is the corporation's directing mind.
[2] Since 1984, the company has been engaged, through the efforts of Dr. Sen, in the development of something called a "Momentum Turbine". In each of the years since 1991, perhaps longer, the Appellant has claimed to be entitled to receive a refundable investment tax credit (ITC) under section 127.1 of the Income Tax Act (the Act). The present appeal is brought from an assessment under the Act for the 1998 taxation year, whereby the Minister of National Revenue (the Minister) refused the Appellant the claimed ITC. The basis of that refusal, as pleaded by the Deputy Attorney General of Canada, was:
...that it [the company] had no qualified expenditures for the SR & ED as the Appellant was not carrying on a business.
It is now common ground that the Appellant company, through the efforts of Dr. Sen has for a number of years carried on scientific research and experimental development. This was at one time disputed by the Minister, but this Court decided that issue in respect of the taxation years 1991 and 1992 in the Appellant's favour.[1] That issue has not been raised by the Minister in relation to the 1998 taxation year.
[3] The legislative scheme by which a taxpayer becomes eligible to receive ITCs, is a complex one. Entitlement to the credits arises under section 127.1 of the Act, but it depends on the taxpayer first establishing that it has the right to a deduction from income under subsection 37(1) of an amount expended on scientific research and experimental development.
[4] Happily, it is not necessary in the present appeal to delve into the complexities of the computation called for by those provisions of the Act. The Respondent takes issue only with the Appellant's ability to meet the requirement of the opening words of subsection 37(1) which are:
Where a taxpayer carried on a business in Canada in a taxation year there may be deducted ...
The position of the Respondent is simply that the Appellant did not carry on business in 1998, because it had no reasonable expectation of profit.
[5] The basis of this conclusion is set out in paragraph 8 of the Reply to the Notice of Appeal, filed by the Deputy Attorney General of Canada. In the Reply it is said that, in assessing the Appellant's income tax return for the 1998 taxation year, the Minister relied on 14 assumptions of fact.
[6] The first assumption is that the Appellant is a research and development company. The second is that Dr. Sen is the majority shareholder and the only employee and he performs all of the work in the company, administrative and scientific research. The third assumption recites the history of the gross income, salaries, other expenses and losses of the company from 1991 to 1998. The next assumption sets out the computation of the loss claimed for the 1998 taxation year. The next one, that the Appellant's business, since 1984, has been working on -- which I take to mean developing a project called "The Momentum Turbine". Next, it is pleaded that the Appellant's gross revenues throughout the years, have been derived entirely from federal ITCs and from Ontario Innovation Tax Credit Refunds. None of this is disputed by the Appellant. At this point, the Minister's assumptions turn from fact to argument. The next one is:
... that, 25 years after the start of the Project, research and development is still being performed with no commercial activity, indicates that the profit motivation is not the main reason for the Project.
Quite apart from the obvious arithmetic error, the leap in logic is startling!
[7] The next assumption is that the deduction the company claims, his salary expense, is a paper transaction only. This is not disputed by the Appellant in the sense that, as Dr. Sen explained it in his evidence, the company does not have revenues sufficient to pay him a salary at the level at which he, as a well-qualified scientist, might expect to be paid if he worked for an arms-length employer. In fact, the only revenues of the company, he agrees, are the tax credit refunds referred to earlier, and to the extent that his salary exceeds those amounts, he takes it in the form of indebtedness from the company, which is subsequently transferred to shareholdings. To the extent that the company is able to pay him part of his salary in cash, it is used to set aside his personal income tax obligations and the company remits it for that purpose.
[8] Again, the Minister turns to argument in assumption 8(i), which reads:
The extent of the losses indicates a non-commercial intention.
The next assumption, (g), is that the Appellant has no relevant plans to increase gross revenues in order to make the project profitable. This assumption was disputed, and refuted, by Dr. Sen in his evidence. Dr. Sen's plan for the company is quite clear. It is to develop the "Momentum Turbine" to the point where he has a patentable, indeed a patented, invention which has great commercial value, at which point he will sell the patent to a venture capitalist, or to an established concern, which will manufacture and produce it. That is, certainly, a plan to increase the gross revenues of the corporation and to make the project profitable. Dr. Sen expressed the opinion that, when the project is completed and the patent ultimately sold, it will be sold for a great deal of money. Why the Minister says there are no relevant plans is not clear to me. I should have thought that any plan intended to turn the losses into profit would be a relevant plan.
[9] It is, next, pleaded in paragraph 8(k) that:
The Appellant was given a reasonable number of years to demonstrate that the Project was viable.
This appears to be a reference to the fact that the company had been permitted ITCs in prior years and, presumably that the Minister, looking at one more year, added to a succession of years with no revenues and some expenditures, had concluded that the project, in his words, was not viable. This conclusion, of course, ignores the fact that any project, which consists of the application of inventive genius, with a view to selling the end product after years of development of the invention, will produce revenues only at the end of the project. Similarly, paragraph 8(l) reads:
The Project, as operated in the 1998 taxation year, was incapable of yielding a profit.
Clearly, it is intended to suggest that no profit could be made in the 1998 taxation year, and again, this assumption ignores the nature of the project. The same may be said of subparagraph 8(m), which reads:
The Appellant had no reasonable expectation of profit from the Project, during the 1998 taxation year.
[10] In subparagraph 8(n), the Deputy Attorney General of Canada turns, as usual, to a statement which is a conclusion of law and the ultimate issue before this Court, which is whether or not the expenses incurred were expenses from a business or property or, in other words, whether or not the Appellant was carrying on a business during the taxation year 1998.
[11] In short, the Minister's sole basis for denying the Appellant the claimed ITCs, is that the Appellant has had no revenues over the years that he has spent developing his "Momentum Turbine", other than the federal and provincial tax credits and it has, therefore, incurred successive losses in each year.
[12] Dr. Sen's evidence revealed that he has worked systematically and continuously for many years on the development of the "Momentum Turbine". He has obtained a patent for it, and made improvements to the original invention. His conception is that this invention has the potential to provide an alternate energy source which, given the world's diminishing supply of energy resources and constantly increasing state of pollution, will be of great value in the 21st century. His intention is clear. It is to develop this invention to the stage of practical application, at which time he intends to sell the patent to a venture capitalist or to an established concern that will manufacture and market it.
[13] I am not called upon in this appeal to decide whether the "Momentum Turbine" will, in the end, be a commercial success. The Minister has concluded that the Appellant did not carry on a business in 1998, simply on the basis that I have outlined above, that is to say, that the lengthy and unbroken string of annual losses leads to the conclusion that this project has no reasonable expectation of profit and, therefore, does not qualify as a business, and the company, therefore, does not qualify as carrying on a business. It has never been alleged, in respect of this appeal, that the turbine is incapable of being a commercial success. Hence, the Appellant was not put to disproving this.
[14] I should perhaps mention at this point that Dr. Sen in giving his evidence, stated that he had, at some time past, written two monographs of a scientific nature, which sold -- although not in large numbers -- to libraries, scientists and others interested in the subject matter of them. The company maintains stocks of these monographs available to be purchased and it advertises their availability. Dr. Sen, I understood, relied heavily on these facts to support the proposition that the company is a company carrying on business. However, the sales of the monographs at best, it seems, were sparse, and even those few sales were in the early 1990s. None have been sold since 1994. I do not consider this to be evidence of a commercial activity and, certainly not of one having a reasonable expectation of profit, or otherwise satisfying the requirements of carrying on a business. If this company ever makes any money, it will not be from these monographs but from the "Momentum Turbine".
[15] The Respondent relied in argument on the decision of this Court in Knight v. M.N.R., 93 DTC 1255. In that case, the Appellant spent a great deal of time and energy, and incurred losses aggregating somewhat more than $120,000, over three taxation years in developing a computer controlled machine tool which he hoped to manufacture and sell. He sought to deduct these losses in the computation of his income. His appeal to this Court from the disallowance of these losses was unsuccessful on the basis that, in the period between 1986 and 1988, he did not have a business, but was simply developing a product which he would later manufacture. He would have a business only after he had succeeded in creating the product. His outlays, it was held, were to develop a capital asset.
[16] This case, on the other hand, is not one in which the Appellant proposes to become a manufacturer or a seller of "Momentum Turbines". It is a case in which the Appellant is developing and refining a concept which will ultimately lead, it is hoped, to a marketable patent of invention which will be sold.
[17] In M.N.R. v. H.J. Freud [1968] C.T.C. 438, the taxpayer expended funds to develop the concept of a small personal sports car, and he built a prototype of it. He endeavoured to interest potential manufacturers in purchasing the concept from him so that they could manufacture it themselves. The enterprise did not succeed, and the Appellant claimed to have business losses to set off against his professional earnings as a lawyer. On appeal to the Supreme Court of Canada, that Court, unanimously, characterized the project as an adventure in the nature of trade and held that it was, therefore, within the definition of a business as it then appeared in section 139 of the Act. In giving the reasons of the Court, Pigeon J. said, at pages 440-41:
It must also be noted that the Income Tax Act defines business so as to include "an adventure or concern in the nature of trade". (Section 139 (1)(e)). By virtue of this definition, a single operation is to be considered as a business although it is an isolated venture entirely unconnected with the taxpayer's profession or occupation. This consequence of the definition has been recognized and given effect to in many cases but I will refer only to one of them namely McIntosh v M.N.R, [1958] S.C.R. 119; [1958] C.T.C. 18, in which it was held that a single venture of speculation in land gave rise to taxable income when profit was obtained as a result of an acquisition made with a view to a profit on the resale.
After quoting from Kerwin C.J. in McIntosh, Pigeon J. then went on:
Such being the principles to be applied in cases when a profit is obtained, the same rules must be followed when a loss is suffered. Fairness to the taxpayers requires us to be very careful to avoid allowing profits to be taxed as income but losses treated as on account of capital and therefore not deductible from income when the situation is essentially the same.
In the present case, appellant does not deny that the venture in itself was an adventure in the nature of trade so that if respondent and his friends had embarked upon it in their own names, the loss would be deductible.
[18] In my view the Appellant in this case, like Freud, is engaged in an adventure in the nature of trade. The definition of "business", as it now appears in subsection 248(1) of the Act is:
"Business" includes a profession, calling, trade, manufacture or undertaking of any kind whatever and, except for the purposes of paragraph 18(2(c), section 54.2, subsection 95(1) and paragraph 110.6(14)(f), an adventure or concern in the nature of trade but does not include an office or employment;
[19] I see no principled distinction between the development of the "Momentum Turbine" by this Appellant and the development of the concept of a small personal sports car by Mr. Freud. In both cases it is an adventure in the nature of trade, and in both cases it is therefore within the definition of the word "business" in the Act. This conclusion, in my view, is reinforced by the decision of the Supreme Court of Canada in J. Friesen v. Canada [1995] 2 C.T.C. 369 and, in particular, in the reasons for judgment of Major J., at pages 374 to 376.
[20] This conclusion does not, however, fully answer the question whether the Appellant, in 1998, was "carrying on a business". Not every person who engages in an adventure in the nature of trade can be said to be carrying on a business. It was held by President Jackett, as he then was, of the Exchequer Court, in Tara Exploration and Development Company Limited v. M.N.R., [1970] C.T.C. 557, that a purchase and the subsequent resale of mining shares in Canada by a company incorporated in Canada, but carrying on all of its other business in Ireland, did not have the result that the Appellant was carrying on business in Canada. In reaching this conclusion, President Jackett said at page 567:
With great doubt as to the correctness of my conclusion, I am of opinion that Section 139(1)(e) does not operate to make a non-resident person subject to Canadian income tax in respect of a profit from an adventure that otherwise does not amount to, and is not part of, a "business". With considerable hesitation, I have concluded that the better view is that the words "carried on" are not words that can aptly be used with the word "adventure". To carry on something involves continuity of time or operations such as is involved in the ordinary sense of a "business". An adventure is an isolated happening. One has an adventure as opposed to carrying on a business.
[21] It is clear that the adventure in the nature of trade in which Tara was engaged was a far different one from that of Freud or of the Appellant before me. President Jackett's self-expressed great doubt and hesitation may, perhaps, result from the obvious fact that there are adventures in the nature of trade that may have widely different characteristics. I have no doubt that he was correct in his conclusion in respect of an adventure of the type before him, which is to say the sale and resale of a commodity, be it shares, land or any other speculative commodity, with no activity in between.
[22] In contradistinction to that, the adventures carried on in Freud and in this case have the degree of continuity which President Jackett found to be lacking in the Tara case. They have continuity of both time and operations.
[23] In my view, the adventure in the nature of trade which I am called on to consider here does amount to the carrying on of a business. I am reinforced in this conclusion by several additional considerations. First, the proceeds of sale of the patent, assuming that the development of it is a success and it is sold as Dr. Sen anticipates for a large sum of money, will fall to be taxed as income from an adventure in the nature of trade. That seems to me to be unavoidable, in the light of the Supreme Court's decision in Freud. Secondly, Parliament, in the most recent manifestation of the definition of "business" in subsection 248(1) of the Act, has been at some pains to exclude adventures in the nature of trade from the definition of "business" in respect of certain specified provisions of the Act, none of which are relevant to the present case. If it had been Parliament's intention to deny inventors access to deductions for scientific research and experimental development and ITCs, it could easily have added subsection 37(1) to that short list of exclusions.
[24] Finally, to conclude that this company, which the Minister admits is engaged in research and development, and whose enterprise I have found to be an adventure in the nature of trade, is foreclosed from any access to scientific research and experimental development deductions and ITCs on this narrow basis, would be contrary to the often repeated instructions of the Supreme Court of Canada that statutory ambiguity must be resolved in a way that will achieve the purpose of the enactment. The purpose of the enactment is clearly to encourage scientific discovery, and invention through research and development. A narrow interpretation of the expression "carrying on business" would certainly not promote the desired effect.
[25] In my view, the Minister in this case was mesmerized by the many years during which this company has expended money for research and development with no revenues to show for it, and has concluded that this string of unbroken losses spelled no reasonable expectation of profit.
[26] There are, of course, scores of cases binding upon me which hold that the existence of a business requires that there be a reasonable expectation of profit. In many cases a long series of losses has been determinative of the absence of a reasonable expectation of profit. I know of no case, however, where this doctrine has been applied to a business which consists of an adventure in the nature of trade. I do not exclude the possibility that what might otherwise be an adventure in the nature of trade, and so a business, may someday, be held not to be because it is so forlorn that no reasonable expectation of it succeeding could be harboured.
[27] Adventures in the nature of trade, however, are speculative by their nature. They often involve great risk, with the prospect of enormous reward. This has been seen over and over again throughout history, and in spectacular numbers in recent years. We are told by the Federal Court of Appeal in The Queen v. Tonn,[2] that the Court should not be quick to second guess the wisdom of business judgment with the knowledge of hindsight. Even more so, it seems to me the Court cannot, absent the most compelling evidence, foretell the failure of invention. Certainly, it would take more than an absence of revenues during the developmental phase in a case such as this, where revenues can only be realized at the end of the adventure, to reach that conclusion.
[28] In the result, therefore, I conclude that the Appellant was carrying on a business in the taxation year 1998. The appeal is allowed with costs and the assessment referred back to the Minister for reconsideration and reassessment on the basis that the Appellant is entitled to the ITC claimed.
Signed at Ottawa, Canada, this 27th day of September, 2000.
"E.A. Bowie"
J.T.C.C.