BETWEEN:
and
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Appeals heard on September 23, and October 3, 2005,
at Montreal, Québec.
Before: The Honourable Justice Louise Lamarre Proulx
Appearances:
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JUDGMENT
The appeals from the assessments made under the Income Tax Act for the 1993 to 1997 taxation years are dismissed, with costs, in accordance with the attached reasons for judgment.
Signed at Ottawa, Canada, this 7th day of February 2006.
BETWEEN:
VLADIMIR STEPANOFF,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
[1] These are appeals for the 1993 to the 1997 taxation years. However, the issues raised concern three years, that is, the 1995 to the 1997 taxation years.
First issue, year 1995: whether an amount received is in the nature of fees or royalties or in the nature of proceeds of disposition.
[2] On May 24, 1991, the Appellant operating as CyberPlan, Enrg. ("CyberPlan"), entered into a licensing agreement with Raconix Corporation ("Raconix"), (Exhibit R-2). During the 1993 taxation year, the Appellant received $331,821 from Raconix. The Appellant did not report this amount in his 1993 tax return.
[3] The assessment for the year 1995 was made in accordance with an Adjustment Request for the years 1993 and 1995, made by the Appellant in 1998 (Tab 14 of Exhibit R-1). The pertinent part reads as follows:
Adjustment Request
...
I respectfully request that I am allowed to adjust my 1993 Tax Return to remove the amount in question. Advances on Royalties of $331,821.00, from Income, and to book this amount as Income in my 1995 Tax Year. I also request that the interest I have paid to date for the 1993 tax year be credited to my account.
[4] The Minister adjusted the Appellant's taxable income for his 1993 and 1995 taxation years by deducting the amount of $331,821 from the Appellant's taxable income for the 1993 taxation year, and including it in the 1995 taxation year.
[5] Now, the Appellant claims that this amount should be treated as a capital amount and not as an income amount. The Appellant submitted that the said amount had been paid for the sale of computer software and related trade secrets, know how and business method assets to Raconix. By entering into the licensing agreement, whereby he granted a 99-year exclusive license to Raconix (pursuant to Clause 4.01), that was tantamount to a sale of these products.
[6] Clause 5 describes the advances on the license fees and the license fees to be paid by Raconix to the Appellant. The licence fees were to be paid on a monthly basis. The relevant clauses are:
5.01 Advances to CyberPlan:Raconix agrees to pay the advances described in Schedule "A" to CyberPlan upon satisfaction of the conditions to each such payment set out in Schedule "A". Each such payment is an advance against, and shall be credited against, the first payments of fees to be paid by Raconix to CyberPlan pursuant this agreement. No payments shall be made to CyberPlan under sections 3.06, 5.02 and 5.03 until such time as all advances have been utilized and applied.
5.02 License Fees: Raconix agrees to pay CyberPlan a fee equal to the higher of 50% of the Gross Licensing Fees collected by Raconix and the Minimum Fees. The payment of such fee to CyberPlan shall be made monthly. On or before the 15th day of each calendar month, Raconix shall provide CyberPlan with a statement indicating the Gross Licensing Fees received by Raconix during the preceding month; which statement shall be accompanied by payment of the fee owing by Raconix to CyberPlan thereon. For the purpose of this Agreement, "Gross Licensing Fees" means all fees collected by Raconix from Customers in exchange for granting such Customers any one or more licences to use any CyberPlan Software. Gross Licensing Fees shall include all fees collected by Raconix from Customers who allow CyberPlan Software to be Beta Tested at their premises. The term "Gross Licensing Fees" shall not include, or there shall be deducted from Gross Licensing Fees, (as the case may be) the following:
...
5.04 Minimum Fees: Raconix shall be free to charge such fees as it wishes to its Customers in exchange for granting such Customers any one or more licences to use any CyberPlan Software. The parties anticipate that the fees charged for licences will be reduced over time as upmarket demand for the CyberPlan Software is satisfied. CyberPlan shall be paid a minimum fee (the "Minimum Fee") by Raconix in connection with licences granted by Raconix to its Customers as follows:
(a) Initially, the Minimum Fee shall be calculated in accordance with Schedule "C". These Minimum Fees have been fixed at 25% of the estimated market value of the licences being granted.
(b) At any time and from time to time after Raconix begins marketing any CyberPlan Software, Raconix may request a review of the Minimum Fee for such CyberPlan Software. Following any such request, the parties shall review the Minimum Fee for such CyberPlan Software with a view to fixing the Minimum Fee at 25% of the market value of the licences being granted. ...
[7] Clause 4.02 outlines what events would be considered a default under the license agreement, including the non-payment of the license fees or the advances on the license fees. It reads as follows:
4.02 Default: It shall be an event of default hereunder (the "Event of Default") if a party hereto (the "Defaulting Party"):
...
(d) if Raconix has not paid to CyberPlan pursuant to this Agreement in licence fees and advances on license fees (the "Aggregate Payments") at least the following minimum amounts (the "Minimum Amount") for the years indicated;
(i) in the period ("Year 1") from the execution of this Agreement until the later of:
(A) the first anniversary of the date of this Agreement, and
(B) the date on which all of the conditions, Deliveries and Acceptances under Schedule "A" have been completed,
the amount of $450,000;
(ii) in the year following Year 1 ("Year 2"), the amount of $675,000;
(iii) in any year following Year 2, an amount equal to the lesser of:
(A) 60% of the Aggregate Payments for the previous year, or
(B) 60% of the Aggregate Payments for the year in question according to a budget for that year which has been prepared by Raconix and which Vladimir Stepanoff will have had an opportunity to review in detail;
provided that the amount by which the Aggregate Payments in Year 2 or any subsequent year exceeds the Minimum Amount for such year shall be added to and included in the Aggregate Payments for the next following year in order to determine whether the Minimum Amount has been paid in such next following year. Raconix shall be entitled to make a voluntary payment to CyberPlan in any year and such voluntary payment shall be added to and included in the Aggregate Payments for such year.
[8] According to Clause 4.02 therefore, the Minimum Amount due to CyberPlan under the agreement for Year 1 was $450,000. In CyberPlan's balance sheet, which appears at Tab 15 of Exhibit R-1, the $331,821 at issue is listed as "Advances" under the heading "Royalties" and is shown as being a part of the minimum fee of $450,000.
[9] The Appellant referred to Interpretation Bulletin IT-386 R, entitled "Eligible Capital Amounts", and more particularly to the example given at paragraph 2(d) of that Bulletin. This paragraph is to the effect that if there were an outright sale of knowledge, the proceeds of that sale would be proceeds of disposition and on capital account.
[10] A summary of the treatment of payments with respect to royalties can be found in Murray v. Imperial Chemical Industries Ltd., [1967] 1 All. E.R. 369, where Lord Denning, MR stated at page 983:
... it seems to me fairly clear that if and in so far as a man disposes of patent rights outright (viz by an assignment of his patent, or by the grant of an exclusive licence) and receives in return royalties calculated by reference to the actual user, the royalties are clearly revenue receipts. If and in so far as he disposes of them for annual payments over the period, which can fairly be regarded as compensation for the user during the period, then those also are revenue receipts (such as the payment of £ 2,500 a year over ten years in CIR v British Salmson Aero Engines Ltd, [1938] 3 All ER 283, and, of course, the royalties of £ 10,000 a year in the present case). If and in so far as he disposes of the patent rights outright for a lump sum, which is arrived at by reference to some anticipated quantum of user, it will normally be income in the hands of the recipient (see the judgment of Lord Greene, MR, in Nethersole v Withers (Inspector of Taxes), [1946] 1 All ER 711, approved by Viscount Simon in the House of Lords, [1948] 1 All ER 400). If and in so far, however, as he disposes of them outright for a lump sum which has no reference to anticipated user, it will normally be capital (such as the payment of £ 25,000 in the British Salmson case). It is different when a man does not dispose of his patent rights, but retains them and grants a non-exclusive licence. He does not then dispose of a capital asset. He retains the asset and he uses it to bring in money for him. A lump sum may in those cases be a revenue receipt (see Rustproof Metal Window Co, Ltd v CIR, per Lord Greene, MR, [1947] 2 All ER 454, who emphasized that it was a non-exclusive licence there). Similarly a lump sum for "know-how" may be a revenue receipt. The capital asset remains with the owner. All he does is to put it to use.
[11] The clauses on payments to be made to the Appellant described license fees and advances thereon and were arrived at by reference to a percentage of the fees collected by Raconix to the users. What matters is the mode of calculation of the payment. Where the payment is based on some quantum of the use of the licensed property, the payment is in the nature of an income payment. If the payment is determined irrespective of the use of the licensed property it may well be a payment in the nature of a capital payment. Here, the payment is based on the use of the licensed property as we have seen in paragraphs 8, 9 and 10 of these reasons. It is therefore a payment in the nature of an income payment.
[12] To conclude, the amount received is in the nature of income and not of capital.
Second point at issue: exchange of shares in the year 1996.
[13] For the year 1996, the issue is the adjusted cost base (the "ACB") of the shares of Transformation Processing Inc. ("TPI") (Ontario), which was determined by the Minister to be $0, and the fair market value of the shares of TPI U.S., which was determined by the Minister to be $0.67 (Canadian) per share.
[14] The facts relied on by the Minister, as stated in the Reply to the Notice of Appeal (the "Reply"), are as follows:
a) TPI Ontario was incorporated in April, 1996 pursuant to the Canada Business Corporations Act;
b) The Appellant was one of the three founding shareholders and held 1.6 million shares, representing 33% of the issued and outstanding shares of TPI Ontario;
c) The Appellant's adjusted cost base for the shares of TPI Ontario was $0;
d) On August 20, 1996, all of the issued and outstanding shares of TPI Ontario were exchanged by the shareholders for 5,910,050 common shares of Samuel-Hamman Graphix-Nevada;
e) The shares of Samuel-Hamman Graphix-Nevada, a corporation incorporated according to the laws of Nevada, were at all materials times publicly traded on the NASDAQ exchange;
f) Following the share exchange, the Appellant held 29% of the common shares of Samuel-Hamman Graphix-Nevada;
g) In March, 1997, Samuel-Hamman Graphix-Nevada changed its corporate name to Transformation Processing Inc. (hereinafter referred to as "TPI" (U.S.)");
h) In February, 1998, TPI" (U.S.) amalgamated with TPI Ontario;
i) As at August 21, 1996, the fair market value of each of the common shares of Samuel-Hamman Graphix-Nevada held by the Appellant was $.67CDN;
j) The foreign exchange rate for U.S. dollars as at August 21, 1996 was 1.3718;
k) The share exchange transaction of August 20, 1996 resulted in a capital gain to the Appellant on the deemed disposition of his shares of TPI Ontario in the amount of $1,146,574 resulting in a taxable capital gain of $859,931.00.
[15] The Appellant admitted paragraphs a), b), d), g), h), and j).
[16] The Appellant included in his Book of Documents, at Tab 34, the analysis of an agent of the Minister in the division of the Business Equity Valuations. Her conclusion was:
CONCLUSION
Based on the best information available to us, we feel a value in the range of $.67 to .92 CDN per share is a reasonable basis upon which to settle the file. Please refer to the attached schedule that shows the effect of the exchange rate and discount applied due to the restricted status of the shares.
...
[17] This was not presented by the Respondent as an expert report. It was a conclusion based on facts. The Appellant did not provide expert testimony on some factual evidence to contradict this evidence. In fact, he used the same amount of $0.67 per share as the ACB of the TPI U.S. shares when, two years later, he disposed of them and claimed a capital loss. At Tab 17 of his Book of Documents (Exhibit A-1), the Appellant included a copy of the market price of the shares apparently obtained online from a website called "Yahoo Finance". While the Appellant's online search request was from July 11, 1996 to August 31, 2004, he chose not to reproduce the results from before November 9, 1998.
[18] Respecting the ACB of the shares of TPI Ontario, the Appellant submitted that he had transferred to TPI (Ontario), the software that he had developed. He referred to a document entitled "Valuation Report" (Tab 10 of Exhibit A-1), page 9 of which stated that the value of the Computer Program is determined to be $12,600,000 U.S. as at July 1, 1996. Therefore, the ACB of the TPI Ontario shares should be higher than zero.
[19] However, the financial statements of TPI for the period ended July 31, 1996, (Tab 24 of Exhibit R-1) and those from August 1, 1996 to August 19, 1996, (Tab 25 of Exhibit R-1), showed "Fixed Assets, Property and Equipment" and "other assets" in the amount of only $368 and $2,662, respectively.
[20] Further, the Appellant could not show where in his own tax returns the sale of the software in the amount of more than one million dollar would have been inscribed.
[21] This matter is essentially a question of fact. While the Appellant claimed that he provided TPI (Ontario) with software in exchange for those shares, resulting in an increased ACB, as mentioned before, he failed to support this claim. As proposed by the Minister, I therefore find that the ACB of the TPI (Ontario) shares was $0. Those shares were exchanged in August 1996 for common shares of Samuel-Hamman Graphix-Nevada whose market value was $0.67. The Appellant did not adduce any acceptable evidence to the contrary.
Third issue: interest received in the year 1997
[22] For the year 1997, the Appellant was assessed to include as income interest in the amount of $142,687.21 that he received from Transcon S.A. Consultoria Técnica ("Transcon"), a Brazilian company.
[23] The facts relied on by the Minister are described as follows in the Reply:
a) The Appellant rendered services to Transcon S.A. − Consultoria Técnica ("Transcon") during the period June, 1978 to April, 1979;
b) As of 1979, Transcon owed the Appellant the sum of $44,493.82CDN ($31,320.44USD);
c) The Appellant entered Canada on January 28, 1986, at which time the foreign exchange rate of U.S. dollars was 1.4206;
d) In 1997, the Appellant received $186,047CDN from Transcon;
e) The average foreign exchange rate of US dollars in 1997 was 1.3844;
f) At the 1997 average foreign exchange rate, the original amount owing from Transcon to the Appellant was $43,360.02CDN;
g) The payment received by the Appellant included the original amount owing of $43,360.02CDN and interest income in the amount of $142,687.21CDN; and
h) The Appellant did not report any of the amount received from Transcon in his tax return for the 1997 taxation year.
[24] The Appellant's position, as per his Notice of Appeal, is the following:
I was a non-resident during the period 1975 through 1986. During 1978-79 I worked for TRANSCON, S.A., of Rio De Janeiro, Brazil and was owed Cad$43,428. Because my client was unable to pay at that time my fees were converted to a debt note at 8% per annum. I unexpectedly received Cad$157,836 in 1997, representing principal and interest. Correspondence with my client shows the constant delays leading to my belief that I would never be paid and explains why I did not report the interest annually after resuming residence in Canada.
[25] The Appellant argued that he should not be assessed for interest income earned in the previous years.
[26] The Appellant rendered services to Transcon from 1975 to 1980. Transcon owed the Appellant the sum of $44,493.82 for those services. In 1997, the Appellant received $186,047.00 from Transcon which represented the original amount of $43,360.02 as well as interest in the amount of $142,687.21. That interest was not reported in any previous years by the Appellant.
[27] Paragraph 12(1)(c) of the Act reads as follows :
Income inclusions
12(1) There shall be included in computing the income of a taxpayer for a taxation year as income from a business or property such of the following amounts as are applicable:
...
Interest
(c) subject to subsections (3) and (4.1), any amount received or receivable by the taxpayer in the year (depending on the method regularly followed by the taxpayer in computing the taxpayer's income) as, on account of, in lieu of payment of or in satisfaction of, interest to the extent that the interest was not included in computing the taxpayer's income for a preceding taxation year;
[28] I refer to the decision of the Federal Court of Appeal in Shaw v. R., [1993] 2 F.C. 190, at paragraphs 17 and 18:
17 The sum paid to Mr. Shaw as compensation, therefore, was payable because of the expropriation of his land, but that is not true of the "interest" payment. The expropriation resulted in the government owing Mr. Shaw a capital sum. The interest on the capital sum, however, was due because the government did not immediately pay that capital sum; it was not owing for "property taken" by an expropriation. Accordingly, the interest was not paid as damages or compensation for expropriation.
18 Unlike the various types of damages, the amount of interest paid to Mr. Shaw was not merged in the total compensation paid; it was calculated as a discrete sum after the total for compensation was ascertained with the agreement of both parties to the expropriation. There is no difficulty here to determine "rationally" what constitutes interest rather than capital. (See Marceau J.A. in Sani Sport Inc.) It should also be noted that the Income Tax Act stipulates that "[w]here a payment under a contract or other arrangement [which] can reasonably be regarded as being in part a payment of interest ... and in part a payment of a capital nature, the part of the payment that can be reasonably be regarded as a payment of interest ... shall ... be included in computing the recipient's income from property" (subsection 16(1) [as am. by S.C. 1980-81-82-83, c. 140, s. 10]). Therefore, the interest paid to James Shaw should be distinguished from the capital sum paid to him as proceeds of disposition of his expropriated property (Wride v. M.N.R., 86-257 (IT), Bonner J., not reported, January 28, 1988 (T.C.C.); Wideman (B) v. MNR, [1983] CTC 2589 (T.C.C.); Hallman & Sable Ltd. v. M.N.R. (1969), 69 DTC 551 (T.A.B.); c.f. Elliott (RA) v. MNR, [1984] CTC 2373 (T.C.C.)).
[29] Likewise, the payment of interest to the Appellant appears as being a payment for a settlement purpose. The interest was not paid on a yearly basis although it may, in the end, have been calculated in this manner. It was paid all at once in the year 1997 and was not reported in previous years. Therefore, pursuant to the clear wording of paragraph 12(1)(c) of the Act, the interest must be included in the year of receipt.
[30] The appeals for the years 1993 and 1994, having no cause of action, are dismissed. The appeals for the years 1995, 1996 and 1997 are dismissed, with costs, for the above reasons.
Signed at Ottawa, Canada, this 7th day of February 2006.
"Louise Lamarre Proulx"
Lamarre Proulx J.
COURT FILE NO.: 2003-1207(IT)G
STYLE OF CAUSE: VLADIMIR STEPANOFF v. HER MAJESTY THE QUEEN
PLACE OF HEARING: Montreal, Québec
DATES OF HEARING: September 23, 2005
October 3, 2005
REASONS FOR JUDGMENT BY: The Hon. Justice Louise Lamarre Proulx
DATE OF JUDGMENT: February 7, 2006
APPEARANCES:
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For the Appellant: |
The Appellant himself |
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Counsel for the Respondent: |
George Boyd Aitken |
COUNSEL OF RECORD:
Firm:
For the Respondent: John H. Sims, Q.C.
Deputy Attorney General of Canada
Ottawa, Canada