Date: 19991214
Dockets: 96-3190-IT-G; 96-3191-IT-G; 96-3810-IT-G; 96-3811-IT-G; 96-3812-IT-G; 96-3813-IT-G; 96-3814-IT-G; 96-3815-IT-G
BETWEEN:
LOUIS DROUIN, NABIL MANSOUR, CURTIS KUNKEL, WILLIAM WHEATON,
Appellants,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
Lamarre Proulx, J.T.C.C.
[1] These appeals were heard on common evidence. The question at issue is whether the Appellants are entitled, for their 1986 taxation year, to deduct non capital losses from, and claim an investment tax credit ("ITC") for, the scientific research and experimental development ("R & D") activities allegedly carried on by a partnership of which they were limited partners. More specifically, the question at issue is whether capital expenditures in the amount of $7,930,000 were indeed incurred, and if they were incurred in this amount, were they incurred for the acquisition of equipment and software for the purpose of R & D activities, within the meaning of section 2900 of the Income Tax Act Regulations (the "Regulations").
[2] The limited partnership, Alexis Limited Partnership ("ALP") was formed on January 15, 1986, under the Partnership Act of British Columbia. The nature of the business intended to be carried on by ALP was to conduct R & D activities relating to electronics and wood products industries. Its initial general partner was Solkan Research Inc. ("Solkan") which was owned 100 % by Mr. Rav Solanki. On February 20, 1986, AMC Research Corp. ("AMC"), another corporation owned by Mr. Rav Solanki, replaced Solkan as a general partner of ALP. On November 1, 1986, Mr. Robert A. Chester purchased all the shares of AMC.
[3] During the course of 1986, units of the partnership were offered at the price of $1,000 per unit. These units were financed by the investors or the limited partners to the extent of 40% by cash payment and the balance, 60% by way of loans from Alexis Holdings Limited ("AHL"), a company incorporated under the laws of Guernsey. As will be seen later, the loans were non recourse loans and no interest was paid.
[4] A person investing in 100 units of the partnership would pay as follows: cash, $40,000, promissory note, $60,000, total $100,000. In the case of the Appellant Louis Drouin, the subscription amount was of $75,000; the partnership losses claimed $60,401.25 and the ITC claimed $14,598.75. In the case of the Appellant Nabil Mansour, the subscription amount was $150,000; the partnership losses claimed $120,802.50 and the ITC claimed $29,197. For the Appellant Curtis Kunkel, the subscription amount was $100,000; the partnership losses claimed $80,535 and the ITC claimed $19,465. For the Appellant William Wheaton, the amount of the subscription was $200,000; the losses $161,070 and the ITC claimed $38,930.
[5] The Appellants stated in their Notice of Appeal that the proceeds of the 1986 issue, cash and loans, were fully expended in that year: on December 31, 1986, the partnership incurred R & D capital expenditures in the amount of $7,930,000 for the acquisition of equipment and software from an arm's length vendor, Tinbon Trading Ltd. ("Tinbon") of Kowloon, Hong Kong, pursuant to a sale and trade agreement dated February 14, 1986, originally entered into by AMC on behalf of the partnership and Ravina International Limited ("Ravina") and later assigned to Tinbon.
[6] The Respondent stated in the Reply to the Notice of Appeal that neither Ravina nor Tinbon had a history of selling and trading R & D equipment, that the major part of the purchase price was fictitious money and that there were no R & D activities. The Reply explains as follows the round journey made by the amount of $6,500,000 and the actual purchase costs of the equipment:
t) On December 31, 1986, at the closing of the First Offering, AHL electronically transferred $6.5 million from the Staten Bank Holland to AMC for the purported purpose of advancing funds to ALP pursuant to the Loan Agreement between ALP, AHL and the investors.
u) However, the electronic transfer was conditional on AMC providing a $6.5 million cheque to the Staten Bank Holland for payment of Tinbon equipment purchases. It is evidenced from the bank statements of Royal Bank and the Staten Bank Holland that there was a circularization of the $6.5 million fund from AHL to AMC to Tinbon and back to AHL on the same day. It should be noted that AHL did not advance any loans required to facilitate the research to the Partnership. The $6.5 million cheque presented at the closing of the First Offering was immediately returned back to AHE through AMC and Tinbon. Based on the bank statements from the Staten Bank Holland, AHL did not have funds in the bank.
...
v) Tin Bon issued invoices totalling $7,930,000.00 (net of subsequent credit notes) to ALP for equipment and software ordered under the Sales and Trading Agreement. The invoices were dated December 18, 1986. By a letter dated December 29, 1986 written on Ravina's letterhead, Ravina, on behalf of Tin Bon, confirmed that title to the equipment had been transferred from Tin Bon to ALP.
w) Based on the invoices ALP claimed to have incurred qualified R & D capital expenditures in the amount of $7,930,000 for the 1986 taxation year.
x) According to information obtained from Inland Revenue (U.K.) Tinbon purchased all equipment for ALP from the following companies:
Northwest Industries U.S U.S. $211,383.30
GTCO Internal Corp. U.S. $3l,420.10
Storagetek U.S. $190,422.55
Lattice Logic U.S.A. U.S. $164,335.00
Data Hardware Inc. U.S. $61,105.26
Tomo Brite Inc. U.S. $43,111.47
TOTAL $707,777.68
y) The equipment was first shipped from the suppliers to various warehouses for re-labelling before being delivered to ALP.
z) ALP, assisted by Coopers & Lybrand ("Coopers"), prepared a T661 for the 1986 taxation year which was distributed to the limited partners for filing as follows:
Investment tax credit on equipment $1,586,000.00
purchased from Tinbon
(20% x $7,930,000.00)
R & D equipment purchased $7,930,000.00
Less: I.T.C. claimed 1,586,000.00
Total 1986 R & D expenditures $6,344,000.00
Less: Total R & D expenditures claimed 5,347,711.00
claimed in 1986
Unclaimed R & D expenditures
end of 1986 $ 996,289.00
[7] Mr. Kamlesh Solanki, a computer consultant, Mr. Emile Ghattas, a certified accountant, Mr. George Franklin Shaw, a semi-retired accountant, Mr. Nabil Mansour, one of the Appellants, Mr. Tim Flessas, a business consultant and Ms. Josée Beaudry, testified on behalf of the Appellants. Mr. Paul William Lancaster, a professional engineer, and Mr. Walter Wong, auditor at Revenue Canada testified for the Respondent. Three books of documents were produced by the Appellants as Exhibit A-1. Three books were produced by the Respondent as Exhibit R-1.
[8] The documents referred to by Mr. Kamlesh Solanki during his testimony are contained in the first of the books of Exhibit A-1. This book includes Tabs 1 to 8, and Tab 36. Mr. Kamlesh Solanki is the brother of Mr. Rav Solanki. He explained that in the year 1986, he had been in the field of computers for 20 years. He was, at that time, a project manager for a corporation called Soltech Systems Inc. ("Soltech"). In Soltech, he had 25% of the shares, his brother Rav had the main part. Soltech was in the design of portable computers. Mr. Solanki stated that Soltech subcontracted a great deal. He had no idea what happened to the Soltech papers. Soltech had made a design of a compatible portable computer and had come to Philips in Montreal to develop a prototype. This is how Mr. Rav Solanki met Mr. Tim Flessas, the Appellants' expert witness. Philips manufactured the computers for Soltech that sold many of them. Mr. Solanki believed that there were 15 employees in Soltech when it began to have financial problems and in the middle of the year 1986 it could not survive.
[9] Tab 1 is an R & D agreement between the partnership and Digital Research Corporation ("DRC") dated February 24, 1986. DRC was a corporation organized by Rav Solanki. Under this agreement, DRC was appointed agent for the partnership with a mandate to hire and manage the staff, which would undertake the R & D project. The project was digital signal processing, surface mounting technology including very large scale mounting. Regarding the acquisition of assets, article 4.01 says that: "All assets required by the Agent to carry out the Program, which assets are generally described in Section 4 of Schedule A, will be purchased by the Partnership and will remain the property of the Partnership". The assets are described in general terms. Regarding the scientific personnel, Mr. Kamlesh Solanki is named with a few others as part of it.
[10] Mr. Kamlesh Solanki stated that when he left Soltech to work for DRC, he brought with him a few people to do the research. In 1986, four or five people worked at DRC. He stated that he gave his brother the specifications of the equipment he needed. When was he consulted for the first time on the purchase of equipment and software? In the early part of 1986. In 1986, he used Soltech's equipment or his own personal equipment because the equipment purchased for DRC's activities did not begin to arrive until a few months into 1987. He did not know at that time of any equipment of the make Abbot. Were any tests ordered or processed prior to purchase? To that question, he answered that he had asked his brother Rav what he needed. The software was Lattice Logic Software. He also stated that when he left DRC, in the year 1988, DRC was still active and the preliminary work had been done: a mask had been developed that was ready to go to the foundry. He left sometime in the summer or fall of 1988. The research work would have come to a halt on February 19, 1989.
[11] At Tab 36 of Exhibit A-1, is found the description of all the equipment that was purchased on December 18, 1986. There are invoices from Tinbon to ALP. The first invoice bearing number 8701 is for $850,000 and it refers to an Abbot VLSI Design and Engineering System, complete with integrated Peripherals and Software, as detailed on attached pages two and three. There is another invoice, bearing number 8702, for the same amount, with the same descriptions, except that it is detailed on pages two, three and four. A third one, bearing number 8703, has the same descriptions, except that it says "as detailed on attached" and the amount is for $750,000. Another one, bearing number 8704, is described exactly in the same manner as the preceding. It is for the same amount, except that if we look at the serial numbers in the preceding invoice, they would end with "03" and this one, they would end with "04" or "05. Invoice bearing 8708, in the amount of $630,000, invoice 8713 in the amount of $830,000 and they are all for equipment of the brand name of Abbot.
[12] At Tab 2 of Exhibit A-1 is found the description of a project prepared by a consultant for DRC.
[13] At Tab 4, there is an agreement between ALP and Datacalc Research Corporation. It is an agreement to perform research in the field of Very Large Scale Integration ("VLSI") technology for ALP. It is dated February 13, 1987 and it is for an amount of $150,000. There is no evidence of the results.
[14] At Tab 5, there is an evaluation of the proposed objectives for research and development to be made by DRC. It is dated June 17, 1987 and it is from R.H.S. Hardy and Associates. The comments were based on documents supplied by DRC. They are the same documents that appear at Tab 2 and that had been described by a consultant. The evaluation agrees with the project as described.
[15] The testimony of Mr. Ghattas was in relation to the prospectus and various financial aspects such as the certification given by a well known firm of accountants. He explained that, according to him, all papers were in proper form and substance. Mr. Ghattas commented on the documents appearing at Tabs 9 to 25 of Exhibit A-1.
[16] At Tab 9 of Exhibit A-1, is found the Offering Memorandum. It is stated in the definition of investor loan agreement, at page 3, that subscribers are granted a loan possibility of up to 60% of the subscription price. The return to investors is described at page 2: for the year ending December 31, 1986, an investment in the amount of $100,000 would incur an estimated 1986 tax saving of $64,000. Therefore, the after tax cost of the investment is $36,000. The estimated 1986 tax savings consist of an investment tax credit of $20,000 and a tax reduction of $44,000, being 55% of net eligible scientific research and experimental development expenditures amounting to 80% of $100,000. Secondary investor is defined, at page 4, as meaning Alexis Holdings Limited, a corporation subsisting under the laws of Guernsey. The manners to subscribe for units are described at pages 6 and 7. The manner followed by the Appellants was that for each unit of $1,000, a cheque for $400 payable to National Trust Company in trust and a promissory note for $600, payable on demand to Alexis Holdings Limited. At page 42, the investor loan agreement provides that the limited partner pledge the units as security for repayment of the loan and that the recourse of the Secondary Investor will be limited to realizing on the security of the units.
[17] "Research and development agreement" is defined at page 4 as the agreement dated February 24, 1986, made between the partnership and a research company. At page 17, it is stated that five corporations will act as agents for the partnership, under the research and development agreement, to hire and manage technical staff to undertake the scientific research and experimental development required for each of the five projects on behalf of the partnership. Each agreement provides for a budget of approved expenditures to cover staff salaries and the research company will receive funds from the partnership based on such budget. The partnership will purchase all assets and other services directly. At page 19, it is stated that the research companies were incorporated for the purpose of participating in the projects described in this memorandum. They presently have no assets or other resources other than arrangements with the partnership in the form of the license and research and development agreements, which are conditional upon adequate funds being raised pursuant to this offering. It is accepted by both parties that there had been no other R & D agreement than the agreement mentioned at paragraph 9 of these Reasons.
[18] At Tab 10 are the 1986 financial statements of Alexis Limited Partnership. Attached is the evaluation of the research project made by Dr. R.H.S. Hardy (T661E.1(a)) and the description of the project (T661E.(b)). It is stated on the last page numbered T661.E(d) that as of December 31, 1986, the Partnership had purchased approximately $7.9 million worth of specialized computer hardware and software. ... No expenditures of a current nature for the propagation of research and development had been incurred at that time. Research staff have been put in place in 1987 and progress has been made on the projects, as outlined in parts (a) and (b) above.
[19] At Tab 11, there is a letter from Mr. Thomas W. Calvert, Ph.D., P.Eng. He states in this letter that he is a professor at Simon Fraser University with appointments in computing science and engineering science. He knows Dr. R.H.S. Hardy, Professor of Engineering Science at Simon Fraser University and it is his opinion that Dr. Hardy is familiar with the area of research and experimental development outlined in the project description, and that he is technically qualified to give an opinion on whether the project is scientific research and experimental development.
[20] At Tab 15 is found the sales and trading agreement, made effective February 14, 1986 and executed by the parties this 16th day of December, 1986, between Ravina International Limited, subsisting under the laws of England and AMC as general partner. In Schedule A of this agreement there is the list of the equipment required for all five projects. They are the same projects described in the offering memorandum and the same equipment.
[21] At Tab 16 is the deed of assignment and release whereby on December 18, 1986 the trading agreement was assigned by Ravina to Tinbon.
[22] At Tab 17 is the loan agreement between AHL and AMC, dated December 31, 1986. AHL agreed to lend money to the extent of $90 million. Schedule A of the loan agreement shows the budgets of the five projects with the five R & D corporations.
[23] Article 2.3 of the loan agreement reads as follows: ... The Lender will make an Advance to the Partnership on the Closing Date under the Discretionary Credit in the amount of $500,000, either by making and delivering to the partnership a promissory note in like amount payable at any time after January 15, 1987 on demand to the Lender by the Partnership or by advancing cash in the amount of $500,000 to the Partnership on December 31, 1986.
[24] At Tab 18 is a promissory note given by ALP to AHL in the amount of $500,000. It is dated December 31, 1986.
[25] At Tab 19 is the loan agreement for the limited partners. It is dated for reference December 31, 1986. It is between AHL, and the Limited Partner and AMC. At Article 2.4, there is an Election to Accrue Interest: [... the investor may elect not to pay the interest due on December 31, 1987 or on any December 31 thereafter but rather to have interest accrue until, and pay interest on, the date the Loan is otherwise due hereunder.] Article 2.5 concerns the Repayment of Loan: [The investor will repay the Loan and all accrued interest thereunder on the earlier of: (a) December 31, 1996; (b) a declaration by the Lender pursuant to paragraph 8.2(a); and (c) exercise by the Investor of his option to require the lender to purchase some or all of his Units under the Option Agreement, except that if the option is exercized for a portion of such Units, the Investor will repay then an amount equal to 60 % of the subscription price of the Units in respect of which the said option is exercized.] Article 8.3 stipulates clearly that it is a non recourse loan on any property of the investors except on the investors' units. It has been admitted that no interest has ever been paid on those so-called loans.
[26] At Tab 26, there is a cheque made to the Staten Bank Holland in the amount of $6.5 million. It is dated December 31, 1986 and it says: "For Tinbon equipment purchase". It is issued from The Royal Bank of Canada, Main Branch, Royal Bank Plaza in Toronto. Although there is only a signature without the name of the corporation, the signature is the same as the one appearing on the various agreements signed by the president of ALP and AMC, that is Mr. Robert Chester.
[27] At Tab 27 there is a letter from The Royal Bank of Canada, Vancouver, dated January 15, 1987 addressed to the Toronto branch. This letter says: "... [... The wire transfer from Staten Bank Holland, was originated on December 31, 1986, in the amount of $6,500,000.00. ... Mr. Robert Chester, President of AMC Research Corp., was notified of the wire on December 31, 1986, and was able to draw a cheque against the account payable to Tinbon Trading Co. on that day ...].
[28] Mr. George Franklin Shaw is a limited partner. He testified that in August 1987, he went unannounced to the office of ALP at the Discovery Park, in Burnaby, B.C. Discovery Park, is a prestigious government building at the disposal of some industries. There were signs identifying the location of ALP's office. He saw the manager, Mr. Chester. There were 10 to 15 computer stations. He asked questions and received satisfactory answers. Everything appeared to him as state-of-the-art equipment. Besides Mr. Chester, there were two other people working and wearing white smocks. He stayed there for about one hour and 45 minutes. Pursuant to this visit, he acquired some more units in December 1987. He admitted in cross-examination that he did not know much about electronic equipment although he is interested in electronic research.
[29] Mr. Tim Flessas was presented as an expert witness who also had actual dealings with the facts of this case. He is a business consultant residing in Athens, Greece. He has a Bachelor of Aeronautical Engineering. At Philips, he was a director of logistics or procurement. He was involved in the deal made by Soltech with Philips regarding the 400 to 500 personal computers manufactured by Philips for Soltech. He stated that he believed that Abbot was an electronic company situated in California.
[30] On December 23, 1986, Mr. Flessas signed a letter (Tab 34) to AMC confirming the report (Tab 33) that he had signed in June 1986. The report is entitled Technical Report on Digital Signal Processing ("DSP") and Surface Mount Technology ("SMT") including Very Large Scale Integration ("VLSI"), prepared for DRC and ALP. The list of equipment appearing in this report is identical to the one appearing at Tab 15 of Exhibit A-1, the sales and trading agreement. It is also identical to the list of equipment appearing in the R & D agreement at Tab 1 of Exhibit A-1. The description of the project is also similar to the description found in these two documents.
[31] In cross-examination, Mr. Flessas was asked how he proceeded for the purchase of the equipment at Philips. He stated that the engineers would tell him: "I need those capabilities". Mr. Flessas would contact various companies and was involved in the selection or what the equipment was able to do. Engineers would make the test run, they would make sure that the equipment did the job. They used the ordinary precautions. The engineers will make sure that the performance is going to be what they want it to be. The choice of the software would belong to the engineers involved with the testing and sorting of the equipment to ensure the compatibility of the hardware and the software.
[32] Mr. Paul Lancaster was the Respondent's expert in this matter. He is a professional engineer who has since 1963 worked in the field of broadcast and telecommunications. He has worked as the head of design and manufacture of various telecommunications undertakings. His report was produced as Exhibit R-3. He explained that his first visit to ALP in Burnaby was on June 27, 1988. At that time, he met Mr. Rav Solanki. Although this was an announced visit, the numerous work stations, six at best, were not working. The software did not seem to work as there were integration difficulties. Mr. Lancaster said that he did not see any libraries or books. He asked that some documentation be sent to him later, and although a written request was made to this effect, no documentation was ever received. There were no copies of their benchmark expectations. The expectation associated with any product development cycle was completely absent from all the projects reviewed. Abbot was and still is a new name for him. He does not know anything about this corporation. There were just no reports to refer to, there was no R & D done.
[33] The conclusions of his report are as follows:
CONCLUSIONS ON ELIGIBILITY
The evidence of normal systematic record keeping and documentation associated with any new product development cycle is completely absent from all the projects reviewed.
The capability of the management to organize and provide facilities and necessary skills in order to address these projects is inadequate. Over the period 1986 to 1988 I was unable to identify any documented or demonstrated proof of novel process, concept or technique normally associated with an R & D environment.
The costs for the equipment purchased appears excessive when the delivery and activation dates are taken into account. The use of the clean room, judging from its current condition seems highly unlikely.
I judge that all the projects reviewed, fail to meet the requirements of Section 37, regulation 2900 of the Income Tax Act.
[34] Mr. Lancaster explained the normal practice followed in a matter of purchasing equipment. First there is a need to survey the suppliers for hardware and software. Then requirements should be indicated to the suppliers and bids should be requested. Then a demonstration should occur to establish that the equipment can do what it is supposed to do. If the hardware is going to be customized, the specifications should be in writing.
[35] Mr. Walter Wong, auditor at the Tax Avoidance Section, was the last witness. Exhibit R-1 contains 100 tabs. At Tab 22 is an extensive report prepared by Mr. Wong on the facts of this appeal. The report is dated March 2, 1995. The problems encountered by Revenue Canada are stated at the beginning of this report. It says: The Partnership had no identifiable R & D work done. The R & D expenditures were inflated for tax purposes ....
[36] At paragraph 11 of his report, Mr. Wong states that: On December 31, 1986,... AHL electronically transferred $6.5 million from the Staten Bank Holland to AMC. ... conditional on AMC providing a $6.5 million cheque to the Staten Bank Holland for payment of Tinbon equipment purchases.... there was a circularization of the $6.5 million fund from AHL to AMC to Tinbon and back to AHL on the same day. At page 25: the bank statements from the Staten Bank Holland show that AHL did not have funds in the bank. All these assertions are based on documents produced in R-1.
[37] At the bottom of page 13 and at page 14 of his report: Our Science Advisors did not conclude that the projects were unfeasible. Rather, in their review of the proposed projects, no identifiable R & D activities could be traced to support existence of an ongoing research effort. There were not suitably qualified R & D personnel in ALP with experience in the field who were able to undertake work of the magnitude proposed. The equipment acquired for the R & D projects was incompatible and therefore, not operational ....
[38] At page 18: The scientific research and development activity of ALP was reviewed by our in-house science advisor, Dr. Morley Lipsett. In his opinion, no evidence of a systematic investigation or anything existed. The project descriptions were only hypothetical. There was no evidence of a systematic review of potential research equipment. There was also insufficient evidence of suitably qualified R & D personnel in the company with experience in the field who were able to undertake work of the magnitude proposed. Dr. Lipsett further stated in his report that the capital equipment seemed redundant and in any event, destined for use in routine and custom engineering.
[39] Mr. Wong also stated in his report that Mr. T. C. Flessas did not inspect the equipment before rendering his opinion on the reasonableness of the acquisition value of the equipment. The equipment was not available for inspection until January 14, 1987. Mr. Flessas expressed his opinion only on the nature of the proposed research program and not a review of the actual R & D program. The feasibility of the proposed research program is not disputed. What is disputed is the actual R & D efforts that characterize the equipment purchased as qualified R & D expenditures and the R & D that occurred.
[40] Mr. Wong indicated that a value of $701,777.68 had been attributed to the equipment by Inland Revenue. At tabs 60 to 62, 65 and 66 are the reports or notes made by Inland Revenue, Special Office London 1, on the value of the electronic equipment purchased. More particularly, a report at tab 61 at paragraph 10, states that: A statement of money received and paid up to 31 March 1988 shows purchases totalling US $596,412.84 whereas the purchases schedule shows a total of US $6,111,552.12. Mr. Wong inferred from all the facts of this case that only an amount of $1,345,000 had been paid by ALP to Tinbon (Tab 22 of the Exhibit R-1, Schedule 10).
[41] Other auditors at Revenue Canada made the following comments (Tabs 8 and 9): The capital equipment claimed was not purchased according to commonly accepted standards for diligent assurance of proper functioning. Tinbon is not an household name in computer, nor is Abbot. The equipment was picked from different suppliers without performing the necessary benchmark testing. Accordingly, ALP ended up with incompatible equipment. Normal practice for $7.9 million worth of equipment would include a detailed review of what is available and from whom, prior to a directed procurement from an unknown supplier. It is unlikely that the equipment, were it new when delivered, and it is not clear that it was, was worth more than a fraction of the claimed amounts. Technical material provided appears to be extracted from unknown sources and does not demonstrate that work was carried out to meet the criteria.
[42] At Tab 95 of Exhibit R-1, is a letter from Revenue Canada to ALP. It is dated March 15, 1988 and it requests information concerning the scientific research and experimental development made for the period ending December 31, 1986. The same request was made April 20, 1988 (Tab 96). On August 3, 1988, there is a letter (Tab 97) addressed to Mr. Rav Solanki, stating the following:
...
During our meeting on June 27th, 1988 with respect to the valuation of the equipment purchased to carry out R & D, you promised to provide Mr. Paul Lancaster with further information which you had available. Mr. Lancaster had requested specifically the following:
- the system specification documentation.
- records of the "benchmark" tests done on the system.
- packing lists itemizing the equipment received.
To date, we have not received any of the material listed above, in spite of our repeated phone calls and your promises to courier the information.
We again request you to provide the information as soon as possible. If we have not received it within 14 days of the date of this letter, we will ask Mr. Lancaster to proceed with his valuation based on the information provided by you to date.
...
[43] Tab 98 of Exhibit R-1, is a letter from Revenue Canada, dated October 6, 1988 stating that the claim for the project did not qualify as R & D.
[44] At Tab 1 of Exhibit R-1, is a letter addressed to the Appellant Kunkel, on February 23, 1990. It is a long letter explaining why the research and development expenditures and the investment tax credit were disallowed. At Tab 2, there is another letter from Revenue Canada, this time originating from Mr. Wong, addressed to Mr. Kunkel, explaining at length the facts relative to the disallowance of the Appellant's claim.
Arguments
[45] Counsel for the Appellants submitted that the Appellants were limited partners and as such did not have to take part in the management of the business. He referred to section 64 of the Partnership Act of British Coulumbia: A limited partner is not liable as a general partner unless he takes part in the management of the business. Counsel also submitted that it is in February 1990, more than three years after the Appellants had made their contribution, that they were informed by Revenue Canada that the latter disputed the purchase costs of the equipment and the existence of R & D activities. Counsel referred also to the fact that Mr. Rav Solanki died in September 1991 in a car accident. This made it very difficult to adduce the evidence that the Appellants would have endeavoured to do. Counsel, as examples, indicated that it is by chance that they have obtained the address of Mr. Flessas and that they have learned about Mr. Kamlesh Solanki's existence and role in the partnership. The burden of proof of the Appellants should be evaluated in this perspective.
[46] Counsel for the Appellants submitted that there were two opposed versions: the Appellants' version is that the equipment had been acquired in accordance with the current practices, that it was in conformity with the proposed projects, that the purchase price was reasonable, that indeed, $6.5 million had been paid, leaving a balance of $1,430,000 and that R & D activities were undertaken. The Respondent's version is the opposite.
[47] Counsel for the Appellants referred to some points of the evidence: First relating to the purchase of the equipment: Mr. Kamlesh Solanki testified that his brother Rav had gone to computer trade shows prior to purchasing the equipment; Mr. Kamlesh Solanki had participated in the development of the specifications; on the instructions of Tinbon, Kamlesh and Rav Solanki went to Lattice Logic to ensure the compatibility of certain equipment; Mr. Flessas had estimated that the equipment was worth the price that was paid and that it was the appropriate equipment.
[48] Regarding the R & D activities, counsel for the Appellants reminded the Court that the Respondent did not contest the value of the R & D project. Therefore, the project was a valid project. The personnel was qualified and the equipment was functional, at least it was in August 1987, when Mr. Shaw visited ALP's office. When Mr. Kamlesh Solanki left DRC to go to England, a mask had been prepared ready to go to the foundry. Counsel submitted that the Respondent's evidence on the matter of the absence of R & D activities was based only on the testimony of the expert witness of the Respondent and on the point of absence of documentation, counsel referred to the decision of the Federal Court of Appeal in RIS-Christie v. R., [1999] 1 C.T.C. 132 and more specifically to the following excerpts:
... Regulation 2900 speaks of research undertaken for the advancement of knowledge and for the purpose of creating new products. It does not state that eligible research must actually achieve those ends.
...
... In the circumstances of this case, I see no need to impose an additional evidentiary burden on the taxpayer of having to adduce documentary evidence relating to the repeatability of testing data.
[49] Counsel for the Respondent submitted that it is up to the taxpayer who wishes to claim business losses for R & D activities to bring forward the evidence of such activities. Counsel contended that the Respondent had adduced complete evidence that the cost of the equipment was inflated, the purchase of the equipment was made contrary to normal practices, and that any systematic investigation was absent.
Conclusion
[50] Paragraph 2900(1) of the Regulations reads as follows:
2900(1) For the purposes of this Part and sections 37 and 37.1 of the Act, “scientific research and experimental development” means systematic investigation or search carried out in a field of science or technology by means of experiment or analysis, that is to say,
(a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view,
(b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view,
(c) experimental development, namely, work undertaken for the purposes of achieving technological advancement for the purposes of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, or
(d) work with respect to engineering, design, operations research, mathematical analysis, computer programming, data collection, testing and psychological research where that work is commensurate with the needs, and directly in support, of the work described in paragraph (a), (b) or (c),
but does not include work with respect to
(e) market research or sales promotion,
(f) quality control or routine testing of materials, devices, products or processes,
(g) research in the social sciences or the humanities,
(h) prospecting, exploring or drilling for, or producing, minerals, petroleum or natural gas,
(i) the commercial production of a new or improved material, device or product or the commercial use of a new or improved process,
(j) style changes, or
(k) routine data collection.
[51] I understand that it is difficult for the limited partners in the present case, to be those who have to adduce the evidence of a systematic investigation or search carried out for the advancement of scientific knowledge and that the equipment had been genuinely acquired for that purpose. They confided in reports made by well known firms of accountants and lawyers, whose role is not in question here. The Appellants were pleased to contribute capital in R & D activities. At the same time that they encouraged research, they obtained tax advantages. It must be said, however, that as limited partners, they have the rights described at section 58 of the Partnership Act:
58. A limited partner has the same right as a general partner
(a) to inspect and make copies of or take extracts from the limited partnership books at all times;
(b) to be given, on demand, true and full information of all things affecting the limited partnership and to be given a formal account of partnership affairs whenever circumstances render it just and reasonable; and
(c) to obtain dissolution and winding up of the limited partnership by court order.
[52] It seems to me that the economy of the Act requires that when a limited partner wishes to claim the business losses of a partnership, as for any taxpayer claiming business losses, evidence of the existence of the business and of the losses incurred must be adduced, and, where the claim is for R & D losses, the evidence of R & D activities must be adduced. I was not referred to any case law and I am not aware of any that found that such evidence did not have to be adduced by a limited partner claiming such business losses.
[53] I will now refer to the decision of RIS-Christie v. R., referred to by counsel for the Appellants, on the absence of documentation. This decision of the Federal Court of Appeal was based on the findings made by the Tax Court Judge, as related at paragraph 16 of that decision, that testing had been undertaken and that the research efforts of Slonimsky and his assistant constituted a technological advancement.
[54] In the present case, there is no evidence of any systematic investigation of any sort or that the research led to a technological advancement, as no pertinent records or information was provided to the Respondent's officials. The evidence revealed that Mr. Rav Solanki, the directing mind, as much on the organization aspect as on the scientific aspect, has been met many times by officials of Revenue Canada and was given ample time and space to provide satisfactory answers.
[55] I refer to paragraphs 32 and 42 of these reasons concerning announced visits and letters requesting information. Notes made by Mr. Lancaster (Exhibit R-6) state that on August 24, 1988, there was a meeting with Mr. Rav Solanki: "Rav was the only contact so far that I had met and claimed to be the spec writer, project manager and in charge of the Alexis group". If the specifications had been written by him or by Mr. Kamlesh Solanki there was no reason at that time why they could not have been provided to Mr. Lancaster as ALP was still in operation. If a mask had been prepared before Mr. Kamlesh Solanki’s departure for London in the middle of 1988 (paragraph 10 of these reasons), it surely could have been shown to the Respondent’s scientific officials and experts since the meetings with Mr. Rav Solanki were at that exact time. If work had been subcontracted, the subcontractors could have provided documentary evidence of their scientific investigation.
[56] It appears evident that the equipment was not purchased according to normal practices. The equipment was purchased without quotation from other suppliers, without specifications, without benchmark testing or performance guarantees and from an unknown electronic maker. On what constitutes normal practices for the acquisition of equipment, the descriptions of these practices given by Mr. Flessas and by Mr. Lancaster on this subject are in concordance (paragraphs 31 and 34 of these Reasons). We have to remember that Mr. Flessas was the head of procurement at Philips (paragraph 29 of these Reasons). It is therefore strange that Mr. Flessas, on whose testimony the Appellants rely, affirms that the equipment was worth the price paid, without ever having seen it, without being able to find the Abbot equipment in any existing catalogue, and this equipment not having been purchased according to the normal practice that he himself followed.
[57] With what money was the equipment purchased? Based on complete documentary evidence appearing at various tabs of Exhibit R-1, the Respondent affirms that most of it, up to the amount of $6,500,000, was fictitious money. A review of this evidence makes it impossible to disagree with this finding. Moreover, commercial logic calls for the same conclusions.
[58] Commercial corporations do not loan money without interest. AHL, without evidencing its financial capabilities, would want us to believe that it loaned millions of dollars without interest: loans were non recourse loans and the interest could have been paid in ten years. Lending businesses do not loan money of this magnitude and R & D businesses, as well, do not spend money of this magnitude, for the purchase of equipment, unless the acquisition is made in a scientific and competitive manner.
[59] There is no other conclusion based on documentary evidence and commercial logic that the amount of $6.5 million made a round trip in the same day and there was no money other than the cash provided by the limited partners in the acquisition costs of the equipment.
[60] It is my view that the evidence brought forward by the Respondent in this case is thorough and the assumptions made by the Minister of National Revenue were satisfactorily proven. This evidence had been provided to the Appellants for a long time and it surely did not take them by surprise.
[61] For the reasons that the purchase cost of the equipment was inflated by $6.5 million and that no systematic investigation was carried on, the appeals are dismissed with costs.
Signed at Ottawa, Canada, this 14th day of December, 1999.
“Louise Lamarre Proulx”
J.T.C.C.