Federal Court of Appeal Decisions

Date: 20030730

Docket: A-105-02

Citation: 2003 FCA 312

CORAM:        DESJARDINS J.A.

NADON J.A.

PELLETIER J.A.

BETWEEN:

PIERRE MAILLOUX

Appellant

and

REVENUE CANADA

Respondent

Hearing held at Montréal, Quebec, on June 18, 2003.

Judgment rendered at Ottawa, Ontario, on July 30, 2003.

REASONS FOR JUDGMENT:                                                                                   DESJARDINS J.A.

CONCURRED IN BY:                                                                                                         NADON J.A.

                                                                                                                                           PELLETIER J.A.

Date: 20030730

Docket: A-105-02

Citation: 2003 FCA 312

CORAM:        DESJARDINS J.A.

NADON J.A.

PELLETIER J.A.

BETWEEN:

PIERRE MAILLOUX

Appellant

and

REVENUE CANADA

Respondent

REASONS FOR JUDGMENT

DESJARDINS J.A.

[1]        The appellant is objecting to a decision by the Tax Court of Canada which dismissed with costs his appeal from two assessments made by the Minister of National Revenue ("the Minister") pursuant to the Income Tax Act ("the Act"), for the taxation years 1993 and 1994 (Mailloux v. Canada, [2002] T.C.J. No. 63 (T.C.C.) (QL), per Judge Tardif).

1.         FACTS

[2]        The appellant operates a business known as Ferme Piluma Enr. ("the farm"), which is a partnership in which the appellant holds 98% of the shares. In the appellant's submission, it is a private experimental farm completely devoted to research, and not a "farming business", as he says the respondent contends. The appellant argued that he should be allowed to have the status of a business devoted entirely to research for the 1993 and 1994 taxation years since the Minister allowed it for the 1991 and 1992 taxation years (see Mailloux v. Canada, [1998] T.C.J. No. 856, at para. 2 (T.C.C.) (QL)), and the farm's projects remained the same for the 1993 and 1994 taxation years.

[3]        For the 1993 and 1994 taxation years the appellant considered that all the farming expenses for his farm, $405,836 in 1993 and $258,402 in 1994, represented qualified scientific research and experimental development expenses ("SR & ED"). Consequently, he claimed investment tax credits of $81,167 in 1993 and $51,680 in 1994 for these expenses in his tax returns.

[4]        Some of the expenses were disallowed by the Minister (see appellant's appeal record, vol. I, pp. 179 and 183), either because they were personal or unsupported or because they were not deductible expenses under s. 37(1)(a) of the Act, or they were not expenses which qualified for the investment tax credit pursuant to s. 127(9) of the Act and ss. 2900, 2902 and 2903 of the Income Tax Regulations ("the Regulations").

[5]        The appellant consequently claimed that the following amounts incurred by the farm should be recognized as research expenses:

For the 1993 taxation year:

an amount of $117,724              as salary

an amount of $7,180                                as transport of merchandise

an amount of $21,186                 as interest

an amount of $9,837                                as milk marketing

an amount of $96,863                 for a prototype

For the 1994 taxation year:

an amount of $31,290                 as salary

an amount of $20,023                as interest

an amount of $16,085                 as milk marketing

2.         TAX COURT OF CANADA DECISION

[6]        Throughout his reasons the trial judge noted that the appellant had not discharged his burden of showing that the Minister's arguments were incorrect. In this regard he noted several deficiencies in the appellant's evidence. These are discussed in the following paragraphs from his reasons:

[17]         The appellant devoted most of his testimony to demonstrating the quality, scope and specificity of Ferme Piluma's operations; he under estimated the importance of submitting adequate evidence relevant to his appeal.

. . . . .

[21]         Dr. Mailloux appeared to believe, and argued, that it was sufficient to prove the purpose behind Ferme Piluma in order to be entitled, automatically and without question, to claim all the expenditures entered in the farms accounting records.

. . . . .

[26]         Rather than presenting detailed and substantial evidence supported by specific explanations and appropriate documentary evidence, the appellant instead chose to make statements and observations with no relevant or direct effect on the validity of his claims. What is more, he admitted a number of errors and confessed his inability to provide explanations that were nevertheless essential to an analysis of his case. Furthermore, he called no one as a witness to correct the many deficiencies arising from his lack of control or from his ignorance of important facts.

. . . . .

[52]         However, he would have had to show, at least through circumstantial evidence, in the absence of direct evidence, that his claims were justified and justifiable. Not only was Dr. Mailloux unable to adduce such circumstantial evidence, but his testimony confirmed rather the validity of a number of aspects of the assessment.

. . . . .

[57]         In the instant case, the balance of probabilities amply favours the validity of the assessment, since the appellant did not fit to submit evidence challenging the responds evaluations. The only evidence adduced by the appellant concerned the status and purpose of the farm, which evidence he supplemented with various comments and observations suggesting that the statutory provisions should be adjusted to suit the project, not the reverse.

[7]        The trial judge concluded that each of the legislative bases on which the appellant based his arguments was invalid. He dismissed the appeal for both assessments.

3.         POINT AT ISSUE

[8]        The point at issue is whether the SR & ED expenses incurred by the appellant on his farm are qualified for computing the investment tax credit.

4.         APPLICABLE LEGISLATION

[9]        For the two taxation years 1993 and 1994 the Court must apply here the Act as it read in 1994. Some of the provisions we are concerned with are the same for both taxation years, 1993 and 1994. Others were amended in 1994 but are applicable to the taxation years ending after December 2, 1992.

[10]      Section 37 of the Act provides that where a taxpayer carries on a business

there may be deducted in computing the income of the taxpayer from the business for the year expenditure on SR & ED carried on in Canada.

[11]      Section 127(5) of the Act provides that there may be deducted from tax payable by a taxpayer under Part I for a taxation year an investment tax credit for SR & ED expenses. The definition of "qualified expenditure" for purposes of the investment tax credit is to be found at s. 127(9) of the Act. It states the following, for the 1993 and 1994 taxation years:

127(9) "qualified expenditure" - "qualified expenditure" means an expenditure in respect of scientific research and experimental development incurred by a taxpayer that is an expenditure in respect of first term shared-use-equipment or second term shared-use-equipment or an expenditure described in paragraph 37(1)(a) or subparagraph 37(1)(b)(i) and includes an amount that is a prescribed proxy amount of a taxpayer, but does not include

127 (9) « dépense admissible » - « dépense admissible » Dépense relative à des activités de recherche scientifique et de développement expérimental engagée par un contribuable et qui représente soit une dépense relative à du matériel à vocations multiples de première période ou du matériel à vocations multiples de deuxième période, soit une dépense visée à l'alinéa 37(1)a) ou au sous-alinéa 37(1)b)(i), et comprend un montant de remplacement visé par règlement, à l'exclusion :

(a) a prescribed expenditure... (My emphasis)

a) d'une dépense prévue par règlement... (Je souligne)

Thus, an expenditure is qualified for the investment tax credit if it is an expenditure covered by s. 37(1)(a) or (b)(i) of the Act and it is not excluded by regulation.

[12]      Section 37(1)(a)(i) and (b)(i) of the Act provides:

[13]      For a current expenditure to be covered by s. 37(1)(a) of the Act, the taxpayer must establish its nature and must show that it is attributable in whole or in part to SR & ED carried on in Canada. Section 37(8)(a)(ii)(A) states the following:

Section 37(8)(d)(i), however, excludes certain expenditures from expenditures with reference to SR & ED activity:

37(8)(d) notwithstanding paragraph (a), references to expenditures on or in respect of scientific research and experimental development shall not include		37(8)d)[Dépenses non admissibles] malgré l'alinéa a), les dépenses afférentes aux activités de recherche scientifique et de développement expérimental ne comprennent pas :
(i)    any capital expenditure made in respect of the acquisition of a building, other than a prescribed special-purpose building, including a leasehold interest therein ...		(i)     les dépenses en capital faites pour l'acquisition d'un bâtiment - sauf s'il s'agit d'un bâtiment destiné à une fin particulière visée par règlement - , y compris un droit de tenure à bail dans ce bâtiment ...

[14]      Sections 2900, 2902 and 2903 of the Regulations applicable to the 1993 and 1994 taxation years read as follows:

2900. (1) For the purposes of this Part and paragraphs 37(7)(b) and 37.1(5)(e) 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,		2900. (1) Aux fins de la présente partie et des alinéas 37(7)b) et 37.1(5)e) de la Loi « recherches scientifiques et développement expérimental » désigne une investigation ou recherche systématique d'ordre scientifique ou technologique, effectuée par voie d'expérimentation ou d'analyse, c'est-à-dire,
(a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view,		a) la recherche pure, à savoir le travail entrepris pour l'avancement de la science sans aucune application pratique en vue,
(b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or		b) la recherche appliquée, à savoir le travail entrepris pour l'avancement de la science avec une application pratique en vue, ou
(c) development, namely, use of the result of basic or applied research for the purpose of creating new, or improving existing, materials, devices, products or processes,		c) la mise au point, à savoir l'utilisation des résultats de la recherche pure ou appliquée dans le but de créer de nouveaux matériaux, dispositifs, produits ou procédés ou encore d'améliorer ceux qui existent,
and, where such activities are undertaken directly in support of activities described in paragraph (a), (b) or (c), includes activities with respect to engineering or design, operations research, mathematical analysis or computer programming and psychological research, but does not include activities with respect to		et, lorsque ces activités sont entreprises pour appuyer directement les activités mentionnées à l'alinéa a), b) ou c), comprend les activités relatives au génie ou au dessin, à la recherche opérationnelle, à l'analyse mathématique ou à la programmation des ordinateurs et à la recherche psychologique, mais elle n'englobe pas les activités se rattachant à
(d) market research or sales promotion; .....		d) la prospection du marché ou la simulation de la vente; .....
2902. For the purposes of the definition "qualified expenditure" in subsection 127(9) of the Act, a prescribed expenditure is		2902. Pour l'application de la définition « dépense admissible » , au paragraphe 127(9) de la Loi, une dépense prescrite est
(a) an expenditure of a current nature incurred by a taxpayer in respect of		a) une dépense de nature courante engagée par un contribuable

(i) the general administration or management of a business, including .....		(i) pour l'administration générale ou la gestion d'une entreprise, y compris
..... (C) an amount described in any of paragraphs 20(1)(c) to (g) of the Act, .....		(C) une somme visée à l'un des alinéas 20(1)c) à g) de la Loi,                                        .....
except any such expenditure incurred by a taxpayer who derives all or substantially all of his revenue from the prosecution of scientific research and experimental development or the sale of rights in or arising out [of] scientific research and experimental development carried on by him; .....		à l'exception des dépenses engagées par un contribuable qui tire la totalité ou la quasi-totalité de ses revenus de la poursuite de recherches scientifiques ou de la vente de droits dans des recherches scientifiques et développement expérimental ou découlant de telles recherches poursuivies par lui; .....
2903. For the purposes of paragraph 37(7)(f) of the Act, a special-purpose building is a building the working areas of which are designed and constructed to have a displacement in any direction of no more than .02 micrometre and to have, per .028 cubic metre of interior airspace ...		2903. Pour l'application de l'alinéa 37(7)f) de la Loi, est un bâtiment destiné à une fin particulière le bâtiment dont les aires de travail sont conçues et construites de telle sorte que leur déplacement, dans toute direction, ne dépasse pas 0,02 micromètre et que l'air intérieur de celles-ci ne contienne, par 0,028 mètre cube d'air ...

5. ANALYSIS

[15]      From the outset the appellant argued in this Court, as in the Tax Court of Canada, that the respondent's position was contradictory since he was denied recognition of the status of an experimental farm devoted entirely to scientific research by the Minister for the 1993 and 1994 taxation years, but this was allowed for the 1991 and 1992 taxation years.

[16]      Nevertheless, it is important to note that in his reply to the amended notice of appeal the Minister indicated that [TRANSLATION] "during the years at issue Ferme Piluma Enr. undertook scientific research into farming efficiency regarding the growing and production of feed, control of a dairy herd, hybridization tests, attempts at new production such as calves for veal and cheese" and that [TRANSLATION] "this work was considered by the Minister of National Revenue to be qualified as scientific research and experimental development projects" (appellant's appeal record, vol. I, p. 24).

[17]      The Minister made a similar admission in an earlier case in the Tax Court of Canada for the 1991 and 1992 taxation years. Judge Archambault echoed this admission at the start of his judgment, stating that the Minister "acknowledged that during 1991 and 1992 Ferme Piluma        was operating a business devoted entirely to scientific research, and also that Mr. Mailloux was entitled to part of its tax credits" (Mailloux v. Canada, [1998] F.C.J. No. 856, at para. 2 (T.C.C.) (QL)).

[18]      What the Minister is challenging in this Court, as he did before Judge Archambault, is that certain expenses incurred by the farm are not qualified and do not give rise to tax credits.

[19]      The expenses disallowed by the Minister may be grouped under the following five headings:

                         (a)        land improvement, land, prototype

                         (b)        interest

                         (c)        salaries

                         (d)        milk marketing

                         (e)        transport and goods

            (a)        Land improvement, land, prototype

[20]      The appellant admitted that the words "improvement of land"and "land" are not applicable to him since there was no purchase of land (appellant's appeal record, vol. I, p. 46). However, he alleged that in the circumstances the word "prototype" is applicable.

[21]      The appellant explained at length before the trial judge that the objective sought at the farm was research and development of new consumer products, including beef and various cheese manufactured from milk produced on the spot.

[22]      The appellant was trying to produce at a reasonable cost meat and cheese containing unusual fats, which are good for the health of consumers, to replace the traditional fats which are often harmful to health. In his submission, it was possible to produce meat and cheese containing nutritive fats, which are healthy and excellent for health, whereas existing products are often composed of fats which have harmful effects on consumers' health.

[23]      As to cheese, the appellant explained to the trial judge the obstacles and the path which led to the marketing of two cheeses, St-Basile and Chevalier Mailloux. He described with justifiable pride the medals and recognition obtained in Canada for the exceptional quality of these two cheeses (appellant's appeal record, vol. I, pp. 43 and 44, paras. 7 to 11). He explained that Chevalier Mailloux had been found in Halifax to be the best raw milk homemade cheese in Canada for 1998 (appellant's appeal record, vol. II, p. 254, lines 3 and 4).

[24]      The research and manufacture of these two cheeses required the construction of a cheese house. This was a building with a roof, walls, foundation, doors and windows but built in the ground, 12 feet underground (appellant's appeal record, vol. II, pp. 309 and 310).

[25]      The appellant argued that the cheese house is an experimental factory prototype and that its construction costs are qualified for the investment tax credits under Interpretation Bulletin IT-151R (November 3, 1975) on the one hand and Information Circular 86-4R2 (August 29, 1998) on the other.

[26]      In his submission, the words "prototype" of a cottage-type cheese house or "pilot plant" for making homemade cheese may be synonymous. He maintained that Interpretation Bulletin IT-151R, of November 3, 1975, and Information Circular 86-4R2 of August 29, 1998, recognize that the construction and operation of a pilot plant is a scientific research expenditure.

[27]      Interpretation Bulletin IT-151R, on which the appellant relied, was issued in 1975. However, it is no longer valid since it has been successively replaced by Interpretation Bulletins IT-151R2 (December 16, 1980), IT-151R3 (June 24, 1988), IT-151R4 (August 16, 1993) and IT-151R5 (October 17, 2000). Interpretation Bulletins IT-151R, IT-151R2 and IT-151R3 do not take into account s. 37(7)(f) of the 1993 Act, which deals with expenditures which do not constitute SR & ED expenditures. Section 37(7)(f) of the 1993 Act was added by the Act to amend the Income Tax Act, S.C. 1988, c. 55, s. 18(14), assented to September 13, 1988. It became s. 37(8)(d)(i) of the 1994 Act. This is the subparagraph that should be referred to in this matter (Gustavson Drilling (1964) Limited v. Canada (The Minister of National Revenue), [1977] 1 S.C.R. 271, at 282 and 283). It specifically excludes capital expenditures made for the acquisition of a building - other than a prescribed special-purpose building.

[28]      The appellant admitted that the cheese house was a building, but was not intended for a specific purpose prescribed by s. 2903 of the Regulations (appellant's appeal record, vol. II, pp. 304 and 305, line 17). Consequently, the trial judge properly concluded that the sum of $96,863 claimed by the appellant for construction of the prototype was an expense excluded by s. 37(8)(d)(i) from qualified expenditures.

[29]      Information Circular 86-4R2 (cancelled), titled "Scientific Research and Experimental Development", of August 29, 1998, on which the appellant also relied, defined a "pilot plant" as

"a non-commercial scale plant in which processing steps are systematically investigated under conditions simulating a full production unit". According to the same document, a "prototype" is a "basis experimental model possessing the essential characteristics of the intended product". The circular describes five possible stages in developing an experimental development project. However, it does not mention that any capital expenditure incurred is a qualified SR & ED expenditure. In any case, whether an expenditure is qualified is to be determined from the Act, not the circular.

[30]      This Court has ruled on the applicable principles in an earlier case involving the same parties (Mailloux v. Canada, [2000] F.C.J. No. 694 (F.C.A.) (QL), on appeal from a decision of Judge Archambault, supra). The debate concerned the appellant's entitlement to investment tax credits for SR & ED expenditures incurred by the farm for the 1991 and 1992 taxation years, in particular a hayloft and interest.

[31]      Speaking for the Court, Létourneau J.A. concluded that Judge Archambault of the Tax Court of Canada had made no error when he decided that the hayloft was a building the capital expenditure on which was not qualified under s. 37(7)(f)(i) of the Act applicable at that time for the 1991 and 1992 taxation years. Létourneau J.A. noted that the hayloft was a "building" and not a structure, and was not a building which fell under the exception applicable to buildings intended for a special purpose under s. 2903 of the Regulations.

[32]      The tax treatment of the cheese house in the case at bar is to the same effect as that of the hayloft.

            (b)        Interest

[33]      The trial judge concluded that the portion of interest corresponding to the interest paid for qualified SR & ED expenditures was deductible and was admitted and allowed by the respondent. Additionally, he concluded that the interest on loans incurred for purposes other than SR & ED was not qualified and they had not been allowed by the respondent.

[34]      The trial judge's first statement is incorrect, since the Minister did not admit that the interest was a qualified SR & ED expenditure.

[35]      In his reply to the amended notice of appeal (appellant's appeal record, vol. I, tab 6, paras. 8(m) and 10, pp. 25 and 26) the Minister disallowed the interest expense which was claimed both for purposes of calculating the investment tax credit and for purposes of calculating SR & ED expenditures deductible from the income received from the farm.

[36]      I conclude that the Minister was right to act as he did and that on this point the trial judge's error does not affect the validity of the assessments.

[37]      The interest expense was not qualified in calculating the investment tax credit as it was an expenditure covered by s. 2902(a)(i)(C) of the Regulations, which indicates that an amount covered by s. 20(1)(c) of the Act (an interest deduction) is a prescribed expenditure. It is thus expressly excluded in the definition of "qualified expenditure" in s. 127(9)(a) of the Act, which excludes "a prescribed expenditure".

[38]      Section 2902 provides for an exception to this rule in the case of "expenditure incurred by a taxpayer who derives all or substantially all of his revenue from the prosecution of scientific research and experimental development or the sale of rights in or arising out [of] scientific research and experimental development carried on by him". That exception cannot be applied to the farm. During the years at issue the latter did not derive all or substantially all of its revenue from the prosecution of scientific research, but also from the sale of hay, milk cattle, cheese and cream, rebates and grants (statements of farming income and expenses, appellant's appeal record, vol. I, tab 9, pp. 103-127).

[39]      The interest expenses disallowed in calculating the SR & ED expenditure are not an expenditure covered by s. 37(1)(a) of the Act.

[40]      The only documentary evidence submitted by the appellant regarding interest is a personal loan of $25,000 by the National Bank of Canada on February 1, 1994 (appellant's appeal record, vol. I, p. 97).

[41]      The appellant indicated that the interest paid in connection with this loan was related either to the construction of the cheese house or to the payment of salaries, or payment for materials or equipment (transcript of Mr. Mailloux's testimony, appellant's appeal record, vol. II, tab 11, p. 320).

[42]      The portion of interest having to do with the building of the cheese house is excluded from qualified expenditure under s. 37(8)(d)(i) of the 1994 Act, since it is capital expenditure on the acquisition of a building.

[43]      The interest expenses must accordingly be disallowed.

(c)        Salaries

[44]      The amounts claimed for salary are composed in part of personal expenditures without supporting documentation, and in part of amounts paid to subcontractors for building of the cheese house (reply to amended notice of appeal, appellant's appeal record, vol. I, tab 6, p. 25, para. 8(j)).

[45]      The appellant admitted that these expenses which were disallowed consisted in part of expenses without supporting documentation and in part of expenses incurred for building the cheese house (transcript of Mr. Mailloux's testimony, appellant's appeal record, vol. I, tab 11, p. 239, line 14, pp. 311-312).

[46]      The trial judge was accordingly fully justified in ruling that this type of expense was not qualified.

(d)        Milk marketing

[47]      The appellant explained that these expenses included payments made to the Fédération des producteurs de lait du Québec ("FPLQ"), the Union des producteurs agricoles ("UPA") and an organization exercising control of the milk industry ("PATLQ") (transcript of Mr. Mailloux's testimony, appellant's appeal record, vol. I, tab 11, p. 326). However, the appellant did not provide any supporting documentation for this.

[48]      The trial judge was therefore justified in describing these payments as payments required of all milk producers and hence expenditures which were not directly attributable to SR & ED.

[49]      The trial judge then concluded that the rest of the milk marketing expenditures were made "for the purposes of market research and quality control or routine testing of products within the meaning of paragraphs 2900(1)(d) and (e) of the Regulations" (appellant's record, vol. I, p. 78). This is a mixed conclusion of fact and law in which it is difficult for this Court to intervene (Housen v. Nikolaisen, [2002] 2 S.C.R. 235).

(e)        Transportation of goods and trucking

[50]      The appellant admitted that these expenditures were associated with construction of the cheese house during the 1993 taxation year.

[51]      The trial judge was obliged to conclude they were excluded under s. 37(8)(d)(i) of the Act. That is what he did.

6.         CONCLUSION

[52]      I would dismiss the appeal with costs.

"I concur

M. Nadon J.A."

"I concur

J.D. Denis Pelletier J.A."

Certified true translation

Suzanne M. Gauthier, C. Tr., LL.L.

                                                    FEDERAL COURT OF CANADA

                                                                 APPEAL DIVISION

                                                          SOLICITORS OF RECORD

FILE:                                                                               A-105-02

STYLE OF CAUSE:                                                     PIERRE MAILLOUX v. REVENUE CANADA

PLACE OF HEARING:                                                Montréal, Quebec

DATE OF HEARING:                                                  June 18, 2003

REASONS FOR JUDGMENT:                                  DESJARDINS J.A.

CONCURRED IN BY:                                                 NADON J.A.

PELLETIER J.A.

DATE OF REASONS:                                                  July 30, 2003

APPEARANCES:

Pierre Mailloux                                                                  FOR THE APPELLANT

Janie Payette                                                                      FOR THE RESPONDENT

SOLICITORS OF RECORD:

Department of Justice - Canada                                       FOR THE RESPONDENT

Montréal, Quebec