Date: 20001128
Docket: 1999-4891-IT-I
BETWEEN:
CDD-REM PROCESS, VACUUM TECHNOLOGY CORP.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
__________________________________________________________________
Agent for the Appellant: James A. Deacur
Counsel for the Appellant: Howard Morton
Counsel for the Respondent: Sointula Kirkpatrick
___________________________________________________________________
Reasons for Judgment
(Delivered orally from the Bench at Toronto, Ontario on October 24, 2000)
Margeson, J.T.C.C.
[1] I thank counsel for their close attention to this matter. I thank the witnesses who testified, as far as the Court is concerned, in a very straightforward and forthright manner.
[2] There are some weaknesses in the Appellant’s case, there is no doubt about that.
[3] It would have been a wiser business practice, especially for a company that was advised by experts and accountants to have invoiced regularly for the work done. The Court only has the evidence of the chief shareholder of one of the companies that was providing the service. His explanation was that they did not invoice because they had a practice in place of making draws and they did not believe they needed to.
[4] That may very well be so but it would have been a much better practice if they had invoiced in the proper manner. The company, on the advice of its accountants would have to decide what was the best manner but the best way would be to bill for the work as they provided it or shortly thereafter with specificity as to what work was provided and the appropriate charges for such work. Then there would be the paper trail that the auditor for the Respondent was looking for.
[5] The Court does not fault him for looking for a paper trail. It could see right away, when he started to testify, what was in his mind when he looked at this file. He was looking at it from the point of view of an auditor, which he is supposed to do. Where is the evidence that this amount of money that is being claimed was for Research and Development expenditures (“R & D”)? He had a right to do that. Whether he came up with the correct methodology or not, is a question which the Court will answer in a minute.
[6] He was within his rights, as a good auditor, to raise the flag as to whether or not the amount that was being claimed was evidenced by documents, information and evidence to such a degree that it substantiated the claim that was being made.
[7] If the only evidence before this Court was an agent of the taxpayer saying, “Oh, yes, we paid the money. That’s what it was for. That was for R & D”, without more, the Appellant would have difficulty in succeeding here. If the evidence given was something that could not be accepted, or believed or if there was no credibility to be attached to the witnesses, there would be great difficulty for the Appellant here. But that was not the case.
[8] There was a glaring error, however. The paper trail was weak. The auditor for the Respondent seized upon that. That is not to say that a mere invoicing would necessarily have been sufficient without more, but it would have helped. The auditor indicated in his evidence that this may not have substantiated the R & D claim satisfactorily, but he did say that it would have helped.
[9] Let the Court observe, as it is entitled to do, on the credibility that it attaches to the evidence given by those who testified. This Court, like the auditor himself, was favourably impressed by the nature of the evidence given by all those who testified. Although his belief of the witnesses is not conclusive of this case it was interesting that he said that he could fairly well believe what the people in the company told him. Those were some of the witnesses who testified before the Court here today.
[10] The Court was impressed by the nature of the evidence given by the witnesses. That goes a long way in assisting the Court in deciding as to whether or not the claims made were indeed valid ones. That is not to say that the Minister was not within his rights to look for more evidence than he had before him to substantiate the claim made.
[11] The Court was impressed by the witnesses. It believed what they had to say.
[12] The accountant who gave testimony was very knowledgeable, had a great deal of experience and was up-to-date on this type of claim. He had worked for Revenue Canada himself before and the nature of his evidence was very helpful to the Court. The Court accepts what he had to say without accepting necessarily his interpretation of the law.
[13] Counsel for the Appellant argued that the Court should allow the appeal and find that in the year 1993, disputed wages in the amount of $22,782 and in the year 1994, disputed wages in the amount of $37,155 should be amounts which the Appellant is entitled to claim in calculating the R & D credit.
[14] He said that the witnesses who testified on behalf of the Appellant, including Mr. Gordon and Mr. Deligiannis could be believed, that their evidence was credible and straightforward. They produced financial statements and records of the company for the years 1993 and 1994 which confirmed the amount of money that was paid out by the Appellant to the two companies which were controlled by the two shareholders who have been referred to here.
[15] The witnesses testified that the amounts that were claimed were paid in the years in question, were paid currently in those years and that cheques were issued to the recipient companies for those amounts. There did not seem to be any issue that the amounts in question were actually paid out as alleged.
[16] Counsel further argued that section 67 is not applicable because the evidence indicated that the Appellant could have charged substantially more money for the services that were provided by these two shareholders than it actually did.
[17] In 1993 it claimed only 25% of the amount that was expended for their wages. In 1994 it claimed 30%. This amount was reasonable, according to counsel for the Appellant, and should be allowed.
[18] He further argued that there is nothing which would entitle the auditor to look at the T4 information of the two recipients of the wages to try and determine what amount should have been allowed for R & D.
[19] This case has nothing to do with the internal operations of the other companies which were operating at arm's length one from the other. This information is not relevant and it does not give the Minister the methodology which he can rely upon to determine what was the amount expended for R & D. Corporate law allows the companies to be set up independently.
[20] Each of the two shareholders made their own decision as to what they were to do in their companies. These were not holding companies. That term has been used but the Court should conclude that they were not holding companies. They were companies which were controlled by the individuals themselves who were the shareholders of those companies, they obviously decided what the companies were to do, but they were not holding companies.
[21] The argument was also made that the Appellant itself was operated independently of these two persons, it made its own decisions and consequently these companies could not be deemed to have been operating at non-arm’s length under the Income Tax Act (“Act”). Secondly, they were not acting at non-arm’s length factually.
[22] The appeals should be allowed with costs.
[23] Counsel for the Respondent said that the issue to be decided is whether or not the Appellant was entitled to claim amounts in excess of those amounts allowed by the Minister, in making its R & D claim in the years in issue.
[24] Secondly, has the income tax credit been properly calculated by the Minister? She referred to subsection 37(1) of the Act.
[25] The Appellant has not shown that it was entitled to the amounts that it was claiming. It has not shown that the Minister's assessment is incorrect. It has not shown that it was entitled to any more credits for R & D than the Minister has allowed.
[26] She referred to subsection 127(9) and argued that the workers, the two shareholders, were not paid for R & D. There was no evidence that the amounts claimed were related to the services which they provided for the Appellant. They were not operating at arm's length from the Payor. There was no evidence of the liability of the company, the Appellant, to pay the amounts which are sought to be deducted here, to the two alleged recipients.
[27] She argued that the Minister was correct in using the methodology that he did, in using the information on the T4s. That was the most accurate method to be used. It is only reasonable that the Court should look to the amount of money that was paid out according to the T4s to the two individuals when trying to calculate what amount should be allotted for R & D. The basis for the calculation should be the amount shown on the T4s of Mr. MacPherson and Mr. Deligiannis.
[28] This was a non-arm’s length situation under paragraph 251.1(b) of the Act.
[29] Further, since it is a non-arm’s length transaction or situation, the Court should be entitled to look beyond the legal operation of the company, to see who the shareholders were. It should look beyond the legalities and look to the way in which the shareholders interacted with the Appellant company. When you do this, one must conclude that the amount of money that was being claimed for R & D was an unreasonable amount of money to be claimed by them in the years in question. One must look beyond the corporate structure.
[30] The appeals should be dismissed.
[31] In reply, counsel for the Appellant said that Revenue Canada cannot dictate to companies how they are to arrange their affairs.
[32] It was contended that at the end of the day, even though the shareholders were paid by cheque from the Appellant for their services for R & D, that was not necessarily all that they received from the Appellant. There may have been other benefits besides that. Nonetheless, that is the company's business. What the Appellant did with the money it received, even if it be three-and-one-half times what it paid out to the service providers, is irrelevant to the issue to be decided here.
[33] Counsel repeated his argument about non-arm’s length in fact and under the Act.
Analysis and Decision
[34] The Court has already said that it accepts the evidence of the witnesses called on behalf of the Appellant. It finds their evidence to be very credible.
[35] The Court makes a finding that the methodology used by the auditor in this particular case was probably dictated by the fact that he was unable to find the paper trail that he was looking for. Indeed in some situations that might have been fatal to the Appellant's case. A paper trail including the use of invoices, which are accurate and issued at proper times showing that the work was done, what the charges were for, how much work was done and how much was paid, is a better way of doing it.
[36] However, the Court is satisfied, on the basis of the evidence heard, that that is not a fatal omission in this particular case to the Appellant's position.
[37] After hearing all of the evidence of the witnesses, referring to the documents that have been placed into evidence, the letters, the financial statements, the evidence of the chartered accountant, the evidence of the shareholders who came before the Court, and attaching great credibility to their evidence, the Court is satisfied that it can accept what they had to say.
[38] The Court is satisfied that the Appellant has established, on a balance of probabilities, that it paid out to these two companies the amount of money in question. The amount does not seem to be in issue in any event.
[39] The main issue is, did it pay it out on account of R & D? The Court is satisfied, on the basis of all of the evidence, that it did. When the Court takes into account the credibility of the witnesses, considers the content of the documents that are before it and applies the appropriate sections of the Act to the evidence, it is satisfied that in the taxation years 1993 and 1994, the disputed wages in the amounts of $22,782 and $37,155 respectively, were also paid out by the Appellant company on account of R & D.
[40] Without the viva voce evidence of the persons who testified, in the absence of the proper paper trail, this result could not have been reached. If the Court did not believe what these witnesses had to say, this result could not be reached.
[41] Insofar as the T4s are concerned, the Court is satisfied that, looking to the T4 information as to what the two shareholders received at the end of the year, and reported for income tax purposes, does not give a proper methodology for calculating the proper amounts expended for R & D.
[42] The Court is satisfied that the auditor for the Respondent had no improper motives in doing what he was doing. He was searching for some method of determining the proper amounts which he thought this company was entitled to claim. He used what was available to him. He looked at the T4s to see what the workers were paid from the Appellant, and that is the figure that he used.
[43] The Court is satisfied that that was not the proper methodology to be used in this case and that the amounts of money that were set out in those T4s do not afford the proper basis for calculating the amount of the R & D payments that were expended in this particular case.
[44] Again, the Court is satisfied that at the end of the day these companies were operating at arm's length from each other. They were not operating at non-arm's length under the Act nor were they operating at non-arm’s length in fact. It can make no unfavourable inference against them under those circumstances. The Court is satisfied that the Minister made the wrong calculations.
[45] The Court is satisfied that the appeals should be allowed with costs and the matter referred back to the Minister for reconsideration and reassessment on the basis that the Appellant company, in the year 1993, should have been able to claim the disputed amount of wages in the amount of $22,782 in calculating its R & D credit, and in the year 1994, the amount of $37,155 in making its calculation, in addition to any amounts already allowed by the Minister for those years. The Appellant is entitled to its costs, to be taxed.
Signed at Vancouver, British Columbia, this 28th day of November 2000.
"T.E. Margeson"
J.T.C.C.