Aeronautic Development Co. v. R - TCC: Taxpayer controlled de facto by non-resident - no ITCs for SRED

Aeronautic Development Co. v. R - TCC:  Taxpayer controlled de facto by non-resident - no ITCs for SRED

Aeronautic Development Corporation v. The Queen (March 13, 2017 – 2017 TCC 39, Hogan J.).

Précis:   The taxpayer claimed refundable SRED investment tax credits (ITCs) in 2009, 2010 and 2011 in connection with the prototyping and certification of an amphibious aircraft known as the Seawind.  CRA denied the ITCs on the basis that the taxpayer was under the de facto control of Mr. Richard Silva, who is a non-resident of Canada.  Shortly prior to trial CRA added a new argument based on an allegation that the taxpayer was under the de jure control of Seawind Development Corporation (“Seawind Corp.”), a corporation legally controlled by Mr. Silva.  The Court rejected the  de jure control argument both because it was pleaded too late and on the evidence adduced.  The Court however accepted the de facto control argument holding that on the evidence Mr. Silva did in fact exercise commercial control over the taxpayer pursuant to the terms of a Development Agreement between Seawind Corp. and the taxpayer.  As a result the appeal was dismissed with costs to the Crown.

Decision:   This case simply boiled down to the fact that Mr. Silva called all the shots in the commercial relationship with the taxpayer:

[62]        As its last line of defence, the Appellant argues that the Development Agreement, the principal source of the alleged economic dependence identified by the Respondent, is precluded from consideration under the Silicon Graphics test by virtue of the exclusionary language of subsection 256(5.1).

[63]        As pointed out by the Respondent, a commercial agreement is excluded under subsection 256(5.1) of the Act only if (i) at the relevant time the corporation and the controller are dealing at arm’s length and (ii) the main purpose of the agreement is to govern the relationship of the corporation and the controller regarding the manner in which the business of the corporation is carried on.

[64]        Considering the evidence as a whole, I find that Mr. Silva and Seawind Corp. and the Appellant were not dealing with each other at arm’s length in each of the relevant taxation years. Therefore, the Exclusion does not apply.

[65]        First, when the Development Agreement was entered into by Seawind Corp., Mr. Silva indirectly, and Seawind Corp. directly, controlled the Appellant. The two corporations were related persons by virtue of subparagraph 251(2)(b) of the Act and, as a result, were deemed not to be dealing at arm’s length by virtue of paragraph 251(5)(a) of the Act.

[66]        The evidence shows that Mr. Silva was the sole person to define the terms and conditions of the Development Agreement. The initial term of the agreement was 15 months. When the term expired, the Appellant did not seek to renegotiate the terms and conditions of the Development Agreement, although by then it was operating at a deficit.

[67]        Not only did Mr. Silva determine the terms and conditions of the parties’ arrangement, the evidence shows that he unilaterally decided that the Markup should not be paid. The Appellant did not object and enforce its right to the payment of the Markup.

[68]        There are other indications of non-arm’s length dealings. The Appellant operated in a hangar belonging to Sea Air. There was no evidence that suggested that the Appellant paid rent for the use of the space. I suspect Mr. Silva did not require the Appellant to enter into a formal lease because the Appellant was economically dependent on Seawind Corp., a corporation wholly owned by Mr. Silva. Seawind Corp. would have had to fund the lease payments under the terms and conditions of the Development Agreement. This would have been tantamount to Mr. Silva paying rent to himself

[69]        The absence of a lease, however, suggests that the parties envisaged that the Appellant would not operate independently of Seawind Corp. and Mr. Silva. If the Appellant had expected to do so, I believe it would have insisted on a lease to avoid being evicted from its place of business when it secured other business. I suspect that Mr. Silva would also have insisted on a lease based on normal commercial terms. Otherwise, the Canadian Resident Shareholders would have benefited from the rent free arrangement if the Appellant secured new clients. The absence of a lease suggests that the parties were not dealing at arm’s length.

[70]        Considering all of the above, I find that the requirement for arm’s length dealings is not satisfied.

The Court rejected the taxpayer’s argument that the Crown should be penalized in costs for the late addition of the failed de jure control argument (the “New Argument”):

[72]        The Appellant requested costs in any event of the cause. It claims that the Respondent violated the rules of procedural fairness when it belatedly raised the New Argument. The Appellant asserts that the Respondent’s conduct was abusive.

[73]        With respect, I do not agree with the Appellant’s assessment of the situation. The Respondent’s counsel owed a duty to his client to present the New Argument. When counsel discovered the late payment of the subscription price for the shares, he immediately advised the Appellant that he would argue that Mr. Silva and Seawind Corp. had de jure control of the Appellant at all relevant times. While the Appellant was correct in asserting that I should not consider the New Argument on grounds of procedural fairness, no delay was caused in the hearing. Therefore, as is the norm when appeals are dismissed, costs are awarded to the Respondent.

As a result the appeal was dismissed with costs to the Crown.