Quebec Revenue Agency c. PCI Géomatics Entreprises inc. (2020)

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Quebec Revenue Agency c. PCI Géomatics Entreprises inc. (2020)

Key Lessons / Points

Both conditional and unconditional repayable contributions can be considered government assistance. They must be assessed against the true intent of the parties involved.
- Assistance involves a predominantly donative intent, rather than a business motive. An assistance agreement between the grantor and the recipient of the assistance will show that the main purpose of the agreement from the grantor’s point of view was something other than profit.
- In this case, the agreement was determined to be government assistance which should have been reported as such on the Appellants’ SR&ED claims.
Different government programs have different requirements. The Strategic Aerospace and Defence Initiative (SADI) expenses are eligible for SR&ED investment tax credits; some SADI loans are considered government assistance.
- Each case is unique and must be individually reviewed. In this case, the funds received by PCI were a conditional loan and not an unconditional loan since it would only have to be repaid, in whole or in part, if PCI’s income was maintained or increased over the years; therefore, the funds were considered government assistance and should have been deducted from the SR&ED amount.

Fiscal Years in Question

2012, 2013, 2014

Court Heard In

Court of Appeal (Montreal, Quebec)

Dates Heard

September 2, 2020

Length of Process

8 years

Neutral Citation

2020 QCCA 1342

Docket

500-09-028280-196

Amount Under Dispute

Not Specified

Decision

[ 3 ]  For the reasons of Justice Hogue, with which Justices Hilton and Hamilton concur, THE COURT:

[ 4 ] GRANTS  the appeal;

[ 5 ] REVERSES  the rectified judgment rendered by the Court of Quebec on April 2, 2019;

[ 6 ] DISMISSES  the respondent’s appeals for assessment;

[ 7 ] REINSTATES  the notices of assessment issued by the QRA for the years 2012, 2013 and 2014;

[ 8 ] THE WHOLE  with legal costs both in the first instance and on appeal.

Summary

The Quebec Revenue Agency (QRA), the Appellant, appealed the rectified judgement by the Court of Quebec in 2019 in which the appeal of PCI Géomatics Entreprises inc. (PCI), the Respondent, was allowed.

The Appellant stated that the trial judge erred in concluding that the contributions made by the Canadian government under the Strategic Aerospace and Defense Initiative (“SADI”) to PCI during their 2012, 2013 and 2014 taxation years did not constitute government assistance. The Appellant believes that the amounts are indeed “government assistance” and should have been claimed as such.

The judge stated that his initial opinion was “that the terms of the agreement concluded between PCI and the Government of Canada clearly make PCI’s obligation to reimburse the contribution made by the government conditional”. To come to a final and fully formed decision the judge completed a thorough evaluation of the SADI agreement, which was signed in 2010 by PCI and the Government of Canada. The formula within the agreement ensures that “PCI must repay the contribution received over 15 years if its gross revenues are stable. It may have to repay up to 1.65 times the contribution received if its income increases sufficiently during the fifteen-year repayment period but may also have nothing to repay if it decreases throughout it.”

The Judge agreed that the fact that the obligation to repay expires after 15 years, independently of the amount reimbursed until then by PCI, constitutes a forgiveness clause and thereby makes the loan conditional and, “by the same token, government assistance within the meaning of the Income Tax Act.”

For this reason the judge granted the QRA’s appeal, reversed the rectified judgement rendered by the Court of Quebec, and reinstated the notices of assessment issued by the QRA for the years 2012, 2013 and 2014.

Key Excerpts

[1] The appellant (“the QRA”) is appealing a rectified judgment rendered on April 2, 2019, by the Court of Quebec, Civil Division, district of Montreal (the Honorable Daniel Dortélus), allowing the appeal of the respondent (“PCI”) and deferring to the QRA the contributions for the years 2012, 2013 and 2014, so that it may issue new ones granting to PCI the credits relating to the salaries related to its research and development activities (“ R&D”) which were refused.

[2] The only issue raised by the appeal is whether the trial judge erred in justifying the court’s intervention by concluding that a contribution made by the Canadian government in PCI does not constitute government assistance. within the meaning of the Taxation Act [1].

[9] PCI is a company involved in R&D activities related to the development of software for the satellite remote sensing industry.

[10] In 2009, it signed an agreement with the Canadian government (then represented by the Minister of Industry) within the framework of a program called the Strategic Aerospace and Defense Initiative (“SADI”), a federal program administered by the Industrial Technologies Office (“ITO”), an agency of Industry Canada. This agreement has been amended twice, in particular, to modify certain provisions and to agree on the creation of security in favour of the State.

[11] Under this agreement, the State undertakes to pay PCI a maximum of $7,665,000. This sum will be paid in several installments, spread over several years, according to certain expenses incurred by PCI. The program allows PCI to choose how it wants to repay the amount invested by offering her two options: 1) through fixed amounts, up to 1.5 times the amount received, or 2) through amounts that vary according to the fluctuation of his income, up to 1.65 times the amount received.

[12] PCI opts for the variable payment method under which the amount it must repay each year depends on the gross income it generates in a given year compared to the income of the previous year. I will come back to this in more detail.

[13] In January 2014, the QRA audited PCI’s tax returns for the years 2011 to 2014. It sought to determine whether the payments it had received from the Canadian government under this agreement constituted “government assistance” within the meaning of section 1029.6.0.0.1 of the Taxation Act since, if such is the case, certain tax credits to which it would otherwise be entitled must be reduced.

[14]  In the opinion that this is indeed “government assistance”, the QRA, therefore, sent PCI assessment for their 2012 to 2014 fiscal years (the year 2011 being prescribed) denying PCI SR&ED tax credits.

[15 ]  PCI opposed these assessments, but the QRA maintained them.

[17] Having first concluded that the agreement contained ambiguities, which, however, he did not identify, the trial judge chose to resort to the general rules of interpretation of contracts to, he said, determine the true intention of Parties.

[18 ]       Relying essentially on the testimony of the financial director of PCI, Mr. Robert Lang, he holds that the parties intended that the loan be repaid. He then points out that the State has the possibility of making a profit on its investment thanks to the formula used, that the parties amended the initial agreement to add guarantees and that it contains restrictive clauses as to the possibility for PCI to pay dividends or sell the business. According to him, these elements suggest that the existing relationship between PCI and the government is more of a joint venture.

[19]       He also rejects the QRA’s proposal that the loan is conditional since its repayment depends on the growth of PCI’s income. In doing so, he essentially relies on the reasons of the majority in the McLarthy case [2] which, according to him, rejects this idea by establishing that a loan is not conditional simply because it may not be repaid at maturity.

[20]       Finally, he affirms that “[t]here is no debt forgiveness clause after 15 years” and that “the QRA’s suggestion on this point is pure speculation” [3].

[21]       He, therefore, concluded that PCI succeeded in demolishing the presumption of validity enjoyed by the assessments and that the QRA has subsequently failed to prove its validity.

[22]       The QRA essentially repeats the grounds it argued before the trial judge. According to it, the agreement is clear: the contribution made by the Canadian government is a conditional loan since it will only have to be repaid, in whole or in part, if PCI’s income is maintained or increased over the years. Moreover, relying on article 2.2 of its appendix 3 and on article 7.1 of its general conditions, it maintains that the obligation to repay expires after 15 years, independently of the amount reimbursed until then by PCI, which she says constitutes a forgiveness clause.

[24]       PCI, for its part, argues that the judge made no palpable and overriding error in his interpretation of the agreement. He exercised his discretion in concluding that it is ambiguous and was right, then, to seek to determine what the intention of the parties, in this case, PCI and the Canadian government, was. A contract, she writes, is not the instrumental writing that establishes it, but rather the common intention of the parties.

[27]       The uncertainties identified by the QRA, as to when the repayments will be made, as to the amount thereof and as to whether they will be made, do not, in its view, lead to the conclusion that the loan is conditional. Relying in turn on the McLarty case [4], it maintains that these uncertainties constitute conditions that in no way affect the very existence of the loan.

[28]       Moreover, she says, it is possible to obtain a contribution from the Government under the SADI program and to benefit simultaneously from tax credits.

[32]       However, I am of the opinion that the terms of the agreement concluded between PCI and the Government of Canada clearly make PCI’s obligation to reimburse the contribution made by the government conditional. Let’s take a closer look.

[33]       The agreement, signed in 2010, has only nine articles but includes seven annexes in which the terms are found. Appendix 1 contains the applicable general provisions, Appendix 2 defines the project undertaken by PCI, Appendix 3 deals with the reimbursement by PCI of the contribution made by the government, while Appendix 5 lays down the terms and conditions surrounding this contribution. Appendices 4, 6 and 7, which respectively deal with communication requirements, the obligation to produce certain reports and the equipment required, are not relevant, moreover, to answer the question in dispute.

[34]       The agreement is amended twice; a first time in April 2010 and a second in July 2013. Since the audit carried out by the QRA took place in 2015, it determined the nature of the government’s contribution in the light of the agreement as amended by these two amendments. I will do the same.

[35]       First, Article 3 of the agreement details PCI’s obligations. Its paragraph (d) reads:

Article 3 – Recipient’s Obligations

3.1       The Recipient covenants and agrees:

(a) […]

(b) […]

(c) […]

(d) to pay Annual Repayment Due and the Maximum Amount to be repaid, as set out in Schedule 3;

[36]       The contribution of the State is for its part provided for in Article 4:

Article 4 – The Contribution

4.1       Subject to all the other provisions of this Agreement, the Minister will make a Contribution to the Recipient in respect of the Project, of the lesser of:

(a) 30% of the Eligible Costs; and

(b) $7,665,000.

4.2       […]

[37]       Section 4.1 of the general conditions contained in Schedule 2 establishes that the Minister will pay this contribution in accordance with the procedure set out in Schedule 5:

4. Claims for Payment

4.1 Payment of Claims

The Minister will pay the Contribution to the Recipient in respect of Eligible Costs incurred on the basis of itemized claims submitted in accordance with the procedures set out in Schedule 5.

[38]       Appendix 3, which must be used to find out the terms of PCI’s obligation to repay the contribution paid by the government, first includes, in article 1, a set of definitions:

APPENDIX 3

Definitions

“Adjustment Factor” is a multiplier applied to the repayment formula to calculate the Annual Repayment Due and is based on how much GBR in the current Recipient Fiscal Year has increased over GBR in the previous Recipient Fiscal Year.

“Annual Repayment Due” means the annual repayment payable by the Recipient to the Minister as set out in section 2 below.

“Benchmark Year GBR” means the GBR for the Recipient Fiscal Year immediately preceding the first year of the Repayment Period.

“Gross Business Revenues” or “BGR” means revenue as reported in the audited consolidated financial statements of PCI Group, as determined in accordance with generally accepted accounting principles, applied on a consistent basis.

“ITO Contribution” means the total amount of the contribution actually disbursed by the Minister under this Agreement.

“Maximum Amount to be repaid” means 1.65 times the ITO Contribution.

“Repayment Period” means the period during which repayments will accrue, as specified in paragraph 2.2 below.

“Repayment Rate” means ITO Contribution/Benchmark Year GBR x Years to Repay).

“Years to Repay” means 15 years.

[39]       This is followed by Article 2, entitled Conditional Repayments, which establishes in detail and using a precise formula, the manner of determining the amount, if any, to be reimbursed by PCI in a given year:

Conditional Repayments

The Recipient will pay to the Minister the Annual Repayment Due during the Repayment Period, as set out below

2.1 Annual Repayment Due for all years of Repayment Period

The annual Repayment Due shall be calculated annually based on the Repayment Rate and year-over-year change in GBR by application of the Adjustment Factor as outlined below.

Annual Growth in Royalty Base Growth Factor Adjustment Factor Repayments

less than 0% → 0% 0 No repayment due

0% to less than or equal to 3% → 3% 1 Nominal repayment, no adjustment

greater than 3% to less than or equal to 6% → 6% 1.25 Royalty increased by 25%

greater than 6% to less than or equal to 9% → 9% 1.33 Royalty increased by 33%

greater than 9% → > 9% 1.5 Royalty increased by 50%

Repayment Calculation
For each year of the Repayment Period, Annual Repayment Due shall be calculated as follows:

Annual Repayment Due = GBR for the Recipient Fiscal Year x Repayment Rate x Adjustment Factor.

[40]       Under these provisions, the amount that PCI must reimburse annually depends on the fluctuation of its gross income. The amount it must repay is in fact equal to its gross income for the year concerned multiplied by the established reimbursement rate multiplied again by the indexation factor which is a function of the fluctuation of its income.

[41]       Thus, PCI must annually repay one-fifteenth of the contribution received if its gross revenues remain stable. If its gross income increases by more than 3% in a given year, the amount it must repay is increased according to the applicable indexing factor. Moreover, it has no reimbursement to make if its gross income decreases since in such a case the indexing factor it must use to carry out the multiplication is zero, which necessarily leads to an amount of zero.

[42]       In fact, the agreed formula ensures that PCI must repay the contribution received over 15 years if its gross revenues are stable. It may have to repay up to 1.65 times the contribution received if its income increases sufficiently during the fifteen-year repayment period but may also have nothing to repay if it decreases throughout it.

[43]       PCI’s only obligation is to pay annual repayments for 15 years. The agreement also contains no provision obliging PCI, at the end of the repayment period, to repay at least the contribution received if it has not been repaid through annual repayments.

[44]       Section 7.1, on the contrary, provides that the agreement will expire once the stipulated maximum amount has been repaid or at the expiry of the repayment period, whichever comes first:

7.1      Repayments to the Minister and Contractual Benefits

The agreement will expire once the total amount to be repaid to the Minister pursuant to Schedule 3 has been repaid, or the Repayment Period set out in Schedule 3 has elapsed, whichever shall first occur.

[46]       It goes without saying that PCI hopes to reimburse it since such a scenario implies that its gross income has been maintained or has increased, but that does not change the fact that the parties have agreed that it would not be refundable if PCI’s gross income instead declines throughout the fifteen-year refund period. Hoping to repay a debt and having an obligation to do so are two separate things.

[47]       PCI also maintains that the State ensured its financial health and its ability to repay the contribution before entering into the agreement while ensuring that it benefited from significant guarantees. This, they say, suggests its intention to get it back.

[48]       Here again, the fact that the government verified PCI’s ability to meet its obligations, and requested that certain guarantees be granted to it, does not change the nature of the obligation contracted by PCI. The government, in doing so, verifies the financial health of PCI and ensures that it benefits from sufficient guarantees in the event of default on its part. The warranties granted to it can only be exercised in the event of a default on the part of PCI. However, no fault can be attributed to it if, its income decreases, it does not reimburse the contribution received.

[50]       The obligation to repay the contribution is indisputably conditional here on the achievement of certain financial results by PCI, which makes it a conditionally repayable loan and, by the same token, government assistance within the meaning of the Income Tax Act. The conditional obligation, let us recall, being that which [depends] on a future and uncertain event, either by suspending its birth until the event happens or until it becomes certain that it will not happen, or by subordinating its extinction to the fact that the event occurs or does not occur [7].

[54]       Mr. McLarthy contracted a debt which he undertook to reimburse under certain conditions. He granted certain guarantees to his creditor and agreed that if at maturity, he were to fail to repay his debt, his recourse would be limited to the exercise of the guarantees. We, therefore, understand that the obligation to repay is not conditional.

[55]       In this case, the agreement does not have the effect of limiting the remedies available to the government in the event of a failure of PCI. Rather, it provides that PCI’s obligation to repay will arise only if its income is maintained or increased, which constitutes a future and uncertain event. This condition affects the very nature of the debt.

[57]       That being the case, the QRA was justified in taking the contribution into account in establishing the expenses eligible for the salary credit.

[58]       It should be noted, in conclusion, that a taxpayer is generally entitled to a tax credit if, during a given year, he actually repays part of the government assistance received [9].

Link to Full Ruling

View the full report here.

Quebec Revenue Agency c. PCI Geomatics Enterprises Inc. (2020) – Current Ruling

Quebec Revenue Agency c. PCI Geomatics Enterprises Inc. (2020)- Unofficial English Translation