CIT Financial Ltd. v. The Queen

CIT Financial Ltd. v. The Queen Court (s) Database Tax Court of Canada Judgments Date 2003-09-05 Neutral citation 2003 TCC 544 File numbers 1999-3593(IT)G Judges and Taxing Officers Donald G.H. Bowman Subjects Income Tax Act Decision Content Citation: 2003TCC544 Date: 20030905 Docket: 1999-3593(IT)G BETWEEN: CIT FINANCIAL LTD., Appellant, and HER MAJESTY THE QUEEN, Respondent. REASONS FOR JUDGMENT BOWMAN, A.C.J. A. Introduction [1] This appeal is from an assessment for the 1993 taxation year of Commcorp Financial Services Inc. ("Commcorp") one of a number of companies that amalgamated to form the appellant, which was formerly called Newcourt Financial Ltd. [2] Originally, there were several issues but the parties have settled all but two. After the remaining issues have been dealt with by the Court, counsel have agreed to prepare a draft judgment in which all of the issues are disposed of. [3] The remaining issues have to do with capital cost allowance ("CCA") on software acquired by Commcorp in 1993. The Minister of National Revenue characterized the series of transactions and each transaction within the series whereby Commcorp acquired the software and then leased it back ultimately to the person who had developed it and used it in its business as an avoidance transaction within the meaning of the General Anti-Avoidance Rule ("GAAR") and determined the tax consequences to Commcorp to be that it was not entitled to claim any CCA on the software. [4] The alternative position is that Commcorp acquired the software from a person with whom it was not dealing at arm's length and the cost to it should be reduced to the fair market value ("fmv"), which the respondent says was not greater than $13,100,000. [5] The appellant concedes that Commcorp acquired the software from a person with whom it was not dealing at arm's length, but contends that the value at the date of the acquisition was $33,091,255. [6] The Crown has abandoned the arguments contained in subparagraphs 13(a)(i), (ii) and (iii), that the software was not acquired by Commcorp, that if acquired it was not acquired for the purpose of gaining or producing income or that the transaction or documents were a sham. [7] This leaves then the question of the application of GAAR and the question of the fmv of the software as well as the question of reasonableness under section 67. B. The transactions - April 1, 1993 [8] The transactions that took place in April, 1993 are described in a Partial Statement of Agreed Facts ("PSAF"), to which are attached the relevant documents. Attached to the PSAF are two charts, Exhibits A and B, in which the legal relationships and flow of funds are set out. These two charts are attached to these reasons. [9] The series of transactions can be summarized briefly. [10] BHP New Zealand Steel Limited (BHP) is a steel manufacturing corporation resident in New Zealand. It owned computer applications software (the "software") that it used in operating its production function at its integrated steel-making facility at Glenbrook, New Zealand and stored data in relation to the financial management of the operation. [11] Commcorp received an appraisal of the software from MACC and Partners Australia Limited at NZ $50,000,000. The Canadian dollar equivalent was $33,091,255. For convenience I shall from time to time in these reasons call this figure $33,000,000. [12] BHP sold the software to Macquarie Leasing (NZ) Limited ("MLL") a subsidiary of Macquarie Bank Limited ("MBL"), an Australian Bank, for Cdn.$33,091,255 for which a promissory note was given. [13] MLL sold the software to 1004583 Ontario Ltd. ("1004583") an Ontario company incorporated for that purpose by Commcorp's lawyers for $33,091,255 for which a promissory note was given. [14] 1004583 leased and licensed the software to Eagle Financial and Leasing Services Limited ("Eagle"), a Cayman company and a subsidiary of Barclays Bank PLC ("Barclays"), a UK bank. [15] The lease was for a term of 11 years expiring April 5, 2004. The lease included purchase options exercisable on April 5, 2002 and April 5, 2004 at an amount equal to the present value, calculated in 2003, of the remaining income stream. [16] Commcorp borrowed $27,770,896.80 from Barclays to be secured by an assignment of specific amounts of rent owing under the lease to Eagle and a portion of the amounts payable upon termination of the lease which corresponded to the outstanding balance of the loan at the relevant time. Recourse under the loan was limited to the assigned payments. [17] Eagle and MLL entered into a sublease and license agreement whereby Eagle subleased and licensed the software to MLL on substantially the same terms as the software had been leased and licensed by 1004583 to Eagle. One difference was that MLL was obliged on closing to prepay to Eagle the total rent payable under the sublease and the first option price. [18] MLL and BHP entered into a sub-sub-lease and license agreement under which MLL sub-subleased and licensed the software to BHP on substantially the same terms as the lease and sublease, except that MLL was obliged at the request of BHP to accept prepayment of $31,933,061 in satisfaction of BHP's obligation under the lease. [19] 1004583 entered into an agreement with Commcorp to sell the software to Commcorp on April 5, 1994 for $33,091,255. [20] 1004583, Commcorp, Eagle, MLL and BHP and Whitaker Nominees Limited, a New Zealand corporation ("Whitaker") entered into an escrow agreement under which BHP was to deliver to Whitaker a copy of the source code, object code and software documentation for the software, a copy of the software and the original valuation. The deposit of this material with Whitaker, as escrow agent, was acknowledged to be delivery of the software under the three software sale and assignment agreements. (i.e. BHP to MLL, MLL to 1004583 and 1004583 to Commcorp) [21] Commcorp, Barclays and Eagle entered into the Eagle Support agreement under which Eagle agreed to pay to Barclays $3,996,708. Barclays also agreed that wherever a "specified payment" became payable under the lease Barclays would pay or cause Eagle to pay out of the proceeds of the bond which Barclays agreed would be purchased with the $3,996,709. The "specified payments" were the scheduled rents and other amounts (including termination amounts) payable under the lease except to the extent that they were not assigned as security under the loan. [22] Barclays wrote to Commcorp agreeing that it would ensure that Eagle would meet its obligations under the agreements to which it was a party. [23] MLL, Eagle, Commcorp and 1004583 entered into a coordination agreement under which the obligations under the lease were divided into "Recourse covenants" which MLL agreed to perform and "Limited recourse covenants" which Eagle agreed to perform. Eagle gave MLL a power of attorney to exercise all of the rights of Eagle under the lease. As part of that agreement Commcorp executed a Non-Disturbance undertaking under which Commcorp agreed to be bound by the terms of the sub-sublease even if there was a default by Eagle or MLL under the lease or the sublease so long as BHP was not in default under the sub-sub lease. [24] MBL guaranteed the obligations of MLL under various agreements. [25] The moneys flowed as contemplated by the various agreements all from and to accounts of the parties at Barclays and the transactions closed on April 5, 1993. Paragraphs 11 and 12 of the PSAF summarize what happened that day: 11. On April 5, 1993 (see attached Exhibit A): (a) BHP assigned and transferred the Software to MLL pursuant to the BHP NZS Software Sale and Assignment Agreement and MLL executed a Promissory Note in favour of BHP in the amount of $33,091,255.00 in satisfaction of the purchase price payable by MLL for the Software, (b) MLL assigned and transferred the Software to 1004583 pursuant to the MLL Software Sale and Assignment Agreement and 1004583 executed a Promissory Note in favour of MLL in the amount of $33,091,255.00 in satisfaction of the purchase price of the Software, (c) 100483 (sic) leased and licensed the Software to Eagle pursuant to the Lease, (d) 1004583 assigned and transferred the Software to Commcorp pursuant to the Commcorp Software Sale and Assignment Agreement, (e) Eagle subleased and sublicenced the Software to MLL pursuant to the Sub-Lease and Licence Agreement. The documents included in Tabs 26-50 were also executed in connection with the above. 12. On April 5, 1993, the flow of funds was as follows: (a) Barclays advanced $27,770,896.80 to Commcorp pursuant to the Loan; (b) Barclays transferred the amounts referred to in the Directions, in accordance with the Directions, namely: (i) $33,091,255 from Commcorp to 1004583; (ii) $1,100,000 from Commcorp to MLL; (iii) $33,091,255 from 1004583 to MLL; and (iv) $33,091,255 from MLL to BHP; (c) BHP paid the amount of $31,933,061 to MLL, as prepayment of the rents and purchase option under the Sub-Sub Lease and Licence Agreement; (d) MLL paid the amount of $31,767,604 to Eagle, as a prepayment of the rents and purchase option under the Sub Lease and Licence Agreement; (e) Eagle paid Barclays the amount of $3,996,708, in accordance with the Eagle Support Agreement; (f) Barclays purchased the Bond for $3,996,709 in accordance with the Eagle Support Agreement, which Bond matured on March 15, 2002 for the amount of $8.13 million; (g) The amount of $27,770,897 ($31,767,604-$3,996,708) remained within Eagle and provided funds to make the lease payments to secure and discharge the Loan. Attached as Exhibit B is a diagram of the cash payments that were made on April 5, 1993. The amount of $1,100,000 referred to above was paid by Commcorp to MLL as fees in connection with the transaction. [26] I need not summarize the other formal steps taken in connection with the transactions including legal opinions. These matters were fully and competently dealt with by major law firms throughout the world. The transactions and the documents that underlay them represent genuine, legally binding and enforceable obligations. They were what they purported to be. [27] A few of the other facts as set out in the PSAF warrant being reproduced because they were considered significant by one or other of the parties and were referred to in argument: 18. The purchase price of the Software was funded by Commcorp using the $27,770,897 to be borrowed from Barclays and $6,420,358 from internal sources. This amount includes $1,100,000 which Commcorp paid to MLL as fees in respect of the transaction. Eagle paid $3.996M to Barclay. The balance of the prepayment rested with Eagle. 19. Before entering into the deal, Commcorp knew that BHP would pay an amount to MLL and MLL would pay an amount to Eagle which was sufficient to cover the obligations of Commcorp to Barclays over the life of the loan. 20. There was no indication to Commcorp that either BHP or Macquarie needed financing. This was not a deal whereby BHP or Macquarie obtained financing from Commcorp. 21. The net cash flow to Commcorp over the term of the deal regardless of whether the first purchase option is exercised is $1,711,907 (as set out Schedules I and II at Tab 72). The payments under the Lease and the principal interest payments required under the Loan are set out in Schedules at Tab 72. This schedule also includes details of the tax deductions anticipated in respect of CCA and interest and the income inclusions for tax purposes. 22. In computing its income for the 1993 taxation year (ending December 31, 1993), Commcorp included the amount of $34,191,255 in its cost of depreciable property in Class 12 of Schedule II to the Income Tax Regulations and deducted the amount of $17,313,740 as capital cost allowance under paragraph 20(1)(a) of the Income Tax Act in computing its income for that year, which amount was disallowed as a deduction by the Minister of National Revenue in reassessing the Appellant. 23. The arrangement in issue in this case was described to the Board of Directors of Commcorp (Tab 73) as a "tax predicated computer software lease that will provide Commcorp with $15MM of tax shelter in 1993 and an additional $15MM in 1994". 24. It was understood by Commcorp before entering into the deal that Eagle would sub-lease and licence the software to MLL and MLL would sub-sub-lease and licence the software to BHP. It was also understood that BHP and Macquarie would prepay their obligations under the Sub-Sub-Lease and Licence Agreement and the Sub-Lease and Licence Agreement, respectively. 25. The Appellant entered into two other deals in the following year based on the same model, involving prepayments to the leasee which was a subsidiary of the lending bank. They are referred to in Minutes of the Board of Directors Meeting of September 21, 1994 (Tab 74) as "tax advantaged software leases booked by the Corporation". 26. Commcorp's primary purpose in entering into the arrangement in issue in this case was to obtain the capital cost allowance arising from the acquisition of the Software in that the capital cost allowance was deductible in the first two years and the rents were receivable over the term of the lease. [28] I am attaching as Exhibits I and II, the Schedules at tab 72 of the PSAF because they illustrate the real economics of the transaction. Obviously the predominant economic motivation from Commcorp's standpoint lay in the tax write off. This is not disputed. Presumably there were tax advantages in New Zealand to BHP, but I do not know exactly what they were. They are not germane to this case. The schedules however demonstrate something else - the essential circularity of the transaction. $33,000,000 was inserted at one end and it ended up back where it started. The only thing that did not move was the software. It stayed where it started - with BHP. No one - Commcorp, the bank, Eagle, BHP or anyone else in the chain - bore the slightest risk. The $33,000,00 was based on a valuation by MCC which had been selected by MBL who had an interest in seeing the deal go through because of the $1,100,000 commission that MLL was to receive. The $33,000,000 valuation bore little relation to the actual cost of developing the software which was more like $11,000,000. [29] The simple fact is any number would have worked because the money all came back to the starting point. I shall deal with this point more fully when I discuss the fmv of the software. [30] The third reason that the schedules are important is that they illustrate the difficulty of determining the tax consequences to deny the tax benefit "as is reasonable in the circumstances". Here the Minister has decided that this is an avoidance transaction not saved by subsection 245(4). The tax benefit is the deduction of CCA on the software. Therefore, so the reasoning goes, the deduction of the CCA should be denied but all of the other consequences over the term of the transaction from 1995 to 2004 are left untouched. Admittedly, the GAAR is something of a blunt instrument, but while it may not be a scalpel neither is it a sledgehammer. [31] The large income and deduction anticipated over the years from 1995 to 2004 are undoubtedly predicated on a cost of $33,000,000 with its consequent tax write off. The GAAR seems to have been enacted to enable the Minister to combat overly aggressive tax avoidance schemes whose fiscal purposes far overshadowed their commercial purposes. It should not be used as an instrument to punish people for engaging in tax avoidance schemes that the Minister does not like by taking away the fiscally beneficial aspect of an avoidance transaction but leaving intact the detrimental aspects. [32] I turn first to the question of the fmv of the software. Two valuations were submitted in evidence by the appellant. The first valuation was prepared by Mr. Geoffrey H. Cooper (the "MACC valuation") before the lease was entered into. The second valuation was made by Mr. Peter Hatges of KPMG. The Crown did not have an opportunity of examining the software before trial because it was not available. When it became available I adjourned the trial to permit the Crown's experts to examine it, but apparently the state it was in after 10 years, with all of the changes that continued use over that period entailed, made any meaningful determination of value as of April 1993 impossible. The Crown therefore relied on reports prepared by Mr. Howard E. Johnson of Campbell Valuation Partners Limited in which he comments on the appellant's expert reports. [33] Before discussing the reports, let us look at just what we are trying to do here. Commcorp bought the software in a non-arm's length transaction and therefore the price under section 69 is deemed to be the fmv. The primary purpose of the purchase was to obtain a tax write off. Therefore one would not expect a party such as Commcorp or anyone else in the chain such as MLL, 1004583 or Eagle or, indeed, BHP, to be concerned about striking a deal that bore any relationship to its inherent commerciality because there was no commercial risk involved to anyone. We are not dealing with a parcel of land or shares in a company. The property to be valued is a unique, special purpose software package developed by BHP for its own purposes in running its steel mill in New Zealand. Its true value to BHP in the conduct of its business is unknown. It could vary within a range of indeterminate magnitude depending on the criteria used. The conventional definition of fmv is too well known to require repetition but it involves postulating a hypothetical vendor and purchaser who are at arm's length, knowledgeable and canny and who would like to make a deal but are not desperate to do so and deciding what sort of a bargain these hypothetical negotiators would strike. As Viscount Simon said in Gold Court Selection Trust Limited v. Humphrey (Inspector of Taxes), [1948] A.C. 459 at 473. ... If the asset is difficult to value but is none the less of a money value, the best valuation possible must be made. Valuation is an art, not an exact science. Mathematical certainty is not demanded, nor indeed is it possible. It is for the commissioners to express in the money value attributed by them to the asset their estimate, and this is a conclusion of fact to be drawn from the evidence before them. [34] The difficulty with attempting to determine the fmv of the software here is that there is no evidence that software that is specifically designed and developed to run a particular steel mill in New Zealand is likely to be bought and sold on the open market. I find it difficult to believe that a steel company is some other part of the world would pay anywhere near $33,000,000 for software designed and developed for BHP's steel mill in New Zealand. The uniqueness of the software is illustrated by section 3.0 of the MACC report which reads: 3.0 The Computing Environment in BHP NZS BHP NZS is New Zealand's largest steel producer employing some 1,900 staff. The company operates an integrated steel mill, comprising iron making plant, steelmaking plant, treatment plant, continuous casting machines, hot strip mill, cold reduction mill, tube and pipe mill and coil coating lines. The company's approach to steel making is different to most in that it uses iron bearing sand as a raw material rather than iron ore. The company exports the majority of its output (approx. 66%) and hence needs to be competitive in the international market place. It does this through being a niche supplier and differentiating itself from major producers by being flexible as to the quantity of a product that can be produced and providing responsive client service. The ability to change schedules and produce small order quantities economically is critical to its competitiveness. BHP NZS is relatively progressive in its implementation of computerised processing management systems and computer based business systems. The company has prepared a Computer Services Business Plan which outlines how CSD will support the operations of the company from the conversion of the raw material through to the despatch of the finished product. The plan identifies the following 6 levels of computerisation. Level 5 - Corporate System Level 4 - Business Support Level 3 - Process Management Level 2 - Process Control Level 1 - Real Time Control Level 0 - Sensors and Activators The plan identifies and maps the extent of integration between each level. The knowledge of and adherence to this plan appeared to be well understood and accepted throughout the total organisation. In fact CSD was seen to be a critical element in the overall achievements of the organisations's strategic and annual plans. While the business and computer information systems had been addressed in the past, the current focus is on computer integrated manufacturing (C.I.M.) which is the horizontal and vertical integration of systems, thereby allowing each level of management access to key data through which decisions, optimisation and continuous improvement can be made. Full implementation of all C.I.M. systems is planned to lead to further cost reductions, e.g. through inventory reduction and cheaper process costs, because of the increased co-ordination that will be possible between individual plants. The approach to application development revolves around heavy user involvement in all development activities - in fact for system development projects the delineation between user and CSD staff is hard to determine, so integrated is the team. While there are formally some 55 staff in CSD there are at least 150 staff company wide involved in computer application development and support roles. The company has adopted an "open system" and distributed processing approach to computer application development using a variety of languages (LINC, ORACLE, FORTRAN) running on multiple hardware platforms (UNISYS, IBM, DEC, SUN). A site wide network based on fibre optics links all processors and facilitates data integration. [35] I have not reproduced the lengthy section 4.0 (Functional and Technical Evaluation of the Software except for one short passage: Based on our review the following broad conclusions were formulated regarding the appropriateness and maintainability of the Software: · While three different programming languages were used for the application development, each language is operationally efficient and well supported. The decision as to which programming language to use was based [on] the hardware platform, nature of processing and likely future technological directions. · There was a heavy emphasis on user involvement and user responsibility acceptance in most stages of software development. This relationship between CSD and users was one of close co-operation. · Considerable effort was devoted to alignment of the application requirements with the business needs. This was a substantial factor in ensuring the delivery of effective, supportive and functional applications. · The Software code appears to be efficiently written and structured to ensure that efficiencies were gained in the overall application development and maintenance tasks. · An "open" system approach has facilitated the integration of applications whereby data can be transmitted between applications regardless of technical platform. · Extensive user functions have been incorporated into the Software to support the business operations. · The Software has been developed using modular programming techniques which aid the system modification of enhancement effect. · The Software is well documented from a technical and user perspective. · While not formally documented, industry standards and methodologies current at the time of development appear to have been used in the development process. · The Software appears to be well maintained with new functionality resulting from user interaction and requests for enhancements and modifications. · The Software has been developed according to a formal strategic plan which identifies the discrete applications and the extent of (vertical and horizontal) integral/relationship with other applications. [36] These passages as well as other passages in the report illustrate the excellence of the software in its application to the business of BHP. I accept this conclusion but what it demonstrates is that however valuable it may be to BHP in running its business it could not be readily adapted to anyone else's business. Its very value to BHP is in inverse relationship to its value to another mill and hence would adversely affect what the software would fetch on the open market. Put differently, any company that wanted to install a computer system to run its steel mill would find it easier and cheaper to develop its own system than to pay $33,000,000 or any other amount for BHP's system and then try to adapt it. The more precisely tailored it is to BHP's business and hence the greater its commercial value to BHP, the less useful or valuable it will be to another user. [37] Faced with the difficulty of finding an open market for the software the MACC report has adopted a valuation method that takes into account replacement cost and historical effort. The following appears in the report: For the purposes hereof, our conclusions as to the value of the Software at any time represents the price, expressed in terms of money, obtainable for the Software in an open and unrestricted market between informed and prudent parties acting at arm's length and under no compulsion to transact. This type of wording with slight variations appears in virtually all valuation reports. It is the traditional definition of fmv used by valuators. I do not take exception to it as a definition. It is not however what the MACC report is determining. No open and unrestricted market for software of this type has been identified. That is why replacement cost had to be resorted to as the only available method that would yield a value. [38] In Aikman v. R., [2000] 2 C.T.C. 2211, affirmed [2002] 2 C.T.C. 147 (F.C.A.) I expressed serious reservations about the use of replacement cost to determine fmv and considered a number of cases where the courts had to determine the fmv of property for which there was no open market. The property there was a disassembled prototype of a lighter-than-air aircraft called the Cyclo-Crane. In that case, however, I had the evidence of a recent arm's length purchase. I do not view the series of purchases for $33,000,000 as affording evidence of fmv. [39] In this case we have the experts for both parties using replacement cost as an acceptable method of determining fmv and, as Viscount Simon said in the Gold Coast case, one has to do the best one can. Moreover the replacement cost of a property that is developed for use in carrying on a business may be some evidence of fmv in the absence of an open market whereas the replacement cost of a museum artifact with no commercial function is clearly not a reliable test. [40] Since all the experts agree that replacement cost is an acceptable test and since I have nothing else to go on, I shall deal with the evidence of value on that basis. [41] The MACC report states: We have formed an opinion as to the value of the Software using the following valuation methodologies: · Replacement cost - the value calculated to be the current cost of replacing the Software in terms of design, development together with user training and documentation. · Historical effort - the effort incurred by BHP NZS in design, development and implementation of the Software. In determining the value of the Software a two staged approach was adopted, which involved: · Estimating the value of the Software based on quantitative methods related to replacement cost. · Adding a factor to replacement cost based on the perceived intellectual knowledge, special skill required to design and develop the Software, its importance to the business operations of the group, and its contribution to earnings. [42] In his testimony Mr. Cooper stated that the words "and implementation" should be deleted. I agree. The cost of implementation forms no part of replacement cost. However the rest of the evidence of Mr. Cooper does not support the contention that he did not include the cost of implementation. [43] In determining the replacement cost of the software Mr. Cooper used several methods: (i) Lines of code. This involves counting the number of lines of operational code (or program statements) and then applying an average number of lines completed per day to arrive at a total number of person days for this application. (ii) Development time. This involves counting the total time required to perform all activities and tasks associated with the development of the software. Mr. Cooper refers to a book by Capers Jones "Applied Software Measurement" where the observation is made that corporate trading systems accidentally omit 30 percent to 70 per cent of effort in the development of software products. Accordingly he made upward adjustments to take this factor into account. (iii) Function point analysis. Function points are the weighted sums of five or six different factors such as algorithms, inputs, outputs and so forth and determining how many can be completed per person month. (iv) Backfire conversion. This is simply a method of verifying the function point analysis by working backwards to the source code. (v) Estimation formulae. This involves applying formulae to the number of lines of code produced. I shall not discuss this method further because Mr. Cooper did not consider it reliable and rejected it. I can see why. It resulted in a replacement cost of $58.7 million (NZ), over $10 million higher than the next highest method. [44] The result of Mr. Cooper's analysis using the various methods is as follows: Lines of code - $47,000,000 (NZ) Development time - $41,100,00 (NZ) Backfire conversion - $52,000,000 (NZ) [45] Mr. Cooper, after setting out these numbers, makes a number of comments on the variances. One such observation is the following: There are variances in value between methods applied across the applications. This demonstrates the volatility of factors used in the calculations. He concludes that the current replacement cost of the software is NZ$47,000,000. To this he adds another NZ$3,000,000 because of the competitive advantage that the use of the software gives it. [46] Frankly, one does not need the assistance of an expert to see the fallacy of this reasoning. If you are determining replacement cost you do so by the best method you can. You do not add to the replacement cost that you have determined some arbitrary percentage based on an unrelated factor having to do with how good the product is. [47] Before I deal with the rebuttal report prepared by the respondent's expert witness there is one piece of evidence that sticks out like a sore thumb. On March 16, 1993 a lawyer acting on behalf of BHP sent a letter to the Commissioner of Inland Revenue of New Zealand setting out the development costs for each application. The figures contained in that letter, as well as those in the MACC report, are as follows: (they were reproduced in Mr. Johnson's report): Application Tax Letter MACC Report Sales Order Administration ('MARKET') NZ$ 1,230,000 NZ$ 6,710,000 Product Design System 725,000 6,380,000 Master Production Scheduling ('MPS') 670,000 3,910,000 Galvanising ('GOSPR') 820,000 3,960,000 Supply System 1,200,000 4,400,000 Financial System Database ('FINSYS') 890,000 4,600,000 Cost Management System ('CMS') 610,000 2,665,000 Rolling Mills Production ('ROLLPC') 1,370,000 5,600,000 Primary Plant Level 3 ('PPL3') 3,000,000 8,165,000 CPD System 675,000 3,800,000 Total NZ$ 11,190,000 NZ$ 50,000,000 (rounded) Conversion Rate to Cdn.$ at the Valuation Date 0.6618 0.6618 Total - Cdn.$ Cdn.$ 7,405.823 Cdn.$ 33,091.255 [48] In the MACC report reference was made to the Capers Jones book Applied Software Measurement which states that most companies tracking systems do not record between 30 and 70 percent of the real effort that goes into software. These percentages are unsubstantiated and may be arbitrary estimates. Nonetheless, let us accept them and see where they take us. [49] If we add the lower and higher percentages for slippage to the figures given to the New Zealand tax authorities of NZ$11,190,000 we arrive at figures of NZ$14,587,000 and NZ$19,023,000 respectively or Cdn.$9,627,204 and Cdn.$12,589,421. [50] I do not intend this calculation to be a stand-alone valuation but it demonstrates how far out of line the MACC report is. Moreover it is consistent with the figures in Mr. Johnson's report. [51] Mr. Johnson's criticisms of the MACC report are specific and detailed. His conclusions are summarized in a letter to respondent's counsel. In summary, based on our review and analysis, in our view, the MACC Report's conclusion of NZ$50 million (approximately Cdn.$33 million) for the fair market value of the Software at the Valuation Date likely is significantly overstated. As explained more fully in Appendix A to this letter, the reasons for our view are: · a letter to the Commissioner of the Inland Revenue Department of New Zealand dated March 16, 1993 wherein BHP New Zealand Steel ('BHP NZS') purports the development cost of the Software to be NZ$11,190,000 (approximately Cdn.$7.4 million); and · specific issues in the MACC Report, which suggest that its value conclusion is overstated. These include the: √ inclusion of implementation and training time as a component of replacement cost, which costs do not form part of replacement cost for the Software program itself from the standpoint of Commcorp Financial Services Inc. ('Commcorp'). Such costs may represent between 20% and 35% of the total time expended, √ daily labour charge rate of NZ$700 adopted by MACC, which may be overstated by 20% to 30%, √ double-counting of overhead costs relating to management and administrative time, which may overstate the adjustment for 'involvement of non-CSD staff' by 5% to 10%, √ double-counting of software development time in respect of 'general purpose code' for certain applications, which may overstate the value of the Software by approximately NZ$2 million (approximately Cdn.$1.3 million), and √ application of a 'business factor' premium, which may overstate the fair market value of the Software to Commcorp by NZ$3 million (approximately Cdn.$2.0 million). Adjusting for the apparent errors and inconsistencies in the MACC Report based on our analysis, the fair market value of the Software at the Valuation Date falls in the range of approximately NZ$18.5 million to NZ$27.3 million, or approximately Cdn.$12 million to Cdn.$18 million. Finally, notwithstanding the adjustments that may be appropriate as outlined above, the MACC Report's conclusion that the residual value of the Software 9 years following the Valuation Date is 35% of the initial fair market value (being NZ$17.5 million, or approximately Cdn.$11.6 million) likely is significantly overstated as well. [52] He supports these conclusions in appendices to the letter. I will not reproduce them here except for the calculation below. I found Mr. Johnson an impressive witness and I accept his conclusions. His recalculation of the fmv of the software is set out in Schedule 2 as follows: Schedule 2 Recalculation of Fair Market Value of the Software Low High Fair market value per MACC Report NZ$ 50,000,000 NZ$ 50,000,000 Business factor premium (3,000,000) (3,000,000) General purpose code (1,880,000) (2,115,000) Sub-total 45,120,000 44,885,000 Management and administrative time 10% 5% (4,512,000) (2,244,250) Sub-total 40,608,000 42,640,750 Average daily labour charge rate 30% 20% (12,182,400) (8,528,150) Sub-total 28,425,600 34,112,600 Implementation and training costs 35% 20% (9,948,960) (6,822,520) Adjusted fair market value NZ$ 18,476,640 NZ$ 27,290,080 Conversion Rate to Cdn.$ at the Valuation Date 0.6618 0.6618 Total - Cdn.$ (rounded) Cdn.$ 12,000,000 Cdn.$ 18,000,000 [53] The MACC report calculates the residual value of the software at the end of nine years to be 35 percent of its fmv in 1993. The implausibility of this assertion is illustrated in Mr. Johnson's report where he says: Residual Value Determination The MACC Report estimates the residual value of the Software at the end of 9 years to be 35% of its 'Assumed Value' (i.e. NZ$17.5 million). When determining the residual value of the Software, the MACC Report assumes (at Section 8.0) that the Software will not be maintained (or modified by Commcorp). Conversely, in Section 10.0, the MACC Report states that "much of the Software is "state of the art" hence to maintain its competitive advantage and value the Software needs to be continually modified and enhanced to cater for changing requirements and business needs". Accordingly, it seems unrealistic that the Software would retain a significant portion of its original value (35%) 9 years after the Valuation Date, with no maintenance or enhancements, when such things are considered critical by MACC. The residual value of 35% after 9 years implies an average compound 'physical depreciation' rate of approximately 11% per annum over that period which, in the absence of appropriate maintenance and enhancements, further serves to illustrate the implausibility of MACC's residual value assumption. By way of comparison, at Section 11.0, the MACC Report states that the residual value of the Software at the end of its remaining life (of 12.75 to 12.8 years from the Valuation Date as estimated by MACC) will be approximately 5% of its value at the Valuation Date (in constant dollars). Accordingly, MACC has assumed that the fair market value of the Software will decline at an average annual compound rate of approximately 11% from 1993 through 2002, but then at an average annual compound rate of approximately 40% from 2002 through the end of 2005. [54] I agree. The idea that software developed in 1993 to run a steel mill would after nine years retain 35 percent of its value strikes me as well beyond the realm of possibility. The fact that the Crown was unable, in 2003, to determine the fmv of the software because of the extensive changes in it over 10 years illustrates how useless it would be without constant upgrading. It is common knowledge that software becomes obsolete very quickly and the evidence here confirms this fact. [55] Even if we applied the unrealistic percentage of 35 percent to Mr. Johnson's estimate of between $12,000,000 and $18,000,000 (Cdn.) we still end up with $4,200,000 to $6,300,000. This strikes me as high. I do not think that realistically one can justify a figure in excess of 15 percent of the fmv in 1993 and this is probably generous. [56] The Crown's own expert gives us a fmv in 1993 of between $12 and $18 million (Cdn.). I am not bound to accept this or any other expert opinion and I think that the actual costs of developing the software as supplied to the New Zealand tax authorities are as reliable an indication of the fmv of this property as one is likely to find, at least as a starting point. Therefore, I think the figure of $18,000,000 is too high. [57] So far as the slippage factor suggested by Capers Jones of between 30 and 70 percent is concerned the 30 percent figure may be realistic whereas the 70 percent factor applied to the BHP figure puts it roughly into the Johnson range of $12,000,000. I think it is fair to give the appellants the benefit of the higher figure which results in a fmv of $13,100,000. I arrive at this figure by adding 70 percent to $7,405,823, the Canadian dollar equivalent of NZ$11,190,000, to arrive at $12,589,899 (Cdn) and rounding it up to Cdn.$13,100,000 which is the figure stated in the Reply to the Notice of Appeal. This is within the range suggested by Mr. Johnson. Thus we have a substantial convergence of these calculations - the figure in the Crown's reply, the range suggested by the Crown's witness and the figure arrived at by taking BHP's own recorded costs and adding the high end of the Capers Jones slippage factor. [58] I can deal briefly with the KPMG report. The rent payable under lease of the software by 1004583 to Eagle is based upon the $33,000,000 MACC valuation. The KPMG report does not value the software. It values the lease based on the rentals which are themselves based on a valuation that in my view is about $20,000,000 too high. If you start from a value of $33,000,000, base your rents on that figure knowing that the money is going to come back to where it started it is not surprising if you end up with a value for the lease that is equal to $33,000,000. [59] If they had started with a figure of $100,000,000 and based the rentals on that amount they could have determined the discounted cash flow to be $100,000,000 and therefore the value of the software with the lease to be that amount. Mr. Johnson commented on the KPMG report as follows: All monetary amounts set out in this letter are expressed in Canadian dollars. In our view, KPMG Report's conclusion that the fair market value of the Software at the Valuation Date was approximately $34 million is unsubstantiated. The principal reasons for our view are that: • KPMG does not specifically address the value of the Software, but rather the lease agreement in respect of the Software. KPMG assumes that its calculation of the present value of the Software lease payments can be taken as the fair market value of the Software. Based on its scope of review, it is evident that KPMG did not perform any meaningful assessment of the Software itself that would have enabled it to reasonably estimate the fair market value of the Software independent of the Software lease; • the approach adopted by KPMG represents a circular calculation. The lease payments were established based on the Software purchase price of approximately $33 million, which in turn was linked to the report prepared by MACC Partners Australia Limited ('MACC') dated April 5, 1993 (the 'MACC Report'). Therefore, it is not surprising that KPMG's calculation of the present value of the lease payments approximates the purchase price amount. If this were not the case, it would represent an arbitrage profit opportunity for either the lessor or the lessee. Therefore, KPMG's approach serves only to verify the mathematical accuracy of the lease payments. It does not address whether the fair market value of the Software on which those lease payments were established is reasonable. As explained in our letter dated April 11, 2003 containing our comments on the MACC Report, in our view MACC's estimate of the fair market value of the Software of approximately $33 million likely is materially overstated. As a result, KPMG's attempt to ascribe the present value of the lease payments to the fair market value of the Software serves to reinforce the errors made by MACC in its determination of the fair market value of the Software; and • the discount rate adopted by KPMG of 8.64% represents a near risk-free rate of return. While such a rate might be appropriate when valuing the Software lease, given the secure nature of the lease payments, it does not represent a reasonable rate of return by which to determine the fair market value of the Software itself. Commercial rates of return required in the development and sale of complex proprietary software programs are significantly higher than risk-free rates of return given the inherent risks involved in such activities. Had KPMG adopted a commercial rate of return reflective of the risks of the Software itself, its calculation of the fair market value of the Software would have been significantly less than $34 million. [60] I accept these conclusions. It is in my view artificial to base a valuation on the discounted cash flow under a lease where the rentals are themselves based upon an excessive valuation and in which it makes no difference what the rentals are because they substantially come back in one form or another to where they started. [61] During argument counsel for the appellant used an analogy of two identical buildings, side by side, where one is completely leased on long term leases to triple A tenants such as a provincial or federal government department and the other on short leases to hippies and beatniks. He says the former building would fetch a much better price than the latter. No doubt he is right but the analogy does not stand up. In the case of the two buildings the leases were negotiated in the open market. Here the lease was simply one link in a closed circuit. [62] The KPMG report confirms the mathematical accuracy of the arrangement but it does not prove anything about fmv. [63] The rest of these reasons will proceed on the basis that the fmv of the software as of April 5, 1993 was $13,100,000. The result that flows from this under section 69 is that Commcorp, who acquired the software from 1004583 in a non-arm's length transaction, acquired it from 1004583 at a cost of $13,100,000. I make no finding on the question of the $1,100,000 paid as a fee to MLL. It was included by Commcorp in the $34,191,255 which it claimed was the capital cost of this software. No separate argument was made on this item. Since the parties will be drafting the formal judgment in any event they can deal with this point or, failing agreement, I can be spoken to. [64] This leaves then the question of reasonableness under section 67 and GAAR under section 245. [65] Section 67 may in some cases perform the same function in an arm's length situation as section 69 does in a non-arm's length one. Generally it is unreasonable to pay in excess of fmv for property and this is true whether the payor is at arm's length with the vendor or not. Section 69 provides an automatic mechanism to reduce an excessive price to fmv where the parties are not at arm's length. In an arm's length relationship section 67 does not automatically apply. Here, however, it is subsumed in the application of section 69. Put differently, section 67 can, at least in this case, add nothing to what section 69 has already done. [66] What, then, about GAAR? The application of GAAR involves a number of steps. GAAR is a weapon of last resort to be invoked only where a transaction or series of transactions perceived as having as their purpose the avoidance of tax work, i.e. achieve their intended fiscal result. If the transaction does not work apart from GAAR in any event there is no need to invoke GAAR. If it does work the next step is to determine whether there is an avoidance transaction resulting in a tax benefit that should be denied. Before coming to the determination of the method of denying the tax benefit "as is reasonable in the circumstances" it must be determined whether it may be considered that the transaction would result directly or indirectly in a misuse of the provisions of the Act or an abuse having regard to the provisions of the Act other than section 245, read as a whole. If it is decided that subsection (4) does not exclude the operation of subsection (2) the consequences must be determined under subsection (2). In applying subsection (2), subsection (5) presents a wide but not exhaustive list of things that may be done. [67] Subsection (7) requires that the tax consequences must be determined only through a notice of assessment, reassessment, additional assessment or determination. [68] On an appeal from an assessment in which GAAR is applied, the Court is entitled to consider every one of the elements described above. If it considers that GAAR applies it is entitled to decide whether the Minister's determination of the tax consequences is appropriate and, if it concludes that it is not, the Court may substitute its own determination. Section 245 gives the Minister no discretionary powers either in deciding that GAAR applies or in deciding the appropriate remedial action to be taken. Therefore the court's powers on an appeal from an assessment made under section 245 are at least as far reaching as the Minister's. [69] Here the appellant admits that the transaction is an avoidance transaction as defined in subsection (3) but contends that there is no misuse or abuse as contemplated by subsection (4) and accordingly subsection (2) does not apply. [70] The Minister has denied the entire claim for CCA. This strikes me as unreasonable and an overreaction. Section 245 is not a penal section. It is not contended by the respondent that the transactions were shams, that the software was not acquired or that it was not acquired for the purpose of gaining or producing income. These arguments were originally pleaded as assumptions but were dropped at trial. Had such arguments been advanced and accepted there would have been no need to invoke section 67 or 69. The result of accepting any of these arguments would have been a denial of the entire CCA claim. GAAR would not even have come into the picture. What I find rather odd is for the Minister to have "assumed" facts that would completely destroy the claim for CCA and then "assume" that GAAR applies. The GAAR assumption is logically inconsistent with the other assumptions pleaded. They cannot stand together. This does not seem to have troubled the Minister who shares, as I assume he does, Emerson's view of inconsistency. [71] In a case such as this one must first consider whether other sections of the Act are effective to eliminate or attenuate the beneficial tax result sought by the taxpayer. This would include specific rules such as section 55, the at-risk rules, the leasing property rules, section 67, or section 69, to mention only a few. If what remains after the application of the specific rules is still a result to which the Minister believes that GAAR should be applied then it must be considered after the specific sections have been considered and, if possible, applied. GAAR does not subsume or encompass the other sections of the Income Tax Act, nor is it a substitute for them. [72] If one proceeds from the twofold premise that the software was acquired for the purpose of gaining or producing income (and the acceptance of this proposition is implicit in the Crown's abandonment of the opposite assumption) and that its cost was $13,100,000 then what room is left for GAAR? The transaction even ceases to be an avoidance transaction and the abuse that results from claiming CCA on an artificially high capital cost is completely eliminated by section 69. [73] If I had concluded that GAAR had applied I would have determined that the appropriate means of denying the tax benefit was to base the CCA on the fmv of the software and not to deny it entirely. It is no abuse of subsection 20(1) of theIncome Tax Act or the Regulations to claim CCA on property at the favourable rates provided for that property. The abuse lies in claiming CCA on an artificially inflated price. That, however, is not an abuse or misuse of the provisions of the Act that requires GAAR. It is an abuse that is readily counteracted by section 69. [74] If one applies GAAR and bases the claim for CCA on the fmv of the software or if one applies section 69 and bases the claim for CCA on the fmv precisely the same result is achieved. If the same result can be achieved without section 245 as with it obviously, as a provision of last resort, section 245 need not be resorted to and it has therefore no application. There is no need to invoke a general anti-avoidance provision to do what a specific provision can do simply and efficiently. [75] The appeal is allowed and the reassessment is referred back to the Minister of National Revenue for reconsideration and reassessment on the basis that the software was acquired by Commcorp from 1004583 at its fair market value of Cnd.$13,100,000. [76] The parties are directed to prepare a draft judgment incorporating the conclusions stated in these reasons as well as any other matters in this litigation that they have settled. [77] Failing agreement on costs the parties should communicate with the Court to determine a suitable date for making representations. Signed at Ottawa, Canada this 5th day of September, 2003. "D.G.H. Bowman" A.C.J. CITATION: 2003TCC544 COURT FILE NO.: 1999-3593(IT)G STYLE OF CAUSE: CIT Financial Ltd. v. The Queen PLACE OF HEARING: Toronto, Ontario DATE OF HEARING: April 28, 29 and 30, 2003 and July 3, 2003 REASONS FOR JUDGMENT BY: The Honourable Associate Chief Justice D.G.H. Bowman DATE OF JUDGMENT: September 5, 2003 APPEARANCES: Counsel for the Appellant: Warren J.A. Mitchell, Q.C., David R. Davies and Paul Tamaki Counsel for the Respondent: Alexandra K. Brown, Kathryn Philpott and Ruth Dick COUNSEL OF RECORD: For the Appellant: Name: Warren J.A. Mitchell, Q.C. Firm: Thorsteinssons Vancouver, British Columbia For the Respondent: Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada Exhibit A Legal Relationships Loan Security Assignment Lease (After sale to Commcorp) Commcorp Software Sale +and Assignment Agreement Lease (Before sale to Commcorp) Sub-Lease and Licence Agreement MLL Software Sale and Assignment Agreement BHP Software Sale and Assignment Agreement Sub Sub Lease and Licence Agreement Exhibit B Flow of Funds on April 5, 1993 $27,770,896 (Loan) $3,996,709 (Eagle Support Agreement) $33,091,255 (Purchase Price) $1,100,000 (Fee) $33,091,255 (Purchase Price) $31,767,061 (Prepayment) $33,091,255 $31,993,061 (Purchase Price) (Prepayment) Commcorp Financial Services Inc. Cash Flow Analysis Auditor Marina Battista y/e Oct 31/93 Full Term 10/30/98 Cross Border Software Lease CASHFLOW.XLS full term Schedule I Date Explanation Cash Flows DR CR Income Tax Consequences tx yr Net Revenue/ (Expense) 5-Apr-93 5-Apr-93 5-Oct-93 5-Oct-93 Purchase of application computer software Fee loan from Barclays Bank Interest Expense Paid Lease Revenue Received $27,770,897 $1,457,972 $33,091,255 $1,100,000 $1,457,972 $33,091,255 Addition to C1 12 $1,100,000 included in cost of asset y/e 93-$17,095,628 CCA available y/e 94-$17,095,628 CCA available $27,770,897 remains in Barclays Bank fully deductible, as interest expense full taxable as revenue 93 94 $(17,095,628) $(17,095,628) $ 5-Apr-94 5-Apr-94 5-Oct-94 5-Oct-94 Interest Expense Paid Lease Revenue Received Interest Expense Paid Lease Revenue Received $1,457,972 $1,457,972 $1,457,972 $1,457,972 fully deductible, as interest expense fully taxable as revenue fully deductible, as interest expense fully taxable as revenue $ $ 5-Apr-95 5-Apr-95 5-Oct-95 5-Oct-95 Interest Expense Paid Lease Revenue Received Interest Expense Paid Lease Revenue Received $1,457,972 $1,457,972 $1,457,972 $1,457,972 fully deductible, as interest expense fully taxable as revenue fully deductible, as interest expense fully taxable as revenue $ $ 5-Apr-96 5-Apr-96 5-Oct-96 5-Oct-96 Interest Expense Paid Lease Revenue Received Interest Expense Paid Lease Revenue Received $1,457,972 $1,457,972 $1,457,972 $1,457,972 fully deductible, as interest expense fully taxable as revenue fully deductible, as interest expense fully taxable as revenue $ $ 5-Apr-97 5-Apr-97 5-Apr-97 5-Oct-97 5-Oct-97 5-Oct-97 Principal Paid Interest Expense Paid Lease Revenue Received Principal Paid Interest Expense Paid Lease Revenue Received $2,843,888 $2,843,888 $1,385,916 $1,457,972 $1,458,677 $1,385,211 none deductible as interest expense fully taxable as revenue none deductible as interest expense fully taxable as revenue 97 $2,844,593 Commcorp Financial Services Inc. Cash Flow Analysis Auditor Marina Battista y/e Oct 31/93 Full Term 10/30/98 Cross Border Software Lease CASHFLOW.XLS full term Schedule I Date Explanation Cash Flows DR CR Income Tax Consequences tx yr Net Revenue/ (Expense) 5-Apr-98 5-Apr-98 5-Apr-98 5-Oct-98 5-Oct-98 5-Oct-98 Principal Paid Interest Expense Paid Lease Revenue Received Principal Paid Interest Expense Paid Lease Revenue Received $2,986,082 $2,986,082 $1,677,451 $1,308,631 $1,765,517 $1,220,565 none deductible as interest expense fully taxable as revenue none deductible as interest expense fully taxable as revenue 98 $3,442,968 5-Apr-99 5-Apr-99 5-Apr-99 5-Oct-99 5-Oct-99 5-Oct-99 Principal Paid Interest Expense Paid Lease Revenue Received Principal Paid Interest Expense Paid Lease Revenue Received $3,135,386 $3,135,386 $2,007,511 $1,127,875 $2,112,905 $1,022,481 none deductible as interest expense fully taxable as revenue none deductible as interest expense fully taxable as revenue 99 $4,120,417 5-Apr-00 5-Apr-00 5-Apr-00 5-Oct-00 5-Oct-00 5-Oct-00 Principal Paid Interest Expense Paid Lease Revenue Received Principal Paid Interest Expense Paid Lease Revenue Received $3,292,156 $3,292,156 $2,380,602 $ 911,533 $2,505,584 $ 786,572 none deductible as interest expense fully taxable as revenue none deductible as interest expense fully taxable as revenue 00 $4,886,206 5-Apr-01 5-Apr-01 5-Apr-01 5-Oct-01 5-Oct-01 5-Oct-01 Principal Paid Interest Expense Paid Lease Revenue Received Principal Paid Interest Expense Paid Lease Revenue Received $3,456,763 $3,456,763 $2,801,734 $ 655,029 $2,948,826 $ 507,937 none deductible as interest expense fully taxable as revenue none deductible as interest expense fully taxable as revenue 01 $5,750,561 5-Apr-02 5-Apr-02 5-Apr-02 5-Oct-02 5-Oct-02 5-Oct-02 Principal Paid Interest Expense Paid Lease Revenue Received Principal Paid Interest Expense Paid Lease Revenue Received $3,629,602 $3,066,304 $1,650,029 $ 353,124 $1,173,357 $ 266,498 none deductible as interest expense fully taxable as revenue none deductible as interest expense fully taxable as revenue 02 $6,076,283 Commcorp Financial Services Inc. Cash Flow Analysis Auditor Marina Battista y/e Oct 31/93 Full Term 10/30/98 Cross Border Software Lease CASHFLOW.XLS full term Schedule I Date Explanation Cash Flows DR CR Income Tax Consequences tx yr Net Revenue/ (Expense) 5-Apr-03 5-Apr-03 5-Apr-03 5-Oct-03 5-Oct-03 5-Oct-03 Principal Paid Interest Expense Paid Lease Revenue Received Principal Paid Interest Expense Paid Lease Revenue Received $3,066,304 $3,066,304 $1,234,959 $ 204,896 $1,299,794 $ 140,061 none deductible as interest expense fully taxable as revenue none deductible as interest expense fully taxable as revenue 03 $5,787,651 5-Apr-04 5-Apr-04 5-Apr-04 Principal Paid Interest Expense Paid Lease Revenue Received $3,066,304 $1,368,033 $ 71,822 none deductible as interest expense fully taxable as revenue 04 $2,994,482 Total Cash Flows $57,529,172 $55,817,265 Net Cash Flows $ 1,711,907 Net Income as Consequences $1,711,905 Assuming that the lease is not terminated prior to completion date of April 4, 2004 Commcorp Financial Services Inc. Cash Flow Analysis Auditor Marina Battista y/e Oct 31/93 as of First Purchase Option 10/30/98 Cross Border Software Lease CASHFLOW.XLS first option Schedule II Date Explanation Cash Flows DR CR Income Tax Consequences tx yr Net Revenue/ (Expense) 5-Apr-93 5-Apr-93 5-Oct-93 5-Oct-93 Purchase of application computer software Fee loan from Barclays Bank Interest Expense Paid Lease Revenue Received $27,770,897 $1,457,972 $33,091,255 $1,100,000 $1,457,972 $33,091,255 Addition to C1 12 $1,100,000 included in cost of asset y/e 93-$17,095,628 CCA available y/e 94-$17,095,628 CCA available $27,770,897 remains in Barclays Bank fully deductible, as interest expense full taxable as revenue 93 94 $(17,095,628) $(17,095,628) $ 5-Apr-94 5-Apr-94 5-Oct-94 5-Oct-94 Interest Expense Paid Lease Revenue Received Interest Expense Paid Lease Revenue Received $1,457,972 $1,457,972 $1,457,972 $1,457,972 fully deductible, as interest expense fully taxable as revenue fully deductible, as interest expense fully taxable as revenue $ $ 5-Apr-95 5-Apr-95 5-Oct-95 5-Oct-95 Interest Expense Paid Lease Revenue Received Interest Expense Paid Lease Revenue Received $1,457,972 $1,457,972 $1,457,972 $1,457,972 fully deductible, as interest expense fully taxable as revenue fully deductible, as interest expense fully taxable as revenue $ $ 5-Apr-96 5-Apr-96 5-Oct-96 5-Oct-96 Interest Expense Paid Lease Revenue Received Interest Expense Paid Lease Revenue Received $1,457,972 $1,457,972 $1,457,972 $1,457,972 fully deductible, as interest expense fully taxable as revenue fully deductible, as interest expense fully taxable as revenue $ $ 5-Apr-97 5-Apr-97 5-Apr-97 5-Oct-97 5-Oct-97 5-Oct-97 Principal Paid Interest Expense Paid Lease Revenue Received Principal Paid Interest Expense Paid Lease Revenue Received $2,843,888 $2,843,888 $1,385,916 $1,457,972 $1,458,677 $1,385,211 none deductible as interest expense fully taxable as revenue none deductible as interest expense fully taxable as revenue 97 $2,844,593 5-Apr-98 5-Apr-98 5-Apr-98 5-Oct-98 5-Oct-98 5-Oct-98 Principal Paid Interest Expense Paid Lease Revenue Received Principal Paid Interest Expense Paid Lease Revenue Received $2,986,082 $2,986,082 $1,677,451 $1,308,631 $1,765,517 $1,220,565 none deductible as interest expense fully taxable as revenue none deductible as interest expense fully taxable as revenue 98 $3,442,968 Commcorp Financial Services Inc. Cash Flow Analysis Auditor Marina Battista y/e Oct 31/93 as of First Purchase Option 10/30/98 Cross Border Software Lease CASHFLOW.XLS first option Schedule II Date Explanation Cash Flows DR CR Income Tax Consequences tx yr Net Revenue/ (Expense) 5-Apr-99 5-Apr-99 5-Apr-99 5-Oct-99 5-Oct-99 5-Oct-99 Principal Paid Interest Expense Paid Lease Revenue Received Principal Paid Interest Expense Paid Lease Revenue Received $3,135,386 $3,135,386 $2,007,511 $1,127,875 $2,112,905 $1,022,481 none deductible as interest expense fully taxable as revenue none deductible as interest expense fully taxable as revenue 99 $4,120,417 5-Apr-00 5-Apr-00 5-Apr-00 5-Oct-00 5-Oct-00 5-Oct-00 Principal Paid Interest Expense Paid Lease Revenue Received Principal Paid Interest Expense Paid Lease Revenue Received $3,292,156 $3,292,156 $2,380,602 $ 911,533 $2,505,584 $ 786,572 none deductible as interest expense fully taxable as revenue none deductible as interest expense fully taxable as revenue 00 $4,886,206 5-Apr-01 5-Apr-01 5-Apr-01 5-Oct-01 5-Oct-01 5-Oct-01 Principal Paid Interest Expense Paid Lease Revenue Received Principal Paid Interest Expense Paid Lease Revenue Received $3,456,763 $3,456,763 $2,801,734 $ 655,029 $2,948,826 $ 507,937 none deductible as interest expense fully taxable as revenue none deductible as interest expense fully taxable as revenue 01 $5,750,561 5-Apr-02 5-Apr-02 5-Apr-02 5-Apr-02 5-Apr-02 Principal Paid Interest Expense Paid Lease Revenue Received First Purchase Option Value Loan Lump Sum Payment $3,629,602 $11,581,939 $1,650,029 $ 353,124 $5,076,144 none deductible as interest expense fully taxable as revenue included on CCA schedule-(recapture) none 02 $14,858,417 Total Cash Flows $56,845,895 $55,133,989 Net Cash Flows $1,711,907 Net Income Tax Consequences $1,711,905 Assuming that the lease is terminated April 4, 2002