U.S. SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549

                                  FORM 10-KSB/A

(MARK ONE)

  [X] ANNUAL REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
                                      1934

                     FOR THE FISCAL YEAR ENDED JULY 31, 2005

                                       OR

 [_] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT
                                     OF 1934

               FOR THE TRANSITION PERIOD FROM ________ TO________

                         COMMISSION FILE NUMBER 0-29248

                              SMARTIRE SYSTEMS INC.
                 (Name of small business issuer in its charter)


    YUKON TERRITORY, CANADA                                   N/A
(State or other jurisdiction of                         (I.R.S. Employer
 incorporation or organization)                          Identification No.)


                            #150 - 13151 VANIER PLACE
                   RICHMOND, BRITISH COLUMBIA, CANADA V6V 2J1
               (Address of principal executive offices) (Zip Code)

                                  604-276-9884
                           (Issuer's telephone number)

       SECURITIES REGISTERED UNDER SECTION 12(B) OF THE EXCHANGE ACT: NONE

         SECURITIES REGISTERED UNDER SECTION 12(G) OF THE EXCHANGE ACT:

                                  COMMON STOCK

                              (TITLE OF EACH CLASS)

Check  whether the issuer (1) filed all reports  required to be filed by Section
13 or 15(d) of the  Exchange  Act during the past 12 months (or for such shorter
period that the registrant was required to file such reports),  and (2) has been
subject to such filing requirements for the past 90 days.
|X| Yes |_| No

Check if disclosure  of delinquent  filers in response to Item 405 of Regulation
S-B is not contained in this form, and no disclosure  will be contained,  to the
best of registrant's  knowledge,  in definitive proxy or information  statements
incorporated  by reference  in Part III of this Form 10-KSB or any  amendment to
this Form 10-KSB. |_|


Indicate by check mark whether the  registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes |_| No |X|


State issuer's revenues for its most recent fiscal year: $1,463,460.

<PAGE>

At  October  14,  2005,  the  aggregate  market  value of common  stock  held by
non-affiliates  was  approximately  $23,252,840  based upon the closing price of
$0.084 reported for such date on the OTC Bulletin Board.

The number of shares  outstanding  of our Company's  common stock at October 15,
2005 was 283,709,549.

Transitional Small Business Disclosure Format (check one):
|_| Yes |X| No




                                  INDEX
                                                                        Page
                                                                      Number
PART I

Item 1.   Description of Business                                          3

Item 2.   Description of Property                                         13

Item 3.   Legal Proceedings                                               13

Item 4.   Submission of Matters to a Vote of Security Holders             14

PART II

Item 5.   Market for Common Equity, Related Stockholder Matters
          and Small Business                                              15

Item 6.   Management's Discussion and Analysis or Plan of Operation       16

Item 7.   Financial Statements                                            26

Item 8.   Changes In and Disagreements With Accountants on
          Accounting and Financial Disclosure                             26

Item 8A.  Controls and Procedures                                         26

Item 8B.  Other Information                                               27

PART III

Item 9.  Directors, Executive Officers and Control Persons; compliance
         with Section 16(a) of the Exchange Act                           27

Item 10. Executive Compensation                                           28

Item 11. Security Ownership of Certain Beneficial Owners and Management
         and Related Stockholder Matters                                  30

Item 12. Certain Relationships and Related Transactions                   32

Item 13. Exhibits                                                         32

ITEM 14. Principal Accounting Fees and Services                           41

                                       2
<PAGE>


CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION

THIS  ANNUAL  REPORT  ON  FORM  10-KSB,  INCLUDING  EXHIBITS  THERETO,  CONTAINS
FORWARD-LOOKING  STATEMENTS  WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES
ACT OF 1933, AS AMENDED, AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934,
AS AMENDED.  THESE  FORWARD-LOOKING  STATEMENTS ARE TYPICALLY  IDENTIFIED BY THE
WORDS "ANTICIPATES",  "BELIEVES",  "EXPECTS", "INTENDS",  "FORECASTS",  "PLANS",
"FUTURE",  "STRATEGY",  OR WORDS OF SIMILAR MEANING. VARIOUS FACTORS COULD CAUSE
ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN THE  FORWARD-LOOKING
STATEMENTS, INCLUDING THOSE DESCRIBED IN "RISK FACTORS" IN THIS FORM 10-KSB. THE
COMPANY  ASSUMES NO  OBLIGATIONS TO UPDATE THESE  FORWARD-LOOKING  STATEMENTS TO
REFLECT ACTUAL  RESULTS,  CHANGES IN  ASSUMPTIONS,  OR CHANGES IN OTHER FACTORS,
EXCEPT AS REQUIRED BY LAW.

                                     PART I

As used in this annual report on Form 10-KSB,  "we," "us," "our," "SmarTire" and
"our Company" refer to SmarTire  Systems Inc. and our  subsidiaries,  unless the
context otherwise requires.

ITEM 1. DESCRIPTION OF BUSINESS

Overview

We develop and market  technically  advanced  tire pressure  monitoring  systems
("TPMSs") for the  transportation  and automotive  industries  that monitor tire
pressure and tire  temperature.  Our TPMSs are  designed  for  improved  vehicle
safety,  performance,  reliability  and fuel  efficiency.  Although,  60% of our
revenues in fiscal 2005 (76 % in fiscal 2004) were earned from the sale of TPMSs
for passenger cars, sales of our bus,  recreational,  truck and motorcycle TPMSs
increased as a percentage of our overall  revenues.  Based on market demand,  we
anticipate  an increase in our total  revenues  and a continued  increase in the
percentage  of our revenues  from sales of our TPMSs for the bus,  recreational,
truck and motorcycle markets during fiscal 2006.

We have three wholly owned  subsidiaries:  SmarTire  Technologies Inc., SmarTire
USA  Inc.  and  SmarTire  Europe  Limited.   SmarTire   Technologies   Inc.  was
incorporated on June 3, 1988 under the laws of the Province of British Columbia,
and was the original developer of our patented technology.  SmarTire USA Inc., a
Delaware  corporation  incorporated on May 16, 1997, is our exclusive  marketing
agency for SmarTire in North America.  SmarTire Europe Limited, a United Kingdom
corporation  incorporated  on February  25,  1998,  is our  exclusive  sales and
distribution operation for Europe.

We are a "foreign  private  issuer",  as such term is defined in Rule 3b-4 under
the Securities  Exchange Act of 1934.  However, we have elected to file with the
SEC the same reports that a domestic  registrant would be required to file under
section 13(a) of the Securities Exchange Act of 1934.

Although we currently sell only TPMSs for passenger  cars,  buses,  recreational
vehicles,  trucks  and  motorcycles,  our  vision  is to become  the  preeminent
provider of wireless sensing and control systems for the vehicle  industry.  Our
vision may be extended to three  basic  types of systems:  sensing,  control and
system applications.

Sensing Applications

Our vision is to  commercialize  a wide array of  sensors,  compatible  with our
TPMSs for the vehicle industry.  We developed a receiver module with Vansco that
functions as a "wireless  gateway" that we began shipping to customers in August
2005.  This module can wirelessly  receive signals from up to 256 new sensors in
addition to signals from tire pressure sensors.  The data from these sensors can
then be placed on the vehicle bus or on a display module.  This ensures that the
driver,  maintenance group or monitoring agencies have access to the sensor data
as required.  In addition to tire pressure monitoring,  customers would have the
ability to access far more data on their  vehicle.  This  translates to a higher
value  proposition  to the  customer,  while  giving us the ability to sell more
products.  We plan to develop one  additional  application in the next year that
can be integrated into our receiver module.

Control Applications

A natural  evolution  of our  product  family is to use the  "wireless  gateway"
module to not only receive signals from sensors but to act on the data received.

The basic  premise is based on using  sensors to interpret a condition  and then
have the "wireless  gateway" module send a control signal to a device to perform
a specified action based on the sensor output.  For example,  when the "wireless
gateway"  module  receives  data from a tire  sensor it can  control a "horn" to
provide an audible warning,  activate a lamp or provide information to a vehicle
display control.

                                       3
<PAGE>

We are currently evaluating a number of other control applications.


Corporate History

We were  incorporated  under the laws of the  Province  of British  Columbia  as
TTC/Truck Tech Corp. on September 8, 1987. We were  initially  formed to develop
and  market  remote  data  sensing,   transmission   and   processing   products
incorporating  patented  technologies to satisfy emerging market requirements in
the transportation industry.

Our company was continued under the Business  Corporations Act (Yukon Territory)
effective  February 6, 2003.  As a result,  our  Memorandum  and  Articles  that
constituted  our  constitutional  documents  while  we were a  British  Columbia
company have been superseded and replaced by Articles of Continuance  filed with
the  Yukon  Registrar  of  Corporations   under  section  190  of  the  Business
Corporations Act (Yukon Territory) and Bylaw No. 1, being a bylaw adopted by our
Board of Directors  relating  generally to the  transaction  of the business and
affairs of our company.  Our continuance as a Yukon  corporation was approved by
special  resolution  adopted by our shareholders at the annual and extraordinary
general meeting held on December 12, 2002. Effective December 10, 2004, we filed
a  Certificate  of Amendment  with the Yukon  Registrar of  Corporations  to our
Articles of  Incorporation  to increase the number of our  authorized  shares of
common stock from 300,000,000  shares to an unlimited number of shares. On March
18, 2005, we filed articles of amendment to our articles of incorporation  which
set  forth  all the  rights  and  preferences  of the  series  A 5%  convertible
preferred stock.

We completed our initial  public  offering on the Vancouver  Stock Exchange (now
the TSX Venture  Exchange) on September  11, 1989. On April 13, 1995, we changed
our name to UniComm  Signal Inc. On December  24,  1997,  we changed our name to
SmarTire  Systems Inc. and effected a reverse stock split  pursuant to which our
common stock was  consolidated  on a 1 for 8 basis.  On December  16, 1998,  our
common stock commenced trading on the Nasdaq SmallCap Market. On March 12, 1999,
we  voluntarily  delisted our common stock from trading on the  Vancouver  Stock
Exchange.  On May 28,  2003,  our  common  stock  ceased  trading  on the Nasdaq
SmallCap Market and is now quoted on the OTC Bulletin Board.

On December 6, 1996, we acquired the Low Tire Pressure  Warning Division of EPIC
Technologies,  Inc. of  Norwalk,  Ohio.  The assets  that we acquired  from EPIC
Technologies  included  specialized  testing  equipment,   patents  and  certain
contractual  rights,  including the rights under a production  program that EPIC
had established with Ford Motor Company.  Under that production program, the Low
Tire Pressure Warning System that we acquired from EPIC Technologies was offered
by Ford  Motor  Company as an option on  Lincoln  Continentals  until the end of
December 2001 when that particular model was discontinued.

Our  acquisition  of EPIC  Technologies'  Low  Tire  Pressure  Warning  Division
accelerated  our entry into the passenger car market.  Recognizing  the emerging
demand for TPMSs in  passenger  cars and light  trucks,  we modified the new car
version of the technology that we had acquired from EPIC Technologies for use in
existing vehicles.  This product was launched into the automotive aftermarket in
June 1997 to support  the market  introduction  of  run-flat  tires.  Automotive
aftermarket  products are sold as optional  add-on  products for automobiles and
are  produced by  third-party  suppliers  such as our company.  The  aftermarket
consists of retailers including tire retailers, automotive electronic stores and
accessory shops, which sell products directly to consumers. Aftermarket products
are distinguishable  from OEM products that are sold as options offered directly
by or through the  manufacturer of the automobile.  OEM products may be produced
by third  party  suppliers  as well,  but are sold to  automobile  manufacturers
rather than to  end-users.  The TPMSs that we supplied to Ford Motor Company for
use on Lincoln Continentals is an example of an OEM product.

On April 20, 1998, we  established  a strategic  alliance with TRW Inc., a large
U.S.-based automotive parts supplier. The strategic alliance was founded on four
agreements between the parties: an Equity Agreement,  a Cooperation  Engineering
Agreement,   an  Original  Equipment   Manufacturer   License  Agreement  and  a
Manufacturing  Agreement.  The  agreements  provided for joint  engineering  and
development  activities  between  the  parties,  and TRW was  granted  exclusive
marketing and distribution rights for some of our products. In addition, TRW had
exclusive  rights  in the  original  equipment  market  for any tire  monitoring
products that it developed  jointly with us and we had  exclusive  rights in the
automotive aftermarket.

Effective August 31, 2001, we restructured our strategic alliance with TRW. As a
result of the  restructuring,  most of the  agreements  that we had entered into
with TRW in 1998 were  cancelled.  However,  TRW retained its equity position in
our company.  By ending our collaboration with TRW in product development and by
providing  that neither we nor TRW will have  exclusive  rights to any products,
the restructuring effectively provided us with immediate access to all levels of
the global automotive and transportation industries.

In December  2002, we entered into an eight-year  supply  commitment  letter for
TPMSs to be offered as part of the OEM package on certain  vehicles  produced by
Aston  Martin.  We are  committed  to supply the systems in response to purchase
orders  submitted  by Aston  Martin from time to time.  Aston  Martin  initially
installed  TPMSs on the V12  Vanquish.  In  September  2004,  Aston Martin began
purchasing  TPMSs for installation on its DB9 model that went into production in
2004.  Aston Martin recently began  purchasing  TPMSs for installation on its V8
Vantage that went into production in 2005.

                                       4
<PAGE>

We completed the development and launch of our second  generation  TPMSs for the
passenger car and light truck market during the fiscal year ended July 31, 2001.
We introduced  our motorcycle  TPMSs for sale into the  aftermarket in September
2002. In February 2004, we introduced a substantially improved second generation
motorcycle TPMSs. During May 2004 this product became commercially available and
we began  shipping it to our customers.  In August 2004, we discovered  that the
sensor/transmitter  may break during  installation  on the subset of  motorcycle
rims with curved rim surfaces  when the strap is torqued to its required  value.
On  September  14, 2004,  we  contacted  the  National  Highway  Traffic  Safety
Administration  ("NHTSA")  to determine  if a Safety  Defect and Non  Compliance
Report was required and we were  advised that it was  necessary.  Our remedy for
the  defect was to recall  100% of  affected  sensor/transmitter  items from the
field  and  replace  both  recalled  and  inventory   sensor/transmitters   with
sensor/transmitters  previously  manufactured by a different  supplier that have
been  tested and known to use  plastics  that  provide the  required  mechanical
properties.  Additionally we wish to ensure that  transmitters  are used only on
rims with flat drop center wells (as originally designed for) and not curved. We
took the following additional precautionary steps:

      o     we added improved warnings and instruction  sheets to new product as
            well as  product  in  inventory  at dealers  and  distributors  that
            clarify flat rim drop center well application only; and

      o     we removed  TPMSs on  motorcycles  with rims with curved drop center
            wells.


At the end of fiscal 2004,  we  estimated  the cost of the recall to be $67,000.
Recall  costs  incurred  to the end of July  2005 were  $46,897.  We have made a
provision in accounts  payable for the  additional  $20,103  that we  anticipate
incurring.  In addition,  we developed a solution to enable us to sell our TPMSs
on  motorcycles  with rims with  curved  drop center  wells.  We  released  this
enhanced  product  during April 2005. To date, the response to the recall by our
customers has been very positive. Although interest in the motorcycle product by
existing and potential  customers  remains  positive,  it is difficult for us to
predict  what the  volume of sales  will be, as this will  depend  primarily  on
market acceptance.

In  February  2003,  we signed a  manufacturing,  co-marketing  and  development
agreement with Hyundai  Autonet  Company,  Ltd.  ("HACO") an established  Korean
automotive electronics supplier. Under this agreement, HACO and our company will
co-develop, manufacture and distribute tire monitoring products to HACO original
equipment  vehicle  manufacturers  and the automotive  aftermarket in Korea. The
agreement provides for the payment to us by HACO of a total of $300,000 in fees,
to cover the cost to develop a receiver and transmitter  that can be used in the
Korean and Japanese markets.  Total payments of $232,500 have been made to date.
The  remaining  $65,000 is payable  upon the launch of these  products  in South
Korea.  We originally  expected to receive an ongoing revenue stream through the
sales of proprietary  components to HACO beginning in early 2004. Currently HACO
is in process of product  validation  testing and is representing the product to
domestic  Korean OEM  manufacturers.  Revenues will begin to be realized if HACO
wins supply agreements from its target  customers.  As at July 31, 2005, we have
recorded an  allowance  for doubtful  accounts of $35,700 as we have  recognized
engineering service revenue of $268,200 to date and we do not have a firm launch
date. We are  currently  negotiating  a final  settlement  with HACO as there is
uncertainty  as to whether the project will be  completed.  In addition,  we are
having  ongoing  discussions  with  HACO  with  regards  to  the  marketing  and
co-development of TPMS.

In October  2003, we signed a contract  manufacturing  services  agreement  with
HACO. Under the terms of the agreement,  HACO was to manufacture our proprietary
line of TPMSs  for sale  and  distribution  globally  by  SmarTire.  As HACO was
recently purchased by Hyundai and Siemens (one of our competitors),  As a result
of this  transaction,  HACO  has  notified  us of  their  intention  to exit the
contract  manufacturing  business.  As such,  we are  currently  negotiating  an
expansion of our current manufacturing agreement with Vansco Electronics LP.

As previously disclosed,  we entered into a two-year agreement with Beijing Boom
Technology  Co. Ltd in October  2003,  to act as a "master  distributor"  of our
TPMSs in mainland  China.  Although the  agreement  provided for a two-year term
ending on October 9, 2005 and automatic  renewal for  successive  one-year terms
provided certain minimum purchase  commitments were met, Beijing Boom Technology
has not  purchased  a material  amount of product  during  fiscal 2005 nor do we
anticipate that they will purchase a significant amount of product in the future
as they are experiencing difficulties penetrating the Chinese market.

On October  12, 2005 we entered  into a seven year  Marketing  and  Distribution
agreement with DANA Corporation through its Heavy Vehicle Technology and Systems
Group.  Under the contract Dana will market and sell  SmarTire's tire monitoring
systems to OEM customers  throughout  North America,  Mexico,  Australia and New
Zealand.  The companies will collaborate on marketing  opportunities to meet the
needs of their global  customers and markets.  DANA is a leading Tier I supplier
in the design and manufacture of commercial  vehicle drive train  components for
medium and heavy duty vehicles for sale to original equipment  manufacturers and
associated original equipment service and the independent aftermarket.


                                       5
<PAGE>

Corporate Information

Our principal executive offices are located at 150-13151 Vanier Place, Richmond,
British  Columbia,  V6V 2J1, and our  telephone  number is (604)  276-9884.  Our
website is located at  www.smartire.com.  Our SEC filings are  available  to the
public from our website or at www.sec.gov.

Government Regulations

Our products are subject to regulation by the  government  agencies  responsible
for radio  frequencies in each country that our TPMSs will be sold. For example,
in the United States  approval must be received from the Federal  Communications
Commission for each product.  Some  countries  require  additional  governmental
approvals in certain  circumstances.  For example,  in the United  Kingdom,  all
electronic  equipment to be installed in emergency  and police  vehicles must be
approved by the Vehicle  Installation  Development  Group, a governmental  body.
Also, as a practical matter, certain non-governmental approvals may be necessary
for market  acceptance of our products in certain  countries.  For example,  the
approval of TUV (an  independent  testing  company) is  considered  necessary to
market our TPMSs in Germany.

We believe  that we have all of the  necessary  governmental  approvals  for our
current TPMSs in our intended market countries.  As each new TPMSs is introduced
to the market, we intend to apply for the necessary approvals.

During our fiscal year ended July 31, 2001, the United States government enacted
the Transportation Recall Enhancement,  Accountability, and Documentation Act of
2000,  commonly known as the TREAD Act. This new  legislation was implemented to
address perceived safety concerns  resulting from poor tire  maintenance,  tread
separation and tire blowouts.  The TREAD Act, among other things,  requires that
the NHTSA,  develop rules and  regulations  that require all new passenger cars,
light trucks and multipurpose passenger vans sold after November 1, 2003 to have
TPMSs installed as standard equipment. The TREAD Act requires that TPMSs must be
capable  of  warning  drivers  if a tire is  significantly  under-inflated.  The
mandated rules and  regulations  were scheduled to be finalized in November 2001
for implementation in 2003.

In July 2001,  NHTSA  published and  circulated a Notice of Proposed Rule Making
that included  provisions  related to the tire  monitoring  requirements  of the
TREAD Act. The Notice of Proposed Rule Making outlined the parameters of systems
that the NHTSA would consider  compliant with the  legislation  and the proposed
periods  for  complying  with the  regulations.  Two  forms  of tire  monitoring
technologies were to be considered:

      o     Direct  tire   monitoring   technologies   are  based  on  dedicated
            sensor/transmitters  located  within the cavity of the tire that are
            usually mounted on the wheel. The transmitter  monitors and measures
            contained  air  pressure  and  temperature   within  each  tire  and
            wirelessly  transmits this  information to a receiver  located in or
            around the  instrument  panel of the  vehicle.  Our  products are an
            example of a direct system.

      o     Indirect  tire  monitoring  technologies  typically  work  with  the
            vehicle's  anti-lock brake system.  Most indirect TPMSs compare each
            wheel's  rotational speed with the rotational speed of other wheels.
            If one tire becomes  significantly  under-inflated  while the others
            remain at proper pressure,  the indirect system  eventually  detects
            the problem  because  that  wheel's  rotational  speed is on average
            slightly higher than that of other wheels.

In the  Notice  of  Proposed  Rule  Making,  the  NHTSA  concluded  that  direct
measurement systems have major advantages over indirect systems as they:

      o     actually  measure the  pressure in each tire and can detect when any
            tire or combination of tires is  under-inflated,  including when all
            tires are under-inflated;

      o     operate while the vehicle is stationary;

      o     are highly accurate and can detect small pressure losses,  some even
            as low as one pound per square inch;

      o     provide  full time  monitoring  even when the  vehicle  is driven on
            bumpy roads,  has  mismatched  tires or has a tire out of balance or
            alignment;

      o     do not need  substantial time to calibrate the system and reduce the
            very real possibility for human error; and

      o     can tell the operator which tire is under-inflated.

On May 31, 2002,  the NHTSA issued part one of a two-part  final rule.  Part one
established a new Federal Motor Vehicle Safety Standard that required a TPMSs be
installed in passenger  vehicles and light trucks to warn the driver when a tire
is below specified pressure levels.  During the first year of the implementation
schedule,  beginning November 1, 2003, at least 10% of each auto  manufacturer's
total production was to be equipped with TPMSs.  This requirement  increases was
to  increase  to 35%  during the  second  year,  65% by the third and 100% after
October 31, 2006.

                                       6
<PAGE>

Part one of the NHTSA final rule contemplated two compliance  options during the
period from  November 1, 2003 to October 31,  2006.  Under the first  compliance
option, a vehicle's TPMSs must alert the driver if one or more tires, up to four
tires, are 25% or more  under-inflated.  Under the second  compliance  option, a
vehicle's  TPMSs must alert the driver if any of the  vehicle's  tires is 30% or
more  under-inflated.  The second  compliance  option  was  adopted by the NHTSA
because  indirect  TPMSs are  currently  not  capable  of meeting  the  stricter
four-tire,  25% requirement under the first compliance option, and it was deemed
appropriate to permit  manufacturers  to continue to use current  indirect TPMSs
while they work to improve those systems.

At the time that it issued the first part of its final rule, the NHTSA announced
that it would closely  monitor the  performance  of indirect  measurement  TPMSs
under the second compliance option. We initially expected the NHTSA to issue the
second part of its final rule on or before March 1, 2005,  and, at that time, to
announce  whether  indirect  TPMSs based on anti-lock  brake  systems would be a
permissible  compliance  option  under the TREAD Act  after  October  31,  2006.
However,  due to a Court of Appeals ruling  discussed  below,  we no longer hold
these  expectations as to the timing and content of the second part of the final
rule.

Three  not-for-profit  advocacy  organizations,  Public Citizen,  Inc., New York
Public  Interest  Research Group and The Center for Auto Safety filed a petition
in United States Court of Appeals for the Second  Circuit  seeking review of the
NHTSA's final rule. The Secretary of Transportation  was named as the respondent
in the matter,  and Alliance of Automobile  Manufacturers was an intervener.  On
August 6, 2003, the United States Court of Appeals, Second Circuit,  granted the
petition for review,  vacated the NHTSA's final rule, and remanded the matter to
the NHTSA for further  rulemaking  proceedings in a manner  consistent  with the
court decision.

The court stated that the NHTSA decision to adopt the second  compliance  option
was both  contrary  to law and  arbitrary,  but that the  adoption  of the first
compliance option was appropriate. In coming to this conclusion, the court found
that,  according to the rule-making  record, the one-tire,  30%  under-inflation
standard  contemplated by the second compliance option would allow automakers to
install  indirect TPMSS that fail to warn drivers in  approximately  half of the
instances  in  which  tires  are  significantly  under-inflated,  and  that  the
four-tire,  25%  under-inflation  standard  contemplated by the first compliance
option would prevent more injuries, save more lives and be more cost-effective.

On September 10, 2004 the NHTSA issued a Notice of Proposed  Rulemaking ("NPRM")
document  defining their current position.  Comments on the proposed  rulemaking
were to be received on or before 60 days after date of  publication  of the NPRM
in the Federal  Register.  The NHTSA proposed a new Federal Motor Vehicle Safety
Standard  requirement  for four tire, 25%  under-inflation  detection.  The rule
proposed requirements for covered vehicles manufactured on or after September 1,
2005.

On April 7, 2005 the NHTSA released their final rule. The NHTSA is proposing the
lead time and phase in schedule described below.

Compliance  with the final rule started  started on October 5, 2005.  Subject to
the special provisions discussed below, the phase-in schedule is as follows:

      o     20% of a vehicle manufacturer's light vehicle production is required
            to comply with the standard  during the period from October 5, 2005,
            to August 31, 2006;

      o     70% must comply  during the period from  September 1, 2006 to August
            31, 2007; and

      o     100% of all light vehicles built on or after  September 1, 2007 must
            comply.

      However, the NHTSA has deferred vehicle manufacturers' compliance with the
            new system malfunction  indicator light requirements until September
            1, 2007. This requirement is discussed below.

The  NHTSA  has  also  decided  to  encourage  early  compliance  by  permitting
carry-forward   and  carry-back   credits.   Vehicle   manufacturers   can  earn
carry-forward  credits for compliant vehicles produced in excess of the phase-in
requirements  that are manufactured  between April 8, 2005 and the conclusion of
the phase-in.  However,  beginning September 1, 2007, all covered vehicles would
be required to comply with the  standard,  without  regard to any earlier  carry
forward  credits.  It will not be permissible for a dealer to install tires on a
new vehicle that would take the vehicle out of compliance  with TPMSs  standard.
With carry-back  credits,  manufacturers may defer compliance with a part or all
of the certification requirements under the standard for the first period of the
phase-in,  provided they certify a correspondingly  increased number of vehicles
during the second period of the phase-in.

                                       7
<PAGE>

Special provisions related to the phase-in include:

      o     The NHTSA has excluded  multi-stage  manufacturers and alterers from
            the  requirements  of the  phase-in and has extended by one year the
            time for compliance by those manufacturers (i.e., until September 1,
            2008).

      o     The final  rule also  excludes  small  volume  manufacturers  (i.e.,
            manufacturers  producing  less than 5,000  vehicles  for sale in the
            U.S.  market  in one year)  from the  phase-in,  requiring  vehicles
            produced  by such  manufacturers  to  comply  with the  standard  on
            September 1, 2007.

Requirements  of the final rule are  summarized  as follows:  New Federal  Motor
Vehicle Safety  Standard 138 requires  passenger cars,  multi-purpose  passenger
vehicles,  trucks,  and buses  with a gross  vehicle  weight  rating of 4,536 kg
(10,000  pounds)  or less,  except  those  with dual  wheels  on an axle,  to be
equipped  with a TPMSs to alert  the  driver  when one or more of the  vehicle's
tires,  up to a  total  of all  four  tires,  is  significantly  under-inflated.
Specifically, the TPMSS must warn the driver when the pressure in one or more of
the vehicle's tires is 25% or more below the vehicle manufacturer's  recommended
cold  inflation  pressure,  or a  minimum  level of  pressure  specified  in the
standard,  whichever  pressure is higher.  Under the new  standard,  if any tire
drops  below the  standard's  activation  threshold,  the TPMSs is  required  to
provide the low tire pressure  warning by  illuminating a yellow telltale within
20 minutes of  additional  travel  within a speed  range of 50-100  km/hr.  This
telltale must remain  illuminated  (and  re-illuminate  upon subsequent  vehicle
start-ups) until the under-inflation condition has been corrected.

Some additional details of the final rule are as follows:

      o     The  TPMSs  to be  used  would  be  required  to  include  a  system
            malfunction  indicator  (provided either by a separate telltale or a
            combined  low tire  pressure/malfunction  indicator  telltale)  that
            would alert the driver in situations in which the TPMSs is unable to
            detect low tire pressure.  This malfunction indicator is required to
            detect  incompatible  replacement  tires,  as well as  other  system
            faults.  Similar  to the low tire  pressure  warning,  the system is
            required to trigger a TPMSs  malfunction  warning telltale within 20
            minutes of  additional  travel  within a speed range of 50-100 km/hr
            after such a malfunction  occurs.  This malfunction  indicator light
            telltale must remain  illuminated (and re-illuminate upon subsequent
            vehicle start-ups) until the TPMSS malfunction has been corrected.

      o     A specific  test course  (i.e.,  the Southern loop of the tread wear
            test  course,  San  Angelo,  Texas),  which  is both  objective  and
            representative of a range of driving  conditions,  would be required
            to be used.

      o     The TPMSs  would  not be  required  to  monitor  the spare  tire (if
            provided)  either when it is stowed or when it is  installed  on the
            vehicle.

      o     For vehicle's  certified under the standard,  vehicle  manufacturers
            would be required to provide in the owners manual an  explanation of
            the purpose of the low tire pressure warning telltale, the potential
            consequences of significantly  under-inflated  tires, the meaning of
            the  telltale  when it is  illuminated,  and what  action the driver
            should take when the telltale is illuminated.

On June 6,  2005,  a lawsuit  was  filed in the U.S.  Court of  Appeals  for the
District of Columbia by Public  Citizen,  the  Goodyear  Tire & Rubber  Company,
Bridgestone Firestone North American Tire, Cooper Tire & Rubber Co., Pirelli and
the Tire Industry Association.

The plaintiffs allege that the NHTSA rule, issued in April 2005, doesn't require
tire pressure monitoring systems to operate with replacement tires and that this
is a dangerous  omission  given that an estimated 61 percent of passenger and 54
percent of light truck mileage  occurs on replacement  tires.  Under the rule, a
malfunction light will come on to alert motorists that the system is not working
with the tires. The plaintiffs  allege that not only would this undermine public
confidence  in the systems,  but it would likely lead to consumers  ignoring the
warning light or having it disabled.

Our direct  measurement  TPMSs generally  exceeds the standard for tire pressure
monitoring  established  by  the  NHTSA.   Accordingly,   we  believe  the  auto
manufacturers must accelerate their  implementation plans in order to meet these
new NHTSA regulations,  which will create additional opportunities to market our
products to OEMs in the automobile industry. In addition, although the TREAD Act
only applies to  passenger  automobiles,  we believe that other motor  vehicles,
including  medium and heavy trucks,  buses and  motorcycles  will be impacted by
this  legislation in subsequent  years. We also believe that compliance with the
TREAD Act by European,  Japanese,  Chinese and other  automakers will accelerate
the adoption of TPMSS globally.

It is difficult to predict the magnitude of the expected  sales  increase or the
exact  timing  of  the  increase  since  our  products  will  continue  to  face
competition from other TPMSs manufactured by our competitors,  and the timing of
additional legislative  initiatives on tire safety, if any, in the United States
and abroad remains uncertain.  We expect that as TPMSs become standard equipment
for new passenger  vehicles,  demand for TPMSS as dealer  installed  options and
aftermarket products will gradually decline.

                                       8
<PAGE>

Strategic Relationships

Our  strategy   includes  the  establishment  of  alliances  to  assist  in  the
development  and  marketing  of our  products and  technologies.  Key  strategic
alliances include:

Dana Corporation. On October 12, 2005 we entered into a seven year Marketing and
Distribution   agreement  with  DANA  Corporation   through  its  Heavy  Vehicle
Technology  and  Systems  Group.  Under the  contract  Dana will market and sell
SmarTire's tire monitoring  systems to OEM customers  throughout  North America,
Mexico,  Australia and New Zealand.  The companies will collaborate on marketing
opportunities to meet the needs of their global customers and markets. DANA is a
leading  Tier I supplier in the design and  manufacture  of  commercial  vehicle
drive train  components  for medium and heavy duty vehicles for sale to original
equipment  manufacturers  and  associated  original  equipment  service  and the
independent aftermarket.

Vansco  electronics LP. On September 12, 2003, we entered into a development and
supply  agreement  with Vansco Ltd. This  agreement  provided for the merging of
Vansco's  vehicle  communication  expertise  with  our  proven  radio  frequency
technology to create a high  sensitivity,  weatherproof,  J1939  controller area
network ("CAN"),  chassis-mounted  receiver.  Vansco manufacturers this receiver
for us.

GE Nova Sensor.  In 2004, our application  specific  integrated  sensor ("ASIS")
procurement  strategy was refined to begin  procuring  the high and low pressure
ASIS's from GE Novasensor.

Alligator  Ventilfabrik GmbH. On December 10, 1999, we entered into an agreement
to develop valve stem designs and tire monitoring  electronic  packaging for new
market  applications  and  new  tire  monitoring   technologies  with  Alligator
Ventilfabrik GmbH ("Alligator").  Based in Giengen, Germany, Alligator currently
supplies  us with  valve  stems  that allow the  attachment  of tire  monitoring
sensors inside the tire.

Product Development

Our  technology  provides  drivers  with real time  information  regarding  tire
pressure and temperature  changes.  This  information  provides the consumer and
commercial  markets with improved vehicle safety,  performance and fuel economy.
Our products have been  engineered and designed for universal  application.  The
sensor/transmitter can be installed on virtually any tire and wheel combination.
Each  sensor/transmitter  contains a custom ASIS.  A receiver  unit and optional
display modules mounted in the vehicle provides  appropriate  alarm  indications
with optional graphical readout.

The custom ASIS is a single  micro-electronic  package  containing  pressure and
temperature sensing elements and a digital logic state machine that functions as
the brains of the sensor/transmitter.  This chip is robust in design,  optimizes
battery life and provides various modes of sensing and communicating that ensure
faster  transmission  of data when problems  occur.  Packaged on a  miniaturized
circuit  board  with the ASIS are  various  components  and our radio  frequency
technology.  Using  this  wireless  radio  frequency  technology,  the  data  is
transmitted through the tire to a remote receiver.

Our  products  feature  transmitter  options  providing  different  installation
choices  for  various  automotive  applications.   A  strap-mounted  transmitter
attached to the wheel offers the most universal installation for a wide range of
tire and wheel assemblies.  A valve-mounted  transmitter attached to the base of
the  valve  offers an  adjustable,  secure  in-tire  installation  for  specific
wheel/rim  profiles.  Once  installed,  the  sensor/transmitters  do not require
ongoing maintenance. The sensor/transmitters communicate to remote receivers and
the data is  displayed  inside the  vehicle.  We have  developed  three  display
options for the  aftermarket  (basic,  integrated  full function and remote full
function) as well as telltale lights, switch blanks and digital displays for OEM
and port of entry applications.

We developed OEM passenger car solutions to support the level of demand that our
management  anticipates from potential  customers in this market sector. The OEM
transmitter features a 50% size and weight reduction over our current generation
transmitter,  as well as  innovative  new  mounting  options  including  bonding
directly to the wheel as well as a more innovative valve mount approach.  We are
currently marketing our existing products to small and medium sized OEMs.

We introduced  our motorcycle  TPMSs for sale into the  aftermarket in September
2002. We introduced a substantially  improved second generation motorcycle TPMSs
at  the  Indy  Motorcycle  Dealers  Show,  held  in  Indianapolis,   Indiana  in
mid-February 2004. During May 2004, this product became  commercially  available
and we  began  shipping  it to our  customers.  As  discussed  under  "Corporate
History"  above,  we  encountered  a  component  defect  issue  as  well  as  an
application  issue with curved rims and initiated a recall in September 2004. We
have corrected the component  defect issue and are currently  shipping TPMSs for
motorcycles that address the issue of rims with curved drop center wells.

                                       9
<PAGE>

On September 12, 2003, we entered into a development  agreement with Vansco Ltd.
This  agreement  provides  for the  merging of  Vansco's  vehicle  communication
expertise  with  our  proven  radio  frequency   technology  to  create  a  high
sensitivity,    weatherproof,    J1939    controller   area   network   ("CAN"),
chassis-mounted  receiver.  The J1939 CAN is the most widely used  communication
standard in commercial vehicles today, allowing for multiplexing,  receiving and
transmitting  of signals from various  sources.  When CAN technology is combined
with our high pressure sensors, we anticipate that this joint development effort
will  result in a new TPMSs  targeted  directly  at OEMs of  commercial  trucks,
buses, agricultural,  construction and recreational vehicles. In November, 2004,
design  validation  testing  and  the  initial  pilot  build  of 300  units  was
completed.  The product has completed design validation testing and has received
regulatory  radio approvals in Europe and North America.  Production  validation
testing has now been completed.  Vansco has now begun to manufacture the product
for us. We currently  sell this product to our lead  customer for this  product,
Motor Coach Industries.

Our  recreational  vehicle and bus TPMSs consist of strap  mounted  transmitters
mounted inside the tires, rugged receivers mounted in the cab or on the chassis,
stand alone graphical  displays or warning lights,  and antennas  mounted on the
chassis.  Our  system  can  also be  integrated  with  existing  OEM in  vehicle
displays.

On October 10, 2003 we entered into a  Co-Marketing  and  Development  Agreement
with Haldex Brake  Products  Ltd.,  and a related  Supply  Agreement with Haldex
Brake Products.  Under the terms of the Co-Marketing and Development  Agreement,
we were to engage in a joint  development  program to integrate  our TPMSSs with
Haldex's Brake Product's  brake systems,  with the view to creating a commercial
high  pressure  TPMSS for  marketing  and resale by Haldex  Brake  Products.  We
anticipated that any new products that result from our collaboration with Haldex
Brake Products would be targeted at both OEMs and aftermarket  applications  for
trailers.  As Haldex requested a hold in the joint development program until the
end of October 2005 due to a lack of  technical  resources on their part and the
fact that the agreement  between our  companies  has changed scope  considerably
since we began  this  program,  we have  asked  for a release  from the  current
contract. Haldex has not yet provided us with the release.

During July 2004, we successfully  completed the initial prototype test phase of
a new battery-less  tire pressure and temperature  monitoring  system.  With the
automotive industry in search of a tire monitoring technology that does not rely
on batteries,  we believe that our next  generation of tire pressure  monitoring
systems could set a new standard.  Current tire pressure  monitoring systems use
battery  power to transmit  pressure and  temperature  information  from sensors
inside the tires to a receiver  located  within the vehicle.  Our new technology
involves  a passive  sensor  inside  each tire that is  energized  by an antenna
located within each wheel arch. It offers significant  improvements over current
battery powered tire monitoring technologies.  Elimination of the battery in the
sensor greatly  reduces its weight,  size and cost.  Sensor life and reliability
are  increased  and  battery   disposal  issues  are  eliminated,   creating  an
environmentally  "green"  solution.  This new approach to tire monitoring allows
tires to be rotated or changed without re-programming the system. It also tracks
tire  revolutions,  a critical  variable in predicting tire life. We have slowed
our  development of a battery-less  system to focus our development on supplying
products required in the commercial market.

Marketing

SmarTire USA and SmarTire  Europe  currently  market our TPMSs in North America,
Europe, South Africa and Australia..

As a result of the  enactment  of the TREAD Act,  we  substantially  changed our
marketing  strategy to take advantage of OEM business for vehicles  manufactured
or imported into the United  States.  We expect that,  as TPMSs become  standard
equipment  for new  passenger  vehicles  in the United  States over the next few
years, demand for TPMSs will increase on a worldwide basis.

The Tread Act,  which mandated tire  monitoring  for all new passenger  cars, is
accelerating  the acceptance of wireless  systems for the vehicle  industry.  We
believe the  convergence of wireless and wired  networks will enable  SmarTire's
wireless   technology  to  interface  with  existing  wired  vehicle   networks,
particularly in commercial  vehicles including trucks,  buses,  recreational and
off-road  vehicles.  We anticipate  this  legislation  will be expanded to cover
these  vehicles.  Based  on  discussions  with  our  customers,  including  Dana
Commercial  Systems,  we forecast  the use of wireless  technology  will rapidly
expand from tire pressure  monitoring to applications  such as brake monitoring,
alarm and security  systems,  vehicle  maintenance and other sensing and control
applications.

Our  current  marketing   strategy  focuses  on  sales  of  our  TPMSs  for  OEM
applications  in  the  commercial,   recreational  and  industrial  markets.  In
approaching  the OEM  market,  we expect to  position  ourselves  as a  wireless
gateway  system  provider by providing  multiple  applications  beyond TPMS. Our
strategy is to provide high quality products to the OEM market which incorporate
the highest level of technology  possible,  at a competitive price. We also plan
to supply the OEM aftermarket through strategic channel partnerships.


Competition

Tire  monitoring  products  can  generally  be divided  between two basic types:
direct  technology  and indirect  monitoring  technologies.  As described in the
National  Highway Traffic Safety  Administration's  report,  and discussed above
under the heading  "Description  of Business - Government  Regulations,"  direct
tire  monitoring  technology  such as that  employed in our  products  currently
provides substantial  advantages over indirect monitoring  technology.  However,
several of our competitors and potential  competitors  have long and established
relationships  with automobile  OEMs and suppliers,  which may make it difficult
for us to compete in the OEM market. Additionally,  automobile manufacturers may
elect to develop their own TPMSs to comply with the TREAD Act.

                                       10
<PAGE>

Our main competitors with respect to direct TPMSs include the following:

Schrader Bridgeport claims to be the world's largest producer of tire valves and
tire-pressure  measurement  equipment  with over $140  million in annual  sales.
Schrader has been in the passenger car TPMSs market since 1996 and their systems
have been used by various OEMs. As a transmitter  supplier,  Schrader has mainly
teamed with separate receiver suppliers to acquire OEM contracts.  Current TPMSs
business appears to be restricted to the passenger car OEMs.

BorgWarner  acquired BERU in February 2005. Beru previously  acquired Doduco and
its tire monitoring  technology.  The company has been supplying TPMSs primarily
as an option to vehicle manufacturers based mainly in Germany. To our knowledge,
the system requires the use of  transmitters  attached to the valve stem (inside
the tire/wheel assembly),  receiving antennas at each of the wheel wells, wiring
harness for  conveying  data to the receiver  and some form of in-dash  display.
This system has been  developed  primarily  for the OEM market for passenger car
applications.  BorgWarner has recently  started  promoting a commercial  vehicle
TPMSs.

Pacific  Industrial Co. Ltd., a Japanese  company,  has developed a product that
measures the air pressure in each tire and sends the data to a receiver  mounted
inside a vehicle.  The products are available on a few vehicles  manufactured in
Asia,  some of which are imported  into North  America.  We believe that Pacific
Industrial's  products resemble the BorgWarner  approach to tire monitoring with
additional antennas and wiring harnesses.

TRW  Automotive  U.S. LLC is a producer of safety and  security  systems for the
global automotive market. It supplies advanced  technology products and services
to the automotive markets. From December 1998 to August 2001, we and TRW jointly
developed  advanced  tire  monitoring  technology  and each has  access  to this
technology,  which encompasses some of our current products. During this period,
we and TRW jointly  developed a common  application  specific  integrated sensor
chip which we use for some of our existing products.

Siemens  Automotive AG is a producer and large supplier of high-tech  automotive
electronic systems. Siemens Automotive's product portfolio focuses on electronic
modules and systems  including  anti-lock brake systems and airbag  electronics.
Siemens Automotive has entered the market and offers direct TPMSs to OEMs.

Wabco is a producer of ABS braking products for the commercial vehicle industry.
Wabco jointly developed their IVTM system with Michelin for commercial vehicles.
The system consists of externally mounted  wheel-fitted  modules which regularly
measure and transmit tire inflation pressure, via an electronic control unit, to
an in-cabin dashboard display monitor. Equipped with visual and acoustic warning
signals,  the display can warn drivers of  abnormally  low tire  pressure,  slow
leaks and punctures.

Our competitive advantages are:

      o     We have over 400 man years of experience  dedicated  specifically to
            tire monitoring;  which we believe is greater than any other company
            in the world;
      o     We  believe we have our tire  monitoring  solutions  installed  on a
            greater variety of automobiles,  trucks, industrial and agricultural
            equipment  and other types of vehicles than any other company in the
            world;
      o     As we have both OEM and  aftermarket  experience,  we believe we are
            more aware of end customer issues and reliability  concerns than any
            other vendor;
      o     We  believe  we  are  the  established  leader  in  tire  monitoring
            performance technology;
      o     We have a strong  patent  portfolio  complemented  by  access to all
            required intellectual property;
      o     We have  been  advised  that we have the  best in Class  transmitter
            radio frequency ("RF") performance;
      o     Our field data supports  that we have the best in class  transmitter
            power management technology;
      o     We have the ability to measure tire temperature as well as pressure;
      o     We provide flexible sensor mounting solutions;
      o     We are  able  to  optimize  the  RF  output  characteristics  during
            rotation  of wheel  assembly  which  provides  consistent  radiation
            patterns;
      o     the  ability  to  interface   with   existing   commercial   vehicle
            communication  networks which allows our system to easily  integrate
            with OEM commercial vehicles;
      o     Prevention of RF collision at start-up and minimization of potential
            interference from other transmitters;
      o     We provide  consistent life performance even at low temperatures and
            we  can  reduce   the  risk  of   chemical   volatility   at  higher
            temperatures.

                                       11
<PAGE>

Indirect Competition

For passenger  cars,  there are several  indirect  monitoring or anti-lock brake
systems,  either  available  on  the  market  or in  prototype  stages.  To  our
knowledge,   none  of  these  prototype  systems  currently  meet  the  proposed
guidelines  set out in the  September  10, 2004 NHTSA's  Notice of Proposed Rule
Making. Given the substantial advantages of direct monitoring technology,  we do
not believe that indirect monitoring technology will be a significant competitor
in the short term.  However, it is likely that the performance of indirect TPMSs
will continue to improve,  and they will likely  benefit from the fact that they
are the least  expensive  way of  complying  with TPMSs  standard  for  vehicles
already equipped with anti-lock braking systems.

One potential future development that could affect the market for both passenger
car and commercial vehicle tire monitoring is the development of a "smart chip".
This is a computer chip that could transmit data and would be manufactured  into
tires.  We believe that Goodyear and  Bridgestone/Firestone  have both completed
some development of such a computer chip.

Raw Materials and Principal Suppliers

We  contract  the   manufacture  of  our  products  to  third   parties.   These
manufacturers  normally provide turnkey  operations  whereby the manufacturer is
responsible  for purchasing  the component  parts for our TPMSs.  Presently,  we
purchase component parts and deliver them to our contract manufacturers. We also
purchase  component  parts on our own  account  for  engineering  and  prototype
development  purposes.  Certain of the  components and raw materials used in our
products are  difficult to obtain and/or  require  purchase  commitments  far in
advance of the  manufacturing  date.  At  present,  our  relationships  with our
current  suppliers are generally  good and we expect that the suppliers  will be
able to meet the anticipated demand for our products through fiscal year 2006.

Dependence on Certain Customers

Due to the early stage  development  of the tire pressure  market in general and
for our Company,  we are still dependent on major customers.  During fiscal 2005
we earned 37% of our revenue from Aston Martin.  We expect that this  dependence
will be reduced as we start to realize sales through our relationships  with new
customers and through our strategic alliances,  including our alliance with Dana
Corporation.


Proprietary Protection

Our intellectual  property is important to protecting our competitive  advantage
and expanding our TPMSs market share. We rely on a combination of patents, trade
secret laws,  confidentiality  procedures and contractual  provisions to protect
our intellectual property.

We hold several patents for our current technologies, which are listed below:

      o     United States Patent 5,231,872  addresses the technology in our tire
            monitoring  product.  It was  issued on  August 3, 1993 and  expires
            August 3, 2010.

      o     United  States  Patent  5,285,189  addresses  the  technology in our
            abnormal tire condition warning system. It was issued on February 8,
            1994 and expires  February 8, 2011.  We  purchased  this patent from
            EPIC Technologies, Inc. in December 1996.

      o     United States Patent 5,335,540  addresses the technology in our tire
            monitoring  product.  It was  issued on  August 9, 1994 and  expires
            August 9, 2011.

      o     United States Patent 5,559,484  addresses certain  technology in our
            data logging tire monitor with condition predictive capabilities and
            integrity checking.  It was issued on September 24, 1996 and expires
            September 24, 2013. We purchased this patent from EPIC  Technologies
            in December 1996.

      o     United States Patent 5,945,908 addresses certain other technology in
            our data logging tire monitor with condition predictive capabilities
            and integrity checking. It was issued on August 31, 1999 and expires
            on August 31, 2016. We purchased this patent from EPIC  Technologies
            in December 1996.

      o     United States Patent 6,357,883  addresses the technology for a wheel
            component  with a cavity  for  mounting  a housing  for  measurement
            apparatus.  It was issued on March 19,  2002 and  expires  March 19,
            2019.

      o     United States Patent 6,805,000  addresses the technology for a wheel
            component  with a cavity  for  mounting  a housing  for  measurement
            apparatus. It was issued on October 25, 2004 and expires October 25,
            2021.

                                       12
<PAGE>

In addition  to our  patents,  we also have access to a number of other  patents
under our license agreements with TRW.

We restructured  our strategic  alliance with TRW effective  August 31, 2001. As
part of the  restructuring,  we  received  a  royalty-free  license  from TRW to
utilize  technology  developed  during the term of the  Cooperative  Engineering
Agreement  that is  patented,  now or in the future,  by TRW. We have  granted a
parallel royalty-free license to TRW.

Research and Development

We  spent  the  following  amounts  on  engineering,  research  and  development
activities during the fiscal years ended July 31, 2005, 2004 and 2003:

2005 - $3,297,011 ($1,949,078 excluding non-cash compensation expense)

2004 - $1,654,690

2003 - $1,177,935


We expect that our annual  research and  development  expenses  will continue to
increase as we work to integrate our current products into vehicle  platforms of
various OEMs seeking to satisfy the needs of their  customers and as we initiate
work on new products that complement our wireless gateway strategy.


Costs of compliance with any environmental laws

Although  we are  required  to comply  with  environmental  laws  regarding  the
disposal of certain hazardous, the cost of compliance is not significant.  While
not required, we plan to become ISO 14001:2004 registered by the end of calendar
2006  (Environmental  System  Registration)  to comply with the  requests of our
customers. We anticipate the cost of registration will be $100,000-$200,000.

Number of Total Employees and Number of Full-time Employees

At September 30, 2005, we had 46 full-time employees, one part-time employee and
one  consultant,  11 of who are in  marketing,  26 of whom  are in  engineering,
research  and  development  and 11 of  whom  are  administrative  and  executive
personnel. There is no collective bargaining agreement in place.

ITEM 2. DESCRIPTION OF PROPERTY

Facilities

Our  principal  executive  offices  are  located at #150 - 13151  Vanier  Place,
Richmond,  British Columbia, V6V 2J1. On March 23, 2005, we extended the term of
our lease to August 31, 2010 and  expanded  our 15,364  square foot  facility by
approximately  4,000 square feet. The lease modification  includes a CDN$100,000
tenant  improvement  allowance.  We have the  right to  terminate  the  lease on
September 1, 2008 provided that we are not in default on our  obligations  under
the lease and we provide 180 days' prior written  notice to our  landlord.  This
facility  consists  of  an  office  and  administration   area,  an  engineering
department, a prototype production facility and a warehouse.

Our subsidiary,  SmarTire Europe Limited, leases a 9,069 square foot facility at
Park 34, Didcot, Oxfordshire,  United Kingdom OX11 7WB for a 15 year term ending
February 20, 2016. This facility consists of an office and  administration  area
and a warehousing area.

We expect that our current  facilities  will be sufficient  for the  foreseeable
future.  To the extent that we require  additional space in the near future,  we
believe  that  we  will  be  able to  secure  additional  leased  facilities  at
commercially reasonable rates.

ITEM 3. LEGAL PROCEEDINGS

                                       13
<PAGE>

On April 21, 2005,  Bristol Investment Fund, Ltd.  ("Bristol"),  a holder of our
discounted  debentures  in the  amount of  $91,726,  commenced  a lawsuit in the
Supreme  Court of New York against us,  essentially  alleging that we wrongfully
refused to honor its  request to convert the debt into  9,268,875  shares of our
common stock. T he lawsuit seeks an order  compelling us to pay $4,393,360  plus
interest  from April 25, 2005 for damages and  attorneys  fees.  The Court heard
argument on a motion for preliminary injunction requiring us to issue the shares
on May 5, 2005 and has not yet ruled on the motion. On June 6, 2005, we filed an
Answer,  Affirmative  Defenses  and  Counterclaims,  denying  liability  to  the
debenture holder and seeking damages from the debenture holder on account of its
prior,  wrongful  conduct.  The parties  have  conducted  some  initial  written
discovery  but have not taken any  depositions.  On October 21, 2005,  the Court
heard oral argument on Bristol's motion for summary judgment,  in which it asked
the Court to enter judgment  against us for more than $4,000,000 and our lawyers
argued against the entry of such judgment. At argument, the Court reserved on it
s decision but indicated that one should be forth coming. In light of the status
of the case, which is in its initial phases and the fact that there has not been
any  discovery,  we cannot  determine the likely  outcome of the legal action or
whether the Court will grant Bristol's motion.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There was no matter  submitted  during  the fourth  quarter  of the fiscal  year
covered by this report to a vote of security  holders,  through the solicitation
of proxies or otherwise.

                                       14
<PAGE>

                                     PART II

ITEM 5. MARKET FOR COMMON  EQUITY AND  RELATED  STOCKHOLDER  MATTERS  MARKET FOR
COMMON STOCK

Our common stock is quoted on the OTC Bulletin Board under the symbol "SMTR.OB".

Until May 28, 2003,  our common stock was quoted on the Nasdaq  SmallCap  Market
under  the  symbol  "SMTR".  The  following   quotations  obtained  from  Canada
Stockwatch  reflect  the  high  and low  bids  for our  common  stock  based  on
inter-dealer prices, without retail mark-up, mark-down or commission and may not
represent actual  transactions.  The high and low bid prices of our common stock
for the periods indicated below are as follows:



           ----------------------------------------------------------
                   QUARTER ENDED           HIGH             LOW
           ----------------------------------------------------------
                   July 31, 2005          $0.184           $0.088
           ----------------------------------------------------------
                  April 30, 2005          $0.241           $0.022
           ----------------------------------------------------------
                 January 31, 2005         $0.037           $0.026
           ----------------------------------------------------------
                 October 31, 2004         $0.094           $0.03
           ----------------------------------------------------------
                   July 31, 2004          $0.055           $0.052
           ----------------------------------------------------------
                  April 30, 2004          $0.120           $0.106
           ----------------------------------------------------------
                 January 31, 2004         $0.195           $0.185
           ----------------------------------------------------------
                 October 31, 2003         $0.22            $0.215
           ----------------------------------------------------------




Our common shares are issued in registered form. Pacific Corporate Trust Company
(10th Floor, 625 Howe Street,  Vancouver,  British Columbia, V6C 3B8 (telephone:
(604)  689-9853,  facsimile  (604) 689-8144) is the registrar and transfer agent
for our common shares.

As of October 14, 2005, we had  283,709,549  shares of common stock  outstanding
and approximately 471 stockholders of record.

DIVIDEND POLICY

We have never  declared or paid  dividends  on our common  stock,  and we do not
anticipate  that we will do so in the  foreseeable  future.  We intend to retain
future  earnings,  if any, for use in our  operations  and the  expansion of our
business.


                                       15
<PAGE>

EQUITY COMPENSATION PLAN INFORMATION

The following table provides certain information with respect to all of our
Company's equity compensation plans in effect as of September 30, 2005.

<TABLE>
<CAPTION>
=========================== ============================= ============================ ============================

                                                                                          Number of Securities
                             Number of Securities to be                                  Remaining Available for
                              Issued Upon Exercise of      Weighted-Average Exercise      Future Issuance Under
                                Outstanding Options,         Price of Outstanding       Equity Compensation Plans
                                Warrants and Rights          Options, Warrants and        (Excluding Securities
                                                                    Rights              Reflected in Column (a))
--------------------------- ----------------------------- ---------------------------- ----------------------------

Plan Category                           (a)                           (b)                          (c)
--------------------------- ----------------------------- ---------------------------- ----------------------------
<S>                                  <C>                             <C>                         <C>
                                     4,950,000                       $0.11                       696,400
Equity compensation plans
approved by
securityholders
--------------------------- ----------------------------- ---------------------------- ----------------------------
                                    103,040,943                      $0.15                      1,649,890
Equity compensation plans
not approved by
securityholders
--------------------------- ----------------------------- ---------------------------- ----------------------------
                                    107,990,943                      $0.15                      2,346,290
Total
=========================== ============================= ============================ ============================
</TABLE>

Recent Unregistered Sales of Securities

By conversion notice dated August 23, 2005, Crescent  International Ltd. elected
to convert  $115,000 of its 8% convertible  debentures plus accrued  interest of
$19,626.67.  In  response,  we issued  4,286,665  shares of our common  stock to
Crescent  International  Ltd.  pursuant  to Rule 506 of  Regulation  D under the
Securities Act.

On June 30, 2005, we closed a Securities Purchase Agreement with Cornell Capital
Partners,  L.P. and Highgate House Funds,  Ltd., both accredited  investors,  in
which  Cornell  Capital  Partners  and  Highgate  House  Funds  agreed to lend a
principal  amount in the aggregate of  $30,000,000 to us in exchange for our 10%
convertible  debentures.  We issued the convertible  debentures to the investors
pursuant to Rule 506 of Regulation D as promulgated  under the Securities Act of
1933, as amended (the "Act"), and/or Section 4(2) of the Act.

On June 2,  2005,  we issued  75,188  shares of our  common  stock to  Newbridge
Securities   Corporation  as  a  placement  agent  fee  on  the  standby  equity
distribution agreement entered into on May 23, 2005.

On May 27, 2005, we closed a Securities  Purchase Agreement with Cornell Capital
Partners, L.P., an accredited investor, in which Cornell Capital Partners agreed
to  lend  a  principal  amount  of  $1,500,000  to us in  exchange  for  our  5%
convertible  debenture.  We issued the  convertible  debenture  to the  investor
pursuant to Rule 506 of Regulation D as promulgated  under the Securities Act of
1933, as amended (the "Act"), and/or Section 4(2) of the Act.

By notice of a warrant  exercise  dated May 12,  2005,  William  Page elected to
exercise  81,327  warrants.  In response,  we issued 32,889 shares of our common
stock to pursuant to Rule 506 of Regulation D under the Securities Act.

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

The  following  discussion  of our  financial  condition,  changes in  financial
condition  and results of  operations  for the fiscal years ended July 31, 2005,
2004 and 2003,  should be read in conjunction  with the audited annual financial
statements and the notes thereto.

Our  consolidated  financial  statements are stated in United States Dollars and
are prepared in accordance  with United  States  Generally  Accepted  Accounting
Principles.

RESULTS OF OPERATIONS

Fiscal Year Ended July 31, 2005 vs. Fiscal Year Ended July 31, 2004

Revenue

Gross  revenue for the fiscal year ended July 31, 2005  decreased to  $1,463,460
from $1,658,279 in our fiscal year ended July 31, 2004. This decrease in revenue
was a result of the following:

                                       16
<PAGE>

      o     Sales of aftermarket  passenger car tire pressure monitoring systems
            (TPMSs) decreased to $307,347 in fiscal year 2005 from $1,087,395 in
            fiscal  year 2004.  The  decrease  in sales was  primarily  due to a
            significant reduction in sales to our Chinese master distributor. We
            forecast  fiscal  year  2006  sales  of  aftermarket  car  TPMSs  to
            approximate fiscal year 2005 sales of TPMSs.

      o     Sales of original  equipment  manufacturer  ("OEM")  passenger TPMSs
            increased  to $572,485  in fiscal year 2005 from  $166,202 in fiscal
            year 2004. The increase was primarily due to an increase in sales to
            Aston Martin,  Ford's  flagship  division.  We forecast sales of OEM
            TPMSs to increase substantially in fiscal year 2006 as we anticipate
            higher sales to Aston Martin.

      o     Sales of  aftermarket  motorcycle  systems  increased to $111,875 in
            fiscal year 2005  compared to $37,744 in fiscal year 2004. In August
            2004, we  discovered  that the  sensor/transmitter  may break during
            installation  on the  subset  of  motorcycle  rims with  curved  rim
            surfaces  when the  strap  is  torqued  to its  required  value.  On
            September 14, 2004 we contacted the National Highway  Transportation
            Safety  Administration  (NHTSA) to determine if a Safety  Defect and
            Non  Compliance  Report was  required and were advised that this was
            necessary.  Our remedy for the defect was to recall 100% of affected
            sensor/transmitter  items from the field and replace  both  recalled
            and   inventory    sensor/transmitters    with   sensor/transmitters
            previously  manufactured  by a  different  supplier  that  have been
            tested  and  known  to  use  plastics   that  provide  the  required
            mechanical properties.  Additionally to ensure that transmitters are
            used  only on rims  with  flat  drop  center  wells  (as  originally
            designed for) and not curved,  the  additional  precautionary  steps
            were taken:

            1)    We added  improved  warnings and an  instruction  sheet to new
                  products  as well as  product  in  inventory  at  dealers  and
                  distributors   that   clarify   flat  rim  drop   center  well
                  application only; and

            2)    We removed  TPMSs on  motorcycles  with rims with  curved drop
                  center wells.

      At the end of fiscal year 2004,  we estimated the cost of the recall to be
$67,000.  Recall costs  incurred to the end of July 2005 were  $46,897.  We have
made a  provision  in  accounts  payable  for  the  additional  $20,103  that we
anticipate incurring.  In addition, we developed a solution to enable us to sell
our TPMSs on  motorcycles  with rims with curved drop center wells.  We released
this enhanced  product during April 2005. To date, the response to the recall by
our  customers  has been very  positive.  Although  interest  in the  motorcycle
product by existing and potential  customers remains  positive,  it is difficult
for us to  predict  what the  volume  of  sales  will be,  as this  will  depend
primarily on market acceptance.

      o     Sales of  aftermarket  recreational  TPMSs  increased to $128,739 in
            fiscal year 2005 from $118,357 in fiscal year 2004. Fiscal year 2004
            sales  include  sales of our high  pressure  transmitters  that were
            released in our fourth quarter and sales of low pressure  sensors to
            monitor the wheels of a towed vehicle or trailer that was introduced
            during our first  quarter  ended  October 31,  2003.  Although it is
            difficult  for us to  predict  what the  volume of sales will be, we
            anticipate  a  substantial  increase in sales during the next fiscal
            year.

      o     Sales of OEM  recreational  TPMSs were  $230,216  in the fiscal year
            2005  compared  to  $64,454  in fiscal  year  2004.  Although  it is
            difficult  for us to  predict  what the  volume of sales will be, we
            anticipate  continued  sales growth of this product  during the next
            fiscal year.

      o     Sales of TPMSs for use on  trucks  were  $5,717 in fiscal  year 2005
            compared  to $22,733  in fiscal  year 2004.  The  majority  of these
            systems  are  currently  being  used  for  test  purposes.  Although
            interest in this product is high,  it is difficult for us to predict
            what the volume of sales will be, as this will depend  primarily  on
            market acceptance.

      o     Sales of  aftermarket  TPMSs for use on buses were $42,430 in fiscal
            2005  compared  to  $42,406  in fiscal  year  2004.  Although  it is
            difficult  for us to  predict  what the  volume of sales will be, we
            anticipate a substantial increase in sales of TPMSs for use on buses
            during the next fiscal year.

      o     Sales of OEM TPMSs for use on buses were $23,533 in fiscal year 2005
            compared to $0 in fiscal year 2004.  Although it is difficult for us
            to  predict  what the  volume  of sales  will be,  we  anticipate  a
            substantial  increase in sales of OEM TPMSs for use on buses  during
            next  year  as  we  only  commenced  shipping  TPMSs  to  Motorcoach
            Industries International in July 2005.

      o     Revenue of $0 was  recorded  for  engineering  changes to modify our
            products pursuant to our Manufacturing, Co-Marketing and Development
            Agreement with Hyundai Autonet Co. Ltd. in fiscal year 2005 compared
            to  $94,800  in the  fiscal  year  2004.  Revenue  from  engineering
            services  is  recognized  on  services  as  they  are  rendered  and
            pre-defined milestones are achieved.

      o     Sales of  miscellaneous  products  were  $41,118 in fiscal year 2005
            compared to $24,188 in fiscal year 2004.

                                       17
<PAGE>

Gross Margin

      Gross margin on product sales decreased to -11.7% in fiscal year 2005 from
12.8% in fiscal year 2004.  The decrease in gross margin in fiscal year 2005 was
due to an inventory write-down of $500,000 for slow moving aftermarket passenger
car  TPMSs.  Without  the  inventory  write-down,  the gross  margin  would have
increased to 22% in fiscal year 2005. Factors that would have resulted in higher
margins if not for the inventory write-down are:

      o     the product mix of systems sold in fiscal year 2005 had higher gross
            margins  than the product  mix of systems  sold in fiscal year 2004;
            and

      o     the  decrease  in the value of the $US  against  the Pound  Sterling
            increased our margins as a higher proportion of our sales during the
            fiscal year 2005 were in Pound Sterling.


Expenses

      Expenses  increased to $12,288,528 in fiscal year 2005 from  $7,186,287 in
fiscal year 2004,  due to  increases  in  marketing,  engineering,  research and
development expenses and depreciation and amortization expenses. The increase in
expenses was  primarily  due to a non-cash  compensation  expense of  $4,279,653
which  was  primarily  a result  of the  increase  in the  value of  outstanding
employee stock options.  Excluding the non-cash compensation  expense,  expenses
were $8,008,875 in fiscal year 2005.

      Engineering,  research and development expenses increased to $3,297,011 in
fiscal year 2005 from  $1,654,690  in fiscal year 2004.  Excluding  the non-cash
compensation   expense  of  $1,347,933,   expenses  in  fiscal  year  2005  were
$1,949,078,  or an increase of $294,388 from fiscal year 2004.  The increase was
primarily  attributed to higher prototype  development costs, an increase in the
number of engineering  employees and  engineering-related  wages and the cost of
our  TS16949  audit.  TS16949  is the  recognized  quality  standard  within the
automotive industry. Wages included a non-cash expense of $74,833 related to the
issuance of common stock to senior engineering employees.

      Marketing  expenses  increased  to  $2,540,730  in  fiscal  year 2005 from
$1,821,122 in fiscal year 2004.  Excluding the non-cash  compensation expense of
$813,545, expenses in fiscal, year 2005 were $1,727,185 or a decrease of $93,937
from  fiscal  year  2004.  The  decrease  was a  primarily  a  result  of  lower
advertising and promotion  expenses and lower travel expenses.  Wages included a
non-cash  expense of $44,494 related to the issuance of common stock to a senior
marketing employee.

      General and administrative expenses increased to $4,953,537 in fiscal year
2005 from  $2,338,758 in fiscal year 2004.  Excluding the non-cash  compensation
expense  of  $2,118,175,  expenses  in fiscal  year 2005 were  $2,835,362  or an
increase  of  $496,604  from  fiscal  year  2004.  The  increase  was  primarily
attributed to an increase in bad debts, higher administration  wages,  insurance
costs,  professional  fees,  wages and the cost of becoming  compliant  with the
Sarbanes Oxley Act of 2002. The increase in professional  fees was primarily due
to the cost of legal  services  incurred  to defend  against  a  lawsuit  from a
debenture holder.  The major increase in administration  wages was primarily due
to a  non-cash  expense  related  to the  issuance  of  common  stock to  senior
management  valued at  $142,251.  The  increase  was  partially  offset by lower
investor relation costs and lower travel costs.

Depreciation and amortization

      Depreciation  and amortization  expense  increased to $1,497,250 in fiscal
year 2005 from  $1,371,717 in fiscal year 2004.  Depreciation  and  amortization
expense is expected to decrease next year with the full  amortization of our OEM
rights to the commercial market.

Interest and finance charges

      Interest and finance  charges  decreased to $3,730,481 in fiscal year 2005
from $4,031,820 in fiscal year 2004. Interest and finance charges in fiscal year
2005 included non-cash  interest of $3,524,805  compared to non-cash interest of
$3,842,107 in fiscal year 2004.

Interest Income

      Interest  income  increased  to $39,241 in fiscal year 2005 from $5,873 in
fiscal year 2004.  This  increase was mainly due to the issuance of  convertible
debentures in June year 2005 that resulted in net proceeds of $10,950,000 to us.

Foreign exchange gain

                                       18
<PAGE>

      A foreign  exchange  gain of  $37,194  was  earned in fiscal  year 2005 as
compared to $12,492 in fiscal year 2004.  Foreign  exchange  gains or losses are
due to fluctuations in currency exchange rates and are impossible to predict.

Gain on settlement of convertible debt

      A gain on settlement of $1,822,033 on the settlement of  convertible  debt
was incurred in fiscal year 2005 as compared to $0 in fiscal year 2004.

Fiscal Year Ended July 31, 2004 vs. Fiscal Year Ended July 31, 2003

Revenue

      Gross  revenue  in the  fiscal  year  ended  July 31,  2004  decreased  to
$1,658,279 from $1,802,596 in our fiscal year ended July 31, 2003. This decrease
in revenue was a result of the following:

      o     Sales of aftermarket  passenger car TPMSs decreased to $1,087,395 in
            fiscal year 2004 from $1,141,210 in fiscal year 2003.

      o     Sales of OEM  passenger  car TPMSs  decreased  to $166,202 in fiscal
            year 2004 from $174,880 in fiscal year 2003.

      o     Sales of aftermarket motorcycle TPMSs decreased to $37,744 in fiscal
            year 2004  compared to $183,589 in fiscal year 2003. We introduced a
            substantially  improved second  generation  motorcycle tire pressure
            monitoring  system (TPMS) at the Indy Motorcycle  Dealers Show, held
            in Indianapolis,  Indiana in mid-February 2004. During May 2004 this
            product  became  commercially  available and we began shipping it to
            our customers.

      o     Sales of  aftermarket  recreational  vehicle  TPMSs were $118,357 in
            fiscal  year 2004  compared  to $26,383 in fiscal  year 2003.  These
            sales  include  sales of our high  pressure  transmitters  that were
            released in our fourth quarter and sales of low pressure  sensors to
            monitor the wheels of a towed vehicle or trailer that was introduced
            during our first quarter ended October 31, 2003.

      o     Sales of OEM recreational  vehicle TPMSs were $64,454 in fiscal year
            2004.  The  majority of these sales  occurred in the fourth  quarter
            after the release our high pressure transmitters.

      o     Sales of  aftermarket  high  pressure  TPMSs  for use on buses  were
            $42,406 in fiscal  year 2004.  All of these  sales  occurred  in our
            fourth quarter after the release our high pressure transmitters.

      o     Sales of  aftermarket  high  pressure  TPMSs  for use on  commercial
            vehicles were $22,733 in fiscal year 2004.  Our customers  purchased
            these  systems  in the fourth  quarter  after the  release  our high
            pressure  transmitters.  The majority of these systems are currently
            being used for test purposes.

      o     Sales of  off-the-road  (OTR)  TPMSs were $1,088 in fiscal year 2004
            compared  to $58,395 in fiscal  year 2003.  Our OTR TPMSs  utilize a
            high-pressure transmitter and is designed primarily for off-the-road
            (OTR) heavy industrial applications and commercial applications. The
            system may potentially be used not only on large mining trucks,  but
            also heavy  mobile  equipment  (such as tractors,  wheeled  loaders,
            graders  and  the  like).  Sales  of  our  off-the-road  (OTR)  tire
            monitoring  systems to date have been limited to those systems which
            are designed for use on large mining trucks.

      o     Revenue of $94,800 was  recorded for  engineering  changes to modify
            our  products  pursuant  to  our  Manufacturing,   Co-Marketing  and
            Development  Agreement with Hyundai  Autonet Co. Ltd. in fiscal year
            2004  compared  to  $173,400  in the fiscal  year  2003.  Revenue is
            determined  by the  percentage of  completion  method.  Revenue from
            engineering  services is recognized on services as they are rendered
            and pre-defined milestones are achieved.

      o     Sales of the  motorsport  TPMSs  decreased to $0 in fiscal year 2004
            from  $44,739 in fiscal year 2003.  As  indicated  above,  we do not
            anticipate  further sales of our  motorsport  TPMSs as our exclusive
            motorsport  distributor,  Pi Research  of  Cambridge,  England,  now
            manufactures  and  markets  their own system.  Accordingly,  we have
            discontinued production of our motorsport TPMSs.

      o     Sales of  miscellaneous  products  were  $23,100 in fiscal year 2004
            compared to $0 in fiscal year 2003.


                                       19
<PAGE>

Gross Margin

      Gross margin on product sales  decreased to 12.8% in fiscal year 2004 from
23.0% in fiscal year 2003. The decrease occurred due to the following factors:

      o     our product mix of systems  sold in fiscal year 2004 had lower gross
            margins than the product mix of systems sold in fiscal year 2003;

      o     our  provision  for our  motorcycle  recall in the amount of $66,801
            decreased our fiscal year 2004 margin by 4%;

      During our third  quarter,  we shifted the majority of our  production  to
Hyundai Autonet, and as we expected, our gross margin increased in our third and
fourth quarters,  after excluding the cost of the motorcycle recall. Although we
expect that our gross margin will continue to increase in fiscal year 2005, this
is dependent on the cost of  components  and the sales  contracts  that we enter
into.

Expenses

      Expenses  increased to $7,186,287  in fiscal year 2004 from  $6,802,391 in
fiscal  year  2003,  as  increases  in  marketing,   engineering,  research  and
development  expenses and depreciation and amortization were partially offset by
a  decrease  in  general  and  administration  expenses.  Non-cash  stock  based
compensation  expense was not  significant  in either fiscal year 2004 or fiscal
year 2003.

      Engineering,  research and development expenses increased to $1,654,690 in
fiscal  year 2004 from  $1,177,935  in  fiscal  year  2003.  This  increase  was
primarily  attributed  to an  increase in  prototype  development  expenses,  an
increase  in product  testing on products  that we have  released in the current
fiscal year, an increase in the number of patents and approval applications, and
an  increase  in the number of  engineering  employees  and  engineering-related
wages.

      Marketing  expenses  increased  to  $1,821,122  in  fiscal  year 2004 from
$1,448,326  in fiscal  year 2003.  The  increase  was  primarily  a result of an
increase in travel and higher  marketing-related  wages,  which  increased  as a
result of the  recruitment of a V.P. of Sales and  Marketing.  This increase was
partially offset by lower tradeshow expenditures.  Trade show expenses in fiscal
year 2003 included the cost of attending the  Automechanika  show, which is held
in Europe every two years.  Fiscal year 2003 also included  expenses of $130,000
in connection with the termination of a management agreement; 50% of this amount
or $65,000 was booked as  marketing  expenses  and 50% was booked as general and
administrative expenses.

      General and administrative expenses decreased to $2,338,758 in fiscal year
2004 from $2,939,260 in fiscal year 2003. The decrease was primarily  attributed
to lower  professional fees,  investor relation costs and administration  wages.
Professional  fees in fiscal year 2003 included an expense of $315,044 to settle
certain potential  unquantified  claims threatened by certain offshore investors
against  our  Company.   Administrative  wages  decreased  as  there  were  less
administrative  employees  during fiscal year 2004 and as explained  above,  our
general and  administrative  expenses  for the year ended July 31, 2003  include
$65,000 that was incurred in  connection  with the  termination  of a management
contract. The decrease was partially offset by an increase in insurance costs.

Depreciation and amortization

      Depreciation  and amortization  expense  increased to $1,371,717 in fiscal
year 2004 from  $1,236,870 in fiscal year 2003.  Depreciation  and  amortization
expense  is  expected  to  remain at  approximately  its  current  level for the
foreseeable future.

Interest and finance charges

      Interest and finance  charges  increased to $4,031,820 in fiscal year 2004
from $3,722,505 in fiscal year 2003. Interest and finance charges in fiscal year
2004 included non-cash  interest of $3,842,107  compared to non-cash interest of
$3,694,914 in fiscal year 2003.

Interest income

      Interest  income of $5,873 was earned in fiscal  year 2004 as  compared to
$2,835 in fiscal year 2003.  This  increase was due to slightly  higher  average
cash balances maintained during fiscal year 2004.

Foreign exchange gain

      A foreign  exchange  gain of  $12,492  was  earned in fiscal  year 2004 as
compared to $192,201 in fiscal year 2003.  Foreign  exchange gains or losses are
due to fluctuations in currency exchange rates and are impossible to predict.

                                       20
<PAGE>

LIQUIDITY AND CAPITAL RESOURCES

CURRENT POSITION

      We have continued to finance our activities primarily through the issuance
and sale of  securities.  We have incurred  losses from  operations in each year
since  inception.  As at  July  31,  2005,  we had  an  accumulated  deficit  of
$75,132,150.  Our net loss for  fiscal  year 2005 was  $14,291,681  compared  to
$10,987,026 for fiscal year 2004. As of July 31, 2005, our stockholders'  equity
was $10,383,957 and we had working capital of $7,510,569.

      Our cash position at July 31, 2005 was  $10,059,763 as compared to $76,670
at July 31, 2004.  This increase was due to the net increase from our operating,
financing and investing activities as described below.

      Our net loss of $14,291,681 in fiscal year 2005 includes  non-cash charges
of $1,497,250 for  depreciation  and  amortization,  $4,279,653 for compensation
expense,  $500,000  for an  inventory  write-down,  $3,524,805  for interest and
finance  charges and a gain on  settlement of debt of  $1,822,033.  Decreases in
non-cash  working  capital  during this period  amounted to  $507,809.  Non-cash
working capital changes included increases in inventory and accounts  receivable
and  decreases  in  prepaid   expenses  and  in  accounts  payable  and  accrued
liabilities.  The net cash used in operating  activities in fiscal year 2005 was
$6,819,995. We may require subsequent financings to meet our operating cash flow
requirements.

      During  fiscal year 2005,  we realized  aggregate  gross cash  proceeds of
$42,595,017 as follows:

      We issued 78,887,710 shares of common stock to Cornell Capital Partners LP
pursuant to nine draw downs  totaling  $2,725,000  from our $15.0 million equity
line of credit, which is described below.

      On May 19, 2004, we entered into a Standby Equity  Distribution  Agreement
with Cornell  Capital  Partners,  an accredited  investor,  in connection with a
24-month,  $15.0  million  equity line of credit  facility.  This  agreement was
terminated  on May 20, 2005 and  replaced  with a $30.0  million  equity line of
credit facility.  The $30 million  agreement was terminated on June 23, 2005 and
replaced with a $160.0 million equity line of credit  facility.  The new Standby
Equity Distribution  Agreement (SEDA) contemplates the potential future issuance
and sale of up to $160.0 million of our common stock to Cornell Capital Partners
over five years subject to certain  restrictions and other obligations.  On June
2, 2005, we issued  75,188  shares at an effective  price of $0.133 per share as
payment for a $10,000  placement agency fee related to the SEDA. On each advance
date we shall pay to the  Investor,  directly  from the gross  proceeds  held in
escrow, an amount equal to five percent (5%) of the amount of each advance.

      In addition we paid to Yorkville  Advisors  Management,  LLC a cash fee of
$16 million  directly from the gross proceeds held in escrow from the closing of
the convertible  debentures dated June 23, 2005.  Yorkville Advisors Management,
LLC is the  general  partner  of  Cornell  Capital  Partners.  This cash fee was
payment for the $160 million equity line of credit facility.

      Aggregate warrant proceeds of $618,217 were realized as follows:

      On  September  24,  2004,  we and  holders of the  discounted  convertible
debentures  signed an agreement  which  provided  for an  immediate  exercise of
18,226,274 warrants at $0.03 for gross proceeds of $546,788.

      On May 5, 2005, a warrant holder exercised 714,286 warrants at an exercise
price of $0.10 for gross proceeds of $71,429.

      On  November  16,  2004 we received  gross  proceeds of $250,000  upon the
issuance of an unsecured  short-term  promissory note to an accredited investor.
The note bears  interest at a rate of 12% per annum and is  repayable  within 30
days of issuance with accrued interest.

      On  November  30,  2004 we received  gross  proceeds of $275,000  upon the
issuance of an unsecured  short-term  promissory note to an accredited investor.
The note bears  interest at a rate of 12% per annum and is  repayable  within 30
days of issuance with accrued interest.  As a commitment fee to loan the Company
money, the holder of the note received $27,500.

      On  February  9, 2005 we received  gross  proceeds  of  $350,000  upon the
issuance of an unsecured  short-term  promissory note to an accredited investor.
The note bears  interest at a rate of 10% per annum and is  repayable  within 30
days of issuance with accrued interest.  As a commitment fee to loan the Company
money, the holder of the note received $35,000.

      On December 15, 2004, we received  gross  proceeds of $2,695,000  upon the
issuance of a three-year  $2,500,000 5% convertible  debenture and five two-year
5% convertible  debentures  aggregating  $195,000.  Principal  under the five 5%
convertible debentures that aggregate $195,000 may be converted by the holder in
whole or in part and from time to time at a conversion price equal to the lesser
of:

                                       21
<PAGE>

      (i) $0.036 or;
      (ii) an amount equal to 80% of the lowest  closing bid price of our common
stock,  as  quoted  on  Bloomberg,  L.P.,  for the 5  trading  days  immediately
preceding  the  conversion  date,  subject to  adjustment as provided for in the
debentures.

      The outstanding principal under the convertible  debentures bears interest
at the rate of 5% per annum, calculated on the basis of a 360-day year. Interest
on the debentures  aggregating $195,000 is payable semi-annually  beginning June
15,  2005 and every  subsequent  six month  period  that the  principal  balance
remains unpaid.

      On March 22,  2005,  we issued 5%  convertible  preferred  stock for gross
proceeds  of  $4,000,000.  The  proceeds  were  used  to  repay  the  $2,500,000
convertible  debenture  entered  into  on  December  15,  2004  and  a  $350,000
promissory note entered into on February 9, 2004. Additional expenses related to
this offering were $20,000.

      On May 20, 2005, we issued a $1,500,000 one-year 5% convertible  debenture
convertible  at the option of the holder at $0.028 per share.  Between  April 25
and April 29, 2005, $1,100,000 of the convertible debenture was placed in escrow
with our  lawyer.  From  escrow,  $457,999  was paid on  April  27,  2005 to two
debenture holders to redeem their convertible debentures.  In addition,  between
May 2, 2005 and May 23, 2005, we entered into release, redemption and settlement
agreements  whereby we redeemed $675,615 of discounted  convertible  debentures.
Consideration  consisted of $402,930  and the  issuance of  9,738,759  shares of
common  stock which were issued at an effective  conversion  price of $0.028 per
share.

      On June  23,  2005,  we  entered  into a  $160.0  million  Standby  Equity
Distribution  Agreement and a $30 million  Securities  Purchase  Agreement  that
resulted in net  proceeds of $10.95  million to us. We paid  Yorkville  Advisors
Management  a cash fee of $16  million in  connection  with the  Standby  Equity
Distribution  Agreement,  and we paid Cornell Capital  Partners a cash fee of $3
million, and a cash structuring fee of $50,000 to Yorkville Advisors Management,
in connection with the Securities Purchase Agreement,  out of the purchase price
paid by  Cornell  Capital  Partners  for the  convertible  debentures  purchased
pursuant  to  the  Securities  Purchase  Agreement.  Refer  to  "Description  of
Securities" for more details regarding the Standby Equity Distribution Agreement
and the  Securities  Purchase  Agreement.  We also issued 62.5 million  warrants
exercisable at $0.16 per share (subject to adjustment  pursuant to adjustment as
described  below) with an expiry period of five years.  Although we have cash of
approximately  $10.1 million at July 31, 2005, as discussed  below under "FUTURE
OPERATIONS",  we may require up to $12.1  million in financing  through the next
twelve months in order to continue in business as a going concern.

      At  January  31,  2005 and April 30,  2005,  we were in  violation  of all
existing convertible  debenture agreements.  As a result of this violation,  the
Company  accreted  interest  to  adjust  the  carrying  value  of  all  existing
convertible debentures to their redemption value.

      As at April 30, 2005, we were in violation of a preferred  share agreement
as a  registration  statement  was not filed with the  Securities  and  Exchange
Commission on the date specified in the agreement. We received an extension from
the preferred shareholders to file a registration statement by June 30, 2005 and
received a waiver for any penalties.

      As we filed a  registration  statement  on July 22,  2005,  we were not in
violation of any existing  convertible  debenture or preferred share agreements,
other than one holder of a  discounted  debenture  in the amount of $91,726  who
provided us with notice of a summons with the Supreme  Court of the State of New
York.  However,  as of  September  23,  2005 we were in  violation  of the other
convertible  debenture  and  preferred  share  agreements  as  we  withdrew  our
registration  statement.  We received a waiver from the debtholders,  other than
the one  debtholder  who provided us with the notice of summons with the Supreme
Court of the State of New York,  and preferred  shareholders  that we are not in
default  pending the filing of a new  registration  statement  and the principal
holder  waives  its  rights  under  the  default  provisions  affected  by  this
non-compliance.

      During fiscal year 2005, we also  purchased  certain  capital assets at an
aggregate cost of $73,511.

      However,  although we have a $160.0 million  standby  equity  distribution
with Cornell, there are certain factors that may prevent us from drawing down on
it. As such, due to the uncertainty of our ability to meet our current operating
and  capital  expenses,  in their  report on the annual  consolidated  financial
statements for fiscal year 2005, our independent  auditors  included  additional
comments in their Auditors' report indicating the existence of substantial doubt
about our ability to continue as a going  concern.  Our  consolidated  financial
statements contain additional note disclosures describing the circumstances that
led to this going concern uncertainity. The consolidated financial statements do
not  include  any  adjustments  that  might  result  from  the  outcome  of this
uncertainty.

      As the  continuation  of our business is dependent  upon the conversion by
certain  holders of our  outstanding  convertible  debentures into shares of our
common  stock or, if such  conversions  do not  occur or are not  sufficient  to
significantly  decrease our  outstanding  repayment  obligation,  our ability to
drawn  down  on our  $160.0  million  equity  line  of  credit,  successful  and
sufficient  market  acceptance of our current products and any new products that
we may  introduce,  the  continuing  successful  development of our products and
related technologies,  and, finally, achieving a profitable level of operations.
The issuance of additional equity securities by us could result in a significant
dilution  in  the  equity  interests  of  our  current  stockholders.  Obtaining
commercial  loans,  assuming  those loans would be available,  will increase our
liabilities and future cash commitments.

                                       22
<PAGE>

      We plan to use our $160.0 million  standby equity  distribution  agreement
with  Cornell  Capital  Partners  to meet the balance of our  estimated  funding
requirements  for the  next  twelve  months  ,  assuming  that we will  meet all
conditions  to effect draw downs under  equity line of credit  facility.  We may
also realize cash proceeds upon the exercise of our outstanding warrants,  which
cannot be assured.

Fiscal Year Ended July 31, 2004

      We have continued to finance our activities primarily through the issuance
and sale of  securities.  We have incurred  losses from  operations in each year
since  inception.  As of  July  31,  2004,  we had  an  accumulated  deficit  of
$59,018,256.  Our net loss for  fiscal  year 2004 was  $10,987,026  compared  to
$9,914,629 for fiscal year 2003. As of July 31, 2004, our  stockholders'  equity
was $3,466,216 and we had working capital of $732,405.

      Our cash  position at July 31, 2004 was $112,951 as compared to $1,843,694
at July 31, 2003.  This decrease was due to the net decrease from our operating,
financing and investing activities as described below.

      Our net loss of $10,987,026 for fiscal year 2004 includes non-cash charges
of $1,371,717 for  depreciation  and  amortization,  $3,842,107 for interest and
finance  expense  and  $98,175  for shares  and  warrants  issued  for  services
received.  Decreases in non-cash  working capital during this period amounted to
$1,860,812.  Non-cash working capital changes  included  increases in inventory,
prepaid expenses and accounts payable and accrued  liabilities and a decrease in
receivables.  An increase in  inventory  of  $2,391,749  accounted  for the most
significant use of cash for working capital.  This increase was primarily due to
the procurement of components for production builds at Hyundai Autonet.

      During  fiscal year 2004,  we realized  aggregate  gross cash  proceeds of
$7,170,265 from financing activities as described below.

      On October 27, 2003,  in order to encourage  early  exercise of a total of
10,769,231  warrants issued to the purchasers of our 7% convertible  debentures,
we offered to reduce the exercise  price of the warrants  from $0.2645 per share
to $0.20 per share.  The offer was open for  acceptance  by the warrant  holders
until November 4, 2003. In consideration  of the warrant  holders'  agreement to
immediately  exercise  their  respective  warrants,  we  offered to issue to the
participating  warrant holders one additional  warrant for each warrant that was
exercised. One of the warrant holders,  Palisades Master Fund accepted our offer
and exercised a total of 3,290,596  outstanding warrants at the reduced exercise
price of $0.20 per share.  On October 27,  2003,  we issued a total of 3,290,596
five-year warrants to Palisades Master Fund, exercisable at an exercise price of
$0.20 per  share,  resulting  in gross  proceeds  of  $658,119.  The  additional
warrants were to be exercisable  for a period of five years at an exercise price
of $0.20 per share.

      On October 27, 2003, our former investment banker HPC Capital  Management,
also agreed to immediately  exercise 194,000  outstanding  common stock purchase
warrants  dated May 16,  2003,  in  consideration  of receiving  one  additional
five-year  warrant with an exercise price of $0.20 per share for each warrant so
exercised.  Of the 194,000  warrants  exercised by HPC Capital  Management under
this arrangement, 180,000 were exercised at an exercise price of $0.13 per share
and 14,000 were exercised at an exercise price of $0.10 per share,  resulting in
gross proceeds of $24,800.

      On November 6, 2003, in order to encourage  early exercise of the warrants
by the remaining three warrant holders,  we offered to reduce the exercise price
of the remaining 7,478,635 warrants from $0.2645 per share to $0.1771 per share.

      On  December  24,  2003,  we  closed a  private  placement  of  discounted
unsecured   convertible   debentures  in  the  aggregate   principal  amount  of
$3,493,590.  We  issued  the  convertible  debentures  at a 22%  original  issue
discount from the face  principal  amount (based on a notional  interest rate of
11% per annum for each year of the two-year term of the  debentures),  resulting
in gross  proceeds  of  $2,725,000,  before the  deduction  of a  $218,000  cash
placement fee subsequently paid to HPC Capital  Management and other expenses of
the offering.  The  discounted  convertible  debentures  do not  otherwise  bear
interest,  and will mature on April 1, 2006. The outstanding principal amount of
each debenture may be converted at any time into shares of our common stock,  in
whole or in part,  at the option of the holder of the  debenture  at an original
set  price of $0.22 per  share.  As a result of  anti-dilution  provisions,  the
conversion price was reduced to $0.028.  The discounted  convertible  debentures
are subject to mandatory redemption in equal monthly payments,  payable in cash.
We may elect to make the  monthly  redemption  payments  in shares of our common
stock at a  conversion  price  equal to the lesser of (i) the set price of $0.22
per share  (subject  to  adjustment  pursuant  to the  anti-dilution  provisions
contained in the  debentures)  and (ii) 85% of the average of the closing prices
of our common stock for the 20 days immediately preceding the applicable monthly
redemption  date,  provided  that  certain  conditions  are met,  including  the
condition that the underlying  shares of common stock will have been  registered
under the Securities Act of 1933, as amended.

                                       23
<PAGE>

      On February 5, 2004, we notified the holders of the discounted convertible
debentures that we had elected to effect the first monthly redemption payment in
shares, and that the election should continue for subsequent  redemption periods
until  revised.  One of the  holders of the  discounted  convertible  debentures
exercised  its right to receive its first  monthly  redemption  payment,  in the
amount of $14,583, in cash.

      On April 28, 2004,  we notified the  debenture  holders that we would make
the monthly redemption  payments in cash commencing June 1, 2004 until otherwise
notified.

      On October 14, 2003, an employee  exercised  79,400 employee stock options
at $0.20 per stock option.

      On April 15,  2004,  we  received  gross  proceeds  of  $750,000  upon the
issuance of an unsecured  short-term  promissory note to an accredited investor.
The note bears  interest at a rate of 8% per annum and is  repayable  within 120
days of issuance with accrued  interest.  As a commitment  fee to loan us money,
the holder of the note received $75,000.

      On April 30, 2004, 500,000 warrants were exercised at $0.104.  Pursuant to
the anti-dilution  provisions contained in certain warrants,  the exercise price
of 25,290,153  outstanding  warrants was reduced to $0.104 per share,  which was
the  deemed  price per share of the  common  stock that was issued to effect the
April 1,  2004  redemption  payment  of our  discounted  convertible  debentures
maturing April 1, 2006.

      On May 19, 2004, we received  gross proceeds of $750,000 upon the issuance
of an unsecured short-term  promissory note to an accredited investor.  The note
bears  interest  at a rate of 8% per annum and is  repayable  within 120 days of
issuance with accrued interest. As a commitment fee to loan us money, the holder
of the note received $75,000.

      The net proceeds realized or to be realized by us from these  transactions
have and are to be used for debt repayment,  working capital and the purchase of
capital assets.

      During fiscal year 2004, we also  purchased  certain  capital assets at an
aggregate  cost of $446,780.  The majority of these capital  assets were sent to
Hyundai Autonet in Korea to facilitate  production of our aftermarket  TPMSs for
passenger cars and motorcycles.


FUTURE OPERATIONS

Presently,  our  revenues  are not  sufficient  to meet  operating  and  capital
expenses. We have incurred operating losses since inception,  and this is likely
to continue for the foreseeable future.

At July 31, 2005, we had cash of approximately  $10.1 million. As our management
projects that we will require a minimum of  $7.5-$22.2  million to fund our debt
repayment,   ongoing  operating  expenses,   working  capital  requirements  and
potential litigation settlement through July 31, 2006, as detailed below, we may
we may require up to $12.1  million in financing  through the next twelve months
in order to continue in business as a going concern.




Marketing                                    $ 1,700,000         $ 2,000,000
Engineering, research and development          1,700,000           2,100,000
General and administrative                     2,200,000           2,700,000
Capital Purchases                                 60,000             400,000
Debt repayment (1)                             3,300,000          15,000,000
General Working Capital (2)                   (1,460,000)                  _
                                             -----------         -----------
TOTAL                                        $ 7,500,000         $22,200,000
                                             ===========         ===========



(1) Our debt is  convertible  into  common  shares of our  company.  Although we
expect our debt  holders to convert  their debt into common  shares,  there is a
risk that we will need to repay our debt in cash.  The  interest  on the debt is
repayable in cash. Debt repayment includes maximum settlement of $4,393,360 plus
interest plus attorney fees with discounted  debtholder that has initiated legal
action.

                                       24
<PAGE>

(2) Our working capital requirements are impacted by our inventory requirements.
Therefore, any increase in sales of our products will be accompanied not only by
an  increase  in  revenues,  but  also by an  increase  in our  working  capital
requirements.

The continuation of our business is dependent upon obtaining further  financing,
market  acceptance  of our current  products  and any new  products  that we may
introduce,  the  continuing  successful  development of our products and related
technologies, and, finally, achieving a profitable level of operations.

As discussed above under the heading "Liquidity and Capital Resources",  we plan
to raise any  additional  capital  required to meet the balance of our estimated
funding  requirements  through July 31, 2005, primarily through the draw down of
our $160.0 million standby equity  distribution  agreement  entered into on June
23, 2005.

The issuance of additional equity securities by us could result in a significant
dilution  in  the  equity  interests  of  our  current  stockholders.  Obtaining
commercial  loans,  assuming  those loans would be available,  will increase our
liabilities and future cash commitments.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

Our consolidated  financial  statements and  accompanying  notes are prepared in
accordance with generally accepted  accounting  principles in the United States.
Preparing  financial  statements  requires  management  to  make  estimates  and
assumptions  that affect the reported amounts of assets,  liabilities,  revenue,
and expenses.  These  estimates  and  assumptions  are affected by  management's
application of accounting policies.  We believe that understanding the basis and
nature of the estimates and assumptions  involved with the following  aspects of
our  consolidated  financial  statements is critical to an  understanding of our
financials.

Going Concern

The  Company  has  incurred  recurring  operating  losses  and has a deficit  of
$75,132,150  and working  capital of $7,510,569 as at July 31, 2005.  During the
year ended July 31, 2005,  the Company used cash of  $6,893,506 in operating and
investing activities.

During fiscal 2005,  the Company  realized  gross cash  proceeds of  $42,595,017
(2004 - $7,170,265) from financing activities,  issued 62.5 million warrants and
arranged a $160.0  million  (2004 - $15.0  million)  equity line of credit (note
11(d)) to fund its  operations.  There can be no assurance  that the Company can
draw down amounts under the equity line of credit as drawdowns are subject to an
effective   Registration  Statement  filed  with  the  SEC.  These  consolidated
financial statements have been prepared on the going concern basis which assumes
that  adequate  sources of  financing  will be obtained as required and that the
Company's assets will be realized and liabilities settled in the ordinary course
of business. Accordingly, these consolidated financial statements do not include
any adjustments  related to the  recoverability of assets and  classification of
assets and liabilities  that might be necessary  should the Company be unable to
continue as a going concern.

Inventory

Inventory is carried at the lower of cost, determined on a weighted average cost
method,  and net realizable  value. The determination of net realizable value is
based on several  assumptions  and  estimates.  We provide an allowance  that we
consider to be reasonable for non-moving or slow moving  inventory items and for
items with expected future  realizable value lower than cost. These  assumptions
and estimates may be inaccurate and may be revised.

The  markets in which we  compete  are  rapidly  changing  due to  technological
developments  and increasing focus on automotive  safety.  Other companies offer
products similar to those offered by us, and target the same customers as we do.
Many of these  companies have  substantially  greater  financial,  marketing and
technical  resources.  We also  anticipate  that the  competition  within  these
markets will increase as demand for the products escalates.  It is possible that
new  competitors  or alliances  among existing  competitors  may emerge and such
competitors may rapidly acquire  significant  market share and make it difficult
for us to sell our current inventory. All of these elements could reduce the net
realizable value of our inventory.


Warranty Obligations

On an ongoing basis, we record our best estimate of our warranty obligations and
product  returns  related to products sold.  These  estimates are made after the
consideration  of contractual  warranty  obligations and historical  experience.
Unforeseen events, including increased technological difficulties with products,
could occur that have not been anticipated in estimating the warranty provision.
Additional costs or estimates will be recognized as determinable.

                                       25
<PAGE>

Revenue Recognition

Our  Company  recognizes  revenue  when  there  is  persuasive  evidence  of  an
arrangement, goods are shipped and title passes, collection is probable, and the
fee is fixed or determinable.  Customer  acceptance is used as the criterion for
revenue  recognition  when the product sold does not have an  established  sales
history  to  allow   management  to  reasonably   estimate  returns  and  future
provisions.  Provisions  are  established  for  estimated  product  returns  and
warranty  costs at the time the  revenue  is  recognized.  Our  Company  records
deferred  revenue  when cash is received  in advance of the revenue  recognition
criteria being met. Revenue from engineering  services is recognized on services
as they are  rendered  and  pre-defined  milestones  are  achieved.  Engineering
services revenue for the year were $0 (2004-$94,800 and 2003 -173,400).

Other Assets

Other assets are recorded at cost and are being  amortized  over five years on a
straight line basis.  Other assets are comprised of licenses to manufacture  and
sell  TPMSs  to the  original  equipment  manufacturers.  On an  ongoing  basis,
management  assesses whether the expected net recoverable amount of the licenses
exceeds the book value of the licenses. The net recoverable amount is determined
on a projected cash flow basis,  undiscounted at an appropriate rate. Our belief
is based on an  undiscounted  cash flow  analysis of  management's  current best
estimate of projected annual sales to the passenger  vehicle and light truck OEM
market plus management's projected sales to the heavy truck OEM market. Although
we  expect  to  generate  cash  flow  from  sales  to  the  original   equipment
manufacturer  market  place,  it is possible that we will not generate cash flow
from sales to the original equipment  manufacturer  marketplace in excess of net
book  value,  or that we will  generate  cash  flow from  sales to the  original
equipment  manufacturer  market in future years after the other assets have been
fully amortized.

Off-Balance Sheet Arrangements

We have  not  entered  into any  transaction,  agreement  or  other  contractual
arrangement with an entity unconsolidated with us under which we have:

o     an obligation under a guarantee contract;
o     a  retained  or  contingent   interest  in  assets   transferred   to  the
      unconsolidated  entity or  similar  arrangement  that  serves  as  credit,
      liquidity or market risk support to such entity for such assets;
o     an obligation,  including a contingent  obligation,  under a contract that
      would be  accounted  for as a  derivative  instrument;  or an  obligation,
      including a contingent  obligation,  arising out of a variable interest in
      an  unconsolidated  entity that is held by, and material to, us where such
      entity provides financing,  liquidity,  market risk or credit risk support
      to, or engages in leasing,  hedging, or research and development  services
      with us.

ITEM 7. FINANCIAL STATEMENTS

Our  consolidated   financial  statements  are  included  beginning  immediately
following  the  signature  page to this  report.  See  Item 13 for a list of the
financial statements and financial statement schedules included.

ITEM  8.  CHANGES  IN AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
FINANCIAL DISCLOSURE

None.

ITEM 8A. CONTROLS AND PROCEDURES

Our Company's Chief Executive Officer and Chief Financial Officer have evaluated
our  Company's  disclosure  controls and  procedures as of the end of the period
covered by this  Annual  Report on Form  10-KSB.  Management  believes  that our
Company's current internal controls and procedures are effective and designed to
ensure that information  required to be disclosed by our Company in its periodic
reports is recorded, processed,  summarized and reported, within the appropriate
time periods  specified by the SEC, and that such information is accumulated and
communicated  to our  Company's  CEO  and CFO as  appropriate  to  allow  timely
decisions to be made regarding required disclosure.

There was no change in the Company's  internal control over financial  reporting
during our Company's fourth fiscal quarter that has materially  affected,  or is
reasonably  likely to materially  affect,  our Company's  internal  control over
financial reporting.

As of October 15, 2005,  there were no significant  corrective  actions taken by
our Company or other  changes made to these  internal  controls.  Our  Company's
management  does not  believe  there were  changes in other  factors  that could
significantly affect these controls subsequent to the date of the evaluation.

                                       26
<PAGE>

ITEM 8B. OTHER INFORMATION

None.
                                    PART III

ITEM 9.  DIRECTORS,  EXECUTIVE  OFFICERS AND CONTROL  PERSONS;  COMPLIANCE  WITH
SECTION 16(a) OF THE EXCHANGE ACT

The  following  table shows the  positions  held by our board of  directors  and
executive officers, and their ages as of September 30, 2005:


Name                     Age     Position
----                     ---     --------
Robert Rudman(1)          [58]      Director, Chairman of the Board
Al Kozak                  [56]      President and Chief Executive Officer
Jeff Finkelstein          [44]      Chief Financial Officer
Erwin Bartz               [44]      Vice President, Business Development
Shawn Lammers             [38]      Vice President, Engineering
William Cronin(1)(2)      [58]      Director
Martin Gannon(1)(2)       [53]      Director
Johnny Christiansen(2)    [50]      Director


(1) Member of the Audit Committee

(2) Member of the Compensation Committee

Family Relationships

There are no family relationships between any of our directors or executive
officers.

Involvement In Certain Legal Proceedings

None of our directors,  executive  officers,  promoters or control  persons have
been involved in any of the following events during the past five years:

      o     any  bankruptcy  petition  filed by or against any business of which
            such person was a general partner or executive officer either at the
            time of the bankruptcy or within two years prior to that time;

      o     any  conviction  in a  criminal  proceeding  or being  subject  to a
            pending criminal proceeding  (excluding traffic violations and other
            minor offences);

      o     been subject to any order,  judgment,  or decree,  not  subsequently
            reversed,   suspended   or  vacated,   of  any  court  of  competent
            jurisdiction,   permanently  or  temporarily   enjoining,   barring,
            suspending  or  otherwise  limiting his  involvement  in any type of
            business, securities or banking activities; or

      o     been found by a court of competent jurisdiction (in a civil action),
            the Commission or the Commodity  Futures Trading  Commission to have
            violated a federal or state  securities or commodities  law, and the
            judgment has not been reversed, suspended, or vacated.

Audit Committee Financial Expert

Our Board of Directors has determined that Martin Gannon,  a member of the audit
committee,  qualifies as an "audit committee  financial  expert" as such term is
defined by Regulation  S-B of the  Securities  Exchange Act of 1934, as amended.
Our Board of Directors has also  determined  that Mr. Gannon is  independent  as
such term is used in Item  7(d)(3)(iv)  of  Schedule  14A  under the  Securities
Exchange Act of 1934, as amended.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the  Securities  Exchange Act of 1934 requires our officers and
directors,  and  persons  who own more  than 10% of our  common  stock,  to file
reports of ownership and changes in ownership with the SEC. Officers,  directors
and greater than 10%  shareholders are required by SEC regulations to furnish us
with copies of all Section 16(a) forms they file.

                                       27
<PAGE>

Based  solely on our  review  of the  copies of such  forms  received  by us, or
written  representations  from certain reporting persons, we believe that during
the  year  ended  July 31,  2005,  all  filing  requirements  applicable  to our
executive officers and directors and greater than 10% shareholders were complied
with.

ITEM 10. EXECUTIVE COMPENSATION

The  following  table  sets  forth,  for the  years  indicated,  particulars  of
compensation awarded to, earned by or paid to:

      o     our chief executive officer;

      o     each of our four most highly compensated executive officers who were
            serving  as  executive  officers  at the  end of the  most  recently
            completed  fiscal  year and whose  total  salary  and bonus  exceeds
            $100,000 per year; and

      o     any  additional  individuals  for whom  disclosure  would  have been
            provided  immediately above but for the fact that the individual was
            not serving as an executive officer of our company at the end of the
            most recently completed fiscal year; (the Named Executive  Officers)
            are set out in the summary compensation table below.

During fiscal 2004, six individuals  served as our executive officers at various
times:  Robert Rudman, Al Kozak, Jeff Finkelstein,  Erwin Bartz,  Shawn Lammers,
and John  Taylor-Wilson.  Mr.  Finkelstein  earned  less than  $100,000 in total
salary and bonuses  during  fiscal 2004,  and,  therefore,  is not  considered a
"Named Executive Officer."

                           Summary Compensation Table



<TABLE>
<CAPTION>
===================================================================================================================================
                          SUMMARY COMPENSATION TABLE
-----------------------------------------------------------------------------------------------------------------------------------
                            Annual Compensation                             Long Term Compensation
-----------------------------------------------------------------------------------------------------------------------------------
                                                                            Awards                         Payouts
-----------------------------------------------------------------------------------------------------------------------------------
Name and                Year       Salary       Bonus          Other        Securities       Restricted    LTIP      All Other
Principal                                                      Annual       Underlying       Shares or     Payouts   Compensation
Position                                                       Compen-      Options/         Restricted
                                                               sation(1)    SARs
                                                                            Share
                                                                            Granted
                                                                            Units
                                                                            (#)
-----------------------------------------------------------------------------------------------------------------------------------
<S>                     <C>      <C>         <C>           <C>           <C>                 <C>         <C>           <C>
Robert Rudman           2005     $ 215,568   $  67,417 (2) $       0     5,840,000           $       0   $       0     $  49,847 (3)
Chairman                2004     $ 217,478   $       0     $       0     1,079,500           $       0   $       0     $       0
(Former                 2003     $ 194,543   $       0     $       0       232,000           $       0   $       0     $       0
President and
Chief
Executive
Officer)
-----------------------------------------------------------------------------------------------------------------------------------
Al Kozak                2005     $ 177,162   $  44,495 (4) $       0     4,540,000           $       0   $       0     $       0
President and           2004     $ 164,983   $       0     $       0       683,000           $       0   $       0     $       0
Chief                   2003     $ 147,585   $       0     $       0       111,000           $       0   $       0     $       0
Executive
Officer
(Former Chief
Operating
Officer)
-----------------------------------------------------------------------------------------------------------------------------------
Jeff                    2005     $ 125,748   $  30,338 (5) $       0     3,000,000           $       0   $       0     $       0
Finkelstein             2004     $  97,490   $       0     $       0       329,610           $       0   $       0     $       0
Chief                   2003     $  82,788   $       0     $       0        70,000           $       0   $       0     $       0
Financial
Officer
-----------------------------------------------------------------------------------------------------------------------------------
Erwin Bartz             2005     $ 130,053   $  88,991 (5) $       0     3,000,000           $       0   $       0     $       0
Vice-                   2004     $ 121,113   $       0     $       0       390,000           $       0   $       0     $       0
President,              2003     $ 108,341   $       0     $       0        55,000           $       0   $       0     $   5,826 (6)
Product
Management
-----------------------------------------------------------------------------------------------------------------------------------
Shawn Lammers           2005     $ 120,452   $  30,338 (5) $       0     3,000,000           $       0   $       0     $       0
Vice-                   2004     $ 108,739   $       0     $       0       332,600           $       0   $       0     $       0
President,              2003     $  94,589   $       0     $       0        15,100           $       0   $       0     $       0
Engineering
===================================================================================================================================
</TABLE>

                                       28
<PAGE>


* The  average  of the  closing  foreign  exchange  rates for  fiscal  2005,  as
calculated by using the reported daily rates posted by the Federal  Reserve Bank
of New York, was  CDN$1.2418 to every  US$1.00.  For the purposes of this table,
executive compensation paid in Canadian currency to the Named Executive Officers
has been  converted  into United  States  currency at the rate of  CDN$1.2418 to
every US$1.00

(1) The  value of  perquisites  and  other  personal  benefits,  securities  and
property  for the Named  Executive  Officers  that do not  exceed  the lesser of
$50,000  or 10% of the total of the  annual  salary  and  bonus is not  reported
herein.

(2)  Represents  the market value of 2,247,244  common  shares issued as a stock
bonus.

(3) Represents  consulting fees of $20,000 earned after Mr. Rudman's resignation
as President and Chief Executive Officer and $29,847 in vacation pay paid.

(4)  Represents  the market value of 1,483,181  common  shares issued as a stock
bonus.

(5)  Represents  the market value of 1,011,260  common  shares issued as a stock
bonus.

(6) Mr. Bartz earned sales commissions of $5,826 in fiscal 2003.

The following table sets forth for each of the Named Executive  Officers certain
information concerning stock options granted to them during fiscal year 2005. We
have never issued stock  appreciation  rights.  We grant options that  generally
vest  immediately at an exercise price equal to the fair market value of a share
of common stock as determined  by its closing  price on the OTC Bulletin  Board.
Until May 28, 2003,  the exercise  price was  determined by its closing price on
the Nasdaq  Capital  Market.  The term of each option  granted is generally five
years from the date of grant.  Options may  terminate  before  their  expiration
dates  if the  optionee's  status  as an  employee  is  terminated  or upon  the
optionee's death or disability.

Options/SAR Grants in the Last Fiscal Year



<TABLE>
<CAPTION>
                          Number of Securities         % of Total
          Name                 Underlying         Options/SARS Granted      Exercise Price         Expiration Date
                          Options/SARS Granted      to Employees in            ($/share)
                                   (#)                Fiscal Year
----------------------------------------------------------------------------------------------------------------------
<S>                            <C>                    <C>   <C>                                              <C> <C>
Robert Rudman                  5,840,000              14.41%$                   0.03                December 19, 2009

Al Kozak                       4,540,000              11.20%$                   0.03                December 19, 2009

Erwin Bartz                    3,000,000               7.40%$                   0.03                December 19, 2009

Shawn Lammers                  3,000,000               7.40%$                   0.03                December 19, 2009

Jeff Finkelstein               3,000,000               7.40%$                   0.03                December 19, 2009

</TABLE>


The  following  table  sets  forth  for each  Named  Executive  Officer  certain
information  concerning  the number of shares  subject to both  exercisable  and
unexercisable  stock options as of July 31, 2005. The values for  "in-the-money"
options are  calculated by determining  the  difference  between the fair market
value of the  securities  underlying the options as of June 30, 2005 ($0.142 per
share) and the exercise price of the  individual's  options.  No Named Executive
Officer exercised options during fiscal 2005.

Aggregated Option/SAR Exercises in Last Fiscal Year and FY-End Option/SAR Values



<TABLE>
<CAPTION>
Name                    Shares      Value        Number of Securities           Value of Unexercised
                     Acquired on   Realized     Underlying Unexercised      In-the-Money Options/SARs at
                     Exercise (#)     ($)     Options/SARs at FY-End (#)             FY-End ($)

                                               Exercisable/Unexercisable      Exercisable/Unexercisable
----------------------------------------------------------------------------------------------------------------------
<S>                      <C>                          <C>                              <C>
Robert Rudman            None        None             3,555,000                        654,080

                                                      3,555,000                   None Exercisable
                                                     Exercisable

Al Kozak                 None        None             5,466,000                        508,480

                                                      5,466,000                   None Exercisable
                                                     Exercisable
</TABLE>

                                       29
<PAGE>
<TABLE>
<CAPTION>
<S>                      <C>                          <C>                              <C>
Erwin Bartz              None        None             3,555,000                        336,000

                                                      3,555,000                   None Exercisable
                                                     Exercisable

Shawn Lammers            None        None             3,392,700                        336,000

                                                      3,392,700                   None Exercisable
                                                     Exercisable

Jeff Finkelstein         None        None             3,417,200                        336,000

                                                      3,417,200                   None Exercisable
                                                     Exercisable
</TABLE>


ITEM 11.  SECURITY  OWNERSHIP OF CERTAIN  BENEFICIAL  OWNERS AND  MANAGEMENT AND
RELATED STOCKHOLDER MATTERS

The following table sets forth, as of October 14, 2005, certain information with
respect to the  beneficial  ownership of the Common  Shares by each  stockholder
known by the  Company to be the  beneficial  owner of more than 5% of the Common
Shares and by each of the Company's  current  directors and executive  officers.
Each  person has sole  voting and  investment  power with  respect to the Common
Shares, except as otherwise indicated. Beneficial ownership consists of a direct
interest in the Common Shares, except as otherwise indicated.

<TABLE>
<CAPTION>
------------------------------------------------- --------------------------------- --------------------------------
                                                        Amount and Nature of                  Percentage
Name and Address of Beneficial Owner                    Beneficial Ownership                  of Class(1)
------------------------------------------------- --------------------------------- --------------------------------

<S>                                                         <C>                                   <C>
William Cronin                                              1,779,746(2)                           *
180 Concord Drive
Madison, Connecticut, USA  06443
------------------------------------------------- --------------------------------- --------------------------------

Martin Gannon                                               1,535,000(3)                           *
1275 Post Road
Fairfield, Connecticut, USA  06824
------------------------------------------------- --------------------------------- --------------------------------

Johnny Christiansen                                         1,150,000(4)                           *
Spurvestien 24
3189 Horten, Norway
------------------------------------------------- --------------------------------- --------------------------------

Robert Rudman                                               9,687,911(5)                         3.33%
#40 - 5740 Garrison Road
Richmond, BC   V7C 5E7
------------------------------------------------- --------------------------------- --------------------------------

Al Kozak                                                    6,949,181(6)                         2.40%
25841 116 Avenue
Maple Ridge, BC  V4R 1Z6
------------------------------------------------- --------------------------------- --------------------------------

Jeff Finkelstein                                            4,434,210(7)                         1.54%
3460 Regent Street
Richmond, BC  V7E 2N1
------------------------------------------------- --------------------------------- --------------------------------

Erwin Bartz                                                 4,566,260(8)                         1.59%
21 Arrow-Wood Place
Port Moody, BC  V3H 4E9
------------------------------------------------- --------------------------------- --------------------------------

Shawn Lammers                                               4,405,479(9)                         1.53%
3460 Regent Street
Richmond, BC  V7E 2N1
------------------------------------------------- --------------------------------- --------------------------------
</TABLE>

                                       30
<PAGE>

<TABLE>
<CAPTION>
<S>                                                           <C>                                  <C>
David Warkentin                                               Nil(10)                              *
20580 Powell Ave.
Maple Ridge, B.C. V2X 3G1
------------------------------------------------- --------------------------------- --------------------------------

Directors and Executive Officers as a Group                34,507,787(11)                       11.01%
------------------------------------------------- --------------------------------- --------------------------------

Cornell Capital Partners, L.P.                             14,157,106(12)                        4.99%
101 Hudson St., Suite 3606
Jersey City, NJ 07302
</TABLE>

* Represents less than 1% of the Company's outstanding stock

(1)   Based on  283,709,549  Common Shares issued and  outstanding as of October
      14, 2005.  Beneficial ownership is determined in accordance with the rules
      of the Securities and Exchange Commission and generally includes voting or
      investment   power  with  respect  to  securities.   Except  as  otherwise
      indicated,  the Company believes that the beneficial  owners of the Common
      Shares listed above, based on information  furnished by such owners,  have
      sole  investment and voting power with respect to such shares,  subject to
      community property laws where applicable.

(2)   Includes  options to acquire up to 1,692,500  Common  Shares,  exercisable
      within sixty days.

(3)   Includes  options to acquire up to 1,525,100  Common  Shares,  exercisable
      within sixty days.

(4)   Includes  options to acquire up to 1,150,000  Common  Shares,  exercisable
      within sixty days.

(5)   Includes  10,257 Common Shares owned by Mr.  Rudman's wife. Mr. Rudman has
      sole voting and dispositive  power over such shares.  Includes  options to
      acquire up to 7,409,000 Common Shares, exercisable within sixty days.

(6)   Consists of options to acquire up to 5,466,000 Common Shares,  exercisable
      within 60 days.

(7)   Includes  options to acquire up to 3,417,200  Common  Shares,  exercisable
      within 60 days.

(8)   Consists of options to acquire up to 3,555,000 Common Shares,  exercisable
      within 60 days.

(9)   Includes  options to acquire up to 3,392,700  Common  Shares,  exercisable
      within 60 days.

(10)  Owns options to acquire up to 2,000,000 Common Shares,  of which 1,000,000
      vest in August 2006 and 1,000,000 vest in August 2007.

(11)  Includes  options to acquire up to 27,607,500  Common Shares,  exercisable
      within 60 days.

(12)  Includes (i) all of the common stock that  potentially  may be issued upon
      the conversion of $4.0 million of 5% series A convertible preferred shares
      in an aggregate amount of 400 million shares, (ii) all of the common stock
      that  potentially may be issued upon the conversion of $30.0 million under
      10% convertible  debentures at a conversion  price of $0.1125 per share in
      an aggregate  of  266,666,667  shares,  (iii) all of the common stock that
      potentially  may be issued upon the  conversion of $1.5 million under a 5%
      convertible  debenture  at a  conversion  price of $0.028  per share in an
      aggregate  of  53,571,429  shares  and (iv) all of the  common  stock that
      potentially  may be issued upon the  exercise of  62,500,000  common share
      purchase  warrants issued to the named selling  stockholder and affiliates
      expiring June 23, 2010 at an exercise price of $0.16 per share, subject to
      adjustment  in accordance  with their  respective  terms.  The 5% series A
      convertible  preferred shares,  the 5% and 10% convertible  debentures and
      share  purchase  warrants  contain  contractual  restrictions  on  Cornell
      Capital Partners' beneficial share ownership that prohibit Cornell Capital
      Partners  and its  affiliates  from  holding  in  excess  of  4.99% of the
      Company's issued and outstanding stock.

                                       31
<PAGE>

Equity Compensation Plan Information

The following  table  provides  certain  information  with respect to all of the
Company's equity compensation plans in effect as of October 14, 2005.


<TABLE>
<CAPTION>
--------------------------- ----------------------------- ---------------------------- ----------------------------

                                                                                          Number of Securities
                             Number of Securities to be                                  Remaining Available for
                              Issued Upon Exercise of      Weighted-Average Exercise      Future Issuance Under
                                Outstanding Options,         Price of Outstanding       Equity Compensation Plans
                                Warrants and Rights          Options, Warrants and        (Excluding Securities
                                                                    Rights              Reflected in Column (a))
--------------------------- ----------------------------- ---------------------------- ----------------------------

Plan Category                           (a)                           (b)                          (c)
--------------------------- ----------------------------- ---------------------------- ----------------------------
<S>                                   <C>                            <C>                          <C>
                                      4,950,000                      $0.11                        696,400
Equity compensation plans
approved by
securityholders
--------------------------- ----------------------------- ---------------------------- ----------------------------
                                    103,040,943                      $0.15                      1,649,890
Equity compensation plans
not approved by
securityholders
--------------------------- ----------------------------- ---------------------------- ----------------------------
                                    107,990,943                      $0.15                      2,346,290
Total
--------------------------- ----------------------------- ---------------------------- ----------------------------
</TABLE>


ITEM 12.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

Other  than as  listed  below,  we have  not  been a party  to any  transaction,
proposed  transaction,  or series of  transactions  in which the amount involved
exceeds or equals $60,000, and in which, to our knowledge, any of our directors,
officers,  five  percent  beneficial  security  holders,  or any  member  of the
immediate  family  of the  foregoing  persons  has had or will  have a direct or
indirect material interest.

Mr.  Christiansen,  a director of our company is a principal in  Visionaire  AS.
During the six months ended  January 31, 2005,  we incurred  expenses of $60,000
for a research report prepared by Visionaire AS on various sensor applications.

The promoters of our company are our directors and officers.

ITEM 13. EXHIBITS

(a) The following documents are filed as part of this report:

Consolidated Financial Statements. See "Index" on Page F-1;

Auditors' Report, dated September 16, 2005 except for note 19 (b) which is as of
September 23, 2005;

Consolidated Balance Sheets at July 31, 2005 and July 31, 2004;

Consolidated  Statements of Operations  and Deficit for the Years Ended July 31,
2005, July 31, 2004 and July 31, 2003;

Consolidated  Statements of Stockholders' Equity and Comprehensive Income (Loss)
for the Years Ended July 31, 2005, July 31, 2004 and July 31, 2003;

Consolidated  Statements  of Cash Flows for the Years Ended July 31, 2005,  July
31, 2004 and July 31, 2003; and

Notes to Consolidated Financial Statements.

(b) Exhibits. See "Exhibit Index".


EXHIBIT
NUMBER     DESCRIPTION
-------    ---------------------------------------------------------------------

   3.1      Certificate of Incorporation of TTC/Truck Tech Corp. dated September
            8, 1987 (1)

   3.2      Memorandum and Articles of TTC/Truck Tech Corp. (1)

   3.3      Memorandum of TTC/Truck Tech Corp. dated September 2, 1987 (1)

                                       32
<PAGE>

   3.4      Altered  Memorandum of TTC/Truck  Tech Corp.  dated October 25, 1991
            (1)

   3.5      Certificate  of Change of Name from  TTC/Truck Tech Corp. to UniComm
            Signal Inc. dated April 13, 1994.(1)

   3.6      Certificate  of Change of Name from UniComm  Signal Inc. to SmarTire
            Systems Inc. dated December 24, 1997.(1)

   3.7      Special  Resolution  and Altered  Memorandum of UniComm  Signal Inc.
            dated October 28, 1994.(1)

   3.8      Special  Resolution  and Altered  Memorandum of UniComm  Signal Inc.
            dated January 17, 1997.(1)

   3.9      Special  Resolution and Altered  Memorandum of SmarTire Systems Inc.
            dated November 17, 1995.(1)

   3.10     Special  Resolution and Altered  Memorandum of SmarTire Systems Inc.
            dated January 16, 1998.(1)

   3.11     Special  Resolution and Altered  Memorandum of SmarTire Systems Inc.
            dated December 5, 2000.(4)

   3.12     Substituted  Articles of SmarTire  Systems Inc.  adopted December 5,
            2000.(4)

   3.13     Articles  of  Continuance,  dated  January  29,  2003 and  effective
            February 6, 2003.(9)

   3.14     Certificate  of  Amendment  issued to SmarTire  Systems  Inc. by the
            Yukon  Registrar  of  Corporations  effective  December 15, 2003 and
            attached  Articles of  Amendment  of  SmarTire  Systems  Inc.  dated
            December 11, 2003.(21)

   3.15     Certificate of Registration of Restated  Articles issued to SmarTire
            Systems  Inc.  by the  Yukon  Registrar  of  Corporations  effective
            December 15, 2003, and attached  Restated  Articles of Incorporation
            of SmarTire Systems Inc. dated December 11, 2003.(21)

   3.16     By-Law No. 1, dated February 6, 2003.(9)


   3.17     Certificate  of Amendment to Articles of  Incorporation  of SmarTire
            Systems Inc.(28)

   3.18     Articles of Amendment to the Articles of  Incorporation  of SmarTire
            Systems Inc. with respect to the series A convertible stock (29)


   10.1     Product  Licensing  Agreement  dated May 5, 1998 between our Company
            and Advantage Enterprises Inc.(2)(3)

   10.2     Management  Agreement between our Company and Shawn Lammers dated as
            of August 1, 1999.(3)

   10.3     Management  Agreement between our Company and Robert Rudman dated as
            of August 1, 1999.(3)

   10.4     Management Agreement between SmarTire Europe Limited and Ian Bateman
            dated as of December 9, 1999.(3)

   10.5     License  Agreement  dated September 20, 1999 between our Company and
            Transense Technologies plc.(3)(2)

                                       33
<PAGE>

   10.6     Management Agreement between our Company and Erwin Bartz dated as of
            January 3, 2001.(5)

   10.7     License  Agreement dated August 31, 2001 between our Company and TRW
            Inc.(6)(2)

   10.8     License  Agreement  dated  August 31, 2001  between TRW Inc. and our
            Company.(6)(2)

   10.9     Management  Agreement  between  our Company and Al Kozak dated as of
            May 1, 2002.(7)

   10.10    Advisory  Agreement  between our Company and Impact Capital  Limited
            dated October 25, 2002.(8)

   10.11    Management  Agreement between our Company and Jeff Finkelstein dated
            as of October 25, 2002.(8)

   10.12    Supply  Agreement  between our Company and Pirelli  Pneumatici dated
            September 24, 2002.(8)(2)

   10.13    Manufacturing,   Co-Marketing  and  Development   Agreement,   dated
            February 6, 2003,  between SmarTire Systems Inc. and Hyundai Autonet
            Co. Ltd.(12)

   10.14    Warrant  Certificate  dated May 16, 2003  registered  in the name of
            Dunwoody Brokerage Services, Inc.(12)

   10.15    Stock Purchase  Warrant dated May 16, 2003 registered in the name of
            HPC Capital Management.(12)

   10.16    Form of Stock  Purchase  Warrant dated May 27, 2003 issued to Impact
            Capital Partners Limited.(12)

   10.17    Securities  Purchase  Agreement,  dated as of July 17,  2003,  among
            SmarTire Systems Inc. and Palisades Master Fund, L.P., Alpha Capital
            AG,   Crescent   International   Ltd.,   and  Goldplate   Investment
            Partners.(13)

   10.18    Registration  Rights  Agreement,  dated as of July 17,  2003,  among
            SmarTire Systems Inc. and Palisades Master Fund, L.P., Alpha Capital
            AG,   Crescent   International   Ltd.,   and  Goldplate   Investment
            Partners.(13)

   10.19    Escrow Agreement,  dated as of July 17, 2003, among SmarTire Systems
            Inc. and Palisades  Master Fund,  L.P.,  Alpha Capital AG,  Crescent
            International  Ltd.,   Goldplate  Investment  Partners  and  Feldman
            Weinstein, LLP, as escrow agent.(13)

   10.20    Form of 8% Convertible Debenture.(13)

   10.21    Form of Stock Purchase Warrant.(13)

   10.22    Stock Purchase Warrant, dated as of July 17, 2003, registered in the
            name of HPC Capital Management.(13)

   10.23    Common Stock Purchase Agreement,  dated as of July 23, 2003, between
            SmarTire Systems Inc. and Talisman Management Limited.(13)

   10.24    Registration  Rights Agreement,  dated as of July 23, 2003,  between
            SmarTire Systems Inc. and Talisman Management Limited.(13)

                                       34
<PAGE>

   10.25    Escrow Agreement,  dated as of July 23, 2003, among SmarTire Systems
            Inc.,  Talisman  Management Limited and Feldman  Weinstein,  LLP, as
            escrow agent.(13)

   10.26    Stock Purchase Warrant, dated as of July 23, 2003, registered in the
            name of Talisman Management Limited.(13)

   10.27    Stock Purchase Warrant, dated as of July 23, 2003, registered in the
            name of HPC Capital Management.(13)

   10.28    Management  Agreement  between our  Company and John  Taylor-Wilson,
            dated as of August 1, 2003.(13)

   10.29    Engagement  Letter  between our Company and HPC Capital  Management,
            dated August 12, 2003.(13)

   10.30    Stock  Purchase  Warrant,  dated August 15, 2003,  registered in the
            name of Epoch Financial Group, Inc.(13)

   10.31    Agreement  in  Principle   between  our  Company  and  Beijing  Boom
            Technology Limited dated September 8, 2003.(14)(2)

   10.32    Master  Distribution  Agreement between SmarTire Systems and Beijing
            Boom Technology Co. Ltd. dated October 17, 2003. (14)(2)

   10.33    Contract  Manufacturing  Services Agreement between SmarTire Systems
            Inc. and Hyundai Autonet Company dated October 17, 2003.(16)(2)

   10.34    Letter  Agreement  dated October 27, 2003 between  SmarTire  Systems
            Inc. and HPC Capital Management.(18)

   10.35    Stock Purchase  Warrant,  dated October 27, 2003,  registered in the
            name of HPC Capital Management.(18)

   10.36    Letter  Agreement  dated October 27, 2003 between  SmarTire  Systems
            Inc. and Palisades Master Fund, L.P.(18)

   10.37    Stock Purchase  Warrant,  dated October 27, 2003,  registered in the
            name of Palisades Master Fund, L.P.(18)

   10.38    Letter  Agreement  dated November 6, 2003 between  SmarTire  Systems
            Inc. and Crescent International Ltd.(19)

   10.39    Stock Purchase Warrant,  dated November 10, 2003,  registered in the
            name of Crescent International Ltd. (19)

   10.40    Letter  Agreement  dated November 6, 2003 between  SmarTire  Systems
            Inc. and Alpha Capital AG.(19)

   10.41    Stock Purchase Warrant, November 10, 2003, registered in the name of
            Alpha Capital AG.(19)

   10.42    Letter  Agreement  dated November 6, 2003 between  SmarTire  Systems
            Inc. and Goldplate Investment Partners.(19)

   10.43    Stock Purchase Warrant,  dated November 10, 2003,  registered in the
            name of Goldplate Investment Partners.(19)

   10.44    Amending Letter  Agreement dated November 10, 2003 between  SmarTire
            Systems Inc. and HPC Capital Management.(19)

   10.45    Amended  Stock  Purchase  Warrant,  dated as of  October  27,  2003,
            registered in the name of HPC Capital Management.(19)

                                       35
<PAGE>

   10.46    Amending Letter  Agreement dated November 10, 2003 between  SmarTire
            Systems Inc. and Palisades Master Fund, L.P.(19)

   10.47    Amended  Stock  Purchase  Warrant,  dated as of  October  27,  2003,
            registered in the name of Palisades Master Fund, L.P.(19)

   10.48    Development  Agreement  dated  September  12, 2003 between  SmarTire
            Systems Inc. and Vansco Ltd.(20)

   10.49    Co-Marketing  and  Development  Agreement  dated  October  10,  2003
            between Haldex Brake Products Ltd. and SmarTire Systems Inc.(20)

   10.50    Supply  Agreement  dated October 10, 2003 between  SmarTire  Systems
            Inc. and Haldex Brake Products Ltd.(20)

   10.51    Securities Purchase Agreement,  dated as of December 19, 2003, among
            SmarTire Systems Inc. and Palisades Master Fund, L.P., Alpha Capital
            AG, Crescent  International  Ltd.,  Goldplate  Investment  Partners,
            Gamma  Opportunity  Capital  Partners,  LP, PEF  Advisors  Ltd.  and
            Bristol Investment Fund, Ltd.(22)

   10.52    Registration Rights Agreement,  dated as of December 24, 2003, among
            SmarTire Systems Inc. and Palisades Master Fund, L.P., Alpha Capital
            AG, Crescent  International  Ltd.,  Goldplate  Investment  Partners,
            Gamma  Opportunity  Capital  Partners,  LP, PEF  Advisors  Ltd.  and
            Bristol Investment Fund, Ltd.(22)

   10.53    Escrow  Agreement,  dated as of December  24, 2003,  among  SmarTire
            Systems Master Fund, L.P., Alpha Capital AG, Crescent  International
            Ltd.,  Goldplate  Investment  Partners,  Gamma  Opportunity  Capital
            Partners,  LP, PEF Advisors Ltd.,  Bristol Investment Fund, Ltd. and
            Feldman Weinstein, LLP, as escrow agent.(22)

   10.54    Form of Discounted Convertible Debenture.(22)

   10.55    Form of Addendum to Discounted Convertible Debenture.(22)

   10.56    Form of Stock Purchase Warrant.(22)

   10.57    Placement  Fee  Payment  and  Subscription  Agreement,  dated  as of
            December 24,  2003,  between  SmarTire  Systems Inc. and HPC Capital
            Management.(22)

   10.58    Stock Purchase Warrant, dated as of December 24, 2003, registered in
            the name of HPC Capital Management.(22)

   10.59    Amendment  Agreement  between  SmarTire  Systems  Inc.  and Talisman
            Management Limited dated January 21, 2004, amending the Common Stock
            Purchase  Agreement  between  the  parties  dated  as  of  July  23,
            2003.(22)

   10.60    Amendment  Agreement  between  SmarTire  Systems  Inc.  and Talisman
            Management Limited dated January 21, 2004, amending the Registration
            Rights Agreement between the parties dated as of July 23, 2003.(22)

   10.61    Form of Promissory note issued to Cornell Capital Partners, LP.(23)

   10.62    Standby Equity Distribution Agreement dated May 19, 2004.(24)

   10.63    Registration Rights Agreement dated May 19, 2004.(24)

   10.64    Escrow Agreement with Cornell Capital Partners, LP.(24)

                                       36
<PAGE>

   10.65    Dealer and Supply Agreement  between SmarTire Systems Inc, Chu Chang
            International Ltd, Beijing Boom Technology Co. Ltd. dated as of June
            3, 2004.(25)

   10.66    Forbearance and Escrow Agreement dated as of September 24, 2004.(26)

   10.67    Promissory  note dated as of November 16, 2004 with Cornell  Capital
            Partners, LP.(27)

   10.68    Promissory  note dated as of November 16, 2004 with Cornell  Capital
            Partners, LP.(27)

   10.69    Form   of   Subscription   Agreement   and   Prospective   Purchaser
            Questionnaire of SmarTire Systems Inc.(28)

   10.70    Form of 5% Convertible Debenture SmarTire Systems Inc.(28)

   10.71    Form of Redemption Warrant of SmarTire Systems Inc.(28)

   10.72    Securities Purchase Agreement dated December 15, 2004 by and between
            SmarTire Systems, Inc. and Cornell Capital Partners, L.P.(28)

   10.73    Registration Rights Agreement dated December 15, 2004 by and between
            SmarTire Systems, Inc. and Cornell Capital Partners, L.P.(28)

   10.74    Form of 5% Convertible Debenture SmarTire Systems Inc.(28)

   10.75    Form of Common Stock Purchase Warrant of SmarTire Systems Inc.(28)

   10.76    2004 Non-US US Stock Incentive Plan of SmarTire Systems Inc.(28)

   10.77    Amendment  Agreement dated February 3, 2005 between SmarTire Systems
            Inc. and Robert Rudman.(29)

   10.78    Amendment  Agreement dated February 3, 2005 between SmarTire Systems
            Inc. and Allan Kozak.(29)

   10.79    Amendment  Agreement dated February 3, 2005 between SmarTire Systems
            Inc. and Jeff Finkelstein.(29)

   10.80    Amendment  Agreement dated February 3, 2005 between SmarTire Systems
            Inc. and Erwin Bartz.(29)

   10.81    Amendment  Agreement dated February 3, 2005 between SmarTire Systems
            Inc. and Shawn Lammers.(29)

   10.82    Amendment  Agreement dated February 3, 2005 between SmarTire Systems
            Inc. and William Cronin.(29)

   10.83    Amendment  Agreement dated February 3, 2005 between SmarTire Systems
            Inc. and Martin Gannon.(29)

   10.84    Amendment  Agreement dated February 3, 2005 between SmarTire Systems
            Inc. and Johnny Christiansen.(29)

   10.85    Registration  Rights  Agreement  dated as of March  22,  2005 by and
            between  SmarTire  Systems,   Inc.  and  Cornell  Capital  Partners,
            L.P.(30)

   10.86    Investment  Agreement  dated as of  March  22,  2005 by and  between
            SmarTire Systems, Inc. and Cornell Capital Partners, L.P.(30)(31)

   10.87    Termination  Agreement  dated as of March  22,  2005 by and  between
            SmarTire Systems, Inc. and Cornell Capital Partners, L.P.(30)

                                       37
<PAGE>

   10.88    Redemption, settlement and release agreement dated April 27, 2005 by
            and between  SmarTire  Systems Inc. and Palisades  Master Fund, L.P.
            and PEF Advisors, Ltd.(32)

   10.89    Redemption,  settlement and release  agreement  dated May 2, 2005 by
            and between  SmarTire Systems Inc. and Gamma  Opportunity  Partners.
            (32)

   10.90    Redemption,  settlement and release  agreement  dated May 4, 2005 by
            and   between    SmarTire    Systems   Inc.   and   Alpha    Capital
            Aktiengesellschaftt, L.P.(32)

   10.91    Redemption,  settlement and release  agreement dated May 13, 2005 by
            and  between  SmarTire  Systems  Inc.  and  Crescent   International
            Ltd.(32)

   10.92    Redemption,  settlement and release  agreement dated May 23, 2005 by
            and  between   SmarTire   Systems  Inc.  and  Goldplate   Investment
            Partners.(32)

   10.93    Registration  Rights  Agreement  dated  as of May  22,  2005  by and
            between SmarTire Systems Inc. and Cornell Capital Partners.(32)

   10.94    Standby Equity  Distribution  Agreement  dated as of May 22, 2005 by
            and between  SmarTire  Systems  Inc.  and Cornell  Capital  Partners
            LP.(32)

   10.95    Investor  Registration  Rights Agreement dated as of May 22, 2005 by
            and between  SmarTire  Systems Inc. and Cornell Capital Partners LP.
            (32)

   10.96    Amended and Restated Convertible Debenture dated as of June 10, 2005
            by and between  SmarTire  Systems Inc. and Cornell Capital  Partners
            LP.(32)

   10.97    Securities  Purchase  Agreement  dated  as of May  22,  2005  by and
            between SmarTire Systems Inc. and Cornell Capital Partners LP.(32)

   10.98    Standby Equity  Distribution  Agreement,  dated as of June 23, 2005,
            between SmarTire Systems Inc. and Cornell Capital Partners, LP.(33)

   10.99    Securities  Purchase  Agreement,  dated as of June 23,  2005,  among
            SmarTire  Systems Inc.,  Cornell Capital  Partners,  LP and Highgate
            House Funds, Ltd.(33)

  10.100    Securities  Purchase  Agreement,  dated as of June 23, 2005,  among
            SmarTire  Systems Inc.,  Cornell Capital  Partners,  LP and Highgate
            House Funds, Ltd.(33)

  10.101    Convertible Debenture,  dated as of June 23, 2005, with a principal
            balance of $20 million,  issued by SmarTire  Systems Inc. to Cornell
            Capital Partners, LP as trustee for LCC Global Ltd.(33)

  10.102    Amended and Restated  Convertible  Debenture,  dated as of July 21,
            2005,  with a principal  balance of $8  million,  issued by SmarTire
            Systems Inc. to Cornell Capital Partners, LP.(34)

  10.103    Amended and Restated  Convertible  Debenture,  dated as of July 21,
            2005,  with a principal  balance of $2  million,  issued by SmarTire
            Systems Inc. to Highgate House Funds, Ltd. (34)

  10.104    Amended  and  Restated  Warrant to  purchase  41,668,750  shares of
            common stock,  dated as of July 21, 2005 issued by SmarTire  Systems
            Inc. to Cornell Capital Partners LP. (34)

                                       38
<PAGE>

  10.105    Amended  and  Restated  Warrant to  purchase  16,668,750  shares of
            common stock,  dated as of July 21, 2005 issued by SmarTire  Systems
            Inc. to Cornell Capital Partners LP. (34)

  10.106    Amended and Restated Warrant to purchase 4,162,500 shares of common
            stock,  dated as of July 21, 2005 issued by SmarTire Systems Inc. to
            Highgate House Funds, Ltd. (34)

  10.107    Registration  Rights Agreement,  dated as of June 23, 2005, between
            SmarTire Systems Inc. and Cornell Capital Partners, LP. (33)

  10.108    Investor Registration Rights Agreement,  dated as of June 23, 2005,
            among  SmarTire  Systems  Inc.,  Cornell  Capital  Partners,  LP and
            Highgate House Funds, Ltd. (33)

  10.109    Management  Agreement  between our Company and Dave Warkentin dated
            as of August 8, 2005. (35)

  10.110    Marketing and distribution agreement with Dana Corporation dated as
            of October 12, 2005 (36)

   14.1     Code of Business Conduct and Ethics Compliance Program. (16)


EXHIBIT
NUMBER     DESCRIPTION
-------    ---------------------------------------------------------------------

   21.1     Subsidiaries of the Small Business Issuer**

   23.1     Consent of KPMG LLP.**

   31.1     Certification  pursuant to section 302 of the  Sarbanes-Oxley Act of
            2002**

   31.2     Certification  pursuant to section 302 of the  Sarbanes-Oxley Act of
            2002**

   32.1     Certification pursuant to 18 U.S.C. section 1350 as adopted pursuant
            to section 906 of the Sarbanes-Oxley Act of 2002**

   32.2     Certification pursuant to 18 U.S.C. section 1350 as adopted pursuant
            to section 906 of the Sarbanes-Oxley Act of 2002**



         ** Filed herewith.

(1)  Incorporated by reference to SmarTire Systems Inc.'s Form 10-KSB filed with
the Securities and Exchange Commission on August 18, 1998.

(2)  Portions of the Exhibit  have been  omitted  pursuant to an order  granting
confidential treatment under the Securities Exchange Act of 1934.

(3)  Incorporated by reference to SmarTire Systems Inc.'s Form 10-QSB filed with
the Securities and Exchange Commission on March 16, 2000.

(4)  Incorporated  by  reference to SmarTire  Systems  Inc.'s  definitive  Proxy
Statement and Information Circular on Schedule 14A filed with the Securities and
Exchange Commission on October 31, 2000.

(5)  Incorporated by reference to SmarTire Systems Inc.'s Form 10-KSB filed with
the Securities and Exchange Commission on October 26, 2001.

                                       39
<PAGE>

(6)  Incorporated  by reference to SmarTire  Systems  Inc.'s Form 10-KSB/A filed
with the Securities and Exchange Commission on August 19, 2002.

(7)  Incorporated by reference to SmarTire Systems Inc.'s Form 10-KSB filed with
the Securities and Exchange Commission on October 25, 2002.

(8)  Incorporated by reference to SmarTire Systems Inc.'s Form 10-QSB filed with
the Securities and Exchange Commission on December 13, 2002.

(9)  Incorporated  by reference to SmarTire  Systems Inc.'s Form SB-2 filed with
the Securities and Exchange Commission on January 23, 2003.

(10)  Incorporated  by reference to  Post-Effective  Amendment No. 1 to SmarTire
Systems Inc.'s Form SB-2 filed with the  Securities  and Exchange  Commission on
March 14, 2003.

(11)  Incorporated  by reference to  Post-Effective  Amendment No. 3 to SmarTire
Systems Inc.'s Form SB-2 filed with the  Securities  and Exchange  Commission on
May 2, 2003.

(12)  Incorporated by reference to SmarTire  Systems Inc.'s Form SB-2 filed with
the Securities and Exchange Commission on June 4, 2003.

(13)  Incorporated by reference to SmarTire  Systems Inc.'s Form SB-2 filed with
the Securities and Exchange Commission on August 18, 2003.

(14)  Incorporated  by reference to SmarTire  Systems Inc.'s Form 8-K filed with
the Securities and Exchange Commission on September 10, 2003.

(15) Incorporated by reference to SmarTire Systems Inc.'s Form 10-KSB filed with
the Securities and Exchange Commission on October 25, 2003.

(16)  Incorporated by reference to SmarTire Systems Inc.'s Form 8-K/A filed with
the Securities and Exchange Commission on January 7, 2004.

(17)  Incorporated  by reference to SmarTire  Systems Inc.'s Form 8-K filed with
the Securities and Exchange Commission on October 24, 2003.

(18)  Incorporated  by reference to  Pre-Effective  Amendment  No. 1 to SmarTire
Systems Inc.'s  registration  statement on Form SB-2/A filed with the Securities
Exchange Commission on November 4, 2003.

(19)  Incorporated  by reference to SmarTire  Systems Inc.'s Form 8-K filed with
the Securities and Exchange Commission on November 13, 2003.

(20) Incorporated by reference to SmarTire Systems Inc.'s Form 10-QSB filed with
the Securities and Exchange Commission on December 12, 2003.

(21)  Incorporated  by reference to SmarTire  Systems Inc.'s Form 8-K filed with
the Securities and Exchange Commission on December 23, 2003.

(22)  Incorporated by reference to SmarTire  Systems Inc.'s Form SB-2 filed with
the Securities Exchange Commission on January 15, 2004.

(23)  Incorporated  by reference to SmarTire  Systems  Inc.'s 8-K filed with the
Securities Exchange Commission on April 28, 2004.

(24)  Incorporated by reference to SmarTire  Systems Inc.'s Form SB-2 filed with
the Securities Exchange Commission on June 2, 2004.

(25)  Incorporated  by reference to SmarTire  Systems  Inc.'s 8-K filed with the
Securities Exchange Commission on June 15, 2004.

(26)  Incorporated  by reference to SmarTire  Systems  Inc.'s 8-K filed with the
Securities Exchange Commission on October 1, 2004.

                                       40
<PAGE>

(27) Incorporated by reference to SmarTire Systems Inc.'s Form 10-QSB filed with
the Securities and Exchange Commission on December 14, 2004.

(28)  Incorporated  by reference to SmarTire  Systems  Inc.'s 8-K filed with the
Securities Exchange Commission on December 21, 2004.

(29)  Incorporated  by reference to SmarTire  Systems  Inc.'s 8-K filed with the
Securities Exchange Commission on February 9, 2005.

(30)  Incorporated  by reference to SmarTire  Systems  Inc.'s 8-K filed with the
Securities Exchange Commission on March 29, 2005.

(31)  Incorporated  by reference to SmarTire  Systems  Inc.'s 8-K filed with the
Securities Exchange Commission on April 1, 2005, as amended.

(32) Incorporated by reference to SmarTire Systems Inc.'s Form 10-QSB filed with
the Securities and Exchange Commission on June 14, 2004.

(33)  Incorporated  by reference to SmarTire  Systems  Inc.'s 8-K filed with the
Securities Exchange Commission on June 30, 2005.

(34)  Incorporated by reference to SmarTire  Systems Inc.'s Form SB-2 filed with
the Securities Exchange Commission on July 22, 2005.

(35)  Incorporated  by reference to SmarTire  Systems  Inc.'s 8-K filed with the
Securities Exchange Commission on August 12, 2005.

(36)  Incorporated by reference to SmarTire Systems Inc.'s 10-KSB filed with the
Securities Exchange Commission on October 28, 2005.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.

Audit Fees

For the fiscal years ended July 31, 2005 and July 31, 2004,  the aggregate  fees
billed by our auditors,  for professional services rendered for the audit of the
Company's annual  financial  statements for the fiscal years ended July 31, 2005
and July 31, 2004, and for the reviews of the financial  statements  included in
the  Company's  Quarterly  Reports  on Form  10-QSB  and to review  registration
statements  submitted to the  Securities  and Exchange  Commission  during those
fiscal years were $188,974 and $111,170 respectively.

Audit-Related Fees

None.

Tax Fees

For the fiscal years ended July 31, 2005 and July 31, 2004,  the aggregate  fees
billed for tax compliance,  tax advice and tax planning by KPMG LLP were $16,106
and $5,230, respectively.

For the fiscal years ended July 31, 2005 and July 31, 2004,  the aggregate  fees
billed for tax  compliance,  tax advice and tax planning by Campbell  Saunders &
Co. were $8,243 and $5,523, respectively.

All Other Fees

None.


Effective May 6, 2003, the Securities and Exchange Commission adopted rules that
require  that before KPMG LLP is engaged by the Company or its  subsidiaries  to
render any auditing or permitted non-audit related service, the engagement be:

      o     approved by the Company's audit committee; or

      o     entered  into  pursuant  to  pre-approval  policies  and  procedures
            established  by the  audit  committee,  provided  the  policies  and
            procedures  are  detailed as to the  particular  service,  the audit
            committee  is  informed  of each  service,  and  such  policies  and
            procedures  do  not  include  delegation  of the  audit  committee's
            responsibilities to management.

                                       41
<PAGE>

The audit  committee  has  pre-approved  all services  provided by the Company's
independent  auditor, has considered the nature and amount of the fees billed by
KPMG LLP,  and  believes  that the  provision  of the  services  for  activities
unrelated to the audit is compatible with maintaining KPMG's  independence.  The
process  the audit  committee  follows  in  pre-approving  audit  and  non-audit
services to be provided  by the auditor in order to ensure  independence  of the
auditor are as follows:

1.    Annually  the  auditor  provides  the audit  committee  with a list of the
      audit-related  and non-audit  services that are anticipated to be provided
      during the year for pre-approval. The audit committee reviews the services
      with the auditor and management  considering  whether the provision of the
      services is compatible with maintaining the auditor's independence.

2.    Upon  pre-approval  of the services on the initial  list,  management  may
      engage the auditor for specific engagements that are within the definition
      of the pre-approved services.

3.    The audit committee delegates approval authority to the Chair of the audit
      committee for requests for services not previously  presented to the audit
      committee  for  pre-approval.  Any  services  approved  by the  Chair  are
      reported to the full audit committee at the next meeting.

4.    A final detailed review of all public accounting  services and fee amounts
      is  performed  by the audit  committee  prior to the audit  opinion  being
      issued at year end. At that time, the auditor provides the audit committee
      with the  annual  independence  letter  and the form and  content  of fees
      disclosure for the Company's annual report.

                                       42
<PAGE>


SIGNATURES

Pursuant to the  requirements of Section 13 or 15(d) of the Securities  Exchange
Act of 1934,  the  registrant  has duly  caused  this report to be signed on its
behalf by the undersigned thereunto duly authorized.

SMARTIRE SYSTEMS INC.



                 By: /s/ Al Kozak
                     --------------------------------------
                     Al Kozak, President and Chief Executive Officer

Date: February 24, 2006



Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed below by the following  persons on behalf of the  registrant and
in the capacities indicated on February 24, 2005:

SIGNATURES



                 /s/ Robert Rudman
                 ----------------------------------------------------
                 Robert Rudman, Chairman


                 /s/ Jeff Finkelstein
                 ----------------------------------------------------
                 Jeff Finkelstein, Chief Financial Officer
                 (Principal Financial and Accounting Officer)


                 /s/ Al Kozak
                 ----------------------------------------------------
                 Al Kozak, President and Chief Executive Officer,
                 (Principal Executive Officer)


                 /s/ Martin Gannon
                 ----------------------------------------------------
                 Martin Gannon, Director


                 /s/ Johnny Christiansen
                 ----------------------------------------------------
                 Johnny Christiansen, Director


                 /s/ Bill Cronin
                 ----------------------------------------------------
                 Bill Cronin, Director




                                       43
<PAGE>

                        Consolidated Financial Statements
                      (Expressed in United States dollars)
   (Prepared in accordance with U.S. generally accepted accounting principles)

                              SMARTIRE SYSTEMS INC.

                       Years ended July 31, 2005 and 2004


                                       F-1
<PAGE>

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Shareholders of SmarTire Systems Inc.

We have audited the consolidated balance sheets of SmarTire Systems Inc. as at
July 31, 2005 and 2004 and the consolidated statements of operations,
stockholders' equity and comprehensive loss and cash flows for each of the years
in the three year period ended July 31, 2005. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.

We conducted our audits in accordance with Canadian generally accepted auditing
standards and the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform an audit to
obtain reasonable assurance whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as at
July 31, 2005 and 2004 and the results of its operations and its cash flows for
each of the years in the three year period ended July 31, 2005 in accordance
with U.S. generally accepted accounting principles.


/s/ KPMG LLP
Chartered Accountants

Vancouver, Canada
September 16, 2005, except for note 19(b) which is as of September 23, 2005

COMMENTS BY AUDITOR FOR U.S. READERS ON CANADA - U.S. REPORTING DIFFERENCE

In the United States, reporting standards for auditors require the addition of
an explanatory paragraph (following the opinion paragraph) when the financial
statements are affected by conditions and events that cast substantial doubt on
the Company's ability to continue as a going concern, such as those described in
note 2 to the financial statements. Our report to the shareholders dated
September 16, 2005 except for note 19(b) which is as of September 23, 2005 is
expressed in accordance with Canadian reporting standards which do not permit a
reference to such events and conditions in the report of independent registered
public accounting firm when these are adequately disclosed in the financial
statements.

/s/ KPMG LLP
Chartered Accountants

Vancouver, Canada
September 16, 2005, except for note 19(b) which is as of September 23, 2005


                                       F-2
<PAGE>

SMARTIRE SYSTEMS INC.
Consolidated Balance Sheets
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

July 31, 2005 and 2004

<TABLE>
<CAPTION>
                                                                        2005               2004
                                                                    ------------       ------------
<S>                                                                 <C>                <C>
Assets

Current assets:
  Cash and cash equivalents                                         $ 10,059,763       $     76,670
  Receivables, net of allowance for doubtful accounts
    of $50,750 (2004 - nil)                                              275,789            259,508
  Inventory (note 4)                                                   2,798,747          3,245,807
  Prepaid expenses                                                       158,188            225,758
                                                                    ------------       ------------
                                                                      13,292,487          3,807,743

Capital assets (note 5)                                                  716,763            824,616

Deferred financing costs (note 12)                                    18,209,280            157,020

Other assets (note 6)                                                  1,066,013          2,147,749
                                                                    ------------       ------------

                                                                    $ 33,284,543       $  6,937,128
                                                                    ============       ============

Liabilities and Stockholders' Equity

Current liabilities:
  Accounts payable and accrued liabilities (note 7)                 $    915,334       $  1,293,251
  Deferred revenue                                                            --             10,830
  Promissory notes payable (note 8)                                           --          1,500,000
  Current portion of convertible debentures                            4,866,584            271,257
                                                                    ------------       ------------
                                                                       5,781,918          3,075,338
Convertible debentures, net of equity portion of $10,111,082
  (2004 - $1,955,356) (note 9)                                        17,118,667            395,574

Preferred shares, net of equity portion of $3,999,999, subject
  to mandatory redemption (July 31, 2004 - nil) (note 10)                      1                 --

Stockholders' equity:
  Share capital (note 11):
    Common shares, without par value:
      Unlimited shares authorized (2004 - 300,000,000)
        278,562,884 shares issued and outstanding
        (2004 - 103,130,761)                                          66,695,717         58,368,020
  Additional paid-in capital                                          18,691,497          4,417,323
  Deficit                                                            (75,132,150)       (59,018,256)
  Accumulated other comprehensive loss                                   128,893           (300,871)
                                                                    ------------       ------------
                                                                      10,383,957          3,466,216
                                                                    ------------       ------------

                                                                    $ 33,284,543       $  6,937,128
                                                                    ============       ============
</TABLE>

Going concern (note 2)
Commitments and contingencies (notes 9(b) and 18) Subsequent events (note 20)
See accompanying notes to consolidated financial statements.

Approved on behalf of the Board


/s/ Robert Rudman      Director                         /s/ Bill Cronin Director
--------------------                                    ---------------
Robert V. Rudman                                        Bill Cronin


                                       F-3
<PAGE>

SMARTIRE SYSTEMS INC.
Consolidated Statements of Operations
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

<TABLE>
<CAPTION>
                                                             2005              2004              2003
                                                        -------------     -------------     -------------
<S>                                                     <C>               <C>               <C>
Revenue                                                 $   1,463,460     $   1,658,279     $   1,802,596

Cost of goods sold (including in the year ended July
  31, 2005 inventory write-down of $500,000)                1,634,780         1,445,563         1,387,365
                                                        -------------     -------------     -------------
                                                             (171,320)          212,716           415,231

Expenses:
  Depreciation and amortization                             1,497,250         1,371,717         1,236,870
  Engineering, research and development                     3,297,011         1,654,690         1,177,935
  General and administrative                                4,953,537         2,338,758         2,939,260
  Marketing                                                 2,540,730         1,821,122         1,448,326
                                                        -------------     -------------     -------------
                                                           12,288,528         7,186,287         6,802,391
                                                        -------------     -------------     -------------

Loss from operations                                      (12,459,848)       (6,973,571)       (6,387,160)

Other earnings (expenses):
  Interest income                                              39,241             5,873             2,835
  Net interest and financing expense (note 13)             (3,730,481)       (4,031,820)       (3,722,505)
  Foreign exchange gain                                        37,194            12,492           192,201
  Gain on settlement of convertible debt (note 9(c))        1,822,033                --                --
                                                        -------------     -------------     -------------
                                                           (1,832,013)       (4,013,455)       (3,527,469)
                                                        -------------     -------------     -------------

Loss for the year                                       $ (14,291,681)    $ (10,987,026)    $  (9,914,629)
                                                        =============     =============     =============

Basic and diluted loss per share                        $       (0.06)    $       (0.13)    $       (0.37)

Weighted average number of common shares used in
  the computation of basic and diluted loss per
  share (note 17)                                         222,981,341        83,356,095        26,771,427
                                                        =============     =============     =============
</TABLE>

See accompanying notes to consolidated financial statements.


                                       F-4
<PAGE>

SMARTIRE SYSTEMS INC.
Consolidated Statements of Stockholders' Equity and Comprehensive Loss
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

<TABLE>
<CAPTION>
                                                            Common shares          Additional     Deferred
                                                     --------------------------      paid-in        stock
                                                        Shares         Amount        capital     compensation       Deficit
                                                     -----------    -----------    -----------   ------------     -----------
                                                                         $              $             $                $
<S>             <C> <C>                               <C>            <C>             <C>              <C>         <C>
Balance at July 31, 2002                              18,711,369     42,514,482        885,461        (17,005)    (38,116,601)
                                                     ===========    ===========    ===========    ===========     ===========

Issuance of common shares for cash upon private
  placements, net of issuance costs of $289,172        6,964,286      1,810,828             --             --              --
Intrinsic value of beneficial conversion feature
  of convertible debentures plus fair value of
  warrants issued                                             --             --      5,157,521             --              --
Conversion of convertible debenture and accrued
  interest to common shares net of issuance
  costs of $628,526                                   24,381,133      3,024,395             --             --              --
Exercise of warrants for cash, net of issuance
  costs of $61,060                                     3,300,000        298,940             --             --              --
Issuance of shares as fees on equity line of
  credit                                                 478,412        300,000             --             --              --
Fair value of agent's warrants issued on private
  placements and convertible debentures                       --             --        502,367             --              --
Debt settlement through issuance of common shares        353,865         77,850             --             --              --
Issuance of shares and repricing of warrants to
  settle a potential claim                               850,000        178,500        136,544             --              --
Compensation expense                                          --             --             --         17,005              --
Loss for the period                                           --             --             --             --      (9,914,629)
Translation adjustment                                        --             --             --             --              --
                                                     -----------    -----------    -----------    -----------     -----------

Balance at July 31, 2003                              55,039,065     48,204,995      6,681,893             --     (48,031,230)
                                                     ===========    ===========    ===========    ===========     ===========

<CAPTION>
                                                          Accumulated
                                                             other
                                                         comprehensive      Stockholders'      Comprehensive
                                                              loss              equity         income (loss)
                                                         --------------     --------------     --------------
                                                                $                  $                  $
<S>                                                            <C>              <C>                <C>
Balance at July 31, 2002                                       (977,291)         4,289,046         (7,000,269)
                                                         ==============     ==============     ==============

Issuance of common shares for cash upon private
  placements, net of issuance costs of $289,172                      --          1,810,828                 --
Intrinsic value of beneficial conversion feature
  of convertible debentures plus fair value of
  warrants issued                                                    --          5,157,521                 --
Conversion of convertible debenture and accrued
  interest to common shares net of issuance
  costs of $628,526                                                  --          3,024,395                 --
Exercise of warrants for cash, net of issuance
  costs of $61,060                                                   --            298,940                 --
Issuance of shares as fees on equity line of
  credit                                                             --            300,000                 --
Fair value of agent's warrants issued on private
  placements and convertible debentures                              --            502,367                 --
Debt settlement through issuance of common shares                    --             77,850                 --
Issuance of shares and repricing of warrants to
  settle a potential claim                                           --            315,044                 --
Compensation expense                                                 --             17,005                 --
Loss for the period                                                  --         (9,914,629)        (9,914,629)
Translation adjustment                                          408,937            408,937            408,937
                                                         --------------     --------------     --------------

Balance at July 31, 2003                                       (568,354)         6,287,304         (9,505,692)
                                                         ==============     ==============     ==============
</TABLE>

See accompanying notes to consolidated financial statements


                                       F-5
<PAGE>

SMARTIRE SYSTEMS INC.
Consolidated Statements of Stockholders' Equity and Comprehensive Loss
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

<TABLE>
<CAPTION>
                                                                                                                    Accumulated
                                                                Common shares         Additional                        other
                                                          ------------------------     paid-in                     comprehensive
                                                            Shares        Amount       capital        Deficit           loss
                                                          -----------   ----------   -----------    ------------   --------------
                                                                            $             $              $               $
<S>                                                       <C>           <C>           <C>            <C>                 <C>
Balance as at July 31, 2003                                55,039,065   48,204,995     6,681,893     (48,031,230)        (568,354)
                                                          ===========   ==========   ===========    ============   ==============

Exercise of stock options for cash (note 11 (e))               79,400       15,880            --              --               --
Intrinsic value of beneficial conversion feature of
  convertible debentures plus fair value of warrants
  issued (note 9)                                                  --           --     2,457,023              --               --
Conversion of convertible debentures and accrued
  interest to common shares allocated pro-rata
  between additional paid-in-capital and common
  shares, net of issuance costs of $156,133 (note 8)       20,882,076    5,344,961    (2,788,277)             --               --
Exercise of warrants for cash, net of issuance costs
  of $78,370 (note 11(f))                                  12,463,231    3,702,985    (1,601,970)             --               --
Issuance of shares and warrants as fees for
  services received (note 11(c))                              200,000       34,800        63,375              --               --
Fair value of agent's warrants issued on private
  placement of convertible debentures (note 8(b))                  --           --        15,699              --               --
Issuance of shares as fees on equity line of credit
  (note 11 (d))                                             3,605,769      375,000      (375,000)             --               --
Cash cost incurred for equity line (note 11(d))                    --           --       (35,420)             --               --
Shares issued upon draw downs on equity line of
  credit, net of issuance cost of $60,601 (note 11(d))     10,861,220      689,399            --              --               --
Loss for the period                                                --           --            --     (10,987,026)              --
Translation adjustment                                             --           --            --              --          267,483
                                                          -----------   ----------   -----------    ------------   --------------

Balance at July 31, 2004                                  103,130,761   58,368,020     4,417,323     (59,018,256)        (300,871)
                                                          ===========   ==========   ===========    ============   ==============

Exercise of stock options for cash (note 11(e))             6,059,998      787,800      (606,000)             --               --
Conversion of convertible debentures and accrued
  interest to common shares allocated pro-rata
  between additional paid-in-capital and common shares     51,340,389    2,147,293      (648,644)             --               --
  (note 9)
Intrinsic value of beneficial conversion feature of
  convertible debt (note 9)                                        --           --    11,005,243              --               --
Settlement of convertible debt (note 9(c))                         --           --      (677,966)     (1,822,033)
Intrinsic value of beneficial conversion feature of
  preferred shares (note 10)                                       --           --     3,999,999              --               --
Financing cost related to preferred shares (note 10)               --           --      (145,000)                              --
Financing cost related to convertible debentures
  (note 9)                                                         --           --    (1,038,037)             --               --
Exercise of warrants for cash, net of issuance
  costs of $46,872 (note 11(e)(ii))                        18,940,560    1,588,643    (1,017,299)             --               --
Cash-less exercise of warrants (note 11 (b)(ii))           13,364,073    1,026,617    (1,026,617)                              --
Shares issued upon draw downs on equity line, net of
  issuance cost of $515,170 (note 11(b)(i))                78,887,710    2,505,766       410,420              --               --
Shares issued as placement fees on equity line of
  credit (note 11(d))                                          75,188       10,000            --              --               --
Shares issued as compensation for services (note 11(c))     6,764,205      261,578            --              --               --
Compensation expense (note 3(o))                                   --           --     4,018,075              --               --
Loss for the period                                                --           --            --     (14,291,861)              --
Translation adjustment                                             --           --            --              --          429,764
                                                          -----------   ----------   -----------    ------------   --------------
Balance at July 31, 2005                                  278,562,884   66,695,717    18,691,497     (75,132,150)         128,893
                                                          ===========   ==========   ===========    ============   ==============

<CAPTION>
                                                          Stockholders'    Comprehensive
                                                              equity       income (loss)
                                                          --------------   --------------
                                                                $                $
<S>                                                          <C>             <C>
Balance as at July 31, 2003                                    6,287,304       (9,505,692)
                                                          ==============   ==============

Exercise of stock options for cash (note 11 (e))                  15,880               --
Intrinsic value of beneficial conversion feature of
  convertible debentures plus fair value of warrants
  issued (note 9)                                              2,457,023               --
Conversion of convertible debentures and accrued
  interest to common shares allocated pro-rata
  between additional paid-in-capital and common
  shares, net of issuance costs of $156,133 (note 8)           2,556,684               --
Exercise of warrants for cash, net of issuance costs
  of $78,370 (note 11(f))                                      2,101,015               --
Issuance of shares and warrants as fees for
  services received (note 11(c))                                  98,175               --
Fair value of agent's warrants issued on private
  placement of convertible debentures (note 8(b))                 15,699               --
Issuance of shares as fees on equity line of credit
  (note 11 (d))                                                       --               --
Cash cost incurred for equity line (note 11(d))                  (35,420)              --
Shares issued upon draw downs on equity line of
  credit, net of issuance cost of $60,601 (note 11(d))           689,399               --
Loss for the period                                          (10,987,026)     (10,987,026)
Translation adjustment                                           267,483          267,483
                                                          --------------   --------------

Balance at July 31, 2004                                       3,466,216      (10,719,543)
                                                          ==============   ==============

Exercise of stock options for cash (note 11(e))                  181,800               --
Conversion of convertible debentures and accrued
  interest to common shares allocated pro-rata
  between additional paid-in-capital and common shares         1,498,649               --
  (note 9)
Intrinsic value of beneficial conversion feature of
  convertible debt (note 9)                                   11,005,243               --
Settlement of convertible debt (note 9(c))                    (2,499,999)              --
Intrinsic value of beneficial conversion feature of
  preferred shares (note 10)                                   3,999,999               --
Financing cost related to preferred shares (note 10)            (145,000)              --
Financing cost related to convertible debentures
  (note 9)                                                    (1,038,037)              --
Exercise of warrants for cash, net of issuance
  costs of $46,872 (note 11(e)(ii))                              571,344               --
Cash-less exercise of warrants (note 11 (b)(ii))                      --               --
Shares issued upon draw downs on equity line, net of
  issuance cost of $515,170 (note 11(b)(i))                    2,916,186               --
Shares issued as placement fees on equity line of
  credit (note 11(d))                                             10,000               --
Shares issued as compensation for services (note 11(c))          261,578               --
Compensation expense (note 3(o))                               4,018,075               --
Loss for the period                                          (14,291,861)     (14,291,861)
Translation adjustment                                           429,764          429,764
                                                          --------------   --------------
Balance at July 31, 2005                                      10,383,957      (13,862,097)
                                                          ==============   ==============
</TABLE>

See accompanying notes to consolidated financial statements.


                                       F-6
<PAGE>

SMARTIRE SYSTEMS INC.
Consolidated Statements of Cash Flows
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

<TABLE>
<CAPTION>
                                                                   2005               2004               2003
                                                               ------------       ------------       ------------
<S>                                                            <C>                <C>                <C>
Cash provided used for:
Operating activities:
  Loss for the year                                            $(14,291,861)      $(10,987,026)      $ (9,914,629)
  Items not affecting cash:
    Depreciation and amortization                                 1,497,250          1,371,717          1,236,870
    Stock-compensation expense                                    4,279,653                 --             17,005
    Non-cash interest, penalties and finance charges              3,524,805          3,842,107          3,694,914
    Inventory write-down                                            500,000                 --                 --
    Issuance of shares and warrants for services received                --             98,175                 --
    Issuance of shares and repricing of warrants to
      settle a potential claim                                           --                 --            315,044
    Gain on settlement of convertible debt (note 9(c))           (1,822,033)                --                 --
  Change in non-cash working capital:
    Receivables                                                     (44,507)           170,127           (182,366)
    Deferred revenue                                                     --                 --              9,423
    Deferred financing expense                                           --                 --             (5,000)
    Inventory                                                       (67,943)        (2,391,749)           594,333
    Prepaid expenses                                                 82,153            (50,265)           240,861
    Accounts payable and accrued liabilities                       (477,512)           374,794           (434,556)
                                                               ------------       ------------       ------------

  Net cash used in operating activities                          (6,819,995)        (7,572,120)        (4,428,101)

Investing activities:
  Purchase of capital assets                                        (73,511)          (446,780)           (62,978)
                                                               ------------       ------------       ------------

  Net cash used in investing activities                             (73,511)          (446,780)           (62,978)

Financing activities:
  Cash received on exercise of stock options                        181,800             15,880                 --
  Cash received on issuance of common shares                             --                 --          2,100,000
  Cash received on exercise of warrants (note 11)                   618,217          2,179,385            360,000
  Proceeds from equity line of credit (note 11)                   2,725,000            750,000                 --
  Proceeds from convertible debentures (note 9)                  34,195,000          2,725,000          5,618,000
  Proceeds from preferred shares (note 10)                        4,000,000                 --                 --
  Proceeds from promissory notes (note 8)                           875,000          1,500,000            250,000
  Repayment of convertible debentures (note 9)                   (3,360,930)                --                 --
  Financing costs                                               (19,989,564)          (626,696)          (886,799)
  Repayment of promissory notes (note 8)                         (2,375,000)          (305,715)        (1,600,000)
                                                               ------------       ------------       ------------

  Net cash provided by financing activities                      16,869,523          6,237,854          5,841,201

Effect of exchange rate differences on cash
  and cash equivalents                                                7,076             14,022            (32,396)
                                                               ------------       ------------       ------------

Net increase (decrease) in cash and cash equivalents              9,983,093         (1,767,024)         1,317,726

Cash and cash equivalents, beginning of year                         76,670          1,843,694            525,968
                                                               ------------       ------------       ------------

Cash and cash equivalents, end of year                         $ 10,059,763       $     76,670       $  1,843,694
                                                               ============       ============       ============

Supplementary information:
  Interest and finance charges paid                            $    235,593       $    189,713       $     27,591
Non-cash investing and financing activities:
  Conversion of convertible debentures to common shares           1,475,517          2,556,684          3,024,395
  Fair value of agents warrants issued in conjunction
    with private placements                                              --             15,699            502,367
  Settlement of debt through issuance of common shares                   --                 --             77,850
  Issuance of shares as consideration for equity line
    of credit                                                     2,725,000            375,000            300,000
  Financing costs included in accounts payable                           --             52,859             30,000
  Shares issued for services                                        261,578                 --                 --
                                                               ============       ============       ============
</TABLE>

See accompanying notes to consolidated financial statements.


                                       F-7
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

1. Operations:

The Company and its subsidiaries develop and market products incorporating
wireless data transmission and processing technologies, primarily for the
automotive and transportation industries. The Company's primary product is a
wireless tire monitoring system which it currently markets for use on passenger
vehicles, motorcycles, recreational vehicles, trucks, buses and other pneumatic
tire applications. All sales of its product are made in this industry segment.

2. Going concern:

The Company has incurred recurring operating losses and has a deficit of
$75,132,150 and working capital of $7,510,569 as at July 31, 2005. During the
year ended July 31, 2005, the Company used cash of $6,893,506 in operating and
investing activities.

During fiscal 2005, the Company realized gross cash proceeds of $42,595,017
(2004 - $7,170,265) from financing activities, issued 62.5 million warrants and
arranged a $160.0 million (2004 - $15.0 million) equity line of credit (note
11(d)) to fund its operations.

The Company may require additional financing to fund its operations as there can
be no assurance that the Company can draw down amounts under the equity line of
credit as drawdowns are subject to an effective Registration Statement filed
with the SEC. Such a registration statement is not yet effective (note 19(b)).
These consolidated financial statements have been prepared on the going concern
basis which assumes that adequate sources of financing will be obtained as
required and that the Company's assets will be realized and liabilities settled
in the ordinary course of business. Accordingly, these consolidated financial
statements do not include any adjustments related to the recoverability of
assets and classification of assets and liabilities that might be necessary
should the Company be unable to continue as a going concern.

3. Significant accounting policies:

(a) Basis of presentation:

These consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries, SmarTire USA Inc., SmarTire Europe Limited, and
SmarTire Technologies Inc. All intercompany balances and transactions have been
eliminated.

(b) Research and development costs:

Research and development costs are expensed as incurred. Equipment used in
research and development is capitalized only if it has an alternative future
use.

(c) Cash and cash equivalents:

Cash and cash equivalents includes investments in short-term investments with a
term to maturity when acquired of 90 days or less.


                                       F-8
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

3. Significant accounting policies (continued):

Cash and cash equivalents included in the statements of cash flows is comprised
of the following amounts:

<TABLE>
<CAPTION>
                                              2005             2004             2003
                                          -----------      -----------      -----------
<S>                                       <C>              <C>              <C>
Cash on hand and balances with banks      $10,059,763      $    76,670      $   264,628
Cash equivalents                                   --               --        1,554,066
                                          -----------      -----------      -----------
                                          $10,059,763      $    76,670      $ 1,818,694
                                          ===========      ===========      ===========
</TABLE>

(d) Inventory:

Inventory of raw materials are recorded at the lower of cost, determined on a
first-in, first-out basis, and net realizable value. Inventory of finished goods
and work-in progress are recorded at the lower of average cost and net
realizable value. Average cost is determined using the weighted-average method
and includes invoice cost, duties and freight where applicable plus direct
labour applied to the product and an applicable share of manufacturing overhead.
A provision for obsolescence for slow moving inventory items is estimated by
management based on historical and expected future sales and is included in cost
of goods sold.

(e) Capital assets:

Capital assets are recorded at cost. Depreciation of computer hardware and
software and office and shop equipment is provided for on the declining balance
basis at 30% per annum. Leasehold improvements are depreciated over the lesser
of their useful lives or the term of the lease.

(f) Deferred financing costs:

Deferred financing costs include cash payments made by the Company in
conjunction with various financing instruments and placements. The fees
associated with the convertible debentures are amortized over the respective
terms of the convertible debentures. Fees related to the Standby Equity
Distribution Agreement (Standby Equity Distribution Agreement) will be amortized
into additional paid-in capital as the Company draws on the Standby Equity
Distribution Agreement.

(g) Other assets:

Other assets include the license to manufacture and sell tire monitoring systems
to the original equipment vehicle manufacturers (note 6). Other assets are
recorded at cost and are being amortized over five years on a straight-line
basis.


                                       F-9
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

3. Significant accounting policies (continued):

(h) Impairment of long-lived assets:

The Company monitors the recoverability of long-lived assets, based on estimates
using factors such as expected future asset utilization, business climate and
future undiscounted cash flows expected to result from the use of the related
assets or to be realized on sale. The Company recognizes an impairment loss if
the projected undiscounted future cash flows are less than the carrying amount.
The amount of the impairment charge, if any, is measured equal to the excess of
the carrying value over the expected future cash flows discounted using the
Company's average cost of funds.

(i) Revenue recognition:

The Company recognizes revenue when there is persuasive evidence of an
arrangement, goods are shipped and title passes, collection is probable, and the
fee is fixed or determinable. Customer acceptance is used as the criterion for
revenue recognition when the product sold does not have an established sales
history to allow management to reasonably estimate returns and future
provisions. Provisions are established for estimated product returns and
warranty costs at the time the revenue is recognized. The Company records
deferred revenue when cash is received in advance of the revenue recognition
criteria being met. Revenue from engineering services is recognized on services
as they are rendered and pre-defined milestones are achieved. Engineering
services revenue for the year were nil (2004-$94,800 and 2003 - $173,400).

(j) Loss per share:

Basic loss per share computations are based on the weighted average number of
shares outstanding during the year. If in a period the Company has outstanding
dilutive stock options and warrants, diluted loss per share is calculated using
the treasury stock method.

(k) Income taxes:

The Company accounts for income taxes in accordance with the asset and liability
method. Under this method, deferred income taxes are recognized for the future
income tax consequences attributable to differences between the financial
statement carrying amounts and their respective income tax bases and for loss
and tax credit carryforwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which temporary differences are expected to be recovered or settled. The effect
on deferred income tax assets and liabilities of a change in tax rates is
recognized in income in the period of enactment. Deferred income tax assets are
evaluated and if their realization is not considered to be "more likely than
not", a valuation allowance is provided.

(l) Warranty costs:

The Company accrues warranty costs upon the recognition of related revenue,
based on its best estimates, with reference to past experience. See note 17(b).


                                      F-10
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

3. Significant accounting policies (continued):

(m) Foreign currency translation:

The Company's functional or primary operating currency is the Canadian dollar.
The Company's financial statements are prepared in Canadian dollars before
translation to the US dollar reporting currency. The Company translates
transactions in currencies other than the Canadian dollar at the exchange rate
in effect on the transaction date. Monetary assets and liabilities denominated
in a currency other than the Canadian dollar are translated at the exchange
rates in effect at the balance sheet date. The resulting exchange gains and
losses are recognized in earnings.

Amounts reported in Canadian dollars have been translated into US dollars as
follows: assets and liabilities are translated into US dollars at the rate of
exchange in effect at the balance sheet date and revenue and expense items are
translated at the average rates for the period. Unrealized gains and losses
resulting from the translation into the reporting currency are accumulated in
accumulated other comprehensive loss, a separate component of stockholders'
equity.

(n) Use of estimates:

The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management at the
date of the financial statements to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported
amounts to revenues and expenses during the reporting period. Significant areas
requiring the use of estimates include estimating the net realizable value of
inventory, the future cash flows for assessing the net recoverable amount of
long-lived assets, stock-based compensation, product returns and accrued
liabilities. Actual results may differ from those estimates.

(o) Stock-based compensation:

The Company has elected under FAS 123, Accounting for Stock-based Compensation,
to account for employee stock options using the intrinsic value method. This
method is described in Accounting Principles Board ("APB") Opinion No. 25,
Accounting for Stock Issued to Employees, and related interpretations. As the
Company grants stock options with an exercise price not less than the market
value of the underlying common shares on the date of grant, no compensation
expense is required to be recognized under APB 25 for fixed plan awards.

If the exercise price of an employee stock option award is not fixed in the
functional currency of the Company or in the currency the employee is paid, the
award is accounted for as a variable award until the award is exercised,
forfeited, or expires unexercised. The Company measures compensation as the
amount by which the quoted market value of the common shares of the Company's
stock covered by the grant exceeds the option price, with changes in the market
price included in the measurement of loss.


                                      F-11
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

3. Significant accounting policies (continued):

FAS 123 uses the fair value method of calculating the cost of stock option
grants. Had compensation cost for employee stock options been determined by this
method, net loss and net loss per share would have been as follows:

<TABLE>
<CAPTION>
                                             2005             2004             2003
                                         ------------     ------------     ------------
<S>                                      <C>              <C>              <C>
Net loss:
  As reported                            $(14,291,861)    $(10,987,026)    $ (9,914,629)
  Stock-based compensation expense
    recognized using intrinsic value
    method (variable award)                 4,018,075               --           17,005
  Stock-based compensation expense
    determined under fair value based
    method for all awards                  (1,101,411)      (1,291,736)        (738,339)
                                         ------------     ------------     ------------

  Pro forma                              $(11,375,197)    $(12,278,762)    $(10,635,963)
                                         ============     ============     ============

Basic and diluted loss per share:
   As reported                                  (0.06)           (0.13)           (0.37)
   Pro forma                                    (0.05)           (0.15)           (0.40)
                                         ============     ============     ============
</TABLE>

The Company recognizes compensation expense on a straight-line basis over the
vesting period beginning on the date the stock option is granted.

The fair value of each option and warrant granted is estimated on the date of
grant using the Black-Scholes option valuation model with the following range of
weighted average assumptions.

                                            2005          2004          2003
                                         ----------    ----------    ----------
Expected dividend yield                           0%            0%            0%
Expected stock price volatility            137-147%      139-152%      128-155%
Risk-free interest rate                  3.54-4.11%    3.28-4.08%      3.6-4.3%
Expected life of options and warrants       5 years     3-5 years     2-5 years
                                         ==========    ==========    ==========

Weighted-average fair values of options granted during the year are as follows:

                                                    2005       2004       2003
                                                   -------    -------    -------
Options whose exercise price at date of grant:
  Equals the market price of stock                 $  0.03    $  0.07    $  0.72
  Exceeds the market price of stock                   0.02       0.16       0.94
                                                   =======    =======    =======


                                      F-12
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

3. Significant accounting policies (continued):

The Company recognizes compensation expense for stock options, common stock and
other instruments issued to non-employees for services received based upon the
fair value of the equity instruments issued as the services are performed and
the instrument is earned.

(p) Fair value of financial assets and liabilities:

Carrying amounts of certain of the Company's financial instruments, including
cash and cash equivalents, accounts receivable, accounts payable and accrued
liabilities, approximate their fair value due to their short maturities. It was
not practicable to estimate the fair value of the convertible debentures and the
redeemable preferred shares, as they are not publicly traded or quoted and an
active and liquid market does not exist for investments with similar terms,
risks and other features. These instruments are convertible into the Company's
common shares that currently trade in a limited volume relative to the number of
shares that are issued and outstanding. The underlying value of the Company is
dependent on future sales, income and product development that are, at least in
part, outside of the Company's control. The existence of doubt about the
Company's ability to continue as a going concern results in uncertainty about
the future, and certain of the instruments are held by related parties.
Information as to the terms, including the determination of carrying values,
interest rates and maturity dates are set out in notes 9 and 10.

(q) Comprehensive income:

Under SFAS 130, Reporting Comprehensive Income, the Company is required to
report comprehensive income, which includes net loss as well as changes in
equity from non-owner sources. The other changes in equity included in
comprehensive income for the periods presented comprise the foreign currency
cumulative translation adjustments. Accumulated other comprehensive loss is
presented in the consolidated statements of stockholders' equity and
comprehensive loss.

(r) Recent accounting pronouncements:

In May 2005, the FASB issued Statement of Financial Accounting Standard No. 154,
"Accounting Changes and Error Corrections - A Replacement of APB Opinion No. 20
and FASB Statement No. 3" ("SFAS No. 154"), that changes the reporting of
certain accounting changes specified in APB Opinion No. 20, "Accounting Changes"
("ABP 20"). APB 20 required that most changes in accounting principle be
recognized by including in net income of the period of the change the cumulative
effect of changing to a new accounting principle. SFAS No. 154 requires
retrospective application for changes in accounting principle, unless it is
impracticable to determine either the cumulative effect or the period-specific
effects of the change. When it is impracticable to determine the period-specific
effects of an accounting change on one or more individual prior periods
presented, SFAS No. 154 requires that the new accounting policy be applied to
the balances of assets and liabilities as of the beginning of the earliest
period for which retrospective application is practicable and that a
corresponding adjustment be made to the opening balance of retained earnings (or
other appropriate balance sheet caption) for that period.


                                      F-13
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

3. Significant accounting policies (continued):

(r) Recent accounting pronouncements (continued):

When it is impracticable for an entity to determine the cumulative effect of
applying a change in accounting principle to all prior periods, SFAS No. 154
requires the new accounting principle to be applied as if it were made
prospectively from the earliest date practicable. SFAS No. 154 is effective for
accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. The adoption of SFAS No. 154 may have a material impact
on the presentation of the Company's financial position or results of operations
in the event that a material change in accounting principle or correction of
error occurs.

In December 2004, the FASB issued Statement of Financial Accounting Standard No.
123 (Revised 2004), "Share-Based Payment" ("SFAS No. 123R") that requires that
the compensation cost relating to share-based payment transactions be recognized
in financial statements. That cost will be measured based on the fair value of
the equity or liability instruments issued. The scope of SFAS No. 123R includes
a wide range of share-based compensation arrangements including share options,
restricted share plans, performance-based awards, share appreciation rights and
employee share purchase plans. SFAS No. 123R replaces SFAS No. 123 and
supersedes APB No. 25. SFAS No. 123, as originally issued in 1995, established
as preferable a fair-value-based method of accounting for share-based payment
transactions with employees. However, that statement permitted entities the
option of continuing to apply the guidance in APB No. 25 as long as the
footnotes to the financial statements disclosed what net income would have been
had the preferable fair-value-based method been used. The Company has not yet
determined the affect that the adoption of this new statement will have on the
Company's historical financial position or results of operations, however it is
expected to include the increase in compensation expense for equity and
liability instruments issued to directors and employees of the company in the
future.

In December 2004, the FASB issued Statement of Financial Accounting Standard No.
153, " Exchanges of Non-monetary Assets - an Amendment of APB Opinion No. 29"
("SFAS No. 153"), that amends APB Opinion No. 29, "Accounting for Non-monetary
Transactions" ("APB No. 29"). The amendments made by SFAS No. 153 are based on
the principle that exchanges of non-monetary assets should be measured based on
the fair value of the assets exchanged. Further, the amendments eliminate the
narrow exception for non-monetary exchanges of similar productive assets and
replace it with a broader exception for exchanges of non-monetary assets that do
not have "commercial substance." Previously, APB No. 29 required that the
accounting for an exchange of a productive asset for a similar productive asset
or an equivalent interest in the same or similar productive asset should be
based on the recorded amount of the asset relinquished. The provisions in SFAS
No. 153 are effective for non-monetary asset exchanges occurring in fiscal
periods beginning after June 15, 2005. The Company does not expect the adoption
of SFAS No. 153 to have a material impact on the Company's financial position or
results of operations.


                                      F-14
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

3. Significant accounting policies (continued):

In December 2004, the FASB issued Statement of Financial Accounting Standard No.
151, "Inventory Costs" ("SFAS No. 151"), that requires abnormal amounts of
inventory costs related to idle facility, freight handling and wasted material
expenses to be recognized as current period charges. Additionally, SFAS No. 151
requires that the allocation of fixed production overhead to the costs of
conversion be based on the normal capacity of the production facilities. The
standard is effective for fiscal years beginning after June 15, 2005. The
Company does not expect the adoption of SFAS No. 151 to have a material impact
on the Company' s financial position or results of operations.

4. Inventory:

                               2005            2004
                            ----------      ----------
      Raw materials         $1,362,608      $1,515,438
      Work in progress          45,332         554,421
      Finished goods         1,390,807       1,175,948
                            ----------      ----------
                            $2,798,747      $3,245,807
                            ==========      ==========

5. Capital assets:

<TABLE>
<CAPTION>
                                                           Accumulated      Net book
      2005                                    Cost        amortization        Value
      ------------------------------      ------------    ------------    ------------
<S>                                       <C>             <C>             <C>
      Computer hardware and software      $    803,638    $    623,123    $    180,515
      Office and shop equipment              1,477,329       1,027,230         450,099
      Leasehold improvements                   224,901         138,752          86,149
                                          ------------    ------------    ------------
                                          $  2,505,868    $  1,789,105    $    716,763
                                          ============    ============    ============

<CAPTION>
                                                          Accumulated       Net book
      2004                                    Cost        amortization        Value
      ------------------------------      ------------    ------------    ------------
<S>                                       <C>             <C>             <C>
      Computer hardware and software      $    697,178    $    509,980    $    187,198
      Office and shop equipment              1,336,068         786,049         550,019
      Leasehold improvements                   207,327         119,928          87,399
                                          ------------    ------------    ------------
                                          $  2,240,573    $  1,415,957    $    824,616
                                          ============    ============    ============
</TABLE>


                                      F-15
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

6. Other assets:

On December 13, 2000, the Company entered into an Assignment and Amendment
Agreement with TRW Inc. ("TRW") that transferred to the Company the license to
manufacture and sell tire pressure monitoring systems to the original equipment
vehicle manufacturers of most medium and heavy duty trucks. Consideration
consisted of 490,072 shares of common stock valued at $1,337,500, based on the
market value of the Company's stock at the date of purchase, plus cash of
$400,000.

On August 31, 2001, the Company and TRW entered into an agreement to restructure
their strategic alliance. Under the terms of restructuring, the Company and TRW
agreed to terminate a number of agreements. The Company has the right to
manufacture and sell tire pressure monitoring systems to the original equipment
vehicle manufacturers market ("OEM"). Consideration consisted of a promissory
note of $2.8 million, carrying an interest rate of 6% per annum plus cash of
$500,000. The balance of principal in the amount of $1,350,000 owed at July 31,
2002 was repaid during fiscal 2003 and interest of $97,542 on this balance was
forgiven by TRW.

The rights are being amortized over five years on a straight-line basis.

<TABLE>
<CAPTION>
                                                                   Accumulated       Net book
      2005                                             Cost        amortization        Value
      ---------------------------------------      ------------    ------------    ------------
<S>                                                <C>             <C>             <C>
      OEM - most medium and heavy duty trucks      $  1,737,500    $  1,574,381    $    163,119
      OEM - all other vehicles                        3,300,000       2,397,106         902,894
                                                   ------------    ------------    ------------
                                                   $  5,037,500    $  3,971,487    $  1,066,013
                                                   ============    ============    ============

<CAPTION>
                                                                   Accumulated       Net book
      2004                                             Cost        amortization        Value
      ---------------------------------------      ------------    ------------    ------------
<S>                                                <C>             <C>             <C>
      OEM - most medium and heavy duty trucks      $  1,737,500    $  1,190,402    $    547,098
      OEM - all other vehicles                        3,300,000       1,699,349       1,600,651
                                                   ------------    ------------    ------------
                                                   $  5,037,500    $  2,889,751    $  2,147,749
                                                   ============    ============    ============
</TABLE>

Management believes that the net book value of its other assets of $1,066,013 as
at July 31, 2005 is recoverable based on expectations of future cash flows from
the Company's future sales of tire pressure monitoring systems. Management's
belief is based on an undiscounted cash flow analysis of management's current
best estimate of projected annual sales to the passenger vehicle and light truck
OEM market plus management's projected sales to the medium and heavy truck OEM
market.


                                      F-16
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

7. Accounts payable and accrued liabilities:

                                                         2005            2004
                                                      ----------      ----------
      Accounts payable                                $  311,296      $  888,652
      Accrued liabilities                                232,629         351,718
      Interest payable on convertible debentures         371,409          52,881
                                                      ----------      ----------
                                                      $  915,334      $1,293,251
                                                      ==========      ==========

8. Promissory notes:

(a) During the year ended July 31, 2004, the Company received total gross
proceeds of $1,500,000 upon the issuance of two unsecured short-term promissory
notes of $750,000 each, to an accredited investor. Each note bore interest at a
rate of 8% per annum and was repayable on August 13, 2004 and September 16, 2004
respectively. As a commitment fee, the holder of the notes received a total of
$150,000.

(b) During the year ended July 31, 2005, the Company received gross proceeds of
$875,000 as follows:

i. On November 16, 2004, the Company received gross proceeds of $250,000 upon
the issuance of an unsecured short-term promissory note to an accredited
investor. There were no fees on the note. The note bore interest at a rate of
12% per annum and was repayable on December 15, 2004.

ii. On November 30, 2004, the Company received gross proceeds of $275,000 upon
the issuance of an unsecured short-term promissory note to an accredited
investor. The note bore interest at a rate of 12% per annum and was repaid on
December 30, 2004. As a commitment fee, the holder of the note received $27,500.

iii. On February 9, 2005, the Company received gross proceeds of $350,000 upon
the issuance of an unsecured short-term promissory note to an accredited
investor. The note bore interest at a rate of 10% per annum and was repaid on
March 16, 2005. As a commitment fee, the holder of the note received $35,000.

(c) During the year ended July 31, 2005, the Company repaid all of its
outstanding promissory notes. In total, the Company repaid $2,375,000 of
principal and $61,462 in interest on its promissory notes.


                                      F-17
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

9. Convertible debentures:

<TABLE>
<CAPTION>
                                                      Redemption                            Balance to
                                                         value              Debt            be accreted
                                                        of debt          component            to debt
                                                     ------------       ------------       ------------
<S>                                                  <C>                <C>                <C>
Balance as at July 31, 2003                          $  1,966,667       $          3       $  1,966,664

  Issuance of 11% discounted convertible
    debentures (b)                                      3,493,590          1,036,567          2,457,023

  Discount in convertible debentures (b)                       --           (768,590)           768,590

  Cash repayment of discounted
    convertible debentures (b)                           (305,715)          (305,715)                --

  Conversion of 8% and 7% convertible
    debentures into common shares (a)                  (1,691,667)        (1,691,667)                --

  Conversion of discounted convertible
    debentures into common shares (b)                    (840,688)          (840,688)                --

  Accretion of deemed debt discount to
    interest expense (b)                                       --          3,236,921         (3,236,921)
                                                     ------------       ------------       ------------

Balance as at July 31, 2004                             2,622,187            666,831          1,955,356

  New issuances:
  5% convertible debentures (c)                         2,695,000          1,964,153            730,847
  5% convertible debentures (d)                         1,500,000                  1          1,499,999
  10% convertible debenture (e)                        30,000,000         21,225,601          8,774,399

  Redemptions/repayments:
  5% convertible debenture (c)                         (2,500,000)        (1,822,033)          (677,967)
  Discounted convertible debentures (b)                  (860,929)          (860,929)                --
  Withholding taxes paid                                  (12,667)           (12,667)                --

  Conversions:
  8% convertible debenture (a)                           (160,000)          (160,000)                --
  Discounted convertible debentures (b)                (1,315,517)        (1,315,517)                --

  Interest accretion:
  8% convertible debentures (a)                                --            274,999           (274,999)
  Discounted convertible debentures (b)                        --          1,680,357         (1,680,357)
  5% convertible debentures (c)                                --             52,881            (52,881)
  10% convertible debentures (e)                               --            163,315           (163,315)

  Penalties and other incurred:
  Discounted convertible debentures (b)                   128,259            128,259                 --
                                                     ------------       ------------       ------------

Balance as at July 31, 2005                            32,096,333         21,985,251         10,111,082
Less: Current portion of convertible debentures         8,109,666          4,866,584          3,243,082
                                                     ------------       ------------       ------------

                                                     $ 23,986,667       $ 17,118,667       $  6,868,000
                                                     ============       ============       ============
</TABLE>


                                      F-18
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

9. Convertible debentures (continued):

As at July 31, 2005 the following convertible debentures with respective
redemption values were outstanding:

i) $115,000 of the 8% convertible debentures issued on July 17, 2003;

ii) $286,333 of the convertible debentures issued at a 22% original discount
from the face principal amount on December 24, 2003;

iii) $195,000 of the 5% convertible debenture issued on December 15, 2004;

iv) $1,500,000 of the 5% convertible debenture issued on May 27, 2005;

v) $30,000,000 of the 10% convertible debentures issued on June 23, 2005.

At January 31, 2005 and April 30, 2005, the Company was in violation of all
existing convertible debenture agreements. As a result of this violation, the
Company accreted interest to adjust the carrying value of all existing
convertible debentures to their redemption value. As at July 31, 2005, the
Company was in compliance with all terms and conditions of all existing
convertible debentures. However, subsequent to year-end, the Company was in
violation of certain terms of its convertible debentures and preferred shares.
The Company has taken certain steps to remedy these violations (note 19(b)).

(a) $1,700,000 - 8% convertible debenture and $2,800,000 - 7% convertible
debenture issued on June 17, 2003.

On June 17, 2003, the Company closed a private placement of 7% convertible
debentures in three 8 tranches pursuant to Rule 506 of Regulation D under the
Securities Act of 1933, for gross proceeds of $2,800,000. On July 17, 2003, the
Company closed another private placement of 8% convertible debentures pursuant
to Rule 506 of Regulation D under the Securities Act of 1933, for gross proceeds
of $1,700,000. Net cash proceeds from the convertible debentures were
$4,016,978.

In connection with the offering of the convertible debentures, the Company
issued 23,846,153 common share purchase warrants which were to expire between
July 17, 2008 and November 10, 2008. These warrants were exercised during the
year ended July 31, 2005. Advisors to the transactions received a cash
commission of $360,000 and 180,000 share purchase warrants: 112,000 share
purchase warrants for a period of five years, and 68,000 share purchase warrants
for a period of three years. The fair value of these warrants at the date of
grant was estimated at $77,640 using the Black-Scholes option valuation model
using weighted average assumptions as disclosed in note 3(o). Additional
expenses related to this offering were $123,022 plus 100,000 share purchase
warrants exercisable at a price of $0.135 per share for a period of five years.
The financing cost will be amortized over the lesser of the life of the
convertible debentures or the date of redemption or conversion into common
shares.


                                      F-19
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

9. Convertible debentures (continued):

Interest on the debentures is payable quarterly on March 1, June 1, September 1
and December 1, and at maturity, in cash or, at the Company's option, in shares
of the Company's common stock at an interest conversion price equal to 90% of
the lesser of the average closing bid price during the 20 trading days
immediately preceding the interest payment date, or the average closing bid
price during the 20 trading days immediately preceding the date on which the
shares are issued if such shares are issued and delivered after the interest
payment date. The Company's right to elect to pay accrued interest in shares of
its common stock is subject to certain conditions, including the requirement
that there shall be an effective registration statement qualifying the resale of
the common stock to be issued to the holders of the convertible debentures in
lieu of a cash interest payment. All overdue accrued and unpaid interest under
the convertible debentures will be subject to a late fee at the rate of 18% per
annum.

The Company may not prepay any portion of the principal amount on any
convertible debenture without the prior written consent of the holder of the
debenture.

The Company will be considered in default of the convertible debentures if
certain events occur. Once an event of default occurs, the holder of a
convertible debenture can elect the Company to immediately repay a mandatory
prepayment amount as outlined in the agreement.

If an event of default occurs, the holder of a convertible debenture can elect
to require the Company to immediately repay a mandatory prepayment amount equal
to the greater of:

i)    120% of the principal amount of the debenture, plus all accrued and unpaid
      interest and any other amounts outstanding in respect of the debenture; or

ii)   120% of the principal amount of the debenture, plus all accrued and unpaid
      interest and any other amounts outstanding

in respect of the debenture, divided by the conversion price of the debenture,
and multiplied by the greater of:

a. the last reported closing bid price for our common stock on the date on which
the payment is due, or

b. the last reported closing bid price for our common stock on the date on which
the payment actually paid.


                                      F-20
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

9. Convertible debentures (continued):

For accounting purposes, the proceeds from the issuance of these convertible
debentures were primarily allocated to the fair value of warrants issued and the
beneficial conversion feature. The fair value of the warrants was calculated
using the Black Scholes option model using assumptions as disclosed in note
3(o). The remaining value of the proceeds of $3 was allocated to debt and is
being accreted to the redemption value of the convertible debentures over the
period from the date of issuance to the initial maturity dates of May 19, 2005
and July 16, 2006.

During the year ended July 31, 2004, $1,691,667 of principal and $41,270 of
interest were converted into common shares resulting in the issuance of
13,601,799 common shares. Interest accretion of $1,732,935 was charged in the
statement of operations as interest expense upon conversion of convertible
debentures.

During the year ended July 31, 2005, $160,000 of principal and interest and were
converted into common shares resulting in the issuance of 6,106,143 common
shares. Interest accretion of $274,999 was charged in the statement of
operations as interest expense upon conversion of the convertible debentures.

(b) $3,493,590 - 11% discounted convertible debentures issued on December 24,
2003 On December 24, 2003, the Company closed a private placement of discounted
unsecured convertible debentures in the aggregate principal amount of
$3,493,590. The Company also issued 7,939,978 warrants exercisable at $0.25
(subject to adjustment pursuant to the anti-dilution provisions contained in the
warrants) with an expiry period of 5 years. The Company issued the convertible
debentures at a 22% original issue discount from the face principal amount
(based on a notional interest rate of 11% per annum for each year of the
two-year term of the debentures), resulting in gross proceeds of $2,725,000. The
discount of $768,590 has been netted against the face value of debentures and is
being amortized over the maturity period. Advisors to the transaction received a
cash commission of $218,000 and 109,000 three year share purchase warrants
exercisable at a price of $0.25 each (subject to adjustment pursuant to the
anti-dilution provisions contained in the warrants). The fair value of these
warrants at the date of grant was estimated at $15,699. The fair value of these
warrants was estimated on the date of issuance using the Black-Scholes option
valuation model using the volatility 141%, risk free interest rate 3.28%,
expected life of warrants 3 years. In addition, expenses of $46,894 for
professional fees related to this transaction were incurred. The discounted
convertible debentures do not otherwise bear interest, and will mature on April
1, 2006. The outstanding principal amount of each debenture may be converted at
any time into shares of the Company's common stock, in whole or in part, at the
option of the holder of the debenture at a set price of $0.22 per share (subject
to adjustment pursuant to the anti-dilution provisions contained in the
debentures). The Company was to make the monthly redemption payments of $145,566
over two years in cash unless during the twenty trading day prior notice period
immediately prior to the applicable monthly redemption date the Company
irrevocably notifies the holder that it will issue underlying shares in lieu of
cash at a conversion price equal to the lesser of:


                                      F-21
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

9. Convertible debentures (continued):

(i) the set price of $0.22 per share (subject to adjustment pursuant to the
anti-dilution provisions contained in the debentures), and

(ii) 85% of the average of the closing prices of the Company's common stock for
twenty days immediately preceding the applicable monthly redemption date,
provided that certain conditions are met, including the condition that the
underlying shares of common stock shall have been registered under the
Securities Act of 1933, as amended.

For accounting purposes, the proceeds from the issuance of these convertible
debentures were allocated to the fair value of the warrants issued and the
intrinsic value of the beneficial conversion feature which amounted to $861,351
and $1,595,672, respectively. The fair value of the warrants was calculated
using the Black-Scholes option valuation model using assumptions consistent with
those disclosed in note 3(o). The remaining proceeds of $1,036,567 was allocated
to debt and is being accreted to the redemption value of the convertible
debentures over the maturity period. Monthly redemption payments for February,
March, April and May 2004 were made in shares of the Company, except for one
cash payment of $14,583. Monthly redemption payments of $145,566 for each of
June and July were made in cash. During the year ended July 31, 2004, holders of
discounted convertible debentures also converted $273,000 of convertible
debentures into common shares. This resulted in additional interest accretion of
$240,085. During the year ended July 31, 2004, interest accretion of $1,206,762
was charged to the statement of operations as interest expense.

During August 2004, the Company defaulted on payments to holders of its
discounted convertible debentures. In response to the default, certain debenture
holders filed legal actions against the Company. On September 24, 2004, the
Company and holders of the discounted convertible debentures signed an agreement
which provided for: withdrawal of legal action; an immediate exercise of
18,226,274 warrants at $0.03 for gross proceeds to the Company of $546,788;
conversion of $734,388 of discounted debentures into 24,479,630 common shares; a
lock-up provision that establishes a daily limit on the number of shares that
can be traded by the debenture holders. In addition, the holders of $308,444 of
discounted debentures converted these debentures to common shares. Between April
27, 2005 and May 23, 2005, the company entered into redemption, release and
settlement agreements with holders of the Company's discounted convertible
debentures. Pursuant to such redemptions, the Company made cash payments of
$860,929 (including a 20% premium amounting to $76,333), and issued 9,738,759
shares of common stock which were issued at an effective conversion price of
$0.028 per share.


                                      F-22
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

9. Convertible debentures (continued):

On April 21, 2005, one holder of this discounted debenture in the amount of
$91,726 provided the Company with notice of a summons with the Supreme Court of
the State of New York. The holder is alleging that the Company wrongfully
refused to honor its request to convert this debt into 9,268,875 common shares
of the Company. The holder is seeking $4,393,360 plus interest from April 25,
2005 and attorneys fees. It is not possible to determine whether the debenture
holder will be successful in their legal action. The Company has recorded a
liability of $128,259 which includes the outstanding principal, premium and
penalties.

During the year ended July 31, 2005, $2,631,033 of principal was converted into
common shares resulting in the issuance of 45,234,246 common shares. Interest
accretion of $1,680,357 was charged to the statement of operations as interest
expense upon conversion of the discounted convertible debentures.

(c) $195,000 - 5% convertible debentures and $2,500,000 - 5% convertible
debenture issued on December 15, 2004

On December 15, 2004 the Company closed two private placements of 5% convertible
debentures, $195,000 maturing on December 15, 2006 and $2,500,000 maturing on
December 15, 2007, for gross proceeds of $2,695,000 and net cash proceeds of
$2,394,644. Advisors to the transactions received cash commissions of $279,250.
Additional expenses related to these offerings were $21,106. The financing cost
was recorded as deferred financing costs and was amortized over the lesser of
the life of the convertible debenture or the date of redemption or conversion
into common shares.

Principal under the convertible debentures is convertible at the option of the
holder as per terms of the agreement.

The Company also has the right to redeem the convertible debentures, in whole or
in part, at 120% of the face value of each convertible debenture. The investor
is to receive 50,000 redemption warrants for every $100,000 redeemed.

For accounting purposes, the Company calculated the intrinsic value of the
beneficial conversion feature amounting to $730,847 and recorded it as
additional paid-in capital. The remaining value of $1,964,153 is recorded as a
liability and will be accreted to its aggregate face value of $2,695,000 over
the maturity period.

Interest on the remaining principal under the convertible debentures that
aggregate $195,000 is payable semi-annually beginning June 15, 2005 and every
subsequent six month period that the principal balance remains unpaid. During
the year, the Company accreted the original assigned debt component to its full
face value, resulting in interest expense of $52,881 being charged to the
statement of operations.


                                      F-23
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

9. Convertible debentures (continued):

On December 15, 2004, SmarTire issued a $2.5 million convertible debenture for
gross proceeds of $2.5 million and net proceeds of $2.2 million. This debenture
was redeemable in whole or in part, at 120% of the face value. For every
$100,000 redeemed, the investor was to receive 50,000 redemption warrants. The
redemption warrants, if issued, were to be exercisable at 120% of the closing
bid price on our as reported by Bloomberg, L.P. for the trading day immediately
preceding the Closing Date.

On issuance of the debenture, under EITF 98-5, SmarTire calculated the intrinsic
value of the beneficial conversion feature as $677,996 and recorded it as
additional paid in capital with the remaining value classified as a liability On
March 22, 2005, the debenture was repaid for $2.5 million from the proceeds from
the issuance of 25,000 mandatory redeemable, convertible preferred stock for
which SmarTire received gross proceeds of $4 million. No redemption warrants
were issued as the preferred shares were issued to the same investor as the $2.5
million convertible debenture. Under EITF 00-27, Issue 12(b), the reacquisition
price allocated to the convertible feature was $2,499,999 (based on a share
price at the reacquisition date of $0.034 and the $0.01 conversion price). The
remaining amount of the reacquisition proceeds of $1 was allocated to the
liability. The difference between the $1,822,004 carrying value of the liability
and the allocated reacquisition proceeds of $1 was recognized as a gain in the
income statement.

The gain on the settlement of the liability portion of the convertible debenture
was recorded in the income statement under APB 26, paragraph 21.

(d) $1,500,000 - 5% convertible debenture issued on May 20, 2005

On May 20, 2005, the Company entered into a Securities Purchase Agreement to
issue a $1,500,000 5% debenture convertible at the option of the holder at
$0.028 per share that matures on September 1, 2006. Principal will be due and
payable in 12 equal installments of $125,000 commencing October 1, 2005 and
subsequent installments will be due and payable on the first day of each
calendar month thereafter until the outstanding principal balance is paid in
full. Interest on the outstanding principal balance is due and payable monthly,
in arrears, commencing on August 1, 2005 and will continue to be payable on the
first day of each calendar month thereafter that any amounts under the
convertible debenture remain payable. Between April 25 and 29, 2005, funds for
$1,100,000 of the convertible debenture were placed in escrow with the Company's
legal council. From escrow, $457,999 was paid on April 27, 2005 to two debenture
holders to redeem their convertible debentures.

For accounting purposes, the Company calculated the intrinsic value of the
beneficial conversion feature amounting to $1,499,999 and recorded it as
additional paid-in capital. The remaining $1 is recorded as a liability and
accreted to its face value of $1,500,000 over the maturity period.

(e) $30,000,000 - 10% convertible debentures issued on June 23, 2005

On June 30, 2005, the Company closed a private placement of unsecured
convertible debentures in the aggregate principal amount of $30.0 million. The
Company paid a cash fee of $3.0 million for the convertible debentures and a
cash structuring fee of $50,000 in connection with the Securities Purchase
Agreement. The Company also issued 62.5 million warrants exercisable at $0.16
per share (subject to adjustment pursuant to adjustment as described below) with
an expiry period of five years. The fair value of these warrants at the date of
grant was estimated at $4,676,087. The fair value of these warrants was
estimated using the Black-Scholes option valuation model using assumptions
consistent with those disclosed in not 3 (o). The convertible debentures bear
interest at 10% per annum, calculated on the basis of a 360-day year, and will
mature on June 23, 2008. The outstanding principal amount of each debenture may
be converted into shares of the Company's common stock, in whole or in part, at
the option of the holder of the debenture at a set price of $0.1125 per share
(subject to a adjustment as described below).


                                      F-24
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

9. Convertible debentures (continued):

The debenture repayment terms are as follows:

(i) 10% convertible debenture due June 23, 2008, with a principal balance of
$20.0 million, with principal and interest payments commencing on November 1,
2005 and subsequent installments due and payable on the first day of each
calendar month thereafter until the outstanding principal balance is paid in
full or the full $20.0 million convertible debenture is converted in full. In
lieu of making an interest payment in cash, the Company may elect to make
interest payments in shares of its common stock, the value of which would be the
closing bid price of its common stock on the date the interest payment is due.
Upon any full conversion by the investor of all of the principal and interest
due under the convertible debenture, all of the payment obligations shall
terminate.

(ii) 10% convertible debenture due June 23, 2008, with a principal balance of
$8.0 million, with interest payments commencing on July 23, 2005 and subsequent
installments due and payable on the first day of each calendar month thereafter
until the outstanding principal balance is paid in full, or the full $8.0
million convertible debenture is converted in full. Principal shall be due and
payable in five equal installments commencing on June 23, 2006 and subsequent
installments shall be due and payable every six months thereafter on the 23rd
day of each calendar month until the outstanding principal balance is paid in
full or the full $8.0 million convertible debenture is converted in full. In
lieu of making an interest payment in cash, the Company may elect to make
interest payments in shares of its common stock, the value of which would be the
closing bid price of its common stock on the date the interest payment is due.
Upon any full conversion by the investor of all the principal and interest due
under the convertible debenture, all of the payment obligations shall terminate.

(iii) 10% convertible debenture due June 23, 2008, with a principal balance of
$2.0 million, with interest payments commencing on July 23, 2005 and subsequent
installments due and payable on the first day of each calendar month thereafter
until the outstanding principal balance is paid in full or the full $2.0 million
convertible debenture is converted in full. Principal shall be due and payable
in five equal installments commencing on June 23, 2006 and subsequent
installments shall be due and payable every six months thereafter on the 23rd
day of each calendar month until the outstanding principal balance is paid in
full or the full $2.0 million convertible debenture is converted in full. In
lieu of making an interest payment in cash, the Company may elect to make
interest payments in shares of its common stock, the value of which would be the
closing bid price of its common stock on the date the interest payment is due.
Upon any full conversion by the investor of all the principal and interest due
under the convertible debenture, all of the payment obligations shall terminate.


                                      F-25
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

9. Convertible debentures (continued):

In the event of any issuances of shares of common stock or rights, options,
warrants or securities convertible or exercisable into common stock at a price
per share of common stock less than the conversion price of the convertible
debentures or exercise price of the warrants, the conversion price of such
convertible debentures and warrants will be reduced to the lower purchase price.
In addition, the conversion price of the convertible debentures and warrants
will be subject to adjustment in connection with any subdivision, stock split,
combination of shares or recapitalization. No adjustment will be made as a
result of exercises of options, issued prior to June 23, 2005, to purchase
shares of common stock issued for compensatory purposes pursuant to any of our
stock option or stock purchase plans.

The 10% convertible debentures provide for various events of default that would
entitle the holders to require the Company to immediately repay 100% of the
outstanding principal amounts, plus accrued and unpaid interest, in cash, or
shares of the Company's common stock with a conversion price reduced to 20% of
the volume weighted average price of the Company's shares of common stock on
June 30, 2005. If an event of default occurs, the Company may be unable to
immediately repay the amount owed, and any repayment may leave the Company with
little or no working capital in its business.

The Company will be considered in default of the 10% convertible debentures if
any of the following events, among others, occurs:

(i) Failure to pay any amount due under a convertible debenture and such failure
to pay remains uncured for 10 days;

(ii) Failure to observe or perform any other covenant, agreement or warranty
contained in, or otherwise commit any breach or default of any provision of the
10% convertible debentures;

(iii) The Company or any of its subsidiaries become bankrupt or insolvent;

(iv) Breach any of the Company's obligations under any other debt or credit
agreements involving an amount exceeding $250,000;

(v) The Company's common stock ceases to be eligible for quotation on the
principal market for its common stock (currently the OTC Bulletin Board), and
fails to be quoted or listed for trading on another principal market (defined to
mean the OTC Bulletin Board, the New York Stock Exchange, American Stock
Exchange, the NASDAQ Small-Cap Market or the NASDAQ National Market) within 20
trading days;

(vi) The Company or any subsidiary experiences a change of control;

(vii) The Company fails to file a registration statement within 60 days from
June 23, 2005 with the Securities and Exchange Commission and such registration
statement is not declared effective by the SEC within 120 days after filing;


                                      F-26
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

9. Convertible debentures (continued):

(viii) If the effectiveness of the registration statement lapses for any reason
or the holder of the convertible debentures is not permitted to resell the
underlying shares of common stock, in either case, for more than five trading
days or an aggregate of eight trading days and;

(ix) Failure to deliver common stock certificates to a holder prior to the fifth
trading day after a conversion date or we fail to provide notice to a holder of
our intention not to comply with requests for conversions of the convertible
debentures; or failure to deliver the payment in cash pursuant to a `buy-in'
within three days after notice is claimed delivered. A "buy-in" occurs if we
fail to issue shares of Common Stock within five trading days after a notice of
conversion is received and the holder requesting conversion purchases (in an
open market transaction or otherwise) Common Stock to deliver in satisfaction of
a sale by such holder of the underlying shares of Common Stock that the holder
anticipated receiving upon such conversion.

The convertible debentures contain a contractual restriction on beneficial share
ownership. They provide that the debenture holders may not convert the
convertible debentures, or receive shares of the Company's common stock as
payment of interest, to the extent that the conversion or receipt of the
interest payment would result in the debenture holders, together with their
respective affiliates, beneficially owning in excess 4.99% of the Company's then
issued and outstanding shares of common stock.

In connection with the execution of the Securities Purchase Agreement, on June
23, 2005, the Company entered into a Registration Rights Agreement with Cornell
Capital Partners and Highgate House Funds pursuant to which the Company agreed
to prepare and file, no later than 60 days after the date of the Registration
Rights Agreement, with the Securities and Exchange Commission a registration
statement on Form S-1 or SB-2 (or, if they are then eligible on Form S-3) under
the Securities Act of 1933, as amended, for the resale by the investors of
266,666,666 shares of the Company's common stock to be issued upon conversion of
the convertible debentures and 62.5 million shares of the Company's common stock
to be issued upon exercise of the investors' warrants.

For accounting purposes, the proceeds from the issuance of these convertible
debentures were allocated to the fair value of the warrants issued and the
intrinsic value of the beneficial conversion feature which amounts to $4,676,089
and $4,098,310 respectively. The fair value of the warrants was calculated using
the Black-Scholes option valuation model using assumptions consistent with those
disclosed in note 3(o). The remaining proceeds of $21,225,601 were allocated to
debt and is being accreted to the redemption value of the convertible debenture
over the maturity period.

Of the total financing fee of $3,050,000, $2,165,500 was charged to deferred
financing costs and $884,500 was charged to additional paid in capital. These
financing fees will be amortized over the lesser of the life of the convertible
debenture and the date of redemption or conversion into common shares.

During the year ended July 31, 2005, the Company recorded $163,315 of interest
expense relating to interest accretion and charged it to the statement of
operations.


                                      F-27
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

10. Preferred shares subject to mandatory redemptions:

On March 22, 2005, the Company closed a private placement of 25,000 5%
convertible Class A preferred shares for gross proceeds of $4,000,000 and net
cash proceeds of $3,865,000. Advisors to the transactions received cash
commission of $115,000. Additional expenses related to this offering were
$20,000. Proceeds of $2,850,000 from this financing were used to settle
$2,500,000 convertible debenture entered into on December 15, 2004 and a
$350,000 promissory note entered into on February 9, 2004.

Principal under convertible preferred shares may be converted into common shares
by the holder in whole or in part from time to time at a conversion price of
$0.01. Upon providing 3 business days advance written notice to holders, during
which time the holder may elect to convert up to all of their convertible
preferred stock, the Company may redeem up to 80% of the convertible preferred
stock, in whole or in part, at 120% of the face value. The $4,000,000
convertible preferred stock is due and payable at maturity on December 22, 2006.

The holders of the preferred shares are entitled to receive dividends or
distributions on a pro rata basis according to their holdings of the preferred
shares when and if declared by our board of directors, in the amount of 5.0% per
year. Dividends will be paid in cash and are cumulative. No declared and unpaid
dividends will bear or accrue interest. Upon the Company's liquidation,
dissolution, or winding-up, whether voluntary or involuntary, before any
distribution or payment is made to any of the holders of common stock or any
series of preferred stock, holders of the preferred shares are entitled to
receive out of the Company's assets, an amount equal to $160 per share of the
preferred share, plus all declared and unpaid dividends thereon, for each share
of the preferred share held by the holder. Under the Registration Rights
Agreements for the preferred shares, the Company will be considered in default
of the preferred shares, if the Company fails to file a registration statement
with the SEC within 30 days from the date of the agreement of March 22, 2005 and
such registration statement is not declared effective by the SEC within 120 days
after filing.

While the legal form of this financial instrument is that of preferred shares,
due to the mandatory redemption on December 22, 2006, the substance of the
instrument is that of a financial liability. For accounting purposes, these
shares are considered to have both a debt and equity component. The equity
component is related to the intrinsic value of the beneficial conversion feature
at the issuance of the instrument and it equaled $3,999,999. The equity
component value is recorded as additional paid-in capital. The remaining value
of $1 is recorded as a liability. The carrying value of the liability portion is
being accreted to its retraction value of $4,000,000, over a period from the
date of issuance to its maturity date of December 22, 2006. Interest accretion
is charged to the statement of operations as interest expense. Total financing
costs of $145,000 was charged to additional paid-in capital as substantially all
the value of preferred shares is treated as equity.


                                      F-28
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

11. Share capital:

(a) Authorized:

On December 10, 2004, the Company's authorized common share capital was
increased to an unlimited number of shares (2004 - 300,000,000) pursuant to a
special resolution of the shareholders adopted at the annual and special annual
meeting of the Company held on December 10, 2004. The Company also has 100,000
preferred shares authorized for issuance, of which 25,000 were issued during the
year (note 10).

On March 18, 2005, the Company filed articles of amendment to its articles of
incorporation that set forth all the rights and preferences of its series A 5%
convertible preferred stock.

(b) Common share and unit offerings:

During the year ended July 31, 2005, the Company received financing from the
drawdown on the equity line as the Company issued 78,887,710 shares at effective
prices ranging from $0.028 to $0.05 per share pursuant to the $15 million
Standby Equity Distribution Agreement for gross proceeds of $2,725,000 and net
proceeds of $2,584,250. In addition, $78,484 was reclassified from additional
paid-in capital to share financing expense to record the proportionate share of
costs on the equity line against the gross amount of draw downs. The issuance of
these shares reduced the set price that the holders of the discounted and 8%
convertible debentures can convert the convertible debentures into common stock
and the exercise price of 14,612,907 warrants outstanding to $0.028.

(c) During the year ended July 31, 2004, 200,000 common shares with a fair
market value of $0.174 per share, 300,000 share purchase warrants with an
exercise price of $0.17 per share and 250,000 share purchase warrants with an
exercise price of $0.20 per share were issued for services received. The fair
value of these warrants at the date of grant was estimated at $63,375. The fair
value of these warrants was estimated on the date of issuance using the
Black-Scholes option valuation model using the weighted average assumptions
consistent with those as described in note 3(o). Fair value of common shares and
warrants of $98,175 has been exercised.

On January 19, 2005, the Company issued 5,752,945 shares of common stock to
certain members of senior management of the Company for services rendered. The
fair value of the shares at the date of issuance was $0.03 per share amounting
to $172,588. In addition, on June 21, 2005, the Company issued 1,011,260 shares
of common stock to a certain member of senior management of the Company for
services rendered. The fair value of the shares at the date of issuance was
$0.088 per share amounting to $88,990.

On May 19, 2004, the Company arranged a $15 million Standby Equity Distribution
Agreement from a private investment company, Cornell Capital partners, LP. The
agreement provided for the Company to, at its discretion, draw down $500,000
every seven business days, subject to an effective registration statement. In
consideration for each draw down, the Company will sell shares of common stock
at a 2% discount to the lowest closing bid prices for the 5 trading days after
an advance notice is given by the Company. In addition, 5% of each advance will
be retained by Cornell Capital as a commission.


                                      F-29
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

11. Share capital (continued):

(d) Standby equity distribution agreements:

On June 1, 2004, the Company filed a registration statement with the Securities
and Exchange Commission to register the $15 million equity line of credit that
was declared effective on June 14, 2004. On June 1, 2004, the Company issued
3,605,769 shares at an effective price of $0.104 per share as payment for the
$365,000 commitment fee and $10,000 placement agency fee related to the Standby
Equity Distribution Agreement. The Company also incurred additional costs of
$35,420 in fees to prepare and file the registration statement. During the year
ended July 31, 2004, the Company effected three draw downs of $250,000 each at
prices of $0.090, $0.065 and $0.059, which resulted in the issuance of
10,861,220 common shares and net proceeds of $689,399. In addition, the Company
incurred an additional $60,000 as a financing expense to advisors of the Standby
Equity Distribution Agreement. On May 19, 2005, this $15.0 million Standby
Equity Distribution Agreement was terminated by the parties.

On May 20, 2005, the Company entered into a Standby Equity Distribution
Agreement with Cornell Capital which provides for the potential issuance and
sale of up to $30.0 million of the Company's common stock to Cornell Capital.
This $30.0 million Standby Equity Distribution Agreement was terminated by the
parties on June 23, 2005 and replaced with a $160.0 million equity line of
credit.

Under the terms of the $160.0 million equity line of credit, the Company, at its
sole discretion, may draw down on this facility, from time to time over a period
of 24 months (or a five-year period if the Company files either an amendment to
the then effective registration statement or a new registration statement is
declared effective after the 24th and 48th month after June 23, 2005) after the
effective date of registration statement to be filed with Securities and
Exchange Commission or until Cornell Capital purchases $160.0 million of shares
of our common stock, whichever occurs first. As at the date of these financial
statements the Company does not have an effective registration statement (note
19(b)). As such, the Company cannot currently draw on this facility.

For each share of common stock purchased under the Standby Equity Distribution
Agreement, Cornell Capital will pay 98% of the lowest closing bid price of our
common stock on the OTC Bulletin Board for the five trading days immediately
following the date of the notice for the draw down. The amount of each advance
is subject to a maximum of $3.0 million per advance, with a minimum of five
trading days between advances. Cornell Capital intends to sell the shares
purchased under the Standby Equity Distribution Agreement at the then prevailing
market price. In addition, Cornell Capital may deduct the amount of any fees,
expenses and disbursements that the Company has not paid from any advance.


                                      F-30
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

11. Share capital (continued):

In addition, the Company paid Yorkville Advisors Management, LLC, the general
partner of Cornell Capital a cash fee of $16.0 million in connection with the
$160.0 million Standby Equity Distribution Agreement.

On June 2, 2005, the Company issued 75,188 shares at an effective price of
$0.133 per share as payment for a $10,000 placement agency fee related to the
Standby Equity Distribution Agreement. The Company also incurred additional
costs of $74,086 to prepare and file the registration statement. These
additional costs are being treated as deferred financing costs (note 12).

(e) Stock-based compensations plans:

At July 31, 2005, the Company had eight stock-based compensation plans that are
described below:

(i) Under the "2000 US Stock Incentive Plan" the Company may grant options to
its employees for up to 200,000 common shares.

(ii) Under the "2000 Stock Incentive Plan" the Company may grant options to its
employees for up to 800,000 common shares.

(iii) Under the "2002 US Stock Incentive Plan" the Company may grant options to
its employees for up to 100,000 common shares.

(iv) Under the "2002 Stock Incentive Plan" the Company may grant options to its
employees for up to 900,000 common shares.

(v) Under the "2003 US Stock Incentive Plan" the Company may grant options to
its employees for up to 2,000,000 common shares.

(vi) Under the "2003 Stock Incentive Plan" the Company may grant options to its
employees for up to 8,000,000 common shares.

(vii) Under the "2004 US Stock Incentive Plan" the Company may grant options to
its employees for up to 3,000,000 common shares.

(viii) Under the "2004 Stock Incentive Plan" the Company may grant options to
its employees for up to 50,000,000 common shares.

The options currently outstanding under the "2003 and 2004 US Stock Incentive
Plan" and the "2003 and 2004 Stock Incentive Plan" generally vest immediately.
The options currently outstanding under the "2000 and 2002 Stock Incentive Plan"
generally vest from two to four years, with the first 20% to 33% vesting at the
date of grant and the balance vesting annually at each anniversary date of the
grant thereafter. The exercise price of each option is based on the fair value
of the common stock at the date of grant. These options have a five year term.


                                      F-31
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

11. Share capital (continued):

<TABLE>
<CAPTION>
                                           2005                      2004                    2003
                                 -----------------------    ----------------------    --------------------
                                                Weighted                  Weighted                Weighted
                                                Average                   Average                 Average
                                                Exercise                  Exercise                Exercise
                                   Shares        Price        Shares       Price       Shares      Price
                                 -----------    --------    ----------    --------    ---------   --------
<S>                                <C>          <C>         <C>           <C>         <C>         <C>
Outstanding, beginning of year     8,469,800    $   0.63     1,714,400    $   2.54    1,677,250   $   3.08
  Options granted                 40,520,000        0.03     9,169,600        0.20      778,300       1.42
  Options exercised               (6,059,998)      (0.03)      (79,400)      (0.20)          --         --
  Options forfeited                 (957,000)      (1.01)   (2,334,800)      (0.38)    (741,150)     (2.80)
                                 -----------    --------    ----------    --------    ---------   --------
Outstanding, end of year          41,972,802    $   0.13     8,469,800    $   0.63    1,714,400   $   2.54
                                 ===========    ========    ==========    ========    =========   ========

<CAPTION>
                          Options outstanding            Options exercisable
                  -----------------------------------   ----------------------
                                Weighted
                                 average     Weighted                 Weighted
                                remaining    average                  average
Range of            Number     contractual   exercise     Number      exercise
exercise prices   of shares       life        price     exercisable    price
---------------   ----------   -----------   --------   -----------   --------
<S>               <C>                 <C>    <C>         <C>          <C>
$0.03 - 0.04      34,260,002          4.42   $   0.03    34,060,002   $   0.03
$0.085 - 0.20      6,410,600          3.13       0.20     6,210,600       0.20
$0.52 - 1.00         136,134          2.46       0.60       136,134       0.60
$1.16 - 8.11       1,166,066          1.39       2.64     1,166,066       2.64
---------------   ----------   -----------   --------   -----------   --------
$0.85 - 6.76      41,972,802          4.13   $   0.13    41,572,802   $   0.13
===============   ==========   ===========   ========   ===========   ========
</TABLE>

Where options issued after January 18, 2001 have an exercise price in a currency
that is not either the (a) functional currency of the Company, or (b) the
currency in which the employee is paid, the options are to be accounted for as
variable plan options and compensation expense will be recorded equal to changes
in the market value of the underlying common shares at each reporting period.
The Company normally grants options in U.S. dollars when the functional currency
of the Company is the Canadian dollar. Most employees of the Company are paid in
either Canadian dollars or British pounds sterling. Accordingly, these employee
options are considered to be variable options.

The compensation expense for these variable options for the year ended July 31,
2005 is $4,018,075 (2004 - nil; 2003 - nil) and is recognized in the financial
statements as engineering, research and development, general and administrative
or marketing expense, based on the classification of the employee's salaries. In
addition, compensation expense is recognized to the extent that options are
granted having an exercise price less than the market price of the underlying
common stock on the date of grant.


                                      F-32
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

11. Share capital (continued):

(f) Warrants:

As at July 31, 2005, warrants outstanding were exercisable for 64,988,141 (2004
- 37,483,485) common shares of the Company. The warrants entitle the holders to
purchase common shares of the Company at prices ranging from $0.10 to $2.80 per
share and expire on various dates until June 22, 2010.

The exercise price of warrants issued were not less than the market price of the
Company's common shares at the date of issuance.

<TABLE>
<CAPTION>
                                           2005                       2004                       2003
                                 ------------------------   ------------------------   ------------------------
                                                Weighted-                  Weighted-                  Weighted-
                                                 average                    average                    average
                                                exercise                   exercise                   exercise
                                   Shares         price       Shares         price       Shares         price
                                 -----------    ---------   -----------    ---------   -----------    ---------
<S>                              <C>            <C>         <C>            <C>          <C>           <C>
Outstanding, beginning of year    37,483,485    $    0.20    32,154,507    $    0.38     2,030,317    $    3.13
Issued                            62,500,000         0.16    19,562,209         0.21    33,543,907         0.27
Exercised                        (34,884,744)        0.03   (12,463,231)        0.25    (3,300,000)        0.11
Expired                             (110,600)        1.70    (1,770,000)        3.30      (119,717)        2.00
                                 -----------    ---------   -----------    ---------   -----------    ---------
Oustanding, end of year           64,988,141    $    0.16    37,483,485    $    0.20    32,154,507    $    0.38
                                 ===========    =========   ===========    =========   ===========    =========
</TABLE>

On September 24, 2004, the holders of the discounted convertible debentures
exercised 18,226,274 warrants at $0.03 for gross proceeds of $546,788, and net
proceeds of $499,916. The fair value of these warrants of $1,017,299 initially
recorded as additional paid-in-capital is reclassified to share capital on
exercise of warrants. On May 5, 2005, a warrant holder exercised 714,286
warrants at an exercise price of $0.10 for gross proceeds of $71,429.

In addition, during the year, the Company received notices of a cashless warrant
exercise from certain holders of the convertible debentures to exercise their
outstanding 15,944,184 warrants. The exercise price of these warrants ranged
from $0.028 to $0.10, for a fair value of $1,026,617. In response, the Company
issued 13,364,073 shares of common stock to the warrant holders.

For the year ended July 31, 2004, the Company realized gross cash proceeds of
$2,179,385 and net cash proceeds of $2,101,015 from the exercise of warrants as
follows:

(i) On April 30, 2004, 500,000 warrants were exercised at $0.104 resulting in
gross cash proceeds of $52,000 and net cash proceeds of $49,920.


                                      F-33
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

11. Share capital (continued):

(ii) On October 27, 2003, the Company offered warrant holders who were issued
warrants with an exercise price of $0.2645 on May 15, 2003 in connection with
the convertible debenture a reduction in their exercise price to $0.20 plus one
additional warrant at $0.20 if they exercised their warrants. A total of
3,290,596 warrants were exercised. In addition, the Company granted 194,000
additional warrants exercisable at a price of $0.20 per share for five years to
a shareholder who also exercised their warrants. On November 6, 2003, the
exercise price of the 7,478,635 warrants initially granted at $0.2645 were
reduced to $0.1771 and were exercised for gross proceeds of $1,324,466.

(iii) During October and November 2003, the fair value of the 10,963,231
warrants of $1,601,970 initially recorded as additional paid in capital was
reclassified to share capital on exercise of the warrants.

(iv) On May 20, 2004, the Company realized gross cash proceeds of $120,000 from
the exercise of 1,000,000 warrants at an exercise price of $0.12 per share.

12. Deferred financing costs:

<TABLE>
<CAPTION>
                                                          2005               2004
                                                      ------------       ------------
<S>                                                   <C>                <C>
$160 million equity line of credit (note 11 (d))
  Commitment fee                                      $ 16,000,000       $         --
  Professional fees                                         74,086                 --
  Agent placement fee                                       10,000                 --
                                                      ------------       ------------
                                                        16,084,086                 --

$30 million 10% convertible debentures (note 9)
  Commissions                                            2,130,000                 --
  Professional fees                                         35,500                 --
                                                      ------------       ------------
                                                         2,165,500                 --

Discounted convertible debenture (note 9)
  Commissions                                              218,000            218,000
  Fair value of agents warrants                             15,699             15,699
  Professional fees                                         46,894             46,894
                                                      ------------       ------------
                                                           280,593            280,593
                                                      ------------       ------------

                                                        18,530,179            280,593
  Amortization                                            (320,899)          (123,573)
                                                      ------------       ------------

                                                      ------------       ------------
                                                      $ 18,209,280       $    157,020
                                                      ============       ============
</TABLE>

The deferred charges related to the discounted convertible debenture are being
amortized over the maturity period. During the year, $197,326 (2004 - $123,573)
was amortized and charged to interest expense. The fees with respect to the
$160.0 million equity line of credit have been deferred pending completion of
the registration statement process.


                                      F-34
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

13. Net interest and financing expenses:

<TABLE>
<CAPTION>
      --------------------------------------------------------------------------------------------
                                                              2005            2004            2003
                                                        ------------------------------------------
<S>                                                     <C>             <C>             <C>
      Interest accreted on convertible debentures       $1,823,026      $  578,363      $3,317,457
      Short-term debt interest expense and finance
      charges                                              112,274       1,206,762           3,513
      Interest paid on convertible debentures              942,892       1,777,721         101,535
      Amortization of deferred financing fees              852,289         468,974         300,000
                                                        ------------------------------------------

                                                        $3,730,481      $4,031,820      $3,722,505
      --------------------------------------------------------------------------------------------
</TABLE>

14. Financial instruments:

(a) Credit risk:

The majority of the Company's activities are concentrated in the automotive
industry and sales are primarily to a few major customers (note 18). To reduce
credit risk, management performs ongoing credit evaluations of its customers'
financial condition. The Company maintains reserves for potential credit losses
based on a risk assessment of its customers.

(b) Foreign currency risk:

The Company operates internationally which gives rise to the risk that cash
flows may be adversely impacted by exchange rate fluctuations. To July 31, 2005,
the Company has not entered into derivatives or other hedging instruments to
mitigate its foreign exchange risk.

15. Related party transactions:

(a) Cornell Capital is considered a related party from a financial perspective
due to the number and size of the financial transactions that were entered into
with the Company during the year ended July 31, 2005. Cornell Capital does not
have influence over the Company's operating or investing activities. During the
year ended July 31, 2005, the Company paid fees of $19,658,134 to Cornell
Capital and its affiliates (2004-$571,500) and the Company had the following
financial instruments outstanding with Cornell Capital as at July 31, 2005:

Financial Instrument                    Amount
-------------------------------------   --------------
Standby equity distribution agreement   $160.0 million
Preferred shares                        $4.0 million
Convertible debentures                  $31.5 million

(b) During the year ended July 31, 2005, the Company incurred expenses of
$60,000 (2004 - nil; 2003 - nil) for a research report to a company in which a
director of the Company has significant influence.

16. Income taxes:

(a) Effective tax rate:

The effective income tax rates differ from the Canadian statutory rates for the
following reasons:

<TABLE>
<CAPTION>
                                                          2005               2004               2003
                                                      -----------        -----------        -----------
<S>                                                   <C>                <C>                <C>
      Canadian statutory tax rate                            35.6%              36.4%              38.5%
      Computed tax expense                            $(5,087,838)       $(3,999,277)       $(3,817,132)
      Foreign losses tax affected at lower rates          103,937              5,162            192,027
      Reduction in effective tax rates                         --           (339,481)                --
      Permanent and other differences                   2,941,029          1,352,012            387,870
      Change in valuation allowance                     2,042,872          2,981,584          3,237,235
                                                      -----------        -----------        -----------
                                                      $        --        $        --        $        --
                                                      ===========        ===========        ===========
</TABLE>


                                      F-35
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

16. Income taxes (continued):

(b) Deferred tax assets and liabilities:

<TABLE>
<CAPTION>
                                                            2005               2004
                                                        ------------       ------------
<S>                                                     <C>                <C>
      Deferred tax assets:
      Fixed and other assets, accounting
        depreciation in excess of tax                   $  1,642,001       $  1,220,775
      Loss carryforwards                                  17,812,576         16,534,418
      Scientific research and development expenses           413,060            382,971
      Share issue costs                                      721,844            549,499
      Others                                                 178,261             37,207
                                                        ------------       ------------
      Total gross deferred tax assets                     20,767,742         18,724,870
      Valuation allowance                                (20,767,742)       (18,724,870)
                                                        ------------       ------------
      Net deferred tax assets                           $         --       $         --
                                                        ============       ============
</TABLE>

In assessing the realizability of future tax assets, Management considers
whether it is more likely than not that some portion or all of the future tax
assets will be realized. The ultimate realization of the future tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible.

For Canadian tax purposes, the Company has approximately $33,600,000 of
non-capital losses for income tax purposes available at July 31, 2005 to reduce
taxable income of future years. These losses will expire as follows:

      2006      $ 8,200,000
      2007          200,000
      2008        4,700,000
      2009        6,000,000
      2010        5,300,000
      2011        6,000,000
      2012        3,200,000
                $33,600,000

Additionally, for Canadian tax purposes, the Company has scientific research and
development expenditures of $1,160,000 available to reduce future taxable income
indefinitely.


                                      F-36
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

16. Income taxes (continued):

For United States tax purposes, the Company has approximately $6,200,000 of net
operating losses for income tax purposes available at July 31, 2005 to reduce
taxable income of future years. These losses will expire as follows:

      2012      $  100,000
      2013       1,000,000
      2019       1,800,000
      2020       1,300,000
      2021         400,000
      2022         800,000
      2023         300,000
      2024         400,000
      2025         100,000
                $6,200,000

For United Kingdom tax purposes, the Company has approximately $11,100,000 of
non-capital losses for income tax purposes available at July 31, 2005 to reduce
taxable income of future years. These losses may be carried forward
indefinitely.

17. Earnings (loss) per share:

The weighted average number of shares outstanding used in the computation of
earnings (loss) per share were as follows:

<TABLE>
<CAPTION>
      -------------------------------------------------------------------------------------------------
                                                             2005             2004             2003
      -------------------------------------------------------------------------------------------------
<S>                                                       <C>               <C>              <C>
      Weighted-average shares used in computation of      222,981,341       83,356,095       26,771,427
      basic earnings (loss) per share

      Potentially dilutive securities excluded in
      calculation of loss per share                       846,988,048       98,697,014       48,997,115
      -------------------------------------------------------------------------------------------------
</TABLE>

Diluted  loss per share has not been  presented  since the  Company is in a loss
position and the effect of the Company's stock options,  debentures and warrants
are anti-dilutive.

18. Commitments and contingencies:

(a) The Company is committed to the following payments under operating leases,
and service agreements for premises and certain equipment and consultants:

      2006      1,308,227
      2007        498,351
      2008        449,424
      2009        447,858
      2010        444,968
      2011        111,007


                                      F-37
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

18. Commitments and contingencies (continued):

(b) Product warranties:

The Company provides for estimated warranty costs at the time of product sale.
Warranty expense accruals are based on best estimate with reference to
historical claims experience. As warranty estimates are based on forecasts,
actual claim costs may differ from amounts provided. An analysis of changes in
liability for product warranties follows:

      Balance, August 1, 2003      $ 20,438

      Provision increase             85,934
      Expenditures                  (16,512)
                                   --------
      Balance, July 31, 2004         89,860

      Provision increase             15,856
      Expenditures                  (55,276)
                                   --------
      Balance, July 31, 2005       $ 50,440
                                   ========

19. Segmented information:

The Company operates in the wireless tire monitoring technology industry.
Management of the Company makes decisions about allocating resources based on
this one operating segment. Geographic information is as follows:

Revenue from external customers:

<TABLE>
<CAPTION>
                                         Revenue from
                                      external customers
                          ------------------------------------------
                             2005            2004            2003
                          ----------      ----------      ----------
<S>                       <C>             <C>             <C>
      United Kingdom      $  746,889      $  225,517      $  261,905
      United States          520,615         651,089         509,228
      China                   15,998         514,365         243,866
      Italy                       --              --         391,169
      Other                  179,958         267,308         396,428
                          ----------      ----------      ----------
                          $1,463,460      $1,658,279      $1,802,596
                          ==========      ==========      ==========
</TABLE>

As at July 31, 2005, 52% (2004-53%) of the Company's fixed assets were in
Canada, 18% (2004-17%) were in Europe and 30% were in Korea (2004-30%).

Major customers, representing 10% or more of total sales, include:

                        2005           2004           2003
                      --------       --------       --------
      Customer A      $546,423       $    <10%      $    <10%
      Customer B       234,244            <10%           <10%
      Customer C           <10%       484,433            <10%
      Customer D           <10%           <10%       391,169


                                      F-38
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

20. Subsequent events:

(a) Subsequent to year-end the holder of the 8% convertible debenture converted
the balance of its $115,000 and interest thereon into common shares of the
Company.

(b) On September 23, 2005 the Company formally requested that a Registration
Statement on Form SB-2 previously filed with the SEC on July 22, 2005 be
withdrawn. The Registration Statement was not previously declared effective by
the SEC and no securities were sold pursuant to the Registration Statement. The
Company's decision to withdraw the Registration Statement resulted in the
non-compliance of certain terms and conditions of the outstanding convertible
debentures and preferred share agreements. The principal holder has, in writing
by date of October 7, 2005, agreed that the Company is not in default of these
agreements pending the filing of a new registration statement and the principal
holder waives its rights under the default provisions affected by this
non-compliance.

21. Contingencies

The Company has settled a series of discounted convertible debentures with the
exception of one with a carrying value of $91,726. On April 21, 2005, one holder
of this discounted debenture in the amount of $91,726 provided the Company with
notice of a summons with the Supreme Court of the State of New York. The holder
is alleging that the Company wrongfully refused to honor its request to convert
this debt into 9,268,875 common shares of the Company. The holder is seeking
$4,393,360 plus interest from April 25, 2005 and attorneys fees. It is not
possible to determine whether the debenture holder will be successful in their
legal action. The Company has recorded a liability of $128,259 which includes
the outstanding principal, premium and penalties.

22. Differences between Canadian and United States Generally Accepted Accounting
Principles and Practices:

These consolidated financial statements have been prepared in accordance with
accounting principles and practices generally accepted in the United States
("U.S. GAAP") which differ in certain respects from those principles and
practices that the Company would have followed had its consolidated financial
statements been prepared in accordance with accounting principles and practices
generally accepted in Canada ("Canadian GAAP").

(a) Under U.S. GAAP, the adoption of U.S. dollar in 2001 as reporting currency
was implemented retroactively, such that prior period financial statements were
translated under the current rate method using foreign exchange rates in effect
on those dates. Under Canadian GAAP, a change in reporting currency is
implemented by translating all prior year financial statement amounts at the
foreign exchange rate on the date of change in reporting currency, which was
July 31, 2001. As a result, there is a difference in share capital, deficit and
cumulative translation adjustment amount under Canadian GAAP as compared to U.S.
GAAP.


                                      F-39
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

22. Differences between Canadian and United States Generally Accepted Accounting
Principles and Practices continued:

(b) Under U.S. GAAP, the Company has elected to continue to apply the guidance
set out in Accounting Principles Board Opinion No. 25, "Accounting for Stock
Issued to Employees" ("APB 25") and related interpretation in accounting for its
employee stock option. As the Company grants options with an exercise price not
less than the market value of the underlying common shares on the date of grant,
no compensation expense is required to be recognized under APB 25. If the
exercise price of employee stock option award is not fixed in the functional
currency of the Company or in the currency the employee is paid, the award is
accounted for as variable award until the award is exercised, forfeited, or
expires unexercised. The Company measures compensation expense as the amount by
which the quoted market value of the common shares of the Company's common stock
covered by the grant exceeds the option price, with changes in the market price
included in the measurement of loss.

Prior to 2003, under Canadian GAAP, no compensation was recorded for employee
options. Subsequent to August 1, 2003, the Company elected to use the fair-value
based method under Canadian GAAP, on a prospective basis, to record compensation
expense for options. Had the Company determined compensation expense for option
grants made to employees after July 31, 2002 based on the fair values at grant
dates of the stock options consistent with the fair value method, the Company's
loss and loss per share would have been as follows:

<TABLE>
<CAPTION>
                                                       2005               2004               2003
                                                  -------------      -------------      -------------
<S>                                               <C>                <C>                <C>
Net loss:
As reported in accordance with Canadian GAAP      $ (12,037,306)     $  (9,082,381)     $  (6,552,235)
Stock-based compensation expense
  included in reported net loss                       1,089,282          1,130,170                 --
Stock-based compensation expense
  determined under fair value
  based method for all awards                        (1,101,411)        (1,257,378)          (458,819)
                                                  -------------      -------------      -------------

Pro forma                                         $ (12,049,435)     $  (9,209,589)      $ (7,011,05)
                                                  =============      =============      =============

Basic and diluted loss per share:
  As reported                                     $       (0.05)     $       (0.11)     $       (0.24)
  Pro forma                                               (0.05)             (0.11)             (0.26)
                                                  =============      =============      =============
</TABLE>


                                      F-40
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

22. Differences between Canadian and United States Generally Accepted Accounting
Principles and Practices (continued):

(c) Under U.S. GAAP, the proceeds from the issuance of convertible debentures
with detachable warrants are allocated to the fair value of warrants issued and
intrinsic value of beneficial conversion feature. The remaining proceeds are
allocated to debt which is being accreted to the redemption value of the
convertible debentures over the maturity period. On the date of conversion of
debt to equity, the difference between the carrying amount and redemption amount
is charged to statement of operations as interest expense.

Under Canadian GAAP, the proceeds from the issuance of convertible debentures
with detachable warrants are allocated to the warrants issued and the conversion
feature based on their fair values. The remaining proceeds are allocated to debt
which is then being accreted to the redemption value of the convertible
debentures over the maturity period. On the date of conversion of debt to
equity, the carrying value of debt is reclassified to equity with no additional
interest accretion. When the Company has the option of repaying the convertible
debentures in cash or its common shares, the entire principal amount of is
recorded as equity. The principal equity is accreted to the redemption value of
the convertible debentures over the maturity period and is charged to deficit.

(d) Under U.S. GAAP, the discount on convertible debt is netted against the
value of debenture, and debt issuance cost is recorded as deferred financing
cost and is amortized over the maturity period. Under Canadian GAAP, the
discount is recorded as deferred financing cost and is being amortized over the
maturity period. Debt issuance cost is charged to equity.

(e) For U.S. GAAP, on settlement of a debenture, a gain was recorded in the
statement of operations of $1,822,033 and a charge to retained earnings was
recorded for the same amount (note 9(c)). For Canadian GAAP, no gain arises,
since the carrying value of liability and equity component of the debenture is
the same as the allocated fair values between liability and equity of the
consideration paid.

<TABLE>
<CAPTION>
                                                       2005                              2004
                                          -----------------------------     -----------------------------
Consolidated                                Canadian                          Canadian
balance sheets                                GAAP          U.S. GAAP           GAAP          U.S. GAAP
------------------------------------      ------------     ------------     ------------     ------------
<S>                                       <C>              <C>              <C>              <C>
Current assets                            $ 13,292,487     $ 13,292,487     $  3,807,743     $  3,807,743
Capital assets                                 716,763          716,763          824,616          824,616
Deferred financing costs (d)                16,206,086       18,209,280          443,016          157,020
Other assets                                 1,066,013        1,066,013        2,147,749        2,147,749
Current liabilities (c)                      1,649,690        5,781,918        2,804,081        3,075,338
Long term convertible debentures (c)         1,272,123       17,118,667                1          395,574
Preferred shares subject to
  mandatory redemption                               1                1               --               --
Stockholders' equity                        28,359,535       10,383,957        4,419,042        3,466,216
                                          ============     ============     ============     ============
</TABLE>


                                      F-41
<PAGE>

SMARTIRE SYSTEMS INC.
Notes to Consolidated Financial Statements
(Expressed in United States dollars)
(Prepared in accordance with U.S. generally accepted accounting principles)

Years ended July 31, 2005, 2004 and 2003

22. Differences between Canadian and United States Generally Accepted Accounting
Principles and Practices (continued):

<TABLE>
<CAPTION>
                                                       2005               2004               2003
                                                   ------------       ------------       ------------
<S>                                                <C>                <C>                <C>
Net loss in accordance with US GAAP                $(14,291,861)      $(10,987,026)      $ (9,914,629)
Effects of difference in accounting for:
  Stock based compensation expense under
    US GAAP (b)                                       4,018,075                 --             17,005
  Stock based compensation
    (recovery) under Canadian GAAP (b)               (1,089,282)        (1,130,170)                --
  Interest accretion and amortization
    of debenture finance costs recorded
    under US GAAP (c)(d)                              2,689,712          3,360,389          3,359,977
  Interest accretion and amortization
    of debenture finance cost under
    Canadian GAAP (d)                                (1,541,917)          (325,574)           (14,588)
  Gain on settlement of convertible debt (d)         (1,822,033)                --                 --
                                                   ------------       ------------       ------------

  Net loss in accordance with
    Canadian GAAP                                   (12,037,306)        (9,082,381)        (6,552,235)
  Beginning deficit in accordance
    with Canadian GAAP                              (51,971,332)       (41,762,812)       (35,210,577)
  Interest on convertible debentures
    and amortization of financing charges (d)        (1,055,763)        (1,126,239)                --
                                                   ------------       ------------       ------------
  Ending deficit in accordance with
    Canadian GAAP                                   (65,064,401)       (51,971,332)       (41,762,812)
                                                   ============       ============       ============
  Basic and diluted loss per
    share (in accordance with Canadian GAAP)              (0.05)             (0.11)             (0.24)
</TABLE>

23. Comparative figures:

Certain figures have been reclassified to conform to the financial presentation
adopted for the current year.


                                      F-42