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

                             FORM 10-KSB (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
$.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

Portions of the definitive Proxy Statement to be filed within 120 days of July
31, 2005, pursuant to Regulation 14A under the Securities Exchange Act of 1934,
are incorporated by reference into Part III hereof .

                                      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 Issuer Purchases of Equity Securities            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                                                                      27

Item 13.  Exhibits                                                            27


<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.

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.


                                                                               3
<PAGE>

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.

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


                                                                               4
<PAGE>

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. HACO was recently
purchased by Hyundai and Siemens (one of our competitors). As a result of this
transaction, HACO has notified us of their intent 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.

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.


                                                                               5
<PAGE>

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.

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.


                                                                               6
<PAGE>

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.

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


                                                                               7
<PAGE>

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.

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.


                                                                               8
<PAGE>

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.

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 TPMSSs 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.


                                                                               9
<PAGE>

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.

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.


                                                                              10
<PAGE>

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.

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.


                                                                              11
<PAGE>

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.

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.


                                                                              12
<PAGE>

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

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. The 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


                                                                              13
<PAGE>

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
wheter 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>
Equity compensation plans            4,950,000                       $0.11                       696,400
approved by
securityholders
----------------------------------------------------------------------------------------------------------------
Equity compensation plans           103,040,943                      $0.15                      1,649,890
not approved by
securityholders
----------------------------------------------------------------------------------------------------------------
Total                               107,990,943                      $0.15                      2,346,290
================================================================================================================
</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

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


                                       16
<PAGE>

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:

      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.


                                                                              17
<PAGE>

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

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.


                                                                              18
<PAGE>

Foreign exchange gain

      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.


                                       21
<PAGE>

      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:

      (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.


                                       22
<PAGE>

      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.

      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 u

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 within 90 days prior to the
date of filing of 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.

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

The information required by PART III other than Exhibits is incorporated by
reference from information contained in SmarTire System Inc.'s definitive Proxy
Statement to be filed .

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".


                                                                              27
<PAGE>

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.

All Other 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 Campbell Saunders &
Co. were $8,243 and $5,523, respectively.

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)

   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)


                                                                              28
<PAGE>

   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)

   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)


                                                                              29
<PAGE>

   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)

   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)


                                                                              30
<PAGE>

   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)

   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)


                                                                              31
<PAGE>

   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)

   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)


                                                                              32
<PAGE>

   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)

   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)


                                                                              33
<PAGE>

   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)

   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 **

   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**


                                                                              34
<PAGE>

            ** 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.

(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.


                                                                              35
<PAGE>

(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.

(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
<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
                            --------------------------------------
                            Robert V. Rudman, CA
                            President, Chairman and
                            Chief Executive Officer

                        Date: October 28, 2005

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 October 28, 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, CEO,
                            (Principal Executive Officer)


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


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


                                                                              37
<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 17)
Subsequent  events (note 19)
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                      (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 16)                                        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>
                                                                     $             $              $              $

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 (SEDA) will be
            amortized into  additional  paid-in  capital as the Company draws on
            the SEDA.

      (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.

<TABLE>
<CAPTION>
                                                       2005         2004         2003
                                                    ----------   ----------   ----------
            <S>                                     <C>          <C>          <C>
            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
                                                    ==========   ==========   ==========
</TABLE>


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

<TABLE>
<CAPTION>
                                                              2005    2004    2003
                                                             -----   -----   -----
            <S>                                              <C>     <C>     <C>
            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
                                                             =====   =====   =====
</TABLE>


                                      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:

                                                   Accumulated    Net book
      2005                               Cost      amortization    Value
      ------------------------------  ----------   ------------   --------
      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
                                      ==========   ============   ========


                                                   Accumulated    Net book
      2004                               Cost      amortization    Value
      ------------------------------  ----------   ------------   --------
      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
                                      ==========   ============   ========


                                      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
                                                ==========   ============   ==========
</TABLE>


<TABLE>
<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 March 22, 2005,  the Company  repaid the  $2,500,000  convertible
            debenture.  For  accounting  purposes,  the  consideration  paid was
            allocated  between the equity and liability  components based on the
            intrinsic  value of the beneficial  conversion  option as equity and
            the remaining  amount as liability at the date of  transaction.  The
            difference  between  the  carrying  value of  liability  and  equity
            components and the fair value of the consideration  paid was charged
            to income  and  deficit  respectively.  This  resulted  in a gain on
            settlement  of  $1,822,003   being  recorded  in  the  statement  of
            operations and a charge to deficit of the same amount.

      (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.

            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
                                       ===========    ========    ==========    ========    =========   ========
</TABLE>


<TABLE>
<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.   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.

14.   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.

15.   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

--------------------------------------------------------------------------------

15.   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

--------------------------------------------------------------------------------

15.   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.

16.   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 basic earnings (loss) per share          222,981,341   83,356,095   26,771,427
                                                    -----------   ----------   ----------
</TABLE>

      Diluted  weighted-average  number of common  shares and  diluted  earnings
      (loss ) per share have 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.

17.   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

--------------------------------------------------------------------------------

17.   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
                                      ========


18.   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:

                                   Revenue from
                                external customers
                       ------------------------------------
                          2005         2004         2003
                       ----------   ----------   ----------
      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
                       ==========   ==========   ==========


      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

--------------------------------------------------------------------------------

19.   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.

20.   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.

21.   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

--------------------------------------------------------------------------------

21.   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

--------------------------------------------------------------------------------

21.   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

--------------------------------------------------------------------------------

21.   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>


22.   Comparative figures:

      Certain  figures  have  been  reclassified  to  conform  to the  financial
      presentation adopted for the current year.


                                      F-42