**U.S.
      SECURITIES AND EXCHANGE COMMISSION**


WASHINGTON,
      D.C. 20549





**FORM
      10-KSB/A Amendment No. 2**





(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
              incorporation
                or organization)
            (I.R.S.
                Employer
              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.





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





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





Transitional
      Small Business Disclosure Format (check one):


|_|
      Yes
      |X| No





**STATEMENT
      REGARDING THIS REPORT**





We
      are
      amending our Form 10-KSB/A for the year ended July 31, 2005 as previously filed
      on February 27, 2006.





We
      have
      had extensive discussions with the Staff of the Securities and Exchange
      Commission, relating to our accounting for the extinguishment of certain of
      our
      convertible debentures. The comments relate to our accounting for the gain
      recorded upon the extinguishment of $2.5 million, 5% convertible debentures
      with
      respect to guidance in EITF 00-27, Issue 12(b). As a result of these
      discussions., we have amended the conversion price used in the calculation
      of
      the accounting gain to reflect that of the closing bid price of our common
      stock
      on the date of extinguishment. We have modified the accounting and footnote
      disclosure related to the extinguishment of the debenture
      accordingly.





The
      effect of the change in methodology for accounting for the (non-cash) gain
      on
      extinguishment of debt on our consolidated statement of operations for the
      year
      ended July 31, 2005, was a decrease in the gain on settlement of convertible
      debt of $1,828,357 which
      resulted in a corresponding increase in our net loss of $1,828,357 and
      a
      reduction in the charge to retained earnings for the settlement. Basic
      and diluted loss per share for the year ended July 31, 2005, increased by $0.01
      to $0.07 per share. The effect on our consolidated balance sheet as of July
      31,
      2005 was an increase in our additional paid in capital and accumulated deficit
      of $6,324 respectively.





Comparative
      figures as at July 31, 2004, and for the years ended July 31, 2004 and July
      31,
      2003 remain unchanged.





In
      all
      other material respects, this Amended Annual Report on Form 10-KSB/A is
      unchanged from the Annual Report on Form 10-KSB/A previously filed by the
      Company on February 27, 2006.








INDEXPage
            
            
            PageNumber
            
            
            NumberPART
                I
            
            
            1Item
                1.
            Description
                of Business
            7Item
                2.
            Description
                of Property
            7Item
                3.
            Legal
                Proceedings
            7Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            7PART
                II
            
            
            7Item
                5.
            Market
                for Common Equity, Related Stockholder Mattersand
                Small Business
            7Item
                6.
            Management's
                Discussion and Analysis or Plan of Operation
            9Item
                7.
            Financial
                Statements
            16Item
                8.
            Changes
                In and Disagreements With Accountants onAccounting
                and Financial Disclosure
            16Item
                8A.
            Controls
                and Procedures
            16Item
                8B.
            Other
                Information
            16PART
                III
            
            
            16Item
                9.
            Directors,
                Executive Officers and Control Persons; compliancewith
                Section 16(a) of the Exchange Act
            16Item
                10.
            Executive
                Compensation
            17Item
                11.
            Security
                Ownership of Certain Beneficial Owners and Managementand
                Related Stockholder Matters
            20Item
                12.
            Certain
                Relationships and Related Transactions
            22Item
                13.
            Exhibits
            22Item
                14.
            Principal
                Accounting Fees and Services
            27









**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.





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.





-1-





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
      the defect was to recall 100% of affected sensor/transmitter items from the
      field and replace both recalled and inventory sensor/transmitters with
      sensor/transmitters previously manufactured by a different supplier that have
      been tested and known to use plastics that provide the required mechanical
      properties. Additionally we wish to ensure that transmitters are used only
      on
      rims with flat drop center wells (as originally designed for) and not curved.
      We
      took the following additional precautionary steps:





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


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




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





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





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





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





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





**Corporate
      Information**





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





**Government
      Regulations**





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





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





-2-





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.





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.





-3-
 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 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.





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.


-4-


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 TPMSs targeted directly at OEMs of commercial trucks,
      buses, agricultural, construction and recreational vehicles. In November, 2004,
      design validation testing and the initial pilot build of 300 units was
      completed. The product has completed design validation testing and has received
      regulatory radio approvals in Europe and North America. Production validation
      testing has now been completed. Vansco has now begun to manufacture the product
      for us. We currently sell this product to our lead customer for this product,
      Motor Coach Industries.





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





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





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





**Marketing**





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





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





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





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





**Competition**





Tire
      monitoring products can generally be divided between two basic types:


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





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





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





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


-5-


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.





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.


-6-


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.




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





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





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




**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".




-7-


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
              LOWJuly
                  31, 2005
              $0.18
              $0.09April
                  30, 2005
              $0.24
              $0.02January
                  31, 2005
              $0.04
              $0.03October
                  31, 2004
              $0.09
              $0.03July
                  31, 2004
              $0.06
              $0.05April
                  30, 2004
              $0.12
              $0.11January
                  31, 2004
              $0.20
              $0.19October
                  31, 2003
              $0.22
              $0.22




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.





**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.




Number
                  of SecuritiesNumber
                  of Securities to be Remaining
              
              Available
                  forIssued
                  Upon Exercise of
              Weighted-Average
                  Exercise
              Future
                  Issuance UnderOutstanding
                  Options,
              Price
                  of Outstanding
              Equity
                  Compensation PlansWarrants
                  and Rights
              Options,
                  Warrants and
              (Excluding
                  SecuritiesRights
              Reflected
                  in Column (a))Plan
                  Category
              (a)
              (b)
              (c)Equity
                  compensation plans
              4,950,000
              $0.11
              696,400approved
                  bysecurityholdersEquity
                  compensation plans
              103,040,943
              $0.15
              1,649,890not
                  approved bysecurityholdersTotal
              107,990,943
              $0.15
              2,346,290
 **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.


-8-





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





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





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




**RESULTS
      OF OPERATIONS**





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





**Revenue**





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





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





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





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





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





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




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





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





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





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





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





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





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





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





**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.





-9-


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




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





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





Depreciation
      and amortization





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





Interest
      and finance charges





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





**Interest
      Income**





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





Foreign
      exchange gain





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 $42,346 (as restated) 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.





-10-


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.




**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.





-11-


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.





**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 $75,138,474.
      Our net loss for fiscal year 2005 was $16,120,218 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 $16,120,218 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 $42,346. Decreases in non-cash working capital
      during this period amounted to $507,809. Non-cash working capital changes
      included increases in inventory and accounts receivable and decreases in prepaid
      expenses and in accounts payable and accrued liabilities. The net cash used
      in
      operating activities in fiscal year 2005 was $6,819,995. We may require
      subsequent financings to meet our operating cash flow requirements.





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





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





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





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





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





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





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





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





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





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





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





(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.





-12-


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





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





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





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





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





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





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





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





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





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





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.





-13-


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.





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
              $
                  2,000,000Engineering,
                  research and development
              1,700,000
              2,100,000General
                  and administrative
              2,200,000
              2,700,000Capital
                  Purchases
              60,000
              400,000Debt
                  repayment (1)
              3,300,000
              15,000,000General
                  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.





(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.





-14-


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 $75,138,474
      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.





**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.





-15-


**Off-Balance
      Sheet Arrangements**





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





o
      an
      obligation under a guarantee contract;


o
      a
      retained or contingent interest in assets transferred to the unconsolidated
      entity or similar arrangement that serves as credit, liquidity or market risk
      support to such entity for such assets;


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





**ITEM
      7. FINANCIAL STATEMENTS**





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





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





None.





**ITEM
      8A. CONTROLS AND PROCEDURES**





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





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





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





**ITEM
      8B. OTHER INFORMATION**





None.


**PART
      III**





**ITEM
      9. DIRECTORS, EXECUTIVE OFFICERS AND CONTROL PERSONS; COMPLIANCE WITH**


SECTION
      16(a) OF THE EXCHANGE ACT





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




Name
              Age
              PositionRobert
                  Rudman(1)
              [58]
              Director,
                  Chairman of the BoardAl
                  Kozak
              [56]
              President
                  and Chief Executive OfficerJeff
                  Finkelstein
              [44]
              Chief
                  Financial OfficerErwin
                  Bartz
              [44]
              Vice
                  President, Business DevelopmentShawn
                  Lammers
              [38]
              Vice
                  President, EngineeringWilliam
                  Cronin(1)(2)
              [58]
              DirectorMartin
                  Gannon(1)(2)
              [53]
              DirectorJohnny
                  Christiansen(2)
              [50]
              Director





(1)
      Member of the Audit Committee





(2)
      Member of the Compensation Committee





**Family
      Relationships**





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





-16-


**Involvement
      In Certain Legal Proceedings**





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





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





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





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





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





**Audit
      Committee Financial Expert**





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





Section
      16(a) Beneficial Ownership Reporting Compliance





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





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





**ITEM
      10. EXECUTIVE COMPENSATION**





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





o
      our
      chief executive officer;





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





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





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





-17-


**Summary
      Compensation Table**




SUMMARY
                  COMPENSATION TABLEAnnual
                  Compensation
              
              Long
                  Term CompensationAwards
              
              
              
              
              
              PayoutsName
                  and
              
              
              Year
              
              
              Salary
              
              
              Bonus
              
              
              
              
              
              Other
              
              
              Securities
              
              
              Restricted
              
              
              LTIP
              
              
              All
                  OtherPrincipal
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              Annual
              
              
              Underlying
              
              
              Shares
                  or
              
              
              Payouts
              
              
              CompensationPosition
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              Compen-
              
              
              Options/
              
              
              Restrictedsation
              
              
              SARs
                  Share(1)
              
              
              GrantedUnits(#)Robert
                  Rudman
              
              
              2005
              
              $
              215,568
              
              $
              67,417
              
              
              (2
              )
              $
              -
              
              
              5,840,000
              
              $
              -
              
              $
              -
              
              $
              49,847
              
              
              (3
              )Chairman
              
              
              2004
              
              $
              217,478
              
              $
              -
              
              
              
              
              $
              -
              
              
              1,079,500
              
              $
              -
              
              $
              -
              
              $
              -(Former
              
              
              2003
              
              $
              194,543
              
              $
              -
              
              
              
              
              $
              -
              
              
              232,000
              
              $
              -
              
              $
              -
              
              $
              -President
                  andChiefExecutiveOfficer)Al
                  Kozak
              
              
              2005
              
              $
              177,162
              
              $
              44,495
              
              
              (4
              )
              $
              -
              
              
              4,540,000
              
              $
              -
              
              $
              -
              
              $
              -President
                  and
              
              
              2004
              
              $
              164,983
              
              $
              -
              
              
              
              
              $
              -
              
              
              683,000
              
              $
              -
              
              $
              -
              
              $
              -Chief
              
              
              2003
              
              $
              147,585
              
              $
              -
              
              
              
              
              $
              -
              
              
              111,000
              
              $
              -
              
              $
              -
              
              $
              -ExecutiveOfficer(Former
                  ChiefOperatingOfficer)Jeff
              
              
              2005
              
              $
              125,748
              
              $
              30,338
              
              
              (5)
              
              $
              -
              
              
              3,000,000
              
              $
              -
              
              $
              -
              
              $
              -Finkelstein
              
              
              2004
              
              $
              97,490
              
              $
              -
              
              
              
              
              $
              -
              
              
              329,610
              
              $
              -
              
              $
              -
              
              $
              -Chief
              
              
              2003
              
              $
              82,788
              
              $
              -
              
              
              
              
              $
              -
              
              
              70,000
              
              $
              -
              
              $
              -
              
              $
              -FinancialOfficerErwin
                  Bartz
              
              
              2005
              
              $
              130,053
              
              $
              88,991
              
              
              (5
              )
              $
              -
              
              
              3,000,000
              
              $
              -
              
              $
              -
              
              $
              -Vice-
              
              
              2004
              
              $
              121,113
              
              $
              -
              
              
              
              
              $
              -
              
              
              390,000
              
              $
              -
              
              $
              -
              
              $
              -President,
              
              
              2003
              
              $
              108,341
              
              $
              -
              
              
              
              
              $
              -
              
              
              55,000
              
              $
              -
              
              $
              -
              
              $
              5,826
              
              
              (6
              )ProductManagementShawn
                  Lammers
              
              
              2005
              
              $
              120,452
              
              $
              30,338
              
              
              (5
              )
              $
              -
              
              
              3,000,000
              
              $
              -
              
              $
              -
              
              $
              -Vice-
              
              
              2004
              
              $
              108,739
              
              $
              -
              
              
              
              
              $
              -
              
              
              332,600
              
              $
              -
              
              $
              -
              
              $
              -President,
              
              
              2003
              
              $
              94,589
              
              $
              -
              
              
              
              
              $
              -
              
              
              15,100
              
              $
              -
              
              $
              -
              
              $
              -Engineering
 -18-


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





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





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





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





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





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





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





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





**Options/SAR
      Grants in the Last Fiscal Year**




Number
                  of Securities
              %
                  of TotalName
              Underlying
              Options/SARS
                  Granted
              Exercise
                  Price
              Expiration
                  DateOptions/SARS
                  Granted
              to
                  Employees in
              ($/share)(#)
              Fiscal
                  YearRobert
                  Rudman
              5,840,000
              14.41%
              $0.03
              December
                  19, 2009Al
                  Kozak
              4,540,000
              11.20%
              $0.03
              December
                  19, 2009Erwin
                  Bartz
              3,000,000
              7.40%
              $0.03
              December
                  19, 2009Shawn
                  Lammers
              3,000,000
              7.40%
              $0.03
              December
                  19, 2009Jeff
                  Finkelstein
              3,000,000
              7.40%
              $0.03
              December
                  19, 2009





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




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




Name
              Shares
              Value
              Number
                  of Securities
              Value
                  of UnexercisedAcquired
                  on
              Realized
                  Underlying
              Unexercised
              In-the-Money
                  Options/SARs atExercise
                  (#)
              ($)
              Options/SARs
                  at FY-End (#)
              FY-End
                  ($)Exercisable/Unexercisable
              Exercisable/UnexercisableRobert
                  Rudman
              None
              None
              3,555,000
              654,0803,555,000
              None
                  ExercisableExercisableAl
                  Kozak
              None
              None
              5,466,000
              508,4805,466,000
              None
                  ExercisableExercisableErwin
                  Bartz
              None
              None
              3,555,000
              336,0003,555,000
              None
                  ExercisableExercisableShawn
                  Lammers
              None
              None
              3,392,700
              336,0003,392,700
              None
                  ExercisableExercisableJeff
                  Finkelstein
              None
              None
              3,417,200
              336,0003,417,200
              None
                  ExercisableExercisable


-19-


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





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




Amount
                  and Nature of
              PercentageName
                  and Address of Beneficial Owner
              Beneficial
                  Ownership
              of
                  Class(1)William
                  Cronin
              1,779,746(2)
              *180
                  Concord DriveMadison,
                  Connecticut, USA 06443Martin
                  Gannon
              1,535,000(3)
              *1275
                  Post RoadFairfield,
                  Connecticut, USA 06824Johnny
                  Christiansen
              1,150,000(4)
              *Spurvestien
                  243189
                  Horten, NorwayRobert
                  Rudman
              9,687,911(5)
              3.33%#40
                  - 5740 Garrison RoadRichmond,
                  BC V7C 5E7Al
                  Kozak
              6,949,181(6)
              2.40%25841
                  116 AvenueMaple
                  Ridge, BC V4R 1Z6Jeff
                  Finkelstein
              4,434,210(7)
              1.54%3460
                  Regent StreetRichmond,
                  BC V7E 2N1Erwin
                  Bartz
              4,566,260(8)
              1.59%21
                  Arrow-Wood PlacePort
                  Moody, BC V3H 4E9Shawn
                  Lammers
              4,405,479(9)
              1.53%3460
                  Regent StreetRichmond,
                  BC V7E 2N1David
                  Warkentin
              Nil
                  (10)
              *20580
                  Powell Ave.Maple
                  Ridge, B.C. V2X 3G1Directors
                  and Executive Officers as a Group
              34,507,787(11)
              11.01%Cornell
                  Capital Partners, L.P.
              14,157,106(12)
              4.99%101
                  Hudson St., Suite 3606Jersey
                  City, NJ 07302







-20-


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





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





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





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





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





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





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





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





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





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





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





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





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





**Equity
      Compensation Plan Information**





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


Number
                  of SecuritiesNumber
                  of Securities to
              
              be
                  Remaining Available forIssued
                  Upon Exercise of
              Weighted-Average
                  Exercise
              Future
                  Issuance UnderOutstanding
                  Options,
              Price
                  of Outstanding
              Equity
                  Compensation PlansWarrants
                  and Rights
              Options,
                  Warrants and
              (Excluding
                  SecuritiesRights
              Reflected
                  in Column (a))Plan
                  Category
              (a)
              (b)
              (c)Equity
                  compensation plans
              4,950,000
              $0.11
              696,400approved
                  bysecurityholdersEquity
                  compensation plans
              103,040,943
              $0.15
              1,649,890not
                  approved bysecurityholdersTotal
              107,990,943
              $0.15
              2,346,290




-21-


**ITEM
      12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS**





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





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





The
      promoters of our company are our directors and officers.





**ITEM
      13. EXHIBITS**





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





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





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





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





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





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





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





Notes
      to
      Consolidated Financial Statements.





(b)
      Exhibits. See "Exhibit Index".




EXHIBITNUMBER  
                  DESCRIPTION3.1
                  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, 2003and
                  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
                  effectiveDecember
                  15, 2003, and attached Restated Articles of Incorporation of SmarTire
                  Systems Inc. dated December 11, 2003.(21)3.16
                  By-Law No. 1, dated February 6, 2003.(9)3.17
                  Certificate of Amendment to Articles of Incorporation of SmarTire
                  Systems
                  Inc.(28)3.18
                  Articles of Amendment to the Articles of Incorporation of SmarTire
                  Systems
                  Inc. with respect to the series A convertible stock
                  (29)10.1
                  Product Licensing Agreement dated May 5, 1998 between our Company
                  and
                  Advantage Enterprises Inc.(2)(3)
  -22-
 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. andHyundai
                  Autonet Co. Ltd.(12)10.14
                  Warrant Certificate dated May 16, 2003 registered in the name of
                  Dunwoody
                  Brokerage Services, Inc.(12)10.15
                  Stock Purchase Warrant dated May 16, 2003 registered in the name
                  of HPC
                  Capital Management.(12)10.16
                  Form of Stock Purchase Warrant dated May 27, 2003 issued to Impact
                  Capital
                  Partners Limited.(12)10.17
                  Securities Purchase Agreement, dated as of July 17, 2003, among
                  SmarTire
                  Systems Inc. and Palisades Master Fund, L.P.,Alpha
                  Capital AG, Crescent International Ltd., and Goldplate Investment
                  Partners.(13)10.18
                  Registration Rights Agreement, dated as of July 17, 2003, among
                  SmarTire
                  Systems Inc. and Palisades Master Fund, L.P.,Alpha
                  Capital AG, Crescent International Ltd., and Goldplate Investment
                  Partners.(13)10.19
                  Escrow Agreement, dated as of July 17, 2003, among SmarTire Systems
                  Inc.
                  and Palisades Master Fund, L.P., Alpha Capital AG,Crescent
                  International Ltd., Goldplate Investment Partners and Feldman Weinstein,
                  LLP, as escrow agent.(13)10.20
                  Form of 8% Convertible Debenture.(13)10.21
                  Form of Stock Purchase Warrant.(13)10.22
                  Stock Purchase Warrant, dated as of July 17, 2003, registered in
                  the name
                  of HPC Capital Management.(13)10.23
                  Common Stock Purchase Agreement, dated as of July 23, 2003, between
                  SmarTire Systems Inc. andTalisman
                  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 FeldmanWeinstein,
                  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)
  -23-
 10.37
                  Stock Purchase Warrant, dated October 27, 2003, registered in the
                  name of
                  Palisades Master Fund, L.P.(18)10.38
                  Letter Agreement dated November 6, 2003 between SmarTire Systems
                  Inc. and
                  Crescent International Ltd.(19)10.39
                  Stock Purchase Warrant, dated November 10, 2003, registered in
                  the name of
                  Crescent International Ltd. (19)10.40
                  Letter Agreement dated November 6, 2003 between SmarTire Systems
                  Inc. and
                  Alpha Capital AG.(19)10.41
                  Stock Purchase Warrant, November 10, 2003, registered in the name
                  of Alpha
                  Capital AG.(19)10.42
                  Letter Agreement dated November 6, 2003 between SmarTire Systems
                  Inc. and
                  Goldplate Investment Partners.(19)10.43
                  Stock Purchase Warrant, dated November 10, 2003, registered in
                  the name of
                  Goldplate Investment Partners.(19)10.44
                  Amending Letter Agreement dated November 10, 2003 between SmarTire
                  Systems
                  Inc. and HPC Capital Management.(19)10.45
                  Amended Stock Purchase Warrant, dated as of October 27, 2003, registered
                  in the name of HPC Capital Management.(19)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., AlphaCapital
                  AG, Crescent International Ltd., Goldplate Investment Partners,
                  Gamma
                  Opportunity Capital Partners, LP, PEF Advisors Ltd. AndBristol
                  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., AlphaCapital
                  AG, Crescent International Ltd., Goldplate Investment Partners,
                  Gamma
                  Opportunity Capital Partners, LP, PEF Advisors Ltd. AndBristol
                  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
                  InternationalLtd.,
                  Goldplate Investment Partners, Gamma Opportunity Capital Partners,
                  LP, PEF
                  Advisors Ltd., Bristol Investment Fund, Ltd. AndFeldman
                  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 CapitalManagement.(22)10.58
                  Stock Purchase Warrant, dated as of December 24, 2003, registered
                  in the
                  name of HPC Capital Management.(22)10.59
                  Amendment Agreement between SmarTire Systems Inc. and Talisman
                  Management
                  Limited dated January 21, 2004, amending theCommon
                  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 theRegistration
                  Management Limited dated January 21, 2004, amending the Registration
                  Rights Agreement between the parties datedas
                  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. datedas
                  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)
  -24-
 10.72
                  Securities Purchase Agreement dated December 15, 2004 by and between
                  SmarTire Systems, Inc. and Cornell Capital Partners,
                  L.P.(28)10.73
                  Registration Rights Agreement dated December 15, 2004 by and between
                  SmarTire Systems, Inc. and Cornell Capital Partners,
                  L.P.(28)10.74
                  Form of 5% Convertible Debenture SmarTire Systems
                  Inc.(28)10.75
                  Form of Common Stock Purchase Warrant of SmarTire Systems
                  Inc.(28)10.76
                  2004 Non-US US Stock Incentive Plan of SmarTire Systems
                  Inc.(28)10.77
                  Amendment Agreement dated February 3, 2005 between SmarTire Systems
                  Inc.
                  and Robert Rudman.(29)10.78
                  Amendment Agreement dated February 3, 2005 between SmarTire Systems
                  Inc.
                  and Allan Kozak.(29)10.79
                  Amendment Agreement dated February 3, 2005 between SmarTire Systems
                  Inc.
                  and Jeff Finkelstein.(29)
 10.80
                  Amendment Agreement dated February 3, 2005 between SmarTire Systems
                  Inc.
                  and Erwin Bartz.(29)10.81
                  Amendment Agreement dated February 3, 2005 between SmarTire Systems
                  Inc.
                  and Shawn Lammers.(29)10.82
                  Amendment Agreement dated February 3, 2005 between SmarTire Systems
                  Inc.
                  and William Cronin.(29)10.83
                  Amendment Agreement dated February 3, 2005 between SmarTire Systems
                  Inc.
                  and Martin Gannon.(29)10.84
                  Amendment Agreement dated February 3, 2005 between SmarTire Systems
                  Inc.
                  and Johnny Christiansen.(29)10.85
                  Registration Rights Agreement dated as of March 22, 2005 by and
                  between
                  SmarTire Systems, Inc. andCornell
                  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. andGamma
                  Opportunity Partners. (32)10.90
                  Redemption, settlement and release agreement dated May 4, 2005
                  by and
                  between SmarTire Systems Inc. and Alpha CapitalAktiengesellschaftt,
                  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. andCornell
                  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 HighgateHouse
                  Funds, Ltd.(33)10.100
                  Securities Purchase Agreement, dated as of June 23, 2005, among
                  SmarTire
                  Systems Inc., Cornell Capital Partners, LP and HighgateHouse
                  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
                  CornellCapital
                  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
                  SmarTireSystems
                  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
                  SmarTireSystems
                  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
                  SystemsInc.
                  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
                  SystemsInc.
                  to Cornell Capital Partners LP.
                  (34)
  -25-
 10.106
                  Amended and Restated Warrant to purchase 4,162,500 shares of common
                  stock,
                  dated as of July 21, 2005 issued by SmarTireSystems
                  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 andHighgate
                  House Funds, Ltd. (33)10.109
                  Management Agreement between our Company and Dave Warkentin dated
                  as of
                  August 8, 2005. (35)10.110
                  Marketing and distribution agreement with Dana Corporation dated
                  as of
                  October 12, 2005 (36)14.1
                  Code of Business Conduct and Ethics Compliance Program.
                  (16)21.1
                  Subsidiaries of the Small Business Issuer**23.1
                  Consent of KPMG LLP**31.1
                  Certification pursuant to section 302 of the Sarbanes-Oxley Act
                  of
                  2002**31.2
                  Certification pursuant to section 302 of the Sarbanes-Oxley Act
                  of
                  2002**32.1
                  Certification pursuant to 18 U.S.C. section 1350 as adopted pursuant
                  to
                  section 906 of the Sarbanes-Oxley Act of 2002**32.2
                  Certification pursuant to 18 U.S.C. section 1350 as adopted pursuant
                  to
                  section 906 of the Sarbanes-Oxley Act of
                  2002**
 **
          Filed
          herewith.





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





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





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





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





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





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





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





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





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





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





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





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





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





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





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





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





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





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





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





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





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





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





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





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


-26-


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




**ITEM
      14. PRINCIPAL ACCOUNTING FEES AND SERVICES.**





**Audit
      Fees**





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





**Audit-Related
      Fees**





None.





**Tax
      Fees**





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





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





**All
      Other Fees**





None.





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





o
      approved by the Company's audit committee; or





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





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





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





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





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





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





-27-


**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/ Leif Pedersen*
              *--------------------------------------*
              *Leif
                Pedersen, President and Chief Executive Officer*
              
              *Date:
                July 3, 2006*








Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of the registrant and in the
      capacities indicated on July 3, 2006:





**SIGNATURES**





*/s/
                Robert Rudman*
              *----------------------------------------------------*
              *Robert
                Rudman, Chairman*
              
              
              */s/
                Jeff Finkelstein*
              *----------------------------------------------------*
              *Jeff
                Finkelstein, Chief Financial Officer*
              *(Principal
                Financial and Accounting Officer)*
              
              
              */s/
                Leif Pedersen*
              *----------------------------------------------------*
              *Leif
                Pedersen, President and Chief Executive Officer*
              *(Principal
                Executive Officer)*
              
              
              */s/
                Martin Gannon*
              *----------------------------------------------------*
              *Martin
                Gannon, Director*
              
              
              */s/
                Johnny Christiansen*
              *----------------------------------------------------*
              *Johnny
                Christiansen, Director*
              
              
              */s/
                Bill Cronin*
              *----------------------------------------------------*
              *Bill
                Cronin, Director*








-28-





**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.




Our
      previous report dated September 16, 2005, except for
      notes 21(b), which is as of September 23, 2005, has been withdrawn and the
      financial statements have been revised as explained in note 1.





*/s/
                KPMG LLP*
              *Chartered
                Accountants*
              
              *Vancouver,
                Canada*
              *September
                16, 2005, except for note 21(b) which is as of September 23,
                2005, and 1 which is as of June 30, 2006.*








**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 3 to the financial statements. Our report to the shareholders dated
      September 16, 2005 except for notes 21(b) which is as of September 23, 2005
      and
      1 which is as of June 30, 2006, 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 notes 21(b) which is as of September 23,
                2005, and note 1 which is as of June 30, 2006.*










-29-


**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




2005
              
              
              2004(as
                  restated -
                note
                  1)AssetsCurrent assets:Cash and cash equivalents
              
              $
              10,059,763
              
              $
              76,670Receivables, net of allowance for doubtful accountsof $50,750 (2004 - nil)
              
              
              275,789
              
              
              259,508Inventory (note 5)
              
              
              2,798,747
              
              
              3,245,807Prepaid expenses
              
              
              158,188
              
              
              225,75813,292,487
              
              
              3,807,743Capital
                  assets (note 6)
              
              
              716,763
              
              
              824,616Deferred
                  financing costs (note 13)
              
              
              18,209,280
              
              
              157,020Other
                  assets (note 7)
              
              
              1,066,013
              
              
              2,147,749$
              33,284,543
              
              $
              6,937,128Liabilities
                  and Stockholders' EquityCurrent
                  liabilities:Accounts payable and accrued liabilities (note 8)
              
              $
              915,334
              
              $
              1,293,251Deferred revenue
              
              
              -
              
              
              10,830Promissory notes payable (note 9)
              
              
              -
              
              
              1,500,000Current portion of convertible debentures
              
              
              4,866,584
              
              
              271,2575,781,918
              
              
              3,075,338Convertible
                  debentures, net of equity portion of $10,111,082(2004 - $1,955,356) (note 10)
              
              
              17,118,667
              
              
              395,574Preferred
                  shares, net of equity portion of $3,999,999, subject tomandatory redemption, (July 31, 2004 - nil) (note 11)
              
              
              1
              
              
              -Stockholders'
                  equity:Share capital (note 12)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
              
              
              58,368,020Additional paid-in capital
              
              
              18,697,821
              
              
              4,417,323Deficit
              
              
              (75,138,474
              )
              
              (59,018,256
              )Accumulated other comprehensive loss
              
              
              128,893
              
              
              (300,871
              )10,383,957
              
              
              3,466,216$
              33,284,543
              
              
              6,937,128


Going
      concern (note 3)


Commitments
      and contingencies (notes 10(b) and 19)


Subsequent
      events (note 21)


See
      accompanying notes to consolidated financial statements.





Approved
      on behalf of the Board





*/s/
                Robert Rudman              /s/
                Martin
                Ganon*
              *-----------------------------------          -----------------------------------*
              *Robert
                V. Rudman           Martin
                Ganon*
              *Director                                                                
                Director*





-30-





**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**




2005
              
              
              2004
              
              
              2003(as
                  restated -
                note
                  1)Revenue
              
              $
              1,463,460
              
              $
              1,658,279
              
              $
              1,802,596Cost
                  of goods sold (including in the year endedJuly 31, 2005 inventory write-down of $500,000)
              
              
              1,634,780
              
              
              1,445,563
              
              
              1,387,365(171,320
              )
              
              212,716
              
              
              415,231Expenses:Depreciation and amortization
              
              
              1,497,250
              
              
              1,371,717
              
              
              1,236,870Engineering, research and development
              
              
              3,297,011
              
              
              1,654,690
              
              
              1,177,935General and administrative
              
              
              4,953,537
              
              
              2,338,758
              
              
              2,939,260Marketing
              
              
              2,540,730
              
              
              1,821,122
              
              
              1,448,32612,288,528
              
              
              7,186,287
              
              
              6,802,391Loss
                  from operations
              
              $
              (12,459,848
              )
              $
              (6,973,571
              )
              $
              (6,387,160
              )Other
                  earnings (expenses):Interest income
              
              
              39,241
              
              
              5,873
              
              
              2,835Net interest and financing expense (note 14)
              
              
              (3,779,151
              )
              
              (4,031,820
              )
              
              (3,722,505
              )Foreign exchange gain
              
              
              37,194
              
              
              12,492
              
              
              192,201Gain on settlement of convertible debt (note 10(c))
              
              
              42,346
              
              
              -
              
              
              -$
              (3,660,370
              )
              $
              (4,013,455
              )
              $
              (3,527,469
              )Loss
                  for the year
              
              
              (16,120,218
              )
              
              (10,987,026
              )
              
              (9,914,629
              )Basic
                  and diluted loss per share
              
              $
              (0.07
              )
              $
              (0.13
              )
              $
              (0.37
              )Weighted
                  average number of common shares used inthe computation of basic and diluted loss pershare (note 18)
              
              
              222,981,341
              
              
              83,356,095
              
              
              26,771,427





See
      accompanying notes to consolidated financial statements.





-31-


**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**


Common
                  Shares
              
              
              Additional
              
              
              Deferred
              
              
              Deficit
              
              
              Accumulated
              
              
              Stockholders'
              
              
              ComprehensiveShares
              
              
              Amount
              
              
              paid-in
              
              
              stock
              
              
              
              
              
              other
              
              
              equity
              
              
              income
                  (loss
              )Capital
              
              
              compensation
              
              
              
              
              
              comprehensiveloss$
              $
              
              
              
              
              $
              $
              
              
              
              
              $
              $
              
              $Balance
                  at July 31, 2002
              
              
              18,711,369
              
              
              42,514,482
              
              
              885,461
              
              
              (17,005
              )
              
              (38,116,601
              )
              
              (977,291
              )
              
              4,289,046
              
              
              (7,000,269
              )Issuance
                  of common shares for cash upon privateplacements, net of issuance costs of $289,172
              
              
              6,964,286
              
              
              1,810,828
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              1,810,828
              
              
              -Intrinsic
                  value of beneficial conversion feature ofconvertible debentures plus fair value of warrantsissued
              
              
              -
              
              
              -
              
              
              5,157,521
              
              
              -
              
              
              -
              
              
              -
              
              
              5,157,521
              
              
              -Conversion
                  of convertible debenture and accruedinterest to common shares net of issuance costsof $628,526
              
              
              24,381,133
              
              
              3,024,395
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              3,024,395
              
              
              -Exercise
                  of warrants for cash, net of issuance costsof $61,060
              
              
              3,300,000
              
              
              298,940
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              298,940
              
              
              -Issuance
                  of shares as fees on equity line of credit
              
              
              478,412
              
              
              300,000
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              300,000
              
              
              -Fair
                  value of agent's warrants issued on privateplacements and convertible debentures
              
              
              -
              
              
              -
              
              
              502,367
              
              
              -
              
              
              -
              
              
              -
              
              
              502,367
              
              
              -Debt
                  settlement through issuance of common shares
              
              
              353,865
              
              
              77,850
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              77,850
              
              
              -Issuance
                  of shares and repricing of warrants tosettle a potential claim
              
              
              850,000
              
              
              178,500
              
              
              136,544
              
              
              -
              
              
              -
              
              
              -
              
              
              315,044
              
              
              -Compensation
                  expense
              
              
              -
              
              
              -
              
              
              -
              
              
              17,005
              
              
              -
              
              
              -
              
              
              17,005
              
              
              -Loss
                  for the period
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (9,914,629
              )
              
              -
              
              
              (9,914,629
              )
              
              (9,914,629
              )Translation
                  adjustment
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              408,937
              
              
              408,937
              
              
              408,937Balance
                  as at July 31, 2003
              
              
              55,039,065
              
              
              48,204,995
              
              
              6,681,893
              
              
              -
              
              
              (48,031,230
              )
              
              (568,354
              )
              
              6,287,304
              
              
              (9,505,692
              )





See
      accompanying notes to consolidated financial statements





-32-


**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**


Common
                  Shares
              
              Additional
              
              
              Deficit
              
              
              Accumulated
              
              
              Stockholders'
              
              
              ComprehensiveShares
              
              
              Amount
              
              
              paid-in
              
              
              
              
              
              other
              
              
              equity
              
              
              income
                  (loss
              )capital
              
              
              
              
              
              comprehensiveloss$
              $
              
              
              
              
              $
              $
              
              
              
              
              $
              $Balance
                  at July 31, 2003
              
              
              55,039,065
              
              
              48,204,995
              
              
              6,681,893
              
              
              (48,031,230
              )
              
              (568,354
              )
              
              6,287,304
              
              
              (9,505,692
              )Exercise
                  of stock options for cash (note 12(e))
              
              
              79,400
              
              
              15,880
              
              
              -
              
              
              -
              
              
              -
              
              
              15,880
              
              
              -Intrinsice
                  value of beneficial conversion feature of convertible
                  debenturesplus fair value of warrants issued (note 10)
              
              
              -
              
              
              -
              
              
              2,457,023
              
              
              -
              
              
              -
              
              
              2,457,023
              
              
              -Conversion
                  of convertible debentures and accrued interest to commonshares allocated pro-rata between additional paid-in-capital and
                  commonshares, net of issuance costs of $156,133 (note 9)
              
              
              20,882,076
              
              
              5,344,961
              
              
              (2,788,277
              )
              
              -
              
              
              -
              
              
              2,556,684
              
              
              -Exercise
                  of warrants for cash, net of issuance costs of $78,370 (note
                  12(f))
              
              
              12,463,231
              
              
              3,702,985
              
              
              (1,601,970
              )
              
              -
              
              
              -
              
              
              2,101,015
              
              
              -Issuance
                  of shares and warrants as fees for services received (note
                  12(c))
              
              
              200,000
              
              
              34,800
              
              
              63,375
              
              
              -
              
              
              -
              
              
              98,175
              
              
              -Fair
                  value of agent's warrants issued on private placement of
                  convertibledebentures (note 9(b))
              
              
              -
              
              
              -
              
              
              15,699
              
              
              -
              
              
              -
              
              
              15,699
              
              
              -Issuance
                  of shares as fees on equity line of credit (note 12(d))
              
              
              3,605,769
              
              
              375,000
              
              
              (375,000
              )
              
              -
              
              
              -
              
              
              -
              
              
              -Cash
                  cost incurred for equity line (note 12(d))
              
              
              -
              
              
              -
              
              
              (35,420
              )
              
              -
              
              
              -
              
              
              (35,420
              )
              
              -Shares
                  issued upon draw downs on equity line of credit, net of
                  issuancecost of $60,601 (note 12(d))
              
              
              10,861,220
              
              
              689,399
              
              
              -
              
              
              -
              
              
              -
              
              
              689,399
              
              
              -Loss
                  for the period
              
              
              -
              
              
              -
              
              
              -
              
              
              (10,987,026
              )
              
              -
              
              
              (10,987,026
              )
              
              (10,987,026
              )Translation
                  adjustment
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              267,483
              
              
              267,483
              
              
              267,483Balance
                  as at July 31, 2004
              
              
              103,130,761
              
              
              58,368,020
              
              
              4,417,323
              
              
              (59,018,256
              )
              
              (300,871
              )
              
              3,466,216
              
              
              (10,719,543
              )Exercise
                  of stock options for cash (note 12(e))
              
              
              6,059,998
              
              
              787,800
              
              
              (606,000
              )
              
              -
              
              
              -
              
              
              181,800
              
              
              -Conversion
                  of convertible debentures and accrued interest to commonshares allocated pro-rata between additional paid-in-capital and
                  commonshares (note 10)
              
              
              51,340,389
              
              
              2,147,293
              
              
              (648,644
              )
              
              -
              
              
              -
              
              
              1,498,649
              
              
              -Intrinsic
                  value of beneficial conversion feature of convertible debt (note
                  10)
              
              
              -
              
              
              -
              
              
              11,005,243
              
              
              -
              
              
              -
              
              
              11,005,243
              
              
              -Settlement
                  of convertible debt (note 10 (c))
              
              
              -
              
              
              -
              
              
              (671,642
              )
              
              -
              
              
              -
              
              
              (671,642
              )
              
              -Intrinsic
                  value of beneficial conversion feature of preferred shares (note
                  11)
              
              
              -
              
              
              -
              
              
              3,999,999
              
              
              -
              
              
              -
              
              
              3,999,999
              
              
              -Financing
                  cost related to preferred shares (note 11)
              
              
              -
              
              
              -
              
              
              (145,000
              )
              
              -
              
              
              -
              
              
              (145,000
              )
              
              -Financing
                  cost related to convertible debenture (note 10)
              
              
              -
              
              
              -
              
              
              (1,038,037
              )
              
              -
              
              
              -
              
              
              (1,038,037
              )
              
              -Exercise
                  of warrants for cash, net of ussuance costs of $46,872(note 12 (e)(ii))
              
              
              18,940,560
              
              
              1,588,643
              
              
              (1,017,299
              )
              
              -
              
              
              -
              
              
              571,344
              
              
              -Cashless
                  exercise of warrants (note 12 (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 12(b)(i))
              
              
              78,887,710
              
              
              2,505,766
              
              
              410,420
              
              
              -
              
              
              -
              
              
              2,916,186
              
              
              -Shares
                  issued as placement fees on equity line of credit (note
                  12(d))
              
              
              75,188
              
              
              10,000
              
              
              -
              
              
              -
              
              
              -
              
              
              10,000
              
              
              -Shares
                  issued as compensation for services (note 12(c))
              
              
              6,764,205
              
              
              261,578
              
              
              -
              
              
              -
              
              
              -
              
              
              261,578
              
              
              -Compensation
                  expense (note 4(o))
              
              
              -
              
              
              -
              
              
              4,018,075
              
              
              -
              
              
              -
              
              
              4,018,075
              
              
              -Loss
                  for the period
              
              
              -
              
              
              -
              
              
              -
              
              
              (16,120,218
              )
              
              -
              
              
              (16,120,218
              )
              
              (16,120,218
              )Translation
                  adjustment
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              429,764
              
              
              429,764
              
              
              429,764Balance
                  as at July 31, 2005 (as restated - note 1)
              
              
              278,562,884
              
              
              66,695,717
              
              
              18,697,821
              
              
              (75,138,474
              )
              
              128,893
              
              
              10,383,957
              
              
              (15,690,454
              )





See
      accompanying notes to consolidated financial statements.





-33-


**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**




2005
              
              
              2004
              
              
              2003(as
                  restaed -
                note
                  1)Cash
                  provided used for:Operating
                  activities:Loss for the year
              
              $
              (16,120,218
              )
              $
              (10,987,026
              )
              $
              (9,914,629
              )Items not affecting cash:Depreciation and amortization
              
              
              1,497,250
              
              
              1,371,717
              
              
              1,236,870Stock-compensation expense
              
              
              4,279,653
              
              
              -
              
              
              17,005Non-cash interest, penalties and finance charges
              
              
              3,573,475
              
              
              3,842,107
              
              
              3,694,914Inventory write-down
              
              
              500,000
              
              
              -
              
              
              -Issuance of shares and warrants for services received
              
              
              -
              
              
              98,175
              
              
              -Issuance of shares and repricing of warrants to settlea potential claim
              
              
              -
              
              
              -
              
              
              315,044Gain on settlement of convertible debt (note 10(c))
              
              
              (42,346
              )
              
              -
              
              
              -Change in non-cash working capital:Receivables
              
              
              (44,507
              )
              
              170,127
              
              
              (182,366
              )Deferred revenue
              
              
              -
              
              
              -
              
              
              9,423Deferred financing expense
              
              
              -
              
              
              -
              
              
              (5,000
              )Inventory
              
              
              (67,943
              )
              
              (2,391,749
              )
              
              594,333Prepaid expenses
              
              
              82,153
              
              
              (50,265
              )
              
              240,861Accounts 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
              
              
              -
              
              
              -
              
              
              2,100,000Cash received on exercise of warrants (note 12)
              
              
              618,217
              
              
              2,179,385
              
              
              360,000Proceeds from equity line of credit (note 12)
              
              
              2,725,000
              
              
              750,000
              
              
              -Proceeds from convertible debentures (note 10)
              
              
              34,195,000
              
              
              2,725,000
              
              
              5,618,000Proceeds from preferred shares (note 11)
              
              
              4,000,000
              
              
              -
              
              
              -Proceeds from promissory notes (note 9)
              
              
              875,000
              
              
              1,500,000
              
              
              250,000Repayment of convertible debentures (note 10)
              
              
              (3,360,930
              )
              
              -
              
              
              -Financing costs
              
              
              (19,989,564
              )
              
              (626,696
              )
              
              (886,799
              )Repayment of promissory notes (note 9)
              
              
              (2,375,000
              )
              
              (305,715
              )
              
              (1,600,000
              )Net cash provided by financing activities
              
              
              16,869,523
              
              
              6,237,854
              
              
              5,841,201Effect
                  of exhange rate difference 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
              )
              
              1,317,726Cash
                  and cash equivalents, beginning of year
              
              
              76,670
              
              
              1,843,694
              
              
              525,968Cash
                  and cash equivalents, end of year
              
              $
              10,059,763
              
              $
              76,670
              
              $
              1,843,694Supplementary
                  information:Interest and finance charges paid
              
              $
              235,593
              
              $
              189,713
              
              $
              27,591Non-cash
                  investing and financing activities:Conversion of convertible debentures to common shares
              
              
              1,475,517
              
              
              2,556,684
              
              
              3,024,395Fair value of agents warrants issued in conjunction withprivate placements
              
              
              -
              
              
              15,699
              
              
              502,367Settlement of debt through issuance of commone shares
              
              
              -
              
              
              -
              
              
              77,850Issuance of shares as consideration for equity line of
                  credit
              
              
              2,725,000
              
              
              375,000
              
              
              300,000Financing costs included in accounts payable
              
              
              -
              
              
              52,859
              
              
              30,000Shares issued for services
              
              
              261,578
              
              
              -
              
              
              -See
                  accompanying notes to consolidated financial statements
 -34-


**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.
      Basis
      of Presentation:





The
      Company has amended  its Form 10-KSB/A for the year ended July 31, 2005 as
      previously filed on February 27, 2006.





The
      Company has had extensive discussions with the Staff of the Securities and
      Exchange Commission relating to its accounting for the extinguishment of
      certain of its convertible debentures. The comments relate
      to its accounting for the gain recorded upon the extinguishment of
      $2.5 million, 5% convertible debentures with respect to guidance in EITF 00-27,
      Issue 12(b). As a result of these discussions., the Company has amended the
      conversion price used in the calculation of the accounting gain to reflect
      that
      of the closing bid price of its common stock on the date of extinguishment.
      The Company has modified the accounting and footnote disclosure related to
      the
      extinguishment of the debenture accordingly.





The
      effect of the change in methodology for accounting for the (non-cash) gain
      on
      extinguishment of debt on the Company's consolidated
      statement of operations for the year ended July 31, 2005, was a decrease in
      the
      gain on settlement of convertible debt of $1,828,357 which
      resulted in a corresponding increase in its net loss of $1,828,357.
      Basic and diluted loss per share for the year ended July 31, 2005, increased
      by
      $0.01 to $0.07 per share. The effect on the Company's consolidated balance
      sheet
      as of July 31, 2005 was an increase in its additional paid in capital and
      accumulated deficit of $6,324 respectively.





Comparative
      figures as at July 31, 2004, and for the years ended July 31, 2004 and July
      31,
      2003 remain unchanged.





2.
      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.





3.
      Going
      concern:





The
      Company has incurred recurring operating losses and has a deficit of $75,138,474
      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


12(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 20(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.





4.
      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.


-35-


**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**





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




2005
              2004
              2003Cash
                  on hand and balances with banks
              $
                  10,059,763
              $
                  76,670
              $
                  264,628Cash
                  equivalents
              -
              -
              1,554,066$
                  10,059,763
              $
                  76,670
              $
                  1,818,694





(d)
      Inventory:





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





(e)
      Capital assets:





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





(f)
      Deferred financing costs:





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





(g)
      Other
      assets:





Other
      assets include the license to manufacture and sell tire monitoring systems
      to
      the original equipment vehicle manufacturers (note 7). Other assets are recorded
      at cost and are being amortized over five years on a straight-line basis.




(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 18(b).





(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.


-36-
  **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**


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.





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:




2005
                (as
                  restated - note 1)
              2004
              2003Net
                  loss:As reported
              $
                  (16,120,218)
              $
                  (10,987,026)
              $
                  (9,914,629)Stock-based compensation expenserecognized using intrinsic valuemethod (variable award)
              4,018,075
              -
              17,005Stock-based compensation expensedetermined under fair value basedmethod for all awards
              (1,101,411)
              (1,291,736)
              (738,339)Pro forma
              $
                  (13,203,554)
              $
                  (12,278,762)
              $
                  (10,635,963)Basic
                  and diluted loss per share:As reported
              (0.07)
              (0.13)
              (0.37)Pro forma
              (0.06)
              (0.15)
              (0.40)
  The
      Company recognizes compensation expense on a straight-line basis over the
      vesting period beginning on the date the stock option is granted.





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




2005
              2004
              2003Expected
                  dividend yield
              0%
              0%
              0%Expected
                  stock price volatility
              137-147%
              139-152%
              128-155%Risk-free
                  interest rate
              3.54-4.11%
              3.28-4.08%
              3.6-4.3%Expected
                  life of options and warrants
              5
                  years
              3-5
                  years
              2-5
                  years
  Weighted-average
      fair values of options granted during the year are as follows:


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





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.


-37-


**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**








(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 10 and 11.





(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.





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.





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.





5.
      Inventory:


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


-38-
  **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.
      Capital assets:




Accumulated
              
              
              Net
                  book2005
              
              
              Cost
              
              
              amortization
              
              
              ValueComputer
                  hardware and software
              
              $
              803,638
              
              $
              623,123
              
              $
              180,515Office
                  and shop equipment
              
              
              1,477,329
              
              
              1,027,230
              
              
              450,099Leasehold
                  improvements
              
              
              224,901
              
              
              138,752
              
              
              86,149$
              2,505,868
              
              $
              1,789,105
              
              $
              716,763Accumulated
              
              
              Net
                  book2004
              
              
              Cost
              
              
              amortization
              
              
              ValueComputer
                  hardware and software
              
              $
              697,178
              
              $
              509,980
              
              $
              187,198Office
                  and shop equipment
              
              
              1,336,068
              
              
              786,049
              
              
              550,019Leasehold
                  improvements
              
              
              207,327
              
              
              119,928
              
              
              87,399$
              2,240,573
              
              $
              1,415,957
              
              $
              824,616
  7.
      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.


Accumulated
              
              
              Net
                  book2005
              
              
              Cost
              
              
              amortization
              
              
              ValueOEM
                  - most medium and heavy duty trucks
              
              $
              1,737,500
              
              $
              1,574,381
              
              $
              163,119OEM
                  - all other vehicles
              
              
              3,300,000
              
              
              2,397,106
              
              
              902,894$
              5,037,500
              
              $
              3,971,487
              
              $
              1,066,013Accumulated
              
              
              Net
                  book2004
              
              
              Cost
              
              
              amortization
              
              
              ValueOEM
                  - most medium and heavy duty trucks
              
              $
              1,737,500
              
              $
              1,190,402
              
              $
              547,098OEM
                  - all other vehicles
              
              
              3,300,000
              
              
              1,699,349
              
              
              1,600,651$
              5,037,500
              
              $
              2,889,751
              
              $
              2,147,749




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.




8.
      Accounts payable and accrued liabilities:


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


-39-
  **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.
      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.


-40-
  **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.
      Convertible debentures:


Redemption
              
              
              
              
              
              Balance
                  tovalue
              
              
              Debt
              
              
              be
                  accretedof
                debt
              
              
              component
              
              
              to
                  debtBalance
                  as at July 31, 2003
              
              $
              1,966,667
              
              $
              3
              
              $
              1,966,664Issuance of 11% discounted convertibledebentures (b)
              
              
              3,493,590
              
              
              1,036,567
              
              
              2,457,023Discount in convertible debentures (b)
              
              
              -
              
              
              (768,590
              )
              
              768,590Cash repayment of discountedconvertible debentures (b)
              
              
              (305,715
              )
              
              (305,715
              )
              
              -Conversion of 8% and 7% convertibledebentures into common shares (a)
              
              
              (1,691,667
              )
              
              (1,691,667
              )
              
              -Conversion of discounted convertibledebentures into common shares (b)
              
              
              (840,688
              )
              
              (840,688
              )
              
              -Accretion of deemed debt discount tointerest expense (b)
              
              
              -
              
              
              3,236,921
              
              
              (3,236,921
              )Balance
                  as at July 31, 2004
              
              
              2,622,187
              
              
              666,831
              
              
              1,955,356New issuances:5% convertible debentures (c)
              
              
              2,695,000
              
              
              1,964,153
              
              
              730,8475% convertible debentures (d)
              
              
              1,500,000
              
              
              1
              
              
              1,499,99910% convertible debenture (e)
              
              
              30,000,000
              
              
              21,225,601
              
              
              8,774,399Redemptions/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
              
              
              10,111,082Less:
                  Current portion of convertible debentures
              
              
              8,109,666
              
              
              4,866,584
              
              
              3,243,082$
              23,986,667
              
              $
              17,118,667
              
              $
              6,868,000


-41-
  **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**


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.





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.





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.


-42-
 **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**
 (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:





(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.





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.





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





On
      issuance of the debenture, under EITF 98-5, SmarTire calculated the intrinsic
      value of the beneficial conversion feature as $677,996 and recorded it as
      additional paid in capital with the remaining value classified as a liability
      On
      March 22, 2005, the debenture was repaid for $2.5 million from the proceeds
      from
      the issuance of 25,000 mandatory redeemable, convertible preferred stock for
      which SmarTire received gross proceeds of $4 million. No redemption warrants
      were issued as the preferred shares were issued to the same investor as the
      $2.5
      million convertible debenture. Under EITF 00-27, Issue 12(b), the reacquisition
      price allocated to the convertible feature was $2,499,999 (based on a share
      price at the reacquisition date of $0.034). The remaining amount of the
      reacquisition proceeds of $1 was allocated to the liability. The difference
      between the $42,346 carrying value of the liability and the allocated
      reacquisition proceeds of $1 was recognized as a gain in the income statement.





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


-43-
  **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**


(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).





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.





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;


-44-
  **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**


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





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





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





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





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





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





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





11.
      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.





12.
      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.


-45-


**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**








(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.





(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.





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.




-46-
  **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**
 
 2005
              
              2004
              2003Weighted
              
              
              
              
              
              Weighted
              
              
              
              
              
              WeightedAverage
              
              
              
              
              
              Average
              
              
              
              
              
              AverageExercise
              
              
              
              
              
              Exercise
              
              
              
              
              
              ExerciseShares
              
              
              Price
              
              
              Shares
              
              
              Price
              
              
              Shares
              
              
              PriceOutstanding,
                  beginning of year
              
              
              8,469,800
              
              $
              0.63
              
              
              1,714,400
              
              $
              2.54
              
              
              1,677,250
              
              $
              3.08Options granted
              
              
              40,520,000
              
              
              0.03
              
              
              9,169,600
              
              
              0.20
              
              
              778,300
              
              
              1.42Options 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
 
 Options
                  outstanding
              
              Options
                  exercisableWeightedaverage
              
              
              Weighted
              
              
              
              
              
              Weightedremaining
              
              
              Average
              
              
              
              
              
              AverageRange
                  of
              
              
              Number
              
              
              contractual
              
              
              Exercise
              
              
              Number
              
              
              exerciseexercise
                  prices
              
              
              of
                  shares
              
              
              life
              
              
              Price
              
              
              exercisable
              
              
              price$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


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)
      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.




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


-47-
  **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**
 
 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.





(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.





13.
      Deferred financing costs:


2005
              
              
              2004$160
                  million equity line of credit (note 12 (d))Commitment fee
              
              $
              16,000,000
              
              $
              -Professional fees
              
              
              74,086
              
              
              -Agent placement fee
              
              
              10,000
              
              
              -16,084,086
              
              
              -$30
                  million 10% convertible debentures (note 10)Commissions
              
              
              2,130,000
              
              
              -Professional fees
              
              
              35,500
              
              
              -2,165,500
              
              
              -Discounted
                  convertible debenture (note 10)Commissions
              
              
              218,000
              
              
              218,000Fair value of agents warrants
              
              
              15,699
              
              
              15,699Professional fees
              
              
              46,894
              
              
              46,894280,593
              
              
              280,59318,530,179
              
              
              280,593Amortization
              
              
              (320,899
              )
              
              (123,573
              )$
              18,209,280
              
              $
              157,020




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.





14.
      Net
      interest and financing expenses:




2005
              
              
              2004
              
              
              2003Interest
                  accreted on convertible debentures
              
              $
              1,823,026
              
              $
              578,363
              
              $
              3,317,457Short-term
                  debt interest expense and finance charges
              
              
              112,274
              
              
              1,206,762
              
              
              3,513Interest
                  paid on convertible debentures
              
              
              942,892
              
              
              1,777,721
              
              
              101,535Amortization
                  of deferred financing fees
              
              
              852,289
              
              
              468,974
              
              
              300,000$
              3,730,481
              
              $
              4,031,820
              
              $
              3,722,505
 -48-
  **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.
        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 19). 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.





16.
      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
              AmountStandby
                  equity distribution agreement
              $160.0
                  millionPreferred
                  shares
              $4.0
                  millionConvertible
                  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.





17.
      Income taxes:





(a)
      Effective tax rate:





The
      effective income tax rates differ from the Canadian statutory rates for the
      following reasons:


2005
                (as
                  restated -
                note
                  1)
              
              
              2004
              
              
              2003Canadian
                  statutory tax rate
              
              
              35.60
              %
              
              36.40
              %
              
              38.50
              %Computed
                  tax expense
              
              $
              (5,738,798
              )
              $
              (3,999,277
              )
              $
              (3,817,132
              )Foreign
                  losses tax affected at lower rates
              
              
              103,937
              
              
              5,162
              
              
              192,027Reduction
                  in effective tax rates
              
              
              
              
              
              (339,481
              )Permanent
                  and other differences
              
              
              3,591,989
              
              
              1,352,012
              
              
              387,870Change
                  in valuation allowance
              
              
              2,042,872
              
              
              2,981,584
              
              
              3,237,235$
              -
              
              $
              -
              
              $
              -





(b)
      Deferred tax assets and liabilities:




2005
              
              
              2004Deferred
                  tax assets:Fixed
                  and other assets, accountingdepreciation in excess of tax
              
              
              1,642,001
              
              
              1,220,775Loss
                  carryforwards
              
              
              17,812,576
              
              
              16,534,418Scientific
                  research and development expenses
              
              
              413,060
              
              
              382,971Share
                  issue costs
              
              
              721,844
              
              
              549,499Others
              
              
              178,261
              
              
              37,207Total
                  gross deferred tax assets
              
              
              20,767,742
              
              
              18,724,870Valuation
                  allowance
              
              
              (20,767,742
              )
              
              (18,724,870
              )Net
                  deferred tax assets
              
              
              -
              
              
              -




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.


-49-


**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**








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.





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.





18.
      Earnings (loss) per share:





The
      weighted average number of shares outstanding used in the computation of
      earnings (loss) per share were as follows:




2005
              2004
              2003Weighted-average
                  shares used in computation of
              222,981,341
              83,356,095
              26,771,427basic
                  earnings (loss) per sharePotentially
                  dilutive securities excluded incalculation
                  of loss per share
              846,988,048
              98,697,014
              48,997,115




Diluted
      loss per share has not been presented since the Company is in a loss position
      and the effect of the Company's stock options, debentures and warrants are
      anti-dilutive.





19.
      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




(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:




-50-


**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**





Balance,
                  August 1, 2003
              
              $
              20,438Provision
                  increase
              
              
              85,934Expenditures
              
              
              (16,512
              )Balance,
                  July 31, 2004
              
              
              89,860Provision
                  increase
              
              
              15,856Expenditures
              
              
              (55,276
              )Balance,
                  July 31, 2005
              
              $
              50,440
  20.
      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
                  fromexternal
                  customers2005
              
              
              2004
              
              
              2003United
                  Kingdom
              
              $
              746,889
              
              $
              225,517
              
              $
              261,905United
                  States
              
              
              520,615
              
              
              651,089
              
              
              509,228China
              
              
              15,998
              
              
              514,365
              
              
              243,866Italy
              
              
              -
              
              
              -
              
              
              391,169Other
              
              
              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
              2003Customer
                  A
              $546,423
              $
                  <10%
              $
                  <10%Customer
                  B
              234,244
              <10%
              <10%Customer
                  C
              <10%
              484,433
              <10%Customer
                  D
              <10%
              <10%
              391,169




21.
      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.





22.

      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.





23.
      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").


-51-


**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**








(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.





(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:


2005
                (as
                  restated -
                note
                  1)
              
              
              2004
              
              
              2003Net
                  loss:As
                  reported in accordance with Canadian GAAP
              
              $
              (12,805,976
              )
              $
              (9,082,381
              )
              $
              (6,552,235
              )Stock-based
                  compensation expenseincluded in reported net loss
              
              
              1,089,282
              
              
              1,130,170
              
              
              -Stock-based
                  compensation expensedetermined under fair valuebased method for all awards
              
              
              (1,101,411
              )
              
              (1,257,378
              )
              
              (458,819
              )Pro
                  forma
              
              $
              (12,098,105
              )
              $
              (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
              )





(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 $42,346 (as restated) and a charge to retained earnings was
      recorded for the same amount (note 10(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.


2005
              
              2004Consolidated
              
              
              Canadian
              
              
              
              
              
              Canadianbalance
                  sheets
              
              
              GAAP
              
              
              U.S.
                  GAAP
              
              
              GAAP
              
              
              U.S.
                  GAAP(as
                  restated -
                note
                  1)Current
                  assets
              
              $
              13,292,487
              
              $
              13,292,487
              
              $
              3,807,743
              
              $
              3,807,743Capital
                  assets
              
              
              716,763
              
              
              716,763
              
              
              824,616
              
              
              824,616Deferred
                  financing costs (d)
              
              
              16,206,086
              
              
              18,209,280
              
              
              443,016
              
              
              157,020Other
                  assets
              
              
              1,066,013
              
              
              1,066,013
              
              
              2,147,749
              
              
              2,147,749Current
                  liabilities (c)
              
              
              1,649,690
              
              
              5,781,918
              
              
              2,804,081
              
              
              3,075,338Long
                  term convertible debentures (c)
              
              
              1,272,123
              
              
              17,118,667
              
              
              1
              
              
              395,574Preferred
                  shares subject tomandatory redemption
              
              
              1
              
              
              1
              
              
              -
              
              
              -Stockholders'
                  equity
              
              
              28,359,535
              
              
              10,383,957
              
              
              4,419,042
              
              
              3,466,216




-52-


**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**





2005
                (as
                  restated -
                note
                  1)
              
              
              2004
              
              
              2003Net
                  loss in accordance with US GAAP
              
              $
              (16,120,218
              )
              $
              (10,987,026
              )
              $
              (9,914,629
              )Effects
                  of difference in accounting for:Stock based compensation expense under US GAAP (b)
              
              
              4,018,075
              
              
              -
              
              
              17,005Stock based compensation(recovery) under Canadian GAAP (b)
              
              
              (1,089,282
              )
              
              (1,130,170
              )
              
              -Interest accretion and amortization of debenture financecosts recorded under US GAAP (c)(d)
              
              
              2,689,712
              
              
              3,360,389
              
              
              3,359,977Interest accretion and amortization of debenture financecost under Canadian GAAP (d)
              
              
              (1,541,917
              )
              
              (325,574
              )
              
              (14,588
              )Gain on settlement of convertible debt (d)
              
              
              (42,346
              )
              
              -
              
              
              -Net loss in accordance with Canadian GAAP
              
              
              (12,085,976
              )
              
              (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
              
              
              (65,113,071
              )
              
              (51,971,332
              )
              
              (41,762,812
              )Basic and diluted loss per share (in accordance with Canadian GAAP)
              
              
              (0.05
              )
              
              (0.11
              )
              
              (0.24
              )




24.
      Comparative figures:





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


-53-