UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C.
20549

FORM 20-F

|   |                                                                                                 
|-- | ------------------------------------------------------------------------------------------------
|o  | REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) or
  (g) OF THE SECURITIES EXCHANGE ACT OF 1934
|   |                                                                                                 
|OR
|  
|x  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
  SECURITIES EXCHANGE ACT OF 1934          
|   | For the
  fiscal year ended December 31, 2008                                                   
|   |                                                                                                 
|OR
|  
|o  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
  THE SECURITIES EXCHANGE ACT OF 1934      
|   | For the
  transition period from ___________ to ____________                                    
|   |                                                                                                 
|OR
|   |                                                                                                 
|o  | SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d)
  OF THE SECURITIES EXCHANGE ACT OF 1934   
|   | Date of
  event requiring this shell company report ____________________                        

Commission File Number: 0-27524

DYNAMOTIVE ENERGY SYSTEMS CORPORATION(Exact name of Registrant as specified in its charter)

Province of British Columbia (Canada)(Jurisdiction of incorporation or
organization)

Suite 140 - 13091 Vanier Place
Richmond, British Columbia V6V 2J1 Canada(Address of principal executive offices)

Securities registered or to be registered pursuant to Section 12(b) of
the Act: None

Securities registered or to be registered pursuant to Section 12(g) of
the Act:Common Shares Without Par Value(Title of Class)

Securities for which there is a reporting obligation pursuant to
Section 15(d) of the Act: None

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Indicate the number of
outstanding shares of each of the issuers classes of capital or common stock
as of the close of the period covered by the annual report: 221,312,201 Shares of Common Stock outstanding at
December 31, 2008

Indicate by check mark if
the registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act. Yes o No x

If this report is an annual
or transition report, indicate by check mark if the registrant is not required
to file reports pursuant to Section 13 or 15(d) of the Securities Act of 1934.
Yes o
No x

Indicate by check mark
whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding
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. Yes x No o

Indicate by check mark
whether the registrant is a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definition of accelerated filer and large
accelerated filer in Rule 12b-2 of the Exchange Act. (Check one):

|                          |                     |                        
|------------------------- | ------------------- | -----------------------
|Large accelerated filer o | Accelerated filer x | Non-accelerated filer o

Indicate by check mark which
financial statement item the registrant has elected to follow. Item 17 x Item 18 o

If this is an annual report,
indicate by check mark whether if the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). Yes o No x

ii

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TABLE OF CONTENTS

PAGE

|                                                       |                                                                               |   |    
|------------------------------------------------------ | ----------------------------------------------------------------------------- | - | ---
|GENERAL                                                |                                                                               |   | 1  
|CAUTIONARY
  NOTE REGARDING FORWARD-LOOKING STATEMENTS |                                                                               | 1
|                                                       |                                                                               |  
|PART I                                                 |                                                                               |   | 2  
|ITEM 1.                                                | IDENTITY OF
  DIRECTORS, SENIOR MANAGEMENT AND ADVISERS                       |   | 2  
|ITEM 2.                                                | OFFER
  STATISTICS AND EXPECTED TIMETABLE                                     |   | 2  
|ITEM 3.                                                | KEY
  INFORMATION                                                             |   | 2  
|ITEM 4.                                                | INFORMATION
  ON THE COMPANY                                                  |   | 10 
|ITEM 4A.                                               | UNRESOLVED
  STAFF COMMENTS                                                   |   | 20 
|ITEM 5.                                                | OPERATING
  AND FINANCIAL REVIEW AND PROSPECTS                                |   | 20 
|ITEM 6.                                                | DIRECTORS,
  SENIOR MANAGEMENT AND EMPLOYEES                                  |   | 30 
|ITEM 7.                                                | MAJOR
  SHAREHOLDERS AND RELATED PARTY TRANSACTIONS                           |   | 37 
|ITEM 8.                                                | FINANCIAL
  INFORMATION                                                       |   | 38 
|ITEM 9.                                                | THE OFFER AND LISTING                                                         |   | 38 
|ITEM 10.                                               | ADDITIONAL
  INFORMATION                                                      |   | 39 
|ITEM 11.                                               | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                    |   | 54 
|ITEM 12.                                               | DESCRIPTION
  OF SECURITIES OTHER THAN EQUITY SECURITIES                      |   | 55 
|                                                       |                                                                               |   |    
|PART II                                                |                                                                               |   | 56 
|ITEM 13.                                               | DEFAULTS,
  DIVIDEND ARREARAGES AND DELINQUENCIES                             |   | 56 
|ITEM 14.                                               | MATERIAL
  MODIFICATIONS TO THE RIGHT OF SECURITY HOLDERS AND USE OF PROCEEDS |   | 56 
|ITEM 15.                                               | CONTROLS AND PROCEDURES                                                       |   | 56 
|ITEM 16A.                                              | AUDIT COMMITTEE FINANCIAL EXPERT                                              |   | 58 
|ITEM 16B.                                              | CODE OF ETHICS                                                                |   | 58 
|ITEM 16C.                                              | PRINCIPAL
  ACCOUNTANT FEES AND SERVICES                                      |   | 58 
|ITEM 16D.                                              | EXEMPTIONS
  FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES                  |   | 58 
|ITEM 16E.                                              | PURCHASES OF
  EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS      |   | 59 
|                                                       |                                                                               |   |    
|PART III                                               |                                                                               |   | 60 
|ITEM 17.                                               | FINANCIAL
  STATEMENTS                                                        |   | 60 
|ITEM 18.                                               | FINANCIAL
  STATEMENTS                                                        |   | 113
|ITEM 19.                                               | EXHIBITS                                                                      |   | 113

iii

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GENERAL

In this Annual
Report: (i) references to we, us, our, the Company or Dynamotive
refer to Dynamotive Energy Systems Corporation and its subsidiaries, unless the
context requires otherwise; (ii) the Company uses the U.S. dollar as its
reporting currency and all references in this document to dollars or $ are
to U.S. dollars, unless otherwise indicated; and (iii) the Company prepares its
financial statements based on Canadian generally accepted accounting principles
(GAAP) and Note 25 to the audited consolidated financial statements included
herein provides a reconciliation of certain financial information presented in
this Annual Report to U.S. GAAP.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING
STATEMENTS

This Annual
Report on Form 20-F for the year ended December 31, 2008 contains
forward-looking statements that involve risks and uncertainties.
Forward-looking statements in this document include, among others, statements
regarding our capital needs, business plans and expectations. Such
forward-looking statements involve assumptions, risks and uncertainties
regarding, among others, the success of our business plan, availability of
funds, government regulations, operating costs, our ability to achieve
significant revenues, our business model and other factors. Any statements
contained herein that are not statements of historical fact may be deemed to be
forward-looking statements. In some cases, you can identify forward-looking
statements by terminology such as may, will, should, expect, plan,
intend, anticipate, believe, estimate, predict, potential or
continue, the negative of such terms or other comparable terminology. In
evaluating these statements, you should consider various factors, including the
assumptions, risks and uncertainties set forth in this report under Risk
Factors and in reports and other documents we have filed with or furnished to
the Securities and Exchange Commission. These factors or any of them may cause
our actual results to differ materially from any forward-looking statement made
in this document. While these forward-looking statements, and any assumptions
upon which they are based, are made in good faith and reflect our current
judgment regarding future events, our actual results will likely vary,
sometimes materially, from any estimates, predictions, projections, assumptions
or other future performance suggested herein. The forward-looking statements in
this document are made as of the date of this document and we do not intend or
undertake to update any of the forward-looking statements to conform these
statements to actual results, except as required by applicable law, including
the securities laws of the United States.

1

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PART I

|                  |                                                      
|----------------- | -----------------------------------------------------
|ITEM 1.           | IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
|                  |                                                      
|Not
  applicable.
|                  |                                                      
|ITEM 2.           | OFFER STATISTICS AND EXPECTED TIMETABLE              
|                  |                                                      
|Not
  applicable.
|                  |                                                      
|ITEM 3.           | KEY INFORMATION                                      

A. SELECTED FINANCIAL DATA

The selected
financial information presented in the table below is derived from the audited
consolidated financial statements of the Company. The audited consolidated
financial statements of the Company for the fiscal years ended December 31,
2008, 2007 and 2006 are included in this filing. The audited consolidated
financial statements of the Company for the fiscal years ended December 31,
2005 and 2004 are included in previous filings. The selected financial
information presented below should be read in conjunction with the Companys
audited consolidated financial statements and the notes thereto, and with the
information appearing under the headings, Information on the Company and
Operating and Financial Review and Prospects.

Our audited
consolidated financial statements have been prepared under Canadian GAAP in
U.S. dollars. Additional information is presented to show the differences which
would result from the application of US GAAP to the Companys financial
information. Refer to Note 25 of the audited consolidated financial statements
included herein for a discussion of the material differences between Canadian
GAAP and US GAAP and their effect on the Companys financial position and
results of operations.

In 2003, the
Company began construction of a BioOil production plant, which was initially
commissioned, or tested for start up, in 2005. In December 2006, the Company
began an upgrade and expansion of this plant to increase its capacity. In 2006,
the Company began construction of another BioOil production plant, which was
completed early in 2008. Accordingly, the financial information presented below
may not be comparable from period to period. See Information on the Company
for a description of the development of our business.

|                                |  |                                        |             |      |   |             |   |      |             |      |   |             |   |   |            |  
|------------------------------- |  | -------------------------------------- | ----------- | ---- | - | ----------- | - | ---- | ----------- | ---- | - | ----------- | - | - | ---------- | -
|                                |  | For the Fiscal Year Ended December 31, |            
|                                |  |                                        |            
|                                |  | 2008                                   |             | 2007 |   | 2006        |   | 2005 |             | 2004 |  
|                                |  |                                        |             |      |   |             |   |      |             |      |  
|(US dollars)                    |  |                                        |             |      |   |             |   |      |             |      |   |             |   |   |            |  
|Operating Data:                 |  |                                        |             |      |   |             |   |      |             |      |   |             |   |   |            |  
|Revenue(1)                      |  | $                                      | 178,106     |      | $ |            |   | $    |            |      | $ |            |   | $ |           |  
|Loss from operations (Cdn GAAP) |  |                                        | (13,279,325 | )    |   | (14,415,849 | ) |      | (14,319,641 | )    |   | (11,822,274 | ) |   | (9,917,889 | )
|Loss from operations (US GAAP)  |  |                                        | (28,964,583 | )    |   | (15,413,857 | ) |      | (14,319,641 | )    |   | (12,756,405 | ) |   | (9,917,889 | )
|Net loss (Cdn GAAP)             |  |                                        | (28,356,265 | )    |   | (14,220,404 | ) |      | (14,252,382 | )    |   | (11,997,344 | ) |   | (9,916,215 | )
|Net loss (US GAAP)              |  |                                        | (28,159,410 | )    |   | (15,218,412 | ) |      | (14,669,647 | )    |   | (13,124,724 | ) |   | (8,405,184 | )
|Net loss per share (Cdn GAAP)   |  |                                        | (0.13       | )    |   | (0.08       | ) |      | (0.09       | )    |   | (0.11       | ) |   | (0.12      | )
|Net loss per share (US GAAP)    |  |                                        | (0.13       | )    |   | (0.08       | ) |      | (0.10       | )    |   | (0.12       | ) |   | (0.10      | )

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|    |                                                                                                                                                                                                                                         
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | In 2008, the
  Company offset product sales of $151,657 against research and development
  expenses as they are considered incidental sales of BioOil until such time as
  the Companys plant has reached commercial production levels.

2

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|                                    |  |                    |             |      |   |             |  |      |             |      |   |             |  |   |            | 
|----------------------------------- |  | ------------------ | ----------- | ---- | - | ----------- |  | ---- | ----------- | ---- | - | ----------- |  | - | ---------- | 
|                                    |  | As at December 31, |            
|                                    |  |                    |            
|                                    |  | 2008               |             | 2007 |   | 2006        |  | 2005 |             | 2004 |  
|                                    |  |                    |             |      |   |             |  |      |             |      |  
|(US dollars)                        |  |                    |             |      |   |             |  |      |             |      |   |             |  |   |            | 
|Balance Sheet Data:                 |  |                    |             |      |   |             |  |      |             |      |   |             |  |   |            | 
|Total assets (Cdn GAAP)             |  | $                  | 34,520,383  |      | $ | 58,935,644  |  | $    | 38,193,699  |      | $ | 16,962,573  |  | $ | 13,198,698 | 
|Total assets (US GAAP)              |  |                    | 33,911,970  |      |   | 57,937,636  |  |      | 38,093,062  |      |   | 16,962,573  |  |   | 13,198,698 | 
|Total liabilities (Cdn GAAP)        |  |                    | 12,358,085  |      |   | 7,770,670   |  |      | 7,058,287   |      |   | 8,670,165   |  |   | 8,911,500  | 
|Total liabilities (US GAAP)         |  |                    | 12,358,085  |      |   | 7,770,670   |  |      | 7,058,287   |      |   | 8,692,977   |  |   | 8,911,500  | 
|Non-controlling interest (Cdn GAAP) |  |                    |            |      |   |            |  |      | 1,354,923   |      |   |            |  |   |           | 
|Non-controlling interest (US GAAP)  |  |                    |            |      |   |            |  |      | 1,354,923   |      |   |            |  |   |           | 
|Shareholders equity (Cdn GAAP)     |  |                    | 22,162,298  |      |   | 51,164,974  |  |      | 29,780,489  |      |   | 8,292,408   |  |   | 4,287,198  | 
|Shareholders equity (US GAAP)      |  |                    | 21,553,885  |      |   | 50,166,966  |  |      | 29,679,852  |      |   | 8,269,596   |  |   | 4,287,198  | 
|Common shares issued                |  |                    | 221,312,201 |      |   | 207,749,673 |  |      | 171,765,776 |      |   | 123,211,875 |  |   | 93,129,798 | 

The Company
has not declared or paid any dividends since incorporation, and does not expect
to pay any dividends in the foreseeable future.

B. CAPITALIZATION AND INDEBTEDNESS

Not applicable.

C. REASONS FOR THE OFFER AND USE OF PROCEEDS

Not
applicable.

D. RISK FACTORS

Any
investment in our common stock involves a high degree of risk. You should
carefully consider the risks described below and all of the information
contained in this report before deciding whether to purchase our common stock.
If any of the following risks actually occur, our business, financial condition
and results of operations could be harmed. The trading price of our common
stock could decline, and you may lose all or part of your investment in our
common stock. We operate in a market environment that is difficult to predict
and that involves significant risks and uncertainties, many of which are beyond
our control. Refer to Cautionary Note Regarding Forward-Looking Statements.

Risks Related to our Business

We
have incurred net losses since commencing business and expect losses to
continue for the foreseeable future.

We have had
limited revenues to date and have not shown a profit since inception. We had a
net loss of $28,356,265 for the year ended December 31, 2008 and a net loss of
$14,220,404 for the year ended December 31, 2007. As at December 31, 2008, we
had cash and cash equivalents of $39,927 and a working capital deficiency of
$10,441,893. As the commercialization of BioOil is a new business, we may
experience problems, difficulties, complications and delays typical for
companies such as ours. Our plants in West Lorne and Guelph have not achieved
production at rated capacity on a sustained basis. Our plant in Guelph is
currently in a shut down mode due to feedstock limitations and our limited
financial resources to make changes at that site. We expect to show a substantial
net loss for the year ended December 31, 2009. We do not expect revenues
to occur in any significant way until we have successfully established
commercial BioOil operations. Accordingly, we may not be able to operate
profitably on a consistent basis, if at all.

3

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Our
ability to continue as a going concern is in substantial doubt.

The ability of
the Company to continue as a going concern is in substantial doubt and is
dependent on achieving profitable operations, commercializing its BioOil production
technology and obtaining the necessary financing in order to develop this
technology. The outcome of these matters cannot be predicted at this time. The
Companys future operations are dependent on the markets acceptance of its
products in order to ultimately generate future profitable operations, and the
Companys ability to secure sufficient financing to fund future operations.
There can be no assurance that the Companys products will be able to secure
market acceptance. Management plans to raise additional equity financing to
enable the Company to complete its development plans. However, there can be no
assurance that we will be successful in raising additional financing. Our
financial statements do not include any adjustments that might result from the
outcome of these uncertainties.

We
have limited plant operating history, which makes it difficult to evaluate our
financial position and our business plan.

We are an
early stage company that has conducted limited plant operations to date.
Accordingly, there is a limited operating history by which to evaluate the
likelihood of our success or our ability to exist as a going concern. We may
not be able to generate sufficient revenues to become profitable. In addition,
we may never commence significant operations or, if we do, we may not be able
to generate sufficient revenues to become profitable.

Federal
tax and other incentives for BioOil production may be eliminated in the future,
which could hinder our ability to operate at a profit.

The BioOil
industry and our business are assisted by various federal tax and other
incentives. The elimination, expiration or reduction of these incentives could
prevent us from being able to sell BioOil at a price higher than our current
cost to produce BioOil. If the federal incentives are eliminated or sharply
curtailed, we believe that a decreased demand for BioOil would result, which
could result in the failure of the business.

We
may need to obtain a significant amount of additional debt and/or equity
capital to complete the commissioning and commercialization of the plants
described in this report, which we may not be able to obtain on acceptable
terms or at all.

We will
require additional capital to fund our business and development plan, including
the development and/or construction of additional BioOil plants. In addition,
once these plants have been constructed, we will have to fund the start-up
operations of these plants until, if ever, the plants generate sufficient cash
flow from their operations. We may also encounter unforeseen costs that could
also require us to seek additional capital. As a result, we expect to seek to
raise additional debt and/or equity funding. The full and timely development
and implementation of our business plan and growth strategy will require
significant additional resources, and we may not be able to obtain the funding
necessary to implement our growth strategy on acceptable terms or at all. An
inability to obtain such funding would prevent us from constructing any
additional BioOil plants. Furthermore, our construction strategy may not
produce material revenues even if successfully funded. We have not yet
identified the sources for the additional financing we require and we do not
have commitments from any third parties to provide this financing. We might not
succeed, therefore, in raising additional equity capital or in negotiating and
obtaining additional and acceptable financing. Our ability to obtain additional
capital will also depend on market conditions, national and global economies
and other factors beyond our control. We might not be able to obtain required
working capital, the need for which is substantial given our business and
development plan. The terms of any future debt or equity funding that we may
obtain may be unfavorable to us and to our stockholders.

We
envision a period of growth that may impose a significant burden on our
administrative and operational resources which if not effectively managed could
impair our growth.

Our strategy
envisions a period of growth that may impose a significant burden on our
administrative and operational resources. Our failure to manage our growth
effectively could prevent us from achieving our goals. The growth of our
business, and in particular, the construction of any additional BioOil
production facilities, will require significant investments of capital and
managements close attention. In addition to the possibility of constructing
additional BioOil production facilities, we may seek to enter into significant
marketing agreements, and other

4

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similar
agreements with companies that currently, or expect to, produce or use BioOil.
Our ability to effectively manage our growth will require us to attract, train,
manage and retain qualified management, technicians and other personnel; we may
be unable to do so. In addition, our failure to successfully manage our growth
could result in our sales not increasing commensurate with our capital
investments.

We
have limited financial and management resources to pursue our growth strategy.

Our growth
strategy may place a significant strain on our management, operational and
financial resources. We have negative cash flow from operations and continue to
seek additional capital. We will have to obtain additional capital either
through debt or equity financing to continue our research and development
strategies and the commercial expansion of our technologies. There can be no
assurance, however, that we will be able to obtain such financing on terms
acceptable to the Company. If adequate funds are not available on acceptable
terms when needed, we may be required to delay, scale-back or eliminate the
manufacturing, marketing or sales of one or more of our products or research
and development programs.

If we raise
additional funds through the issuance of equity or convertible securities,
these new securities may contain certain rights, preferences or privileges that
are senior to those of our Common Shares. Additionally, the percentage of
ownership of the Company held by existing shareholders will be reduced.

We
will be dependent on third parties for expertise in the design and construction
of BioOil plants and any loss or impairment of these relationships could cause
delay and added expense. In addition, we currently have no binding definitive
construction agreements with such parties and their failure to perform could
hinder our ability to operate profitably.

The number of
engineering and construction firms with the necessary expertise to design and
build BioOil plants and their available capacity is limited. We will be
dependent on our relationships with third parties for engineering and
construction expertise. Any loss of, or damage to, these relationships,
particularly during the construction and start-up period for the plant(s), may
significantly delay or even prevent us from commencing operations at additional
facilities and result in the failure of our business. The time and expense of
locating new consultants and contractors could result in unforeseen expenses
and delays. Unforeseen expenses and delays may reduce our ability to generate
revenue and profitability and significantly damage our competitive position in
the BioOil industry.

We will be
highly dependent upon contractors to design and build any future BioOil plants,
but we have not signed definitive binding construction agreements with any of
these companies. We have not yet negotiated or executed definitive design-build
agreements with any party and there is no assurance that such agreements will
be executed in a timely manner or at all. If we do not execute definitive,
binding design-build agreements with third parties, or if any such third party
terminates its relationship with us after initiating construction, there is no
assurance that we would be able to obtain a replacement general contractor.

We
may depend on others for sales of our products, which may place us at a
competitive disadvantage and reduce profitability.

We expect to
hire third-party marketing firms to market some of the BioOil we plan to
produce. As a result, we expect to be dependent on any BioOil broker that we
engage. There is no assurance that we will be able to enter into contracts with
any BioOil broker on terms that are favorable to us. If the BioOil broker
breaches the contract or does not have the ability, for financial or other
reasons, to market all of the BioOil we produce, we may not have any readily
available means to sell our products. Our lack of a sales force and reliance on
third parties to sell and market our products may place us at a competitive
disadvantage. Our failure to sell all of our BioOil may result in less income
from sales, reducing our revenue stream.

We
will be required to hire and retain skilled technical and managerial personnel.

Personnel
qualified to operate and manage BioOil plants are in great demand. Our success
depends in large part on our ability to attract, train, motivate and retain
qualified management and skilled employees, particularly managerial, technical,
sales, and marketing personnel, technicians, and other critical personnel. Any
failure to attract and retain the highly-trained managerial and technical
personnel may have a negative impact on our operations,

5

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which would
have a negative impact on revenues. There can be no assurance that we will be
able to attract and retain skilled persons and the loss of skilled technical
personnel would adversely affect our company.

We
are dependent upon our officers for management and direction, and the loss of
any of these persons could adversely affect our operations and results.

We are dependent
upon our officers for execution of our business plan. The loss of any of our
officers could have a material adverse effect upon our results of operations
and financial position. We do not maintain key person life insurance for any
of our officers. The loss of any of our officers could delay or prevent the
achievement of our business objectives.

Increases
in site or plant construction costs may require us to raise additional capital.

We anticipate
that third-party contractors will construct any additional plants we elect to
pursue for a fixed contract price, based on the plans and specifications in the
anticipated design-build agreements. The estimated cost of constructing BioOil
production plants is based on managements best estimates, and there is no
assurance that the final cost of one or more of our plants will not be higher.
There is no assurance that there will not be design changes or cost overruns
associated with the construction of plants. Shortages of steel, concrete or
other building materials or labor could affect the final cost and final
completion date of any project. In addition, specific site conditions at any
plant site may increase construction costs. Any significant increase in the
estimated construction cost of the plant could require us to raise additional
capital.

Construction
delays or defects could result in delays in increasing our production and sale
of BioOil and negatively affect our operations and financial performance.

Construction
projects often involve delays for a number of reasons including delays in
obtaining permits, delays due to weather conditions, or other events. Also, any
changes in political administrations at each level that result in policy
changes towards BioOil could also cause construction and/or operation delays.
If it takes longer to increase the production capacity of the West Lorne
facility than anticipated or if it takes us longer to construct any other plant
we decide to construct, our ability to generate revenues could be impaired. In
addition, there can be no assurance that defects in materials and/or
workmanship will not occur. Such defects could delay the commencement of
enhanced capacity operations of the plant or cause us to halt or discontinue
the plants operation or reduce the intended production capacity. Halting or
discontinuing plant operations could delay our ability to generate revenues.

Plant
sites, including our plants, may have unknown environmental problems that could
be expensive and time consuming to correct which may delay or halt plant
construction and delay our ability to generate revenue.

BioOil and
some of its derivative products may be deemed to be hazardous wastes for which
liability may be imposed upon us should any contamination from improper storage
or handling occur. Liability costs associated with environmental cleanups of
contaminated sites historically have been very high as have been the level of
fines imposed by regularity authorities upon parties deemed to be responsible
for environmental contamination. We have obtained limited insurance protection
but this may not be sufficient insurance protection from such liabilities if
they should ever arise. If contamination should take place for which we are
deemed to be liable, potentially liable or a responsible party, the resulting
costs could have a material effect on our business.

We may
encounter hazardous conditions at or near each of our facility sites that may
delay or prevent construction or operation of a particular facility. If we
encounter a hazardous condition at or near a site, work may be suspended and we
may be required to correct the condition prior to continuing construction or
further production. The presence of a hazardous condition would likely delay or
prevent construction of a particular facility and may require significant
expenditure of resources to correct the condition. If we encounter any
hazardous condition during construction, estimated sales and profitability may
be adversely affected.

Any
operational disruption at our facilities could result in a reduction of our
sales volume, and could cause us to incur substantial losses.

If operations
at any of our facilities experience a significant interruption due to a major
accident or damage by severe weather or other natural disasters, our ability to
generate revenues could be adversely impacted. In addition,

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our operations
may be subject to labor disruptions and unscheduled downtime, or other
operational hazards inherent in our industry, such as equipment failures,
fires, explosions, abnormal pressures, blowouts, pipeline ruptures,
transportation accidents and natural disasters. We have not operated the West
Lorne facility or facility in Guelph, Ontario at or near capacity for an
extended period and cannot be sure that we will be able to do so. Some of these
operational hazards may cause personal injury or loss of life, severe damage to
or destruction of property and equipment or environmental damage, and may
result in suspension of operations and the imposition of civil or criminal
penalties. Our insurance may not cover or be adequate to fully cover the
potential operational hazards described above.

Our
technology may not prove commercially viable.

Our technology
is currently being tested at a commercial scale. Ongoing efforts at
commercialization may expose operational flaws and unanticipated costs that may
inhibit or preclude ultimate market acceptance. Our technology has not
demonstrated it can generate positive cash flow or a return on investment.

We
may be sued or become a party to litigation, which could require significant
management time and attention and result in significant legal expenses and may
result in an unfavorable outcome which could have a material adverse effect on
our business, financial condition, results of operations and cash flows.

We may be
subject to lawsuits from time to time arising in the ordinary course of our
business. We may be forced to incur costs and expenses in connection with
defending ourselves with respect to such litigation and the payment of any
settlement or judgment in connection therewith if there is an unfavorable
outcome. The expense of defending litigation may be significant. The amount of
time to resolve lawsuits is unpredictable and defending ourselves may divert
managements attention from the day-to-day operations of our business, which
could adversely affect our business, results of operations and cash flows. In
addition, an unfavorable outcome in any such litigation could have a material
adverse effect on our business, results of operations and cash flows.

We
may be unable to protect our intellectual property, which could negatively
affect our ability to compete.

Patents and
other intellectual property are a critical aspect of the present operation and
future success of our business. Policing unauthorized use of our proprietary
technologies and other intellectual rights could entail significant expense and
could be difficult or impossible, particularly given that the laws of some
countries afford little or no effective protection of our intellectual property.
Given the nature of our business, third parties may bring claims of copyright,
patent or trademark infringement against us. Further, third parties may claim
that we have misappropriated their creative ideas or otherwise infringed on
their proprietary rights in connection with our technologies. Any claims of
infringement, with or without merit, could be time consuming to defend, result
in costly litigation, divert management attention, require us to enter into
costly royalty or licensing agreements or prevent us from using important
technologies or methods.

We rely or may
rely on a combination of trademark, trade name, confidentiality agreements, and
other contractual restrictions on disclosure to protect our intellectual
property rights. We also enter into confidentiality agreements with our
employees, consultants, and corporate partners, and control access to and
distribution of our confidential information. These measures may not preclude
the disclosure of our confidential or proprietary information. Despite efforts
to protect our proprietary rights, unauthorized parties may attempt to copy or
otherwise obtain and use our proprietary information. Monitoring unauthorized
use of our confidential information is difficult, and we cannot be certain that
the steps we take to prevent unauthorized use of our confidential information
will be effective.

We
must develop and expand our sales and marketing capabilities.

Our sales and
marketing experience is very limited. We will be required to further develop
our marketing and sales force in order to effectively demonstrate the
advantages of our technology over more traditional technology, as well as other
competitors technology. We may not be able to establish adequate sales and
distribution capabilities, and there is no guarantee that our sales and
marketing experience will be successful.

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Changes
in environmental regulations or violations of the regulations could be
expensive and hinder our ability to operate profitably.

We are and
will continue to be subject to extensive air, water and other environmental
regulations and will need to maintain a number of environmental permits to
construct and operate our plants. If for any reason, any of these permits are
not granted, construction costs for the plants may increase, or the plants may
not be constructed at all. Additionally, any changes in environmental laws and
regulations could require us to invest or spend considerable resources in order
to comply with future environmental regulations. Violations of these laws and
regulations could result in liabilities that affect our financial condition and
the expense of compliance alone could be significant enough to reduce profits.

Our
strategic alliances may not achieve their goals.

We expect to
partially rely on strategic alliances for development contracts, assistance in
research and development and marketing expertise. Even if we are successful in
forming these alliances, they may not achieve their goals.

Risks Related
to the BioOil Industry

Our
financial performance will be dependent on prices for waste and residual
materials we use in the production of BioOil which are subject to and
determined by market forces outside our control. An increase in the prices for
these input commodities will materially affect our ability to operate at a
profit.

Our results of
operations and financial condition will be significantly affected by the cost
and supply of the biomass materials we use in the production of BioOil. The
price of these inputs is influenced by weather conditions and other factors
affecting crop yields, farmer planting decisions, and general economic, market
and regulatory factors. These factors include government policies and subsidies
with respect to agriculture and international trade, and global and local
demand and supply. The significance and relative effect of these factors on the
price of these inputs is difficult to predict. Any event that tends to
negatively affect their supply, such as adverse weather or crop disease, could
increase these materials prices and potentially harm our business. In addition,
we may also have difficulty, from time to time, in sourcing these materials on
economical terms due to supply shortages. Such a shortage could require us to
suspend operations until these materials are available at economical terms,
which would have a material adverse effect on our business, results of
operations and financial position. The price we pay for these materials at a
facility could increase if an additional BioOil production facility is built in
the same general vicinity.

Price
increases in such inputs or a lack of supply of such inputs could increase
production costs, reduce profit margins and negatively affect cash flow. This
is especially true if market conditions do not allow us to pass through
increased costs to our customers. There is no assurance that we will be able to
pass through higher raw material prices to our customers. If a period of high
raw material prices or other inputs were to be sustained for some time, such
pricing may reduce our ability to operate and generate revenues. In certain
instances, we could decide to limit or even cease production of BioOil for a
period of time.

Declines in the prices of BioOil will have a
significant negative impact on our financial performance.

Our revenues will
be greatly affected by the price at which we can sell our BioOil. These prices
can be volatile as a result of a number of factors. These factors include the
overall supply and demand, level of government support, and the availability
and price of competing products. BioOil prices generally parallel the movement
of petroleum oil prices. Oil prices are difficult to forecast because the
market reflects the global economy, which is subject to political upheaval,
natural disasters, and other factors. Even the slightest rumor of political
instability can significantly affect the price of oil. Further, exchange rates
play a key role in domestic oil pricing.

There can be
no assurance as to the price of BioOil in the future. Any downward changes in
the price of BioOil may result in lower revenue which would decrease our
income.

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The
BioOil production and marketing industry is extremely competitive. Many of our
competitors have greater financial and other resources than we do and one or
more of these competitors could use their greater resources to gain market
share at our expense.

Many of our
competitors in the BioOil production and marketing industry have substantially
greater production, financial, research and development, personnel and
marketing resources than we do. As a result, our competitors may be able to
compete more aggressively than we could and sustain that competition over a
longer period of time. Our lack of resources relative to many of our
competitors may cause us to fail to anticipate or respond adequately to new
developments and other competitive pressures. This failure could reduce our
competitiveness and cause a decline in our market share, sales and
profitability.

The markets
for alternative energy technologies is highly competitive, and other providers
of such technologies, especially producers of ethanol from biomass, may have
various advantages in competition with ours. Many of our competitors have
established long-standing relationships with power generation companies,
utilities, manufacturers and others that we view as potential customers.

We face market
acceptance barriers that do not affect already established technologies. To
date, our technology has gained only limited market acceptance.

Competition
from the advancement of alternative fuels may lessen the demand for BioOil and
negatively impact our profitability.

Alternative
fuels, gasoline oxygenates and BioOil production methods are continually under
development. A number of automotive, industrial and power generation
manufacturers are developing alternative clean power systems using fuel cells
or clean burning gaseous fuels. Like BioOil, the emerging fuel cell industry
offers a technological option to address increasing worldwide energy costs, the
long-term availability of petroleum reserves and environmental concerns. Fuel
cells have emerged as a potential alternative to certain existing power sources
because of their higher efficiency, reduced noise and lower emissions. Fuel
cell industry participants are currently targeting the transportation,
stationary power and portable power markets in order to decrease fuel costs,
lessen dependence on crude oil and reduce harmful emissions. If the fuel cell
and hydrogen industries continue to expand and gain broad acceptance, and
hydrogen becomes readily available to consumers for motor vehicle use, we may
not be able to compete effectively. This additional competition could reduce
the demand for BioOil, which would negatively impact our profitability.

Changes
and advances in BioOil production technology could require us to incur costs to
update our BioOil plants or could otherwise hinder our ability to compete in
the BioOil industry or operate profitably.

Advances and
changes in BioOil production technology may make the BioOil production technology
installed in our current plants or any of our future plants, less desirable or
obsolete. These advances may also allow competitors to produce BioOil at a
lower cost than us. If we are unable to adopt or incorporate technological
advances, our BioOil production methods and processes could be less efficient
than our competitors, which could cause us to become uncompetitive or
completely obsolete. If competitors develop, obtain or license technology that
is superior to ours or that makes our technology obsolete, we may be required
to incur significant costs to enhance or acquire new technology so that our
BioOil production remains competitive. Alternatively, we may be required to
seek third-party licenses, which could also result in significant expenditures.
We cannot guarantee or assure that third-party licenses will be available or,
once obtained, will continue to be available on commercially reasonable terms.
These costs could negatively impact our financial performance by increasing our
operating costs and reducing our net income.

As
domestic BioOil production comes to grow, BioOil prices may decline which could
significantly reduce sales.

The number of
BioOil plants being developed and constructed is increasing. If the demand for
BioOil does not grow at the same pace as increases in supply, we would expect
the price for BioOil to decline. Declining BioOil prices will result in lower
revenues and may reduce or eliminate profits.

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Risks Related to our Common Stock

The
ability to trade the Companys stock may be limited.

Shares of our
common stock currently trade on the Over-the-Counter Bulletin Board market.
This market may not provide the same liquidity for the trading of securities as
NASDAQ or other exchanges. Our stock presently falls within the definition of a
penny stock as defined in SEC rules.

Generally, the
penny stock rules require a broker-dealer, before executing a transaction in a
penny stock to deliver a standardized risk disclosure document prepared by the
SEC that provides information about penny stocks and the nature and level of
risks in the penny stock market. The broker-dealer must also provide the
customer with current bid and offer quotations for the penny stock, the
compensation of the broker-dealer and its salesperson in the transaction, and
monthly account statements showing the market value of each penny stock held in
the customers account. In addition, the penny stock rules generally require
that the broker-dealer must make a special written determination that the penny
stock is a suitable investment for the purchaser and receive the purchasers
written agreement to the transaction. These disclosure requirements may have
the effect of reducing the level of trading activity in the secondary market
for a stock that is subject to the penny stock rules. Therefore, investors may
find it more difficult to sell their shares.

Our
stock price is volatile and could decline in the future.

Market prices
for our common stock are influenced by many factors and are subject to
significant fluctuations in response to variations in our operating results and
other factors. Historically, the trading price of our stock has been volatile.
Factors that could affect our future stock price, and create volatility in our
stock price, include the price and demand for BioOil, the price and
availability of oil and gasoline, regulatory changes that affect the price of
BioOil, the existence or discontinuation of legislative incentives for
renewable fuels, the trading price of the stock of our competitors, investor
perceptions of the Company, interest rates, general economic conditions and
those specific to the industry, developments with regard to our operations and
activities, our future financial condition, and changes in our management.

We
do not foresee paying cash dividends in the foreseeable future.

We have not
paid cash dividends on our stock and we do not plan to pay cash dividends on
our stock in the foreseeable future.

|        |                           
|------- | --------------------------
|ITEM 4. | INFORMATION ON THE COMPANY

A. HISTORY AND DEVELOPMENT OF THE COMPANY

General

The Companys
principal business is the development and commercialization of technology for
biomass-to-liquid fuel conversion using a process called Fast Pyrolysis. Fast
Pyrolysis is a process that rapidly heats biomass in the absence of oxygen to
produce a liquid fuel (BioOil). BioOil is a clean, renewable fuel which,
providing the equipment is suitably modified, can replace natural gas, diesel
and other fossil fuels to produce power, mechanical energy and heat in certain
industrial boilers, fuel gas turbines and other industrial applications. The
Company aims to generate significant amounts of energy, in the form of BioOil
fuels, based upon utilization of relatively abundant and inexpensive biomass
waste streams from agricultural and forest operations and other post-industrial
biomass residues. In many cases, the feedstock sources are costly to dispose of
and therefore are available at little to no cost or are potentially revenue
generating when converted into BioOil. The process of biomass to energy
conversion is sustainable, renewable and greenhouse gas neutral, and is
consistent with other renewable energy sources such as wind, hydro and solar.
We believe that the significant advantage of biomass energy over other
renewable forms of energy, is that biomass is capable of delivering energy on a
24/7 basis, whereas wind, hydro and solar energy sources are all subject to
natural fluctuations often entailing downtime.

Dynamotive is attempting to
establish its patented technology as the industry standard for the production
of liquid biomass based fuels (other than ethanol and biodiesel), in
competition with other pyrolysis technologies, and other

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biomass to energy
applications. The Companys Fast Pyrolysis process converts raw forest
and agricultural biomass residues such as sawdust, sugar cane bagasse, rice
husks and wheat straw, amongst others, into three fuel types: Liquid (BioOil), Solid (char) and Gas
(non-condensable gases). The non-condensable gases are used to fuel the
pyrolysis process, and char, which is similar to coal, is a re-useable green
fuel. The entire system is a closed loop with virtually no emissions or waste
by-products. The process was developed by Resource Transforms
International, Ltd. (RTI).

The Company and its partners
are also engaged in research and development on a range of derivative products
that, if successful, could further enhance the market and value for BioOil as
an alternative fuel and product source.

Development of Our Business

The Company was incorporated
on April 11, 1991 in the Province of British Columbia, Canada, under the name
of Dynamotive Canada Corporation. On October 31, 1995, the shareholders
approved a change of name to Dynamotive Technologies Corporation and on June
26, 2001, the shareholders again approved a change of name to Dynamotive Energy
Systems Corporation.

In 1996, the
Company obtained the exclusive worldwide rights from RTI for air emission
control products from this technology. In 1998, this exclusive arrangement with
RTI was expanded to include the Fast Pyrolysis process and virtually any new
products derived from BioOil including fuels and slow release fertilizers. In
February 2000, the Company acquired the patent to this technology from RTI and
entered into a research agreement with RTI on biofuels and BioOil derivative
products. The research agreement has terminated and the patents are now owned
royalty-free by the Company.

In
September 2006, the Company and Pendana Limited BVI (Pendana) also entered
into joint venture agreement
to establish Dynamotive Biomass Resource Corporation (DBRC) (a company
incorporated federally in Canada) with the purpose of securing biomass and to
source project development opportunities and additional biofuel and green
credit pipeline opportunities. Pursuant to terms of the agreement, the Company
earned a 51% interest in DBRC by contributing cash of $500,000 and granting
DBRC certain rights associated with specific biomass development opportunities
in Canada, South America, and Europe. In return for a 49% ownership in DBRC,
Pendanas contribution amounted to cash payments totaling $2,000,000. In addition, the Company agreed to lend
DBRC up to $1 million, with terms to be entered into at a later date. Pendana
further agreed to provide a $20 million revolving line of credit to DBRC. Any
sums advanced under this credit facility shall at Pendanas sole discretion, be
repayable on demand and shall bear interest at 4% above the rate of the Royal
Bank of Scotland. Pendana shall be entitled to security in the projects or
assets funded under this clause of the credit facility. As at December 31, 2007
and to date, no funds have been advanced by Pendana under this credit facility.

In
September 2006, the Company and Pendana also entered into an agreement in
connection with the Companys then wholly-owned subsidiary Dynamotive Europe Limited (DEL). The agreement was made
in an effort
to establish DEL as a permanent presence in Europe to develop European
projects. Under the terms of the agreement, Pendana completed a private
placement with the Company, whereby the Company issued 2,332,361 common shares
and 583,090 share purchase warrants for gross cash proceeds of $2,000,000. The
warrants were exercisable at $1.26 and expired unexercised on February 24,
2007. In addition, the Company issued a total of 3,000,000 warrants, with an
exercise price of $1.2375, to Pendana, 1,000,000 of these warrants expired
unexercised on April 24, 2007 and the remaining 2,000,000 warrants expired
unexercised on February 28, 2007. Pendana also received a 20% interest in DEL,
with Dynamotive maintaining the remaining 80% interest. The Company further
agreed to loan DEL $2,000,000 on commercial terms.

Pursuant
to the terms of the agreement, 20% of the net cash generated by DEL will be
distributed to Pendanas agent and 80% to the Company in settlement of the
intercompany debt. In the event DEL wishes to seek further debt or equity
funding to finance specific projects at any time following the date of the
agreement, Pendana shall have the right of first refusal.

In July 2007, the Company
entered into a share exchange agreement with Pendana, whereby Pendana agreed to
sell its 49% (490,000 common shares) of DBRC in consideration of the issuance
of 2,000,000 common shares of the Company having a fair value of $1.02 per
share which were issued to Pendana in August 2007.

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In October
2008, the Company and Pendana Limited (Pendana) entered into a share purchase
agreement where Pendana (the beneficial owner of one share representing 20% of
DEL) sold the one share of DEL to the Company for £1 and DEL again became a
wholly owned subsidiary of the Company. The Company continues to consolidate
DEL for each of the years presented.

As at December 31, 2008, the
Company had six wholly-owned subsidiaries, which are described below under
Organizational Structure.

The principal executive
office of the Company is Suite 140 - 13091 Vanier Place, Richmond, British
Columbia, Canada, V6V 2J1 (Telephone: 604-295-6800).

B. BUSINESS OVERVIEW

General

Dynamotives
primary focus is to commercialize its patented BioOil production technology and
establish this technology as the worldwide industry standard for production of
BioOil as a clean, renewable fuel utilizing biomass feedstocks. To support this
goal, the Company plans over the next year to develop full commercial scale
BioOil production facilities in conjunction with its alliance partners and then
expand upon its existing marketing efforts to generate new licensees throughout
Canada, Europe, the USA, Asia and Latin America.

The Company is
currently commercializing its Fast Pyrolysis biomass-to-energy technology that
converts low or zero cost forest and agricultural biomass residues into liquid
BioOil that is then used as a green renewable fuel alternative for power
generation, industrial use or as the raw material for a range of derivative
products. In 2005 the Company completed construction of its first 100 tonnes
per day (tpd) commercial scale plant (which has been upgraded and expanded to
130 tpd capacity), located adjacent to the Erie Flooring and Wood Products
manufacturing plant in West Lorne, Ontario, Canada. In addition, the Company
completed a 200 tpd plant in Guelph, Ontario, Canada which was commissioned and
entered operation in early 2008.

In the second
half of 2008 the Guelph plant was idled due to feedstock issues and financial
constraints and currently remains in a shut down mode. Prior to shut down the
Guelph plant was handling a number of different feedstocks, including
construction wood waste material. This material was found to have an excess of
foreign substances which caused fouling and other operational difficulties. The
Company is currently investigating a number of alternative financing and
business structures and potential feedstock supplies to utilize the plant and
to bring it into regular operation.

Initial
applications for BioOil are targeted for generating heat, power and mechanical
energy in industrial boilers, gas turbines and stationary reciprocating
engines. The Companys Fast Pyrolysis process converts raw forest
and agricultural biomass residues such as sawdust, sugar cane bagasse, rice
husks and wheat straw, amongst others, into three fuel types: Liquid (BioOil), Solid (char) and Gas
(non-condensable gases). The char produced in this process can also be
used as a fuel or as a feedstock for the production of charcoal briquettes, in
its raw form as a coal or coke alternative; or in other potential value added
applications including use as a soil enhancer (CQuestTM); activated
carbon for use in the water and wine industries and carbon black for domestic
and industrial uses. The char can also be added back into the BioOil to produce
an Intermediate grade BioOil (BioOil Plus) with higher energy content. The
non-condensable gases are re-cycled in the Fast Pyrolysis process and provide
the majority of the energy required for the process.

The Company
has also developed, at bench scale, processes for the upgrading of BioOil into
UBA and UBB which have less acidity, lower water content and lower oxygen
content. If successfully developed and produced at larger scale, UBA would be
an industrial fuel and UBB would be suitable as a transportation fuel or as a
feedstock into the conventional petroleum refining process.

Development and Commercialization of our
Technology

The six phases
of our development and commercialization program are as described below:

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Phase 1:Bench
scale, proof of concept was completed by RTI in 1996. Dynamotive licensed the
Fast Pyrolysis technology in 1997 and purchased the exclusive worldwide rights
to the technology from RTI in 2000.

Phase 2:In 1997,
Dynamotive built a 0.5 tonnes per day (tpd) prototype plant in Vancouver, BC,
which was upgraded in 1998 to a capacity of 2 tpd. This plant has operated for
over 3,000 hours.

Phase 3:In 2001,
Dynamotive entered into a strategic alliance with Tecna S.A. of Argentina to
develop commercial energy systems based on Dynamotives pyrolysis technology in
Latin America and other markets on a non-exclusive basis. Tecna would also collaborate
with Dynamotive to provide technical design and optimization input on
Dynamotives BioOil production technology. Tecna has provided valuable
technical support, engineering and consulting services to validate the basic
engineering and operation of the BioOil technology and to evaluate and quantify
the potential for improvements to the efficiency of the BioOil technology. This
work has been on going since and resulted in confirmation of the basic BioOil
designs and process efficiencies, development of process designs and equipment
specification and design details that are being incorporated into the current
BioOil plant designs.

Phase 4:Dynamotive
completed commissioning of a new 10 tpd pilot plant in March 2001 which was
de-commissioned in December 2002. The plant was built to industrial
specifications complete with a state-of-the-art distributed control system
(DCS). The plant had a production capacity of 6,000 liters of BioOil per day
and achieved or exceeded this capacity output for more or less continuous
periods of up to 10 days at a time. The plant has exceeded design parameters
operating on a continuous basis at 50% above its nominal design capacity.

Phase 5:Following
the 10 tpd pilot, Dynamotive began construction of a 100 tpd commercial scale
plant, with initial commissioning in 2005. This plant processes wood residues
and is designed for continuous 24-hour production at commercial scale although
this capacity has only been achieved for short periods of time since
commissioning. This project is also intended to demonstrate continuous
operation of end use applications (boilers/kilns and gas turbines). The
principal goal of the commercial demonstration project is to demonstrate the
economics of the process, and to secure future engineering, procurement and
construction (EPC) commitments from the Companys current partners and
potential future service and equipment providers. Ultimately, the Company
expects these EPC commitments to facilitate lending commitments to execute on
BioOil project developments as part of the Companys final commercialization
phase.

During 2006,
the plant was either producing or available (e.g. reactor warm) for 135 days.
During this period, the West Lorne plant produced BioOil and Char for a number
of purposes including BioOil shipments to the US of $123,954 and deliveries of
electricity to the grid of $30,966; successful commercial scale fuel
demonstrations in a number of industries within Canada; running of the turbine;
providing BioOil for business development and research initiatives in North
America and Europe (including emulsification development); and providing a
commercial scale platform for the Company in its evaluation of design and
process improvements for its 200tpd unit now in commissioning in Guelph.

In December
2006, the Company began an upgrade and expansion of the West Lorne plant to
increase its capacity to 130 tonnes per day. The expansion has been completed
and the facility re-entered operations in the first quarter of 2008. During
2008 the West Lorne plant the plant was either producing or available (e.g.
reactor warm) for 45 days. During this period, the West Lorne plant produced
BioOil and Char for a number of purposes including BioOil shipments (primarily
to the US) of $63,976; Char sales of $12,146; service sales of $74,941 as well
as incidental deliveries of electricity to the grid.

The West Lorne
facility has provided Dynamotive with a showcase of its commercial BioOil
technology to many interested companies and government institutions and has been
fundamental in the Companys successes in sale of plant and master licenses
previously disclosed and those currently in negotiation.

Phases 6:In 2008
the Company commissioned and completed initial operation of its first 200 tpd
plant, located in Guelph, Ontario, Canada. Dynamotive and partners plan to
develop multiple commercial plants at the 200 tpd scale and larger and to bring
the costs of the plants down significantly. The Company is presently seeking to
secure rights to multiple high disposal cost biomass waste streams around the
world, in order to accelerate its commercial efforts. The Company believes that
by securing rights to these biomass waste streams and related BioOil, power

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and/or energy
purchase commitments will be able to catalyze the development of commercial
BioOil projects that incorporate the design, engineering and licensing of its
Fast Pyrolysis technology.

Phases 7:The
Company intends to develop pilot scale and then commercial scale production of
upgraded BioOil (referred to as UBA and UBB) which would have less acidity,
lower water content and lower oxygen content. If successfully developed and
produced at larger scale, UBA would be an industrial fuel and UBB would be
suitable as a transportation fuel or as a feedstock into the conventional
petroleum refining process. The Company also continues to pursue the
development of commercially attractive derivative chemicals from BioOil.

The Company
has commitments of approximately $0.6 million in capital expenditures in 2009.

By virtue of
being derived from biomass residues, all BioOil fuels are considered to be
carbon dioxide and greenhouse gas neutral. When combusted, they produce no
sulfur dioxide and significantly reduced nitrogen oxide emissions compared with
hydrocarbon fuels, therefore having significant environmental benefits over
these fuels with respect to atmospheric pollution.

BioOil Production Process

In the Fast
Pyrolysis process, biomass waste materials are rapidly heated in the absence of
oxygen in a reactor. The rapidly vaporized volatiles are then quickly
condensed, forming a liquid fuel referred to as BioOil, solid char and
non-condensable gases. Depending upon the feedstock used (many different
sources of feedstock have been bench tested thus far), the process typically
produces 60-75 tons of BioOil, 15-20 tons of char and approximately 15 tons of
non-condensable gases from 100 tons of biomass residues. The Company believes
that the overall simplicity of the Fast pyrolysis process and the fact that all
the major equipment is already well proven in existing related industrial
applications gives the Companys BioOil technology competitive advantages over
other pyrolysis conversion technologies such as lower capital and operating
costs, higher product yields, a significantly higher quality BioOil and the
flexibility to process a wide variety of feedstocks.

The Company
began producing batch quantities of BioOil in 1997 in its 0.5 tpd Fast
Pyrolysis pilot plant located at the Companys research and development
facility in Vancouver, BC. By the end of 1998, the BioOil Technology Group had
upgraded, commissioned and operated the plant to a capacity of two tpd on a
continuous basis. In 1999, further changes were made to the feed system, Fast
Pyrolysis reactor, cyclone, and instrumentation and control systems to provide
increased stable operation. Once these changes were made, the Fast Pyrolysis
was re-commissioned and produced BioOil of sufficiently high quality to meet
fuel specification requirements as defined by our engine testing partners.

The Companys
10 tpd BioOil plant was commissioned in March, 2001. Commissioning included a
sustained 10 day, 24 hr/7 day a week operation which demonstrated that this
design with minor adjustments could process 14.5 tpd rather than the estimated
10 tons. The Company believes that the plant conforms to all applicable British
Columbia safety, electrical and mechanical design standards, utilizing
state-of-the-art smart instrumentation and a high-powered industrial-grade
distributed control system. The Company adopted this design policy in order to
facilitate easy scale-up to commercial plant capacities.

BioOil Production Facilities and Markets

During 2004,
the Company began construction of its first 100 tpd plant in Ontario, Canada at
the Erie Flooring and Wood Products (Erie Flooring) facilities in West Lorne,
Ontario, Canada (West Lorne). The integrated plant utilizes wood residue from
Erie Floorings operations and is comprised of wood conditioning equipment,
pyrolysis plant and power island. Pyrolysis and generation equipment are to be
provided by Dynamotive and Magellan Aerospace, Orenda division (Orenda)
respectively. Erie Flooring provides wood residue for the project and will
receive char for process heat for its operations. The project began to export
green power on a limited basis to Ontarios grid system in 2005.

The Company
has entered into lease, wood supply, steam and other agreements with Erie
Flooring, which allow for operation of the plant. The Company has received its
generation license from the Ontario Energy Board and has an interconnection
agreement with Hydro One for the export of electric power to the Ontario
electricity grid and in January 2007 was approved for a contract with the
Ontario Power Authority to sell all of its electricity at

14

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C$110/Mwh over
a 20 year period with certain annual inflation related adjustments. On April 5,
2007 the Company entered into certain amended agreements with Erie Flooring
regarding the supply by Erie Flooring of wood to the West Lorne BioOil plant
over the next 12 years at no charge and the provision of char from the BioOil
plant to Erie at no charge. In relation to these agreements, the Company agreed
to pay for the purchase and installation of a char based boiler system and
related char delivery infrastructure. The terms include an immediate payment of
$500,000 to Erie Flooring and a further $359,000 to Erie in equal monthly
payments plus 8% interest, over the next 10 years for the purchase of the
boiler.

A small fire
in an isolated area of the West Lorne Plant occurred on April 10th 2008. There
were no injuries and there was no need to evacuate the plant. No significant
damage to the plant is reported, and product storage areas were not affected.
Work continues to investigate the event and establish a schedule for repairs,
which are expected to take approximately two months. The total cost of the
repairs was approximately $300,000 and the majority of these costs were covered
by insurance.

Due to
difficulties in operating levels and feedstock limitations, the Company has
made a $5.1 million valuation allowance to reduce the book value of the West
Lorne plant.

During 2006
and 2007, the Company constructed a 200 tpd BioOil production facility in
Guelph, Ontario, Canada. The Company owns the plant and intends to lease it to
Evolution BioFuels Inc., the entity that will operate the plant. The plant was
commissioned in early 2008 and is designed to produce BioOil Plus, which is a
mixture of BioOil and char. In the second half of 2008, the Company put the
plant into shut-down mode due to feedstock issues and financial constraints.
The Company is currently in discussions with Evolution Biofuels about possibly
changing the business structure. Accordingly, the Company has made an $8.8 million
valuation allowance to reduce the book value of the Guelph plant.

The Company
believes that the near term commercial application for BioOil is as a clean
burning fuel that can be used to replace natural gas, diesel and other fossil
fuels in boilers, gas turbines and slow and medium speed reciprocating engines
for heat and power generation, to replace natural gas in the forest industry
and for lumber dry kiln and lime kiln applications. Initial markets are
expected to include Canada, the US, Europe, Latin America, Asia and Island
based economies.

Orenda is in
the second phase of a program to develop a commercial gas turbine package
fueled by Dynamotives BioOil. The 2.5 MW (megawatt) GT2500 turbine was
successfully commissioned on BioOil in 2005 and is at the West Lorne site.
Orenda has also identified further commercial scale projects for its turbines
and BioOil, in addition to West Lorne as referred to above.

Dynamotive
also targets the industrial fuels market. Working with the Canadian federal
department of Natural Resources CANMET Energy Technology Centre in Ottawa,
Ontario, it developed a burner nozzle design for stable BioOil fuel combustion.
This has created opportunities for early commercial applications for BioOil as
a clean burning fuel to replace natural gas, diesel and other fossil fuels in
the multi-billion dollar industrial boilers, kiln fuels and specialty heating
applications markets. Testing of BioOil in lumber kilns was successfully
completed in 2002. In 2003, Dynamotive completed pilot scale limekiln testing
of BioOil fuel in conjunction with the University of British Columbia (UBC) and
in July 2006 completed an industrial scale lime kiln burn in British Columbia,
Canada. In 2006 and 2007, the Company also completed test burns in greenhouses
and in an aluminum smelter with Alcoa. Customers for BioOil fuels could
potentially include local, regional and international power generators and
electrical utilities (fuel substitution in large scale power plants and fuel
for district heating), fuel distributors, forest companies (natural gas
substitute in lime kilns, lumber kilns and boilers), oil and gas producers
(steam production for extraction) and manufacturing companies (process heat)
including sawmills, pulp mills and greenhouses. Beyond the programs above,
testing continued with various industrial burner and boiler combustion experts
and manufacturers and with industrial customers in 2008. These tests are a
necessary prerequisite to long term fuel sales agreements.

The Company
has completed a series of production runs converting 100% softwood bark derived
from spruce, pine and fir into fuel quality BioOil. Lower value bark residues
are a major problem for the forest industry; as bark has little or no value and
is costly to dispose of. Canada, for example, produces approximately 18 million
tons of sawmill residues per year of which 5 to 6 million tons are considered
wastes and are subsequently incinerated or landfilled.

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BioOil Applications and Derivative Products

BioOil has a
wide range of potential commercial applications. As the BioOil industry matures
it has the potential to follow a similar development path as the petroleum
industry, beginning with exploitation of basic unrefined BioOil fuels for power
generation and district heating followed by upgrading, blends and emulsions for
transportation. Development of higher value products, including agro-products,
resins, adhesives, specialty chemicals, slow release fertilizers and other
derivatives, may occur as refining and processing techniques are established by
future licensees or partnerships with Dynamotive. Over time, we anticipate that
BioOil will be refined in much the same way that petroleum is today in order to
derive the highest value energy and chemical products.

The Company is
following a staged approach to product development, focusing initially on the
earliest and most appropriate application of BioOil as a clean, renewable fuel
to generate power and heat in industrial boilers and kilns, gas turbines and
stationary reciprocating engines. The Company is also supporting efforts to
develop a next generation of higher-value fuels, including upgraded BioOil
(UBA and UBB) BioOil/ethanol blends, BioOil/diesel emulsions and catalytic
reforming of BioOil to produce synthetic fuels and bio-methanol. BioOil also
has potential as a raw material to produce agro-products such as slow release
fertilizers and other high-value products.

Over the
longer term, the Company believes that exploitation of specialty chemicals
contained in BioOil has the potential to create significant value. Dynamotive
and collaborating research institutions are developing techniques to extract
chemicals such as hydroxyacetaldehyde, levoglucosan, levoglucosenone, acetol,
acetic acid and formic acid. These chemicals have a wide variety of possible
applications including food flavorings, adhesives, resins, pharmaceuticals,
bio-based pesticides and paper brighteners.

Char Production

Char is a
significant co-product of the Companys pyrolysis process comprising 15% to 20%
yield from the input biomass at a value of approximately one half that of
BioOil on a weight basis when used for fuel purposes. Char is a granular solid
with properties similar to coal. At 23  30 Giga Joules per tonne, pyrolysis
char has a higher heating value than wood and many grades of coal. Like BioOil,
it is a green fuel which is CO2 (carbon dioxide) neutral and contains
virtually no sulfur. Char can be either sold separately or ground down and
re-introduced to the BioOil (as in Guelph) to create BioOil Plus, an
intermediate grade higher energy content industrial fuel.

A commercial
scale BioOil plant processing 200 tpd of wood residue is expected to produce
approximately 13,000 tons per year of char with a total energy value of
approximately 300,000 Giga Joules, dependent on the composition and species of
the feedstock.

Early stage
applications of char will focus on direct substitution or augmentation of
fossil fuels to produce process heat and power via commercially available
technologies in BioOil plants, sawmills, thermal power generation and cement
production. Char as a soil enhancer (CquestTM) has been
successfully tested and has been sold in limited quantities. In 2007 and 2008
the Company conducted testing in Iowa and elsewhere using char as a soil
enhancing agent in order to develop the potential use of char to increase soil
fertility and crop yield.

Char also has
potential for use as a feedstock for manufacturing of charcoal briquettes.
Dynamotive char has been successfully tested at industrial scale and the
prototype briquettes showed excellent results, meeting or exceeding all
charcoal industry quality standards.

Sales and Marketing

The Company
has been conducting its own sales and marketing activities and to date has sold
a minimal amount of its product. The Company currently has two plants in Canada
and is developing opportunities globally. There is no seasonality in
current
operations. Marketing of fuels is conducted directly with industrial customers.
As commercial operations increase, the Company plans to expand its sales and
marketing activities internally, as well as engage third parties to assist in
the sales and marketing of the Companys products.

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Strategic Partners, Investment and Government
Funding

The Companys
BioOil technologies are consistent with the environmental and economic
objectives of many governments around the world.

The Company
has received strong support from Canadian government departments and funded
entities.

During 1997,
the Company entered into a contribution agreement with Industry Canada-Industrial Technologies Office (ITO) (formerly
known as Technology Partnerships Canada) whereby the Company is entitled to
receive a maximum of approximately $6.7 million (Cdn$ 8.2 million) or 37% of
eligible expenditures, as defined in the agreement. The agreement, as amended,
specifies that in the event commercial viability is achieved, then the
assistance is repayable, commencing January 1, 2005 based on a 2.5% royalty
from sales of specified products resulting from the project to a maximum of
$13.1 million (Cdn$16.0 million) or until the expiration of contract on
December 31, 2016.

ITO is a key
element in the federal governments innovation strategy, leveraging private
sector investments in research, development and innovation in critical,
leading-edge technologies. As at December 31, 2008, the Company had claimed
US$6.7 million to fund pre-commercial Fast Pyrolysis research and development.
The contribution agreement was amended to confirm a maximum reimbursement cap of
$6.7 million and extend the agreement to March 31, 2008. The Company is
required to repay these funds from a 2.5% royalty on certain future sales up to
a maximum of US$13.1 million. The Company will focus all funding from the
amended contribution agreement towards construction of a full commercial-scale
forestry demonstration BioOil facility in Canada. An initial royalty payment of
$4,876 has been recorded at December 31, 2008.

In 2003, the
Company was approved to receive a funding contribution for the West Lorne
Project from Sustainable Development Technology Canada (SDTC). On March 5, 2004
the Company signed the Contribution Agreement with SDTC, confirming their $ 4.3
million (C$5,000,000) capital grant to the Project, subject to completion of
the agreed work plan and documentation of eligible costs and other reporting
requirements over a three year period following completion of the Project (the
Contract Period). In 2004, the Company received the three payments totaling
$3.2 million (C$3.7 million) from SDTC. In November 2005, the Company received
a payment of $0.7 million (C$0.8 million) from SDTC. In December 2006, the
Company received the remaining $0.4 million (C$0.5 million). The funds received
from SDTC have been accounted for as a credit to the carrying cost of the West
Lorne Plant.

Raw Materials and Suppliers

For the most part, the Companys products are
custom designed and manufactured and are not produced for inventory. BioOil
plants will only be produced for specific projects with procurement commencing
when project funding has been fully committed.

The Company outsources the final assembly of
its products prior to sale and does not manufacture the major components of its
systems. The manufactured components and materials used in the Companys
products are obtained from both domestic and foreign sources. Historically,
lead-time for delivery of materials has not been a problem.

While the Company has chosen to use only a
limited number of manufacturers to produce the components for its technologies,
in the opinion of management, the Company has a readily available supply of
components and raw materials for all of its anticipated products from various
sources and does not anticipate any difficulties in obtaining the components
and raw materials necessary to its business. These components comprise
primarily pyrolysis reactor chambers, burner assemblies, and conveyers.

The Company believes that this licensing and
focused, outsourced manufacturing strategy allows it to deliver superior
products without the high capital expenditures that the Company would otherwise
require in order to manufacture the components in house. As a result of
limiting the number of suppliers for the key components for the Companys
products, the Company believes it is better able to control costs while still
maintaining high quality specifications for the components manufacture.
Moreover, the Company believes that it is better able to limit the number of
third parties who have access to the Companys proprietary technologies.

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Competition

Many of our
competitors in the BioOil production and marketing industry have substantially
greater production, financial, research and development, personnel and
marketing resources than we do. As a result, our competitors may be able to compete
more aggressively than we could and sustain that competition over a longer
period of time. Our lack of resources relative to many of our competitors may
cause us to fail to anticipate or respond adequately to new developments and
other competitive pressures. This failure could reduce our competitiveness and
cause a decline in our market share, sales and profitability.

The markets
for alternative energy technologies is highly competitive, and other providers
of such technologies, especially producers of ethanol from biomass, may have
various advantages in competition with ours. Many of our competitors have
established long-standing relationships with power generation companies,
utilities, manufacturers and others that we view as potential customers.

We face market
acceptance barriers that do not affect already established technologies. To
date, our technology has gained only limited market acceptance.

Intellectual Property

The Company
considers patents to be an important aspect of the Companys business. The
Company protects its intellectual property such as trademarks, patents, product
designs, manufacturing processes and new product research and concepts. These
rights are protected through patents and trademark registrations, the
maintenance of trade secrets and, when necessary and appropriate. The Company
also maintains stringent procedures to maintain the secrecy of its confidential
business information. These procedures include the establishment of need to
know criteria for the dissemination of certain information and the use of
written confidentiality agreements in cases where the sharing of proprietary
information with third parties is necessary.

As of June 19,
2009, the Companys key patent is protected in 12 countries with patent
applications pending in 4 countries and is scheduled to expire between years
2016 and 2017. Patents were granted in 2008 for protection in New Zealand and
Ukraine with respect to an enhancement of the key patent to expire in year
2025. In respect of this patent enhancement, a US Patent was granted in
February 2006 to expire in year 2024 and based on this, a US PCT application
was filed in February 2005; a Eurasian patent application filed in March 2006;
patent applications for protection in Cuba, Mexico, Norway, and Regional Europe
filed in 2007 and also during the year, an international PCT application was
filed for another patent enhancement of the key patent.

Research and Development

The company
conducts research and development in respect of its production process and
products produced or that may be produced. For the years 2008, 2007 and 2006,
the Company had expended on an annual basis $1,506,213, $2,053,914, and
$4,629,465 respectively, on research and development. Of these amounts, $nil, $
nil and $227,121 respectively, were reimbursed by government funding. In 2008,
the Company also offset product and service sales of $151,657 (2007 - $13,911,
2006 - $154,560;) against research and development expenses, which are
considered incidental sales of BioOil until such time as the Companys plant
has reached commercial production levels.

Effect of Governmental and Environmental Protection Regulations

Operators of the Companys pyrolysis plants
will be subject to extensive federal, provincial, state or foreign governmental
and environmental laws. If full commercial use of BioOil in power generation,
heat and other applications commences, the Company will become subject to
various federal, local and foreign laws and regulations pertaining to the
discharge of material into the environment, the use of biological waste
products as feedstock, and otherwise relating to the protection of the
environment. The Company believes that it has been in compliance with such laws
to date.

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Organizational Structure

(FLOW CHART)

Note:

|   |                                                                                                                                                                                                                                                                                                                                                                               
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*  | Dynamotive
  Europe Ltds 75% owned subsidiary - Border Biofuels Ltd and its subsidiaries
  were petitioned into bankruptcy in December 2002 and are currently in
  liquidation.                                                                                                                                                                                              
|   |                                                                                                                                                                                                                                                                                                                                                                               
|** | In Sep 2006,
  Dynamotive Energy Systems Corp has 50% voting rights and the management has
  determined that DBRC met the criteria of a variable interest entity (VIE)
  and accordingly has consolidated the accounts of DBRC into DESCs
  consolidated financial statements In July 2007, the company acquired the
  balance of the ownership and DESC owns 100% of DBRC.

As at December
31, 2008, the Company had six wholly-owned subsidiaries Dynamotive Canada Inc.,
federally incorporated under the laws of Canada in 2000; Dynamotive USA Inc.
incorporated under the laws of Delaware, U.S.A. in 2006; Dynamotive
Latinoamericana S.A., incorporated under the laws of Buenos Aires, Argentina in
2006; First Resources Corporation, incorporated under the laws of British
Columbia, Canada in 2006; Dynamotive Biomass Resource Corporation, incorporated
under the laws of British Columbia, Canada in 2006; and Dynamotive Europe
Limited, formally known as Dynamotive Technologies (UK) Ltd, incorporated in
the United Kingdom in 1996. In addition, the Company owes 99.98% interest in
the West Lorne BioOil Co-Generation LP, formed under the laws of Ontario,
Canada in 2003. Dynamotive Canada Inc. acts as the General Partner of the
Limited Partnership, which operates the West Lorne BioOil and electricity
generation plant.

Dynamotive
Corporation, incorporated under the laws of Rhode Island, U.S.A. has been
inactive and was a wholly owned until December 12, 2008 when a 51% interest was
sold to an officer of the Company for nominal consideration. Prior to this
date, Dynamotive Corporation was consolidated. Subsequent to that date, results
are accounted for using the equity method.

Employees

The Company
currently has 25 full-time employees.

Property, Plants and Equipment

The Companys
office facilities are leased. The Companys corporate headquarters, leased for
a two-year period which commenced in May 2009, are located in a business park
complex in Richmond, BC, Canada with

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approximately
4,000 square feet of office space. The Companys principal capital assets are
the West Lorne and Guelph BioOil Plants discussed above.

We own a
commercial scale BioOil and electricity plant located in West Lorne, Ontario,
Canada that converts raw wood into three fuel types, BioOil, char and
non-condensable gases, using the Fast Pyrolysis process. The plant is
approximately 18,000 square feet in size. Construction of the plant was
completed in 2005, with a capacity of processing 100 tonnes per day of wood. In
December 2006, we began an upgrade and expansion of this facility to increase
its capacity to 130 tonnes per day which has been completed. We are currently
commissioning the facility and the facility is expected to begin regular
operations in mid 2008.

In April 2007,
the Company entered into amended agreements with Erie Flooring and Wood
Products (Erie) regarding the supply by Erie of wood chips to the West Lorne
BioOil plant over the next 12 years at no charge and the provision of char from
the BioOil plant to Erie at no charge. In relation to these agreements,
Dynamotive has paid for the purchase and installation of a char based boiler
system and related char delivery infrastructure at Erie. There remains a $0.6
million commitment toward the completion of this char based boiler system. The
asset will be amortized evenly over the life of the wood supply contract. As
the recovery of the amount is not probable the $998,008 asset has been
expensed under US GAAP.

We own a
commercial scale BioOil plant located in Guelph, Ontario, Canada that also
converts raw biomass residues into BioOil, char and non-condensable gases,
using the Fast Pyrolysis process. The plant is approximately 52,000 square feet
in size. Construction of the plant was completed in 2007, and the plant is
capable of processing 200 tonnes per day of wood. The plant was commissioned in
ealy 2008 and in the second half of 2008 the facility was put into shut-down
mode due to feedstock issues and due to financial limitations.

|         |                                             
|-------- | --------------------------------------------
|ITEM 4A. | UNRESOLVED STAFF COMMENTS                   
|         |                                             
|None.    |                                             
|         |                                             
|ITEM 5.  | OPERATING AND FINANCIAL REVIEW AND PROSPECTS

Overview

The financial
information presented below should be read in conjunction with our audited
consolidated financial statements and the notes thereto, and with the
information appearing under the headings Information on the Company and
Operating and Financial Review and Prospects, included elsewhere herein.

Our audited
consolidated financial statements have been prepared under Canadian GAAP in
U.S. dollars. Additional information is presented to show the differences which
would result from the application of US GAAP to the Companys financial
information. Refer to Note 25 of the audited consolidated financial statements
included herein for a discussion of the material differences between Canadian
GAAP and US GAAP and their effect on the Companys financial position and
results of operations.

In 2003, we
began construction of a BioOil production plant in West Lorne, Ontario, which
was initially commissioned (tested for start up) in 2005. In December 2006, we
began an upgrade and expansion of this plant to increase its capacity. In 2006,
we began construction of another BioOil production plant in Guelph Ontario,
which was commissioned in early 2008 and put into shut-down mode in the second
half of 2008. Accordingly, the financial information presented below may not be
comparable from period to period. See Information on the Company for a
description of the development of our business.

Our Business

Our principal
business is the development and commercialization of technology for
biomass-to-liquid fuel conversion using a process called Fast Pyrolysis. Fast
Pyrolysis is a process that rapidly heats biomass in the absence of oxygen to
produce a liquid fuel (BioOil). BioOil is a clean, renewable fuel which,
providing the equipment is suitably modified, can replace natural gas, diesel
and other fossil fuels to produce power, mechanical energy and heat in certain
industrial boilers, fuel gas turbines and other industrial applications. We aim
to generate significant amounts of energy, in the form of BioOil fuels, based
upon utilization of relatively abundant and

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inexpensive
biomass waste streams from agricultural and forest operations and other
post-industrial biomass residues. In many cases, the feedstock sources are
costly to dispose of and therefore are available at little to no cost or are
potentially revenue generating when converted into BioOil. The process of
biomass to energy conversion is sustainable, renewable and greenhouse gas
neutral, and is consistent with other renewable energy sources such as wind,
hydro and solar. We believe that the significant advantage of biomass energy
over other renewable forms of energy, is that biomass is capable of delivering
energy on a 24/7 basis, whereas wind, hydro and solar energy sources are all
subject to natural fluctuations often entailing downtime.

Plan of Operations

We have
completed the expansion of the capacity of our plant located in West Lorne,
Ontario, Canada to 130 tpd, and have completed constructions and testing of our
200 tpd plant located in Guelph, Ontario, Canada. We plan to ramp up sales and
marketing of our West Lorne production in 2009, and with our partners, going
forward we plan to develop multiple commercial plants at the 200 tpd scale and
larger and to bring the costs of the plants down significantly. The Company has
put the Guelph plant into shut-down mode and is currently assessing alternative
feedstock supplies and possible changes to its business structure and finances.
We are presently seeking to secure rights to multiple high disposal cost
biomass waste streams around the world, in order to accelerate its commercial
efforts. We believe that by securing rights to these biomass waste streams and
related BioOil, power and/or energy purchase commitments will be able to
catalyze the development of commercial BioOil projects that incorporate the design,
engineering and licensing of its Fast Pyrolysis technology.

The Company is
currently assessing a number of scenarios including the possibility of moving
the plant in Guelph to another location. The impairment provision determined by
management represents managements best estimate of the realizable value of the
plant under various scenarios. Note, there is significant measurement
uncertainty in determining the amount of the impairment provision as management
used significant estimates that related to the determination of recoverability
of property, plant and equipment costs.

We have funded
our operations primarily from the sale of our common stock. As at December 31,
2008, we had cash and cash equivalents of $39,927 and a working capital
deficiency of $10,441,893. We plan to spend approximately $6 million in 2009 to
pursue our plan of operations for the next 12 months. With the current cash on
hand of $39,927 and estimated cash flow from product sales of under $1 million,
we do not have sufficient internally generated cash flows to satisfy our cash
requirements over the next 12 months. To meet those cash requirements we will
need to secure equity and debt financing in the amount of $5 to 6 million or
more. There is no assurance however that we will obtain positive cash flow from
product sales or be able to obtain sufficient equity or debt financing to
satisfy our cash requirements for the next 12 months.

Beyond the
next 12 months, we will be required to obtain additional financing in order to
continue our plan of operations as we anticipate that we will not earn
sufficient revenues. We anticipate that additional funding will be in the form
of equity financing from the sale of our common stock plus debt financing.
However, there can be no assurance that we will be able to raise sufficient
funding from the sale of our common stock to fund our business plan going
forward.

Results of Operations

During the
year ended December 31, 2008, the Company recorded a net operating loss of
$28,356,265 compared to a net operating loss of $14,220,404 for the year 2007.
The increase in operating loss in 2008 as compared to 2007 was primarily
attributable to (i) an increase in amortization and depreciation; (ii) an
increase in interest expense; (iii) an increase in foreign exchange loss; (iv)
an increase in write-down of property, plant & equipment; (v) an increase
in loss on return of services deposits and offset by (vi) an increase in
revenue; (vii) a decrease in marketing and business development expense, (viii)
a decrease in research and development expenditures, (ix) a decrease in general
and administrative expense; (x) in increase in gain on reduction in bonus and
vacation accrual. During the year ended December 31, 2007, the Company recorded
a net operating loss of $14,220,404 compared to a net operating loss of
$14,252,382 for the year 2006. The minor decrease in operating loss in 2007 as
compared to 2006 was primarily attributable to (i) a decrease in marketing and
business development expense, (ii) a decrease in research and development
expenditures, (iii) a decrease in interest expense; (iv) an increase in foreign
exchange gain; partially offset by (v) an increase in general and
administrative expense and (vi) an increase in amortization and depreciation.

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In 2008, the
Company had a similar level of operating activity as in 2007, but with the
focus on commissioning of the Guelph plant and the re-start of the West Lorne
plant in early to mid-2008, as well as continuing project development
activities. There were a number of new project initiatives internationally and
the Company has been evolving to better support these activities along with the
sales and operating activities at the plants. Staffing levels remained broadly
the same.

Revenue

Revenue for
2008 was $178,106 compared to $nil in 2007 (2006 - $nil). The increased revenue
for 2008 was due to the Company recognizing the Rika Ltd. master license fee of
$523,841 net of writing down the outstanding loan due from Rika Ltd of $345,735
at the end of the two year agreement term during the first quarter of 2008.

During 2008, the
Company netted $151,657 (2007 - $13,911; 2006 - $154,560) of product and
service sales against research and development expenses, which are considered
incidental sales of BioOil, char and electricity until such time as the
Companys plants have reached commercial production levels. Commercial
production levels are reached when the plant is producing a positive cash-flow
and operations are considered to be sustainable at that level.

Interest and other
income for 2008 were $5,349 compared to $207,099 in 2007 (2006 - $493,610). The
$5,349 other income for 2008 was mainly from the sale of small tools during the
year. The decrease from 2006 to 2007 was due mainly to lower cash balances and
therefore decreased interest income from investments in short-term money market
deposits.

Royalty fees

Royalty fees
paid for 2008 were $4,876 compared to $nil in 2007 (2006 - $nil). Under the
amended agreement with Industrial Technologies Office (ITO), it specifies
that the assistance is repayable, commencing January 1, 2005 based on royalties
from sales of specified products resulting from the project, to a maximum of
$13.1 million (Cdn$16 million) or until the expiration of contract on December
31, 2016. Although the Company has not achieved commercial viability, some
revenues have been recorded from the project. $4,876 repayment has been accrued
as royalty fee during 2008.

Expenses

The basic and
diluted loss per common share was thirteen cents ($0.13) for the year 2008
compared to eight cents ($0.08) for the year 2007. The increase in basic and
diluted loss per share for 2008 was due to a combination of the increase in the
loss for the year and the increase in the weighted average number of Common
Shares outstanding from 189,573,764 in 2007 to 211,448,521 in 2008. The basic
and diluted loss per common share was eight cents ($0.08) for the year 2007
compared to nine cents ($0.09) for the year 2006. The decrease in basic and
diluted loss per share for 2007 was due to a combination of the decrease in the
loss for the year and the increase in the weighted average number of Common
Shares outstanding from 153,685,553 shares in 2006 to 189,573,764 in 2007.

Write-down of
property, plant and equipment in 2008 was $15,792,909, which relates to the
impairment in the estimated fair value of the plants in West Lorne ($5,675,813)
and in Guelph ($10,117,096). In addition to the write-down of the West Lorne
and Guelph plants, the Company also recorded a write-down on the long-term deferred
asset in West Lorne of $225,826. The above write-downs are inclusive of
$2,054,992 of related foreign exchange effect. These impairment charges
occurred due to the Companys review of the fair value of the plant assets
after assessing recent operating history of the plants and taking into account
market conditions and sales expectations. In Guelph, the Company also took into
account the plants shut down status and considered alternative scenarios as to
how the plant could best be brought back into use in a profitable manner.

Marketing and
business development expenses were $828,368 in 2008 compared to $1,601,723 in
2007. The decrease was due mainly to the decrease of business development
activities, including public and investor relations, during the 2008 period.
Marketing and business development expenses were $1,601,723 for 2007 compared
to $1,768,063 in 2006. The decrease was due mainly to decreased business
development activities and participation in major environmental conferences
during the 2007 period.

22

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For the years
2008, 2007 and 2006, the Company had expended on an annual basis $1,506,213,
$2,053,914 and $4,629,465 respectively, on research and development. Of these
research and development expenditures, the amount reimbursed by government
funding was $nil for 2008 and 2007 compared to $227,121 in 2006. In 2008, the
Company also offset product and service sales of $151,657 (2007 - $13,911; 2006
- $154,560) against research and development expenses, which are considered
incidental sales until such time as the Companys plant has reached commercial
production levels. The level of research and development expenditure has
decreased in 2008 in support of development of the commercial scale plant and
other product development activities. The decrease was due to reduced activity
in engineering development of the commercial scale plant and other product
development activities.

General and
administrative expenses were $9,650,644 for 2008 compared to $11,026,616 in
2007. The decrease in 2008 was a combination of decreased activity in the
general and administrative area and management of the Companys development
activities related to its 200 tpd plant in Guelph, Ontario, a decrease in
non-cash compensation expenses and a reduction in bonus accrual, partially
offset by increased activities in the Companys U.S. and Argentina offices.
General and administrative expenses were $11,026,616 for 2007 compared to
$7,763,275 in 2006. The increase in 2007 was mainly due to increased activity,
an increase in consulting expenses, an increase in non-cash compensation of
$739,577 and an increase in the Companys development activities with its 200
tpd plant in Guelph, Ontario.

Amortization
and depreciation expenses increased to $169,914 in 2008 from $144,168 in 2007.
Amortization and depreciation expenses increased slightly to $144,168 in 2007
from $124,067 in 2006.

Interest
expenses increased to $333,477 in 2008 from $22,207 in 2007. The interest
expenses incurred in 2008 were due mainly to the accretion of the asset
retirement obligation liability, interest expense on long-term debt and
short-term debt with companys directors, officers and shareholders. Interest
expense decreased in 2007 to $22,207 from $505,340 in 2006 due mainly to the
decrease in long-term and convertible debenture financing.

Currency
exchange loss in 2008 amounted to $1,115,596 compared to the gain of $418,868
in 2007, due to the strengthening in the US dollar versus the Canadian dollar
during 2008. Currency exchange gain in 2007 amounted to $418,868 compared to a
gain of $88,888 in 2006. These non-cash changes were due to the exchange rate
fluctuations of the US dollar.

Loss on
settlement of accounts payable decreased to $nil in 2008 from $111,108 in 2007.
Loss on settlement of accounts payable increased to $111,108 in 2007 from
$98,189 in 2006 due to a non-cash compensation payment exceeding the book value
of the outstanding payable.

Loss on sale
of interest in subsidiary was $nil in 2008 and 2007. Loss on sale of interest
in subsidiary was $nil in 2007 compared to $420,400 in 2006. The loss of
$420,400 in 2006 was due mainly to the sale of a 20% interest of Dynamotive
Europe Limited and the loss arises from the issue of common share purchase
warrants related to this transaction.

Loss on return
of services deposits $125,073 in 2008 and $nil in 2007 ($nil in 2006). The loss
was due mainly to the return of Company common shares held on deposit, which
when returned were below the fair market value at the date the deposit was
paid.

The Company
recorded a gain on reduction in bonus and vacation accrual of $1,070,930 in
2008 and $nil in 2007 ($nil in 2006). On May 29, 2008 the Companys
Compensation Committee agreed with the motion of certain Company executives to
make this reduction in the accrual. These amounts were previously accrued as at
December 31, 2007 and included in results to that time.

Going forward,
the Company expects to have increased sales and project development activities,
both in North America and overseas. With the West Lorne increasing production
product sales should increase through the remainder of 2009 and beyond. Also,
successful operation of the plants should lead to additional project
development activity.

23

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Liquidity and Capital Resources

During the year
ended December 31, 2008, the Company used cash in operating activities and in
investing activities of $3,186,228 and $3,616,962 respectively, and generated
cash from financing activities of $5,419,366. During the year ended December
31, 2007, the Company used cash in operating activities and in investing
activities of $10,809,770 and $21,018,846 respectively, and generated cash from
financing activities of $24,008,567. During the year ended December 31, 2006,
the Company used cash in operating activities and in investing activities of
$9,402,744 and $10,339,843 respectively, and generated cash from financing
activities of $27,641,031.

The principal
sources of liquidity during the year ended December 31, 2008 were (i)
$3,816,579 in net proceeds after deducting related issue costs and expenses
from private placement offerings of the Companys Common Shares and the
exercise of Common Share options and warrants for cash, (ii) $2,762,870
increase in short-term debt; (iii) $381,398 decrease in government grant
receivable; less (iv) $35,900 in repayment of loan and (v) $1,505,581 repayment
of short-term loan.

For the previous
year ended December 31, 2007, the principal sources of liquidity during the
year ended December 31, 2007 were (i) $22,983,149 in net proceeds after deducting
related issue costs and expenses from private placement offerings of the
Companys Common Shares and the exercise of Common Share options and warrants
for cash, (ii) $130,000 in deposits for Common Shares to be issued in 2008
pursuant to the exercise of warrants, (iii) $500,000 of joint-venture deposit
received, (iv) $419,351 decrease in government grant receivable; less (v)
$23,933 in repayment of loan.

For the year ended
December 31, 2006, the principal sources of liquidity during the year ended
December 31, 2006 were (i) $27,495,575 in net proceeds after deducting related
issue costs and expenses from private placement offerings of the Companys
Common Shares and the exercise of Common Share options and warrants for cash,
(ii) $18,091 in deposits for Common Shares to be issued in 2007 pursuant to the
exercise of warrants, (iii) $1,500,000 increase in joint-venture deposit
received; less (iv) $899,184 decrease in long term loan and (v) $473,451
increase in government grant receivable.

Overall change in cash
position in 2008 was a decrease in cash of $1,756,895 as compared to a decrease
of $7,549,712 in the previous year 2007. Overall cash flows decreased in 2008
due to decreased acquisition of capital assets (Guelph and West Lorne plants)
and significantly decreased equity financing activities, offset by an increase
in debt financing during the year. During the previous year ended December 31,
2007, overall change in cash position was a decrease in cash of $7,549,712 as
compared to an increase of $7,918,066 in the previous year, 2006. Overall cash
flows decreased in 2007 due to decreased financing activities and significantly
increased acquisition of capital assets (Guelph and West Lorne plants). During
the year ended December 31, 2006, overall change in cash position was an
increase in cash of $7,918,066 as compared to an increase of $1,291,497 in the
previous year in 2005. Overall cash inflows increased during 2006 due to
significantly increased financing activities.

The net amount of
cash used in operating activities during 2008 decreased by 71% (over cash used
in operating activities during 2007) due to the construction of the Companys
200 tpd plant in Guelph, Ontario was done in previous year 2007 and 2006. Cash
used in operating activities consisted primarily of a net loss for 2008 of
$28,356,265 and $178,106 in recognition of deferred revenue, less non-cash
expenses of (i) amortization of $169,914, (ii) non-cash interest and accretion
expenses of $68,636, (iii) loss on refund of services deposit of $125,073, (iv)
equity compensation expenses of $2,524,138, (v) foreign exchange loss of
$1,115,596, (vi) net change in non-cash working capital balances related to
operations of $5,326,051, and (vii) write-down of property, plant and equipment
of $16,018,735.

The net amount of
cash used in operating activities during 2007 increased by 15% (over cash used
in operating activities during 2006) due to the construction of the Companys
200 tpd plant in Guelph, Ontario. Cash used in operating activities consisted primarily
of a net loss for 2007 of $14,220,404 less non-cash expenses of (i)
amortization of $144,168, (ii) loss on settlement of accounts payable of
$111,108, (iii) loss on purchase of interest in subsidiary of $238,346 and (iv)
equity compensation expenses of $3,632,561.

The net amount of
cash used in operating activities during 2006 increased by 40% (over cash used
in operating activities during 2005) due to the construction of the Companys
200 tpd plant in Guelph, Ontario and the resulting increase in business
development activities. Cash used in operating activities consisted primarily
of a net loss for

24

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2006 of $14,252,382
less non-cash expenses of (i) amortization of $124,067, (ii) accretion expense
in the amount of $208,022, (iii) loss on settlement of accounts payable of
$98,189, (iv) loss on sale of interest in subsidiary of $420,400, and (v)
equity compensation expenses of $4,337,590.

Financing
activities during 2008 generated a net increase in cash of $5,419,366,
primarily from the Companys private placements of Common Shares of $3,816,579
and from the short-term debt with the Companys directors, officers and
shareholders of $2,762,870 less repayment of short-term loan of $1,505,581.
Financing activities during 2007 generated a net increase in cash of
$24,008,567, primarily from the Companys private placements of Common Shares
and contribution received from joint venture of $500,000. Financing activities
during 2006 generated a net increase in cash of $27,641,031, primarily from the
Companys private placements of Common Shares and contribution received from
joint venture of $1,500,000.

Investing
activities in 2008 resulted in use of cash, in the amount of $3,616,962. This
amount was incurred in the acquisition of capital assets (Guelph and West Lorne
plants) of $3,963,628 and a decrease of long-term loan receivable of $346,666.
Investing activities in 2007 resulted in the use of cash, net of grants, in the
amount of $21,018,846 that consisted of $20,172,180 incurred in the acquisition
of capital assets (Guelph plant and West Lorne plant), an increase of long term
deferred assets of $500,000, and an increase of long term loan receivable of
$346,666. Investing activities in 2006 resulted in the use of cash, net of
grants, in the amount of $10,339,843 that consisted of $10,496,423 incurred in
the acquisition of capital assets (Guelph plant), $21,016 expended on patents,
and a $177,596 decrease in restricted cash.

As at December
31, 2008, the Company had a working capital deficiency of $10,441,893 and
incurred a net loss of $28,356,265 for the year ended December 31, 2008, and
has an accumulated deficit of $115,676,448.

In 2008, the
Company recorded $178,106 license revenue. Sales revenue going forward is
uncertain and the Company is therefore dependent on its financing activities to
fund its operations. The proceeds from the recent equity financing will be
applied to finance the Companys ongoing research and development and
commercial demonstration activities and to support its efforts to obtain the
award of customer contracts. Dynamotive will be required to raise sufficient
additional funds to finance its commercialization strategy. The raising of
additional finance to fund operations is subject to uncertainty. There is no
assurance that such financing will be available on commercially reasonable
terms, if at all. Dynamotives operations are subject to all of the risks
inherent in the establishment of a new business enterprise and in particular
Dynamotive will require significant additional financing in the future to
develop and market its technology to its full potential.

In addition to
contemplated equity offerings during 2009, the Company has a receivable from
the Government of Canadas ITO program both for expenditures made in 2005 and
technical and project related expenditures in 2006. The Companys agreement
with Technology Partnerships Canada pertains to maximum funding of US$6.7
million (C$8.235 million), of which $6.4 million (C$ 7.8 million) has been
received as of December 31, 2008 and $0.3 million is included in government
grants receivable.

During the
first quarter of 2008, the Company raised subscription funds of $1.0 million
relating to the private placement commenced during the first quarter of 2008 at
subscription price $0.65 per share. 1.48 million shares and 56,430 Common Share
Purchase Warrants were issued as a result of this funding.

During the
second quarter of 2008, the Company raised subscription funds of $0.7 million
relating to the private placement commenced during the second quarter of 2008
at subscription price at $0.35 per share. 1.96 million shares and 0.97 million
Common Share Purchase Warrants were issued as a result of this funding.

During the
third quarter of 2008, the Company raised subscription funds of $0.8 million relating
to the private placement commenced during the second quarter of 2008 at
subscription price at $0.35 per share. 2.4 million shares and 1.18 million
Common Share Purchase Warrants were issued as a result of this funding.

During the
fourth quarter of 2008, the Company raised subscription funds of $1.3 million
relating to the private placement commenced during the fourth quarter of 2008
at subscription price at $0.20 per share. 6.4 million shares and 3.2 million
Common Share Purchase Warrants were issued as a result of this funding.

25

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In total, the
Company raised from private placements during 2008 $3.8 million in cash for a
total of 12.2 million Common Shares and 5.4 million Common Share Purchase
Warrants.

In December 2008, the
Company entered into a secured demand loan (initially intended to enter a
secured convertible debenture) facility with a director of the Company for a
total of up to $2 million and $1.0 million has been advanced to the Company.
This demand loan has an interest rate of 8% and is due within 10 days of
demand, made anytime from the date of the Companys completion of current
funding and/or receipt of certain government funds, whichever comes first,
which are expected to occur in early 2009.

The Company currently has
minimal cash on hand and expects to require additional funding for the
commercial expansion of its technologies through the year 2009 and beyond as
we anticipate that we will not earn sufficient revenues to cover operating
expenses. Given market
conditions and other factors, there can be no guarantee that the Company will
be successful in securing additional finance. If adequate funds are not
available on acceptable terms when needed, the Company may be required to
delay, scale-back or eliminate the manufacturing, marketing or sales of one or
more of its products or research and development programs. The outcome of these
matters cannot be predicted at this time. The Companys future operations are
dependent on the markets acceptance of its products in order to ultimately
generate future profitable operations, and the Companys ability to secure
sufficient financing to fund future operations. There can be no assurance that
the Companys products will be able to secure market acceptance. Management
plans to raise additional equity financing to enable the company to complete
its development plans.

The Company expects to spend
approximately $6 million in its operations in the next 12 months and has
capital expenditure commitments of approximately $0.6 million. The Company does
expect to have increases in product sales and licenses over the coming months
and years, but these are not expected to cover operating requirements in the
near future..

In recognition
of our liquidity and capital resources, our independent public accountants have
included a comment in their report on our accompanying consolidated financial
statements for the year ended December 2008, that expresses substantial doubt
as to our ability to continue as a going concern.

The Companys
2009 financing plan is structured to enable ramp-up of operations at the West
Lorne production plant; completion of the related char boiler system and the
re-start of the 200 tonne per day (tpd) Guelph BioOil plant. The core of the
strategy surrounds market and project based equity financing that minimizes
equity dilution while raising sufficient capital for operations and projects.
In addition, the Company will seek asset backed debt financing if such
facilities are available on reasonable commercial terms. In connection with the
Companys West Lorne char boiler system project, the Company has committed to
construction commitments of approximately $0.6 million at December 31,
2008.

The Companys
funding plan for 2009 is structured so that equity placements explained above
will maintain Company and project operations. Additionally, the Company
contemplates a private placement and project finance strategy which, with other
project funding and sales, are expected to fund the Companys contributions to
future projects and the West Lorne Char boiler system completion. Any delay in
securing project funding for a project will delay the commissioning of that
project. As mentioned previously, there is no assurance however that the
Company will obtain positive cash flow from product sales or be able to obtain
sufficient equity or debt financing to satisfy its cash requirements for the
next 12 months.

Critical Accounting Policies

Our
consolidated financial statements are prepared based on the accounting policies
described in Note 2 to our consolidated financial statements included herein.
The preparation of financial statements in conformity with Canadian generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
notes. Actual results could differ from these estimates.

26

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Revenue Recognition

Product Sales

The Company
recognizes revenue from the sale of products, including BioOil, char, and other
by-products, upon shipment of the product when the risk and reward of ownership
has been transferred to the customer, provided that the amount is fixed or
determinable and collection is reasonably assured.

Licenses and Royalties

Revenue from
license agreements may include multiple elements within a single contract.
Payments received under license agreements may include the following:
non-refundable fees at inception of the contract, fees for services to be
performed, milestone payments for specific achievements, and royalty payments
based upon resulting sales of products. Agreements with multiple elements are
separated into significant discrete units of accounting based on the relative
fair value of each element. Revenue is recognized for each element when all
significant acts have been completed and delivery has occurred with no
substantial risk of return and collectability is reasonably assured. When the
fair value cannot be determined, revenue is deferred until objective evidence
exists or recognized as the final elements are delivered. Any amounts not
recorded during the term of the license are recorded at the time of the license
expiry.

Deferred
revenue is comprised of amounts received prior to the satisfaction of the
revenue recognition criteria described above and includes non-refundable
amounts related to sales of master license and plant license agreements. Master
license agreements grant the licensee the exclusive right and license to use
and commercially exploit the Companys BioOil technology including the rights
to manufacture, market, distribute, and sub-license the technology for the
production of BioOil within a specific territory. Plant license agreements
grant a licensee the right to use and commercially exploit the Companys BioOil
technology for the development of one or more pyrolysis plant facilities.

In 2006, the
Company received a total of $950,000 in payments from three unrelated companies
as licensing fees. $500,000 from Rika Ltd. as payment for a Master License to
develop project opportunities in the Ukraine and the Baltic republics using
Dynamotives patented pyrolysis technology; $150,000 from Classic Power Inc. as
an initial payment on a Plant License for Guelph, Ontario, Canada; $200,000
from Renewable Oil Corporation Pty Ltd. (ROC) for a Master License to develop
project opportunities in Australia and $100,000 from ROC as a deposit on an
initial plant license and $300,000 initial engineering design services.

Revenue in
2008 and Deferred revenue in 2007 and 2006 is net of a $345,735 convertible
loan to entities controlled by Rika Ltd.

All the above
funds are non-refundable and have been recorded as deferred revenue.

Government
Assistance and Investment Tax Credits

Government
assistance towards current expenses is included in the determination of income
for the period as a reduction of the expenses to which it relates. Amounts
received for future expenditures are recorded as a current liability.
Government assistance towards the acquisition and construction of property,
plant and equipment is deducted from the cost of the related property, plant
and equipment. Government grants receivable are recorded when the Company has
incurred the qualifying expenditure and there is reasonable assurance the
receipts will be recovered.

Repayment of
contribution is contingent solely upon the Companys ability to generate
revenue from the sale of specified products or technology. Accordingly,
liability of repayment will only be accrued when sales of the products or
technology have been generated.

Investment tax
credits are accounted for under the cost reduction method whereby they are
netted against the expense or capital asset to which they relate. Investment
tax credits are recorded when the Company has incurred the qualifying
expenditures and there is reasonable assurance the tax credits will be
realized. As at December 31, 2007 and 2006, no investment tax credits have been
recognized.

27

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Research and
Development Costs

Research costs
are expensed in the period incurred. Development costs are expensed in the
period incurred unless the Company believes the development project meets
Canadian generally accepted accounting criteria for deferral and amortization.
In evaluating these criteria the Company considers technological feasibility to
be established only when a product demonstrates it operates under conditions
which are acceptable to target customers. If management determines that the
development of products to which such costs have been capitalized is not
reasonably certain, or that costs exceed recoverable value, such costs are
charged to operations. The Company has not capitalized any development costs
for any of the year ends presented.

During the
year ended December 31, 2008, the Company netted product and service sales of
$151,657 (2007 - $13,911, 2006 - $154,560;) against research and development
expenses, which are considered incidental sales of BioOil until such time as
the Companys plant has reached commercial production levels.

Projects Under
Development

The Company
expenses all preliminary stage costs incurred with respect to a potential
capital project, including costs related to the consideration of alternatives,
feasibility studies, and activities occurring prior to the decision to proceed
with the project until the capital project meets the Companys capitalization
policy and is considered a project under development. The Company begins to
capitalize costs for projects under development when it has determined that it
is more likely than not that the financing for the capital project is available
and it is more likely than not that the Company will be able to meet the
requisite local and other governmental regulations to develop the capital
project.

For those
capital projects that meet the Companys capitalization policy, the Company
capitalizes incremental costs that are directly identifiable with the specific
capital project until the capital project is substantially complete and ready
for its intended use. Financing costs, including interest, are capitalized when
they arise from indebtedness incurred, directly or indirectly, to finance the
construction of the capital project. Capitalization of financing costs will
cease when a capital project is considered to be substantially complete and
ready for its intended use.

Annually, or
whenever events and circumstances indicate that the carrying value of the
assets might be impaired and the carrying value may not be recoverable, the
Company performs evaluations to assess the recoverability of its projects under
development. When the carrying value of projects under development is determined
to exceed its recoverable amount, an impairment loss is recorded to reduce the
carrying value of the projects under development to its fair value.

No
amortization is recorded on projects under development as assets are not yet
available for use.

Stock Based
Compensation Plan

The Company
has two stock based compensation plans - a stock appreciation rights (SA
Rights) plan, which expired on December 31, 2008, and a stock option plan for
directors and employees, which are described in note 16. Under the terms of the
stock option plan the Company may grant fixed options or options whose vesting
is contingent on future performance. Compensation is recognized under the fair
value based method when fixed or performance based stock options are granted to
employees and directors. Compensation for SA Rights to be settled in cash are
accrued at their fair value at the date of grant and re-measured at each
financial statement date until they are exercised. Compensation for SA Rights
to be settled in shares is accrued at their fair value at the date of grant but
is not re-measured at each financial statement date.

The Company
may also issue stock options and warrants to employees or as consideration for
services rendered by non-employees. Such equity awards are recorded at their
fair value using the Black Scholes option pricing model, as compensation
expense or capitalized to long-term assets under construction when the Company
receives the related services and the equity awards vest. No compensation is
recognized in connection with options and warrants awarded in connection with
private placements, since the share issue costs are netted against the proceeds
raised. All unvested or modified options for non-employees are re-measured on
each balance sheet date until such options vest.

28

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Asset Retirement
Obligations

The Company
records the fair value of an asset retirement obligation as a liability in the
period in which it incurred a legal obligation associated with the retirement
of tangible long-lived assets that result from the acquisition, construction,
development, and/or normal use of the assets and when a reasonable estimate of
the fair value can be made. The obligation is measured initially at fair value
using present value methodology, and the resulting costs capitalized into the
carrying amount of the related asset. In subsequent periods, the liability will
be adjusted for any changes in the amount or timing of the underlying future
cash flows. Capitalized asset retirement costs will be depreciated on the same
basis as the related asset and the discount accretion of the liability is
included in determining the results of operations. As at December 31, 2008, the
Company estimated the fair value of the asset retirement obligations was
$229,312 (2007 - $246,939; and 2006 - $nil).

Recent Accounting Pronouncements  See Notes
3 and 25 to the audited consolidated financial statements

Research and Development, Patents and
Licenses, etc.

The Company
considers patents to be an important aspect of the Companys business. The Company
protects its intellectual property such as trademarks, patents, product
designs, manufacturing processes and new product research and concepts. These
rights are protected through patents and trademark registrations, the
maintenance of trade secrets and, when necessary and appropriate. The Company
also maintains stringent procedures to maintain the secrecy of its confidential
business information. These procedures include the establishment of need to
know criteria for the dissemination of certain information and the use of
written confidentiality agreements in cases where the sharing of proprietary
information with third parties is necessary.

As of June 19,
2009, the Companys key patent is protected in 12 countries with patent
applications pending in 4 countries and is scheduled to expire between years
2016 and 2017. Patents were granted in 2008 for protection in New Zealand and
Ukraine with respect to an enhancement of the key patent to expire in year
2025. In respect of this patent enhancement, a US Patent was granted in
February 2006 to expire in year 2024 and based on this, a US PCT application
was filed in February 2005; a Eurasian patent application filed in March 2006;
patent applications for protection in Cuba, Mexico, Norway, and Regional Europe
filed in 2007 and also during the year, an international PCT application was
filed for another patent enhancement of the key patent.

Research costs
are expensed in the year incurred and are recorded net of incidental product
sales. Development costs are expensed in the year incurred unless the Company
believes the development project meets Canadian generally accepted accounting
criteria for deferral and amortization. In evaluating these criteria the
Company considers technological feasibility to be established only when a
product demonstrates it operates under conditions, which are acceptable to
target customers.

If management
determines that the development of products to which such costs have been
capitalized is not reasonably certain, or that costs exceed recoverable value,
such costs are charged to operations

Please refer
to the Results of Operations above for additional information on research and
development.

Trend Information

BioOil, as a
fuel competes with conventional energy sources and other alternative energy
industrial fuels. Therefore, price trends in the broad energy industry and
developments in the alternative energy sector will affect the commercial
viability and attractiveness of BioOil. The economic attractiveness of BioOil
production is significantly affected by the availability of suitable biomass
feedstock, the price of which may be effected on a regional basis by competing
uses for the feedstock from other industries. The price of emissions credits,
which can result from combustion of BioOil which displaces hydrocarbon fuels,
may be affected by many outside factors including legislated requirements and
international agreements.

29

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Off-Balance Sheet Arrangements

The Company
does not have any off-balance sheet arrangements that have or are reasonably
likely to have a current or future effect on our financial condition, changes
in financial condition, revenues or expenses, results of operations, liquidity,
capital expenditures or capital resources that is material to investors.

Tabular Disclosure of Contractual Obligations

The following
table provides information as of December 31, 2008 as to our contractual
obligations and commitments for the periods indicated:

|                                               |  |       |           |                  |  |             |  |             |         |                   |  |        |  |  |         | 
|---------------------------------------------- |  | ----- | --------- | ---------------- |  | ----------- |  | ----------- | ------- | ----------------- |  | ------ |  |  | ------- | 
|Contractual
  Obligations                      |  | Total |           | Less than 1 year |  | 1  3 years |  | 3  5 years |         | More than 5 years | 
|                                               |  |       |           |                  |  |             |  |             |         |                   | 
|Premise lease obligations                      |  |       | 368,000   |                  |  | 218,000     |  |             | 138,000 |                   |  | 12,000 |  |  | Nil     | 
|Operating lease obligations  Office equipment |  |       | 29,000    |                  |  | 18,000      |  |             | 11,000  |                   |  | Nil    |  |  | Nil     | 
|Long-term debt obligations                     |  |       | 299,000   |                  |  | 36,000      |  |             | 72,000  |                   |  | 72,000 |  |  | 119,000 | 
|Short-term and related party debt              |  |       | 1,257,289 |                  |  | 1,257,289   |  |             | Nil     |                   |  | Nil    |  |  | Nil     | 
|Construction commitments                       |  |       | 600,000   |                  |  | 600,000     |  |             | Nil     |                   |  | Nil    |  |  | Nil     | 
|                                               |  |       |           |                  |  |             |  |             |         |                   |  |        |  |  |         | 
|Total                                          |  |       | 2,553,289 |                  |  | 2,129,289   |  |             | 221,000 |                   |  | 84,000 |  |  | 119,000 | 

We have an
operating lease for office facilities of our head office.

|        |                                           
|------- | ------------------------------------------
|ITEM 6. | DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES

Directors and Senior Management

The Companys
directors and executive officers currently are:

|                                |  |     |  |                                                       
|------------------------------- |  | --- |  | ------------------------------------------------------
|Name                            |  | Age |  | Position                                              
|                                |  |     |  |                                                       
|Richard
  Chen-Hsing Lin (2)(3) |  | 65  |  | Chairman,
  President, Operations-China and Director  
|R. Andrew
  Kingston (3)        |  | 49  |  | President,
  Chief Executive Officer and Director     
|Desmond Radlein, Ph.D. (1),(3)  |  | 61  |  | Director                                              
|Shing-Cheng
  Hong (1)(2)       |  | 76  |  | Director                                              
|Chih-Lin Chu(1)                 |  | 42  |  | Director                                              
|Brian
  Richardson              |  | 47  |  | Chief
  Financial Officer                             
|Thomas J.
  Bouchard            |  | 48  |  | Chief
  Operating Officer                             
|Laura Santos                    |  | 59  |  | Corporate
  Secretary                                 
|Jeffrey Lin                     |  | 39  |  | Vice
  President, Business Development-China and Japan

|    |                                                                                    
|--- | -----------------------------------------------------------------------------------
|(1) | Member of
  the Audit and Corporate Governance Committee of the Board of Directors.
|    |                                                                                    
|(2) | Member of
  the Compensation Committee of the Board of Directors.                  
|    |                                                                                    
|(3) | Member of the Executive Committee of the
  Board of Directors.                     

Richard Chen Hsing Lin.
Mr. Lin has been a Director of the Company since 1992 and Chairman of the
Company since May of 1995. He is the past President of the Taiwan Chamber of
Commerce in Canada. Mr. Lin is also co-founder, Vice President and Secretary of
Neoventi Technology Corporation since 1991 and Neoventi Investment Corporation
since 1992, and has been a Director of Concert Industries Ltd. since December
1992. Mr. Lin was also President of the Taiwan Chamber of Commerce in B.C., and
Vice President of R.C.A. Taiwan. Mr. Lins son,

30

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Jeffrey Lin,
is the Companys Vice President, Business Development for China and Japan. (See
Jeffrey Lins affiliations below)

Robert Andrew Kingston.Mr. Kingston was
appointed President and CEO in April 1999. Mr. Kingston has held senior
positions in multi-national oil companies, property and investment corporations
and financial institutions in Europe, the USA and South America. From 1996 to
1999, Mr. Kingston was advisor to public and private companies in the U.S.
Canada and the U.K. From 1995 to 1996, Mr. Kingston was senior advisor to the
Chairman of Rotch Property Group Ltd., a UK property investment and development
company with assets in excess of US $7 billion. From 1992 to 1995, Mr. Kingston
was a financial advisor on corporate restructuring for Interpetrol S.A., a
South American oil trading company that at the time was partly owned by the
Argentine National Oil Company (NYSE: YPF). He held a number of positions with
the Gatoil Group of Companies from 1986 to 1990, a fully integrated, privately owned
oil conglomerate, including Managing Director of Gatoil Services (UK) Limited
and Financial Vice President of Gatoil Enterprises Inc. (USA). He also worked
for Price Waterhouse & Co. and Ducilo S.A., a subsidiary to E.1. DuPont de
Nemours & Co.

Desmond Radlein, Ph.D.
Dr. Radlein became a Director of the Company in December 1997, retired in
August 2002 and was re-appointed in August 2003. Dr. Radlein has been the
President of RTI - Resource Transforms International, Ltd., an R&D company
specializing in pyrolysis technology and applications, since 1994. Dr. Radlein
received a B.Sc: in Chemistry (1986) from the Alcan Scholar University of the
West Indies in Jamaica and M.Sc. in Theoretical Chemistry (1970) from the
University of Calgary in Alberta. He received his Ph.D. from the University of
Cambridge, England (1975) in Physical Chemistry. He was a member of the Board
of the Waterloo Region Community Legal Services from 1994 to 1995. Dr. Radlein
was also an Associate Research Professor at the Chemical Engineering Department
of the University of Waterloo from 1987 to 1994. He is an inventor or
co-inventor of 10 patents on pyrolysis and petroleum processing and has also
authored over 20 publications in various scientific journals. Some of his
research activities include: pyrolytic production of fermentable sugars,
fundamental studies on biomass pyrolysis mechanisms, catalytic hydropyrolysis
for hydrocarbon production and catalyst development for gasification.

Shing-Cheng Hong.
Mr. Hong became a Director of the Company in December 1997. With 40 years of
financial and industrial background, Mr. Hong led a 42-member management team
of Hotung Venture Capital Corp. where he served as its President since 1987.
Hotung is the leading venture capital group in Taiwan and currently manages
total funds of US$7 billion. Thirty-three additional venture capital funds were
also established under his leadership; including Daitung VC; Yuantung VC;
Litung VC; Futung VC and Wantung VC. Mr. Hong retired in 2001 from Hotung and
now serves as Chairman of Giga Venture Partners & Co.

Chih-Lin Chu. Mr.
Chu became a Director of the Company in June 2001. He is General Manager for
Business Development at China Strategic Holdings Limited (CSH) since March
2000. CSH is a public company listed on Hong Kong Exchange with investments in
energy, tire manufacturing, breweries, paper, pharmaceuticals and other light
and heavy industries including power plants, diesel engine manufacturing,
cement, chemical plants, electrical machinery and auto parts as well as
information technology and e-commerce related projects. From 1999 to 2000, Mr.
Chu was Vice Chairman and President, China Operation for Tricom Holdings
Limited, also a public company in Hong Kong with a focus on telecommunication
products. Since 1994, Mr. Chu has been involved in business development and
government relationship in China for various companies including Cathay Pacific
Airline O.B.C. G.S.A., Shanghai E&T Wako Express Co. Ltd and Shanghai
Tricom Limited. Mr. Chu received his MBA from the China Europe International
Business School in China.

Brian Richardson, C.A., MBA.
Mr. Richardson was appointed Chief Financial Officer of the Company in August
2003. From 1993 - 2002, Mr. Richardson was a financial consultant in a variety
of industries, including working for four years as a project manager for
Westcoast Energy on gas and electric infrastructure projects in Latin America.
In the early 1990s, he was CFO of a publicly traded venture capital firm,
helping to bring it onto the TSE via a reverse take-over. Mr. Richardson also
worked in investment banking, and as CFO of a biotech start-up. He has
significant experience in project planning, management and control and in
working with early stage technology companies. Mr. Richardson received his designation
as a Chartered Accountant in 1987, and in 1990, was on the Director Generals
Honours List and graduated with a MBA degree from IMD in Switzerland.

Thomas J. Bouchard.
Mr. Bouchard was appointed Chief Operating Officer of the Company in January
2008. Mr. Bouchard brings extensive experience from the process manufacturing
industry including materials, quality control

31

---



and packaging
industry segments. For over 20 years at General Electric, he successfully held
numerous operational and general management positions in its plastics business
in the U.S., Canada and Europe. Most recently he was the VP & GM  Americas
for Consumer Solutions at MeadWestvaco and prior to that Mr. Bouchard was the
CEO of MetricVision Inc., where he led the successful turnaround and sale of
this venture-capital-backed manufacturer and marketer of laser-based quality
control products. A member of the Potomac Officers Club, Mr. Bouchard also
serves on the board of directors of Sigma Space Corporation and Segmented
Sensor Technologies, Inc. He earned a Master of Science degree in Management
from Purdue University and a Bachelors degree in Chemistry from Williams
College.

Laura Santos, BFA.
Mrs. Santos has been Secretary of the Company since March 1998, Assistant
Secretary and Executive Assistant from 1994 to 1998. Prior to joining the
Company, she was Accounting Supervisor with Everex Systems from 1990 to 1993;
Senior Accounting Assistant with Walbar, Canada from 1989 to 1990 and with
CitiBank, N.A. and Chemical Bank in New York from 1983 to 1988. She was also
Assistant to the Executive Secretary of the Philippine American Chamber of
Commerce in New York from 1982 to 1983. Mrs. Santos graduated with a Bachelor
of Fine Arts degree from the University of the East, Philippines.

Jeffrey Lin, B.Sc. MBA, CMA. Mr. Lin joined Dynamotive in 1994 and has
been appointed VP Business Development to lead the Companys expansion efforts
in Japan and China. Before joining the business development team, Mr. Lin
previously held positions as the Director of Finance and Project Manager with
the Company. Mr. Lin has the technical knowledge, business and financial
experience as well as the cultural background and the language skills to open
new business opportunities in Asia.

Compensation of Directors and Senior
Management

The following
table provides a summary of compensation paid or payable to directors and
senior management during the year ended December 31, 2008(1):

|                         |  |              |         |             |  |                                |  |  |          |  
|------------------------ |  | ------------ | ------- | ----------- |  | ------------------------------ |  |  | -------- | -
|Name                     |  | Salary
  ($) |         | Bonus
  ($) |  | Long-term Incentive Plan
  ($) | 
|                         |  |              |         |             |  |                                | 
|Richard Chen-Hsing Lin   |  |              | 333,381 |             |  | 42,288                         |  |  | 26,834(4 | )
|Robert Andrew Kingston   |  |              | 521,430 |             |  | 66,142                         |  |  | 41,472(4 | )
|Curtin Winsor, Jr., Ph.D |  |              | 17,986  | (2)         |  |                               |  |  |         |  
|Shing-Cheng Hong         |  |              | 17,424  | (2)         |  |                               |  |  |         |  
|Desmond Radlein          |  |              | 155,405 | (2)(3)      |  |                               |  |  |         |  
|Chih-Lin Chu             |  |              | 9,368   | (2)         |  |                               |  |  |         |  
|George Terwilliger       |  |              | 11,616  | (2)         |  |                               |  |  |         |  
|Wayne Keast              |  |              | 1,124   | (2)         |  |                               |  |  |         |  
|Brian Richardson         |  |              | 230,316 |             |  | 57,579                         |  |  | 7,498(5  | )
|Laura Santos             |  |              | 145,199 |             |  | 36,300                         |  |  | 7,261(6  | )
|Jeffrey Lin              |  |              | 145,199 |             |  | 36,300                         |  |  | 7,261(6  | )

Notes:

|    |                                                                                                                                             
|--- | --------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Except as
  otherwise noted, all compensation are disclosed in U.S. dollars based upon
  2008s average exchange rate of $0.9368 per dollar.
|    |                                                                                                                                             
|(2) | 50% to be paid in cash
  ($34,286) and 50% in shares (total of 104,907 restricted common shares).                                           
|    |                                                                                                                                             
|(3) | Including
  consulting fees of $144,351.                                                                                                    
|    |                                                                                                                                             
|(4) | Unissued
  shares earned pursuant to 25% on the 1/3 of annual salary, priced at $1.29
  per share determined on March 1, 2007.              
|    |                                                                                                                                             
|(5) | Unissued
  shares earned pursuant to 10% on the 1/3 of annual salary, priced at $1.29 per
  share determined on March 1, 2007.              
|    |                                                                                                                                             
|(6) | Unissued
  shares earned pursuant to 15% on the 1/3 of annual salary, priced at $1.29
  per share determined on March 1, 2007.              

32

---



The following table lists stock
options outstanding at December 31, 2008 to purchase common shares of the
Company held by directors and senior management:

|                           |  |                  |  |                |       |             |                         
|-------------------------- |  | ---------------- |  | -------------- | ----- | ----------- | ------------------------
|Name                       |  | Number of Shares |  | Exercise Price |       | Expiry Date
|                           |  |                  |  |                |       |             |                         
|Richard Chen
  Hsing Lin   |  | 750,000          |  |                | $0.50 |             | 02-Feb-10 to
  29-Apr-12
|Richard Chen
  Hsing Lin   |  | 300,000          |  |                | $0.23 |             | 30-Aug-13               
|Richard Chen
  Hsing Lin   |  | 605,660          |  |                | $0.20 |             | 30-Aug 13 to
  31-Mar-14
|Richard Chen
  Hsing Lin   |  | 3,000,000        |  |                | $0.45 |             | 31-Jul-14               
|Richard Chen
  Hsing Lin   |  | 1,000,000        |  |                | $0.58 |             | 31-Jul-14               
|Richard Chen
  Hsing Lin   |  | 150,000          |  |                | $1.60 |             | 12-Jul-09               
|Richard Chen
  Hsing Lin   |  | 1,800,000        |  |                | $1.22 |             | 30-Nov-10 to
  01-Jan-12
|Robert
  Andrew Kingston   |  | 775,000          |  |                | $0.50 |             | 02-Feb-10 to
  23-Feb-12
|Robert
  Andrew Kingston   |  | 333,750          |  |                | $0.20 |             | 31-Jan-13               
|Robert
  Andrew Kingston   |  | 300,000          |  |                | $0.23 |             | 10-Apr-13               
|Robert
  Andrew Kingston   |  | 2,400,000        |  |                | $0.22 |             | 10-Apr-13               
|Robert
  Andrew Kingston   |  | 3,000,000        |  |                | $0.45 |             | 31-Jul-14               
|Robert
  Andrew Kingston   |  | 1,000,000        |  |                | $0.58 |             | 31-Jul-14               
|Robert
  Andrew Kingston   |  | 150,000          |  |                | $1.60 |             | 12-Jul-09               
|Robert
  Andrew Kingston   |  | 1,800,000        |  |                | $1.22 |             | 30-Nov-10 to
  01-Jan-12
|Curtin Winsor,
  Jr., Ph.D |  | 30,000           |  |                | $0.45 |             | 22-Dec-09 to
  01-Jul-10
|Curtin
  Winsor, Jr., Ph.D |  | 23,000           |  |                | $1.16 |             | 30-Nov-11               
|Curtin
  Winsor, Jr., Ph.D |  | 23,000           |  |                | $0.33 |             | 24-Jul-12               
|Desmond
  Radlein, Ph.D    |  | 46,000           |  |                | $0.45 |             | 22-Dec-09 to
  01-Jul-10
|Desmond
  Radlein, Ph.D    |  | 15,000           |  |                | $1.16 |             | 30-Nov-11               
|Desmond
  Radlein, Ph.D    |  | 15,000           |  |                | $0.33 |             | 24-Jul-12               
|Desmond
  Radlein, Ph.D    |  | 600,000          |  |                | $1.15 |             | 01-Nov-09 to
  31-Oct-11
|Shing-Cheng
  Hong         |  | 23,000           |  |                | $0.45 |             | 01-Jul-10               
|Shing-Cheng
  Hong         |  | 23,000           |  |                | $1.16 |             | 30-Nov-11               
|Shing-Cheng
  Hong         |  | 23,000           |  |                | $0.33 |             | 24-Jul-12               
|Chih-Lin Chu               |  | 30,000           |  |                | $0.45 |             | 22-Dec-09 to
  01-Jul-10
|Chih-Lin Chu               |  | 15,000           |  |                | $1.16 |             | 30-Nov-11               
|Chih-Lin Chu               |  | 15,000           |  |                | $0.33 |             | 24-Jul-12               
|George
  Terwilliger       |  | 25,000           |  |                | $1.16 |             | 30-Nov-11               
|George
  Terwilliger       |  | 15,000           |  |                | $0.33 |             | 24-Jul-12               
|Brian
  Richardson         |  | 400,000          |  |                | $0.48 |             | 21-Jan-09 to
  30-Sep-09
|Brian
  Richardson         |  | 1,200,000        |  |                | $0.58 |             | 30-Sep-09 to
  30-Sep-12
|Brian
  Richardson         |  | 100,000          |  |                | $1.60 |             | 12-Jul-09               

33

---



|                      |  |                  |  |                |       |             |                         
|--------------------- |  | ---------------- |  | -------------- | ----- | ----------- | ------------------------
|Name                  |  | Number of Shares |  | Exercise Price |       | Expiry Date
|                      |  |                  |  |                |       |            
|Laura Santos          |  | 10,000           |  |                | $1.00 |             | 2-Feb-10                
|Laura Santos          |  | 80,000           |  |                | $1.50 |             | 14-Jun-10 to
  31-Jan-11
|Laura Santos          |  | 15,000           |  |                | $0.50 |             | 28-Apr-12               
|Laura Santos          |  | 100,000          |  |                | $0.23 |             | 30-Aug-13               
|Laura Santos          |  | 122,308          |  |                | $0.20 |             | 30-Aug-13 to
  14-Mar-14
|Laura Santos          |  | 1,000,000        |  |                | $0.48 |             | 31-Dec-09 to
  31-Dec-13
|Laura Santos          |  | 100,000          |  |                | $1.60 |             | 12-Jul-09               
|Laura Santos          |  | 225,000          |  |                | $1.22 |             | 30-Nov-10 to
  01-Jan-12
|Jeffrey Lin           |  | 110,000          |  |                | $1.00 |             | 02-Feb-10               
|Jeffrey Lin           |  | 15,000           |  |                | $0.50 |             | 28-Apr-12               
|Jeffrey Lin           |  | 1,000,000        |  |                | $0.48 |             | 31-Dec-09 to
  31-Dec-13
|Jeffrey Lin           |  | 100,000          |  |                | $1.60 |             | 12-Jul-09               
|Jeffrey Lin           |  | 225,000          |  |                | $1.22 |             | 30-Nov-10 to
  01-Jan-12
|Bouchard,
  Thomas J. |  | 500,000          |  |                | $0.88 |             | 01-Jan-11 to
  31-Dec-11

Dr. Desmond
Radlein provides consulting services to the Company with respect to the
Companys research and development initiatives conducted in Waterloo, Ontario,
including the establishment of research programs and protocols as well as
development of research partnership programs with universities to further the
Companys technology.

Board Practices

All Directors
are elected annually at the Companys Annual Meeting of Shareholders. The
executive officers of the Company are appointed annually at the first meeting
of the Companys Board of Directors held after each annual meeting of
shareholders. Each director and executive officer of the Company holds office
until his or her successor is duly elected and qualified or until his or her
death or resignation or until he or she shall be removed in the manner provided
by the Companys by-laws. There is no arrangement or understanding between any
director or executive officer and any other person pursuant to which any
director or executive officer is selected. None of our directors or officers
are related, except for Jeffrey Lin and Richard Lin who are related.

The Company maintains
standing Executive, Compensation and Audit and Corporate Governance Committees,
but does not have a nominating committee. The Executive Committee is comprised
of Dr. Desmond Radlein, Messrs. R. Andrew Kingston and Richard Chen-Hsing Lin.
The purpose of the Committee is to act on behalf of the full Board between
regularly scheduled Board meetings, usually when timing is critical to transact
routine, administrative Board matters between Board meetings; to review and
provide counsel regarding material issues prior to Board submission and to
provide oversight of management succession plan for Key Executive positions.

The Companys
Audit and Corporate Governance Committee (whose members until March 31, 2009
were Mr. Shing-Cheng Hong, Dr. Curtin Winsor, Jr. and Mr. George Terwilliger
III; and subsequent to March 31 2009 were Mr. Shing-Cheng Hong, and Mr. Chih
Lin Chu and Dr. Desmond Radlein joined the committee on June 3, 2009), assists
the Board of Directors in carrying out its oversight responsibilities relating
to the financial, accounting and reporting processes of the Company on behalf
of the Board by reviewing the independence of the Companys independent
auditors, the adequacy of internal accounting and financial controls, the
quality of financial reporting and accounting estimates involving the use of
significant management judgment, and the Companys compliance with related
legal and regulatory requirements.

34

---



The
Compensation Committee of the Board of Directors makes recommendations to the
Board of Directors on compensation issues, including (i) salary levels for
officers; (ii) executive compensation plans; (iii) the review of employee
benefit programs; (iv) the review of proposed compensation plans applicable to
the Companys officers and employees; and (v) the administration of the
Companys stock option plans as authorized by the Board. The Committee is
comprised of Dr. Curtin Winsor, Jr. (until March 31, 2009), Mr. Shing-Cheng
Hong and Mr. Richard Chen-Hsing Lin.

The Board
approved in May 2004 a new compensation plan as proposed by the Compensation
Committee for non-management Board members and Committee chairs, as follows: a)
annual retainer of $8,166, and $4,083for Board members and Committee chairs
respectively, payable in 50% cash and 50% in common stock priced at the market
closing price on the day of the AGM or the average of the five trading days
prior to the AGM, whichever is lower; b) 15,000 and 8,000 stock options for
Board members, and Committee chairs, respectively; the term of the stock
options is for four (4) years; c) Board and Committee meeting fees $245 per
meeting under two (2) hours and $980 per meeting over two (2) hours, payable in
50% cash and 50% in common stock priced on the last trading day of the
respective quarter at the lower of the price on such day or the average of the
previous five trading days. Shares when issued with respect to these fees are
restricted for a twelve-month period and subject to Rule 144 of the Securities
Act of 1933. The Compensation Committee of the Board regularly reviews the
appropriateness of Directors compensation. The directors are also reimbursed
for out-of-pocket expenses such as reasonable traveling, hotel and other
expenses incurred in and about the business of the Company.

Executive officers
of the Company who also act as directors of the Company do not receive any
additional compensation for services rendered in their capacity as directors,
other than as paid by the Company to such executive officers in their capacity
as executive officers.

Employees

The following
table lists the number of employees at the end of the period for each of the
past three financial years broken down by geographic location.

|          |      |      |     
|--------- | ---- | ---- | ----
|          | 2008 | 2007 | 2006
|          |      |      |     
|Canada    | 25   | 31   | 36  
|US        | 4    | 2    | 0   
|Argentina | 3    | 3    | 0   
|Total     | 32   | 36   | 36  

Share Ownership

The following
table sets out the names of directors and senior management, the period of time
during which each has been a director or senior manager of the Company, and the
number of common shares of the Company beneficially owned by each of them,
directly or indirectly, or over which control or direction is exercised and
percentage of ownership as at May 31, 2009:

|                                                                                 |  |                                                                      |  |                                      
|-------------------------------------------------------------------------------- |  | -------------------------------------------------------------------- |  | -------------------------------------
|Name                                                                             |  | Periods during which
  has served as a 
  Director or Senior Manager |  | Shares Owned and
  % of Ownership (1)
|                                                                                 |  |                                                                      |  |                                      
|Richard
  Chen-Hsing Lin(2)Chairman, President, Operations-China and 
  Director |  | Since 1992                                                           |  | 4,739,565 Common shares(2)2.13%      
|Robert
  Andrew Kingston(3)President, Chief Executive Officer and Director       |  | Since 1999                                                           |  | 787,085 Common shares(3)0.35%        
|Shing-Cheng
  Hong(4)Director                                                    |  | Since 1997                                                           |  | 165,412 Common shares(4)0.07%        

35

---



|                                                                         |  |                                                                      |  |                                      
|------------------------------------------------------------------------ |  | -------------------------------------------------------------------- |  | -------------------------------------
|Name                                                                     |  | Periods during which
  has served as a 
  Director or Senior Manager |  | Shares Owned and
  % of Ownership (1)
|                                                                         |  |                                                                      |  |                                      
|Chih-Lin Chu(5)Director                                                  |  | Since 2001                                                           |  | 29,345
  Common shares(5)0.013%      
|Desmond
  Radlein, Ph.D.Director                                         |  | 1997  2002 and 
  2003 to present                                   |  | 80,767 Common shares(6)0.03%         
|Brian
  Richardson 
  Chief Financial Officer                            |  | Since 2003                                                           |  | 171,500 Common shares 
  0.08%       
|Laura Santos
  
  Corporate Secretary                                    |  | Since 1998                                                           |  | 21,988 Common shares 
  0.01%        
|Jeffrey Lin 
  Vice President, Business Development  
  China and Japan |  | Since 2005                                                           |  | 64,283 Common shares 
  0.03%        
|Thomas J.
  Bouchard 
  Chief Operating Officer                          |  | January 2008                                                         |  | Nil                                  

Notes:

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The information as to
  shares beneficially owned or controlled is not within the knowledge of the
  management of the Company and has been furnished by the respective directors
  and officers. Our directors and officers also hold options to purchase our
  shares as described below                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|(2) | Includes 4,739,565 Common
  Shares, of which 2,256,816 Common Shares are held by Cantai Property Limited
  (Cantai), a company controlled by Mr. Lin; 354,218 shares of Mr. Lin and
  1,450,794 shares of Cantai are held under Leede Financial; also includes
  172,912 Common Shares held by Neoventi Technology Corporation over which Mr.
  Lin has voting and disposition powers. Mr. Lin also holds options to purchase
  up to an aggregate of 9,646,003 Common Shares of which 605,660 are held by
  Cantai (3,000,000 Common Shares at an exercise price of $0.45, expiring on
  July 31, 2014; 1,000,000 Common Shares (1,000,000 common shares non-vested)
  at an exercise price of $0.58, expiring on July 31, 2014; 750,000 Common
  Shares at an exercise price of $0.50, expiring from February 2, 2010 to April
  28, 2012; 300,000 Common Shares at an exercise price of $0.23, expiring on
  August 30, 2013; 2,646,003 Common Shares (605,660 under the name of Cantai)
  at an exercise price of $0.20, expiring from May 8, 2011 to March 31, 2014;
  150,000 Common Shares at an exercise price of $1.60, expiring July 12, 2009
  and 1,800,000 Common Shares (600,000 common shares non-vested) at an exercise
  price of $1.22, expiring from November 30, 2010 to November 30,
  2012)). Mr. Lin also holds rights to purchase up to an aggregate of
  388,901 Common Shares of which 191,117 are held by Cantai (388,901 Common
  Shares at an exercise price of $0.01, expiring from June 30, 2010 to
  September 29, 2016).                                                                                            
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|(3) | Includes 787,085 Common
  Shares held in the name of Cape Fear Limited (CFL), an Isle of Man company
  which all shares are held by an arms length trustee of a discretionary trust
  of which Mr. Kingston is a beneficiary. Mr. Kingston also holds options to
  purchase up to an aggregate of 12,172,083 Common Shares of which 3,033,750
  are held by CFL: (3,000,000 Common Shares at an exercise price of $0.45,
  expiring on July 31, 2014; 1,000,000 Common Shares (1,000,000 common shares
  non-vested) at an exercise price of $0.58, expiring on July 31, 2014; 300,000
  Common Shares (under the name of CFL.) at an exercise price of $0.23,
  expiring on August 30, 2013; 2,400,000 Common Shares (under the name of CFL)
  at an exercise price of $0.22, expiring from August 30, 2013 to December 22,
  2013; 333,750 Common Shares (under the name of CFL) at an exercise price of
  $0.20, expiring on August 30, 2013; 775,000 Common Shares at an exercise
  price of $0.50, expiring from February 2, 2010 to February 23, 2012; 150,000
  Common Shares at an exercise price of $1.60, expiring on July 12, 2009;
  400,000 Common Shares at an exercise price of $0.20, expiring on May 8, 2011;
  2,013,333 Common Shares at an exercise price of $0.30, expiring on May 8,
  2011 and 1,800,000 Common Shares (600,000 common shares non-vested) at an
  exercise price of $1.22, expiring from November 30, 2010 to November 30,
  2012)). Mr. Kingston also holds rights to purchase up to an aggregate of
  89,301 Common Shares at an exercise price of $0.01, expiring from June 30,
  2010 to April 30, 2011).
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|(4) | Mr. Hong also holds options
  to purchase up to an aggregate of 69,000 Common Shares (23,000 Common Shares
  at an exercise price of $0.45, expiring on July 1, 2010; 23,000 Common Shares
  at an exercise price of $1.16, expiring on November 30, 2011 and 23,000
  Common Shares at an exercise price of $0.33, expiring on July 24, 2012).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|(5) | Mr. Chu also holds options
  to purchase up to an aggregate of 60,000 Common Shares (30,000 Common Shares
  at an exercise price of $0.45, expiring from December 22, 2009 to July 1,
  2010; 15,000 Common Shares at an exercise price of $1.16, expiring on
  November 30, 2011 and 15,000 Common Shares at an exercise price of $0.33,
  expiring on July 24, 2012).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|(6) | Dr. Desmond Radlein also
  holds options to purchase up to an aggregate of 676,000 Common Shares (46,000
  Common Shares at an exercise price of $0.45, expiring from December 22, 2009
  to July 1, 2010; 15,000 Common Shares at an exercise price of $1.16, expiring
  on November 30, 2011; 15,000 Common Shares at an exercise price of $0.33,
  expiring on July 24, 2012 and 600,000 Common Shares at an exercise price of
  $1.15, expiring from November 1, 2009 to November, 1, 2011).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

36

---



The Directors and Officers
beneficially own or effectively control as a group a total of 6,059,945 shares
which represents 2.72% of the total issued and outstanding shares of the
Company.

The Directors and Senior
Management hold a total of 30,035,306 options. 10,885,306 options are granted
and exercisable between $0.19 and $0.33 each; 13,084,000 options are granted
(10,734,000 are exercisable and 2,350,000 are unexercisable) between $0.45 and
$0.58 each; and 6,066,000 options are granted (4,382,667 are exercisable and
1,683,333 are exercisable) between $0.78 and $1.60 each. 10,885,306 unexercised
options were in the money and 19,150,000 unexercised options were out of the money
based on the average trading price of $0.34 per Common share as listed on the
OTCBB as at May 31, 2009.

Percentage of class is
calculated based on the outstanding common shares as at May 31, 2009 of
222,867,272.

The Company has a
Stock Option Plan (the Plan), enabling the Company to provide its directors,
officers and employees with an opportunity to share in increases in the value
of the Companys shares. The Plan is intended to attract and retain the
services of directors, officers, employees and consultants to the Company for
the benefit of the Company and its shareholders and to provide additional
incentive for such directors, officers and employees to continue to work in the
best interests of the Company and its shareholders through continuing ownership
of its Common Stock. A Post-Effective Amendment to the Plan was filed with the
US Securities Commission on March 4, 2008 to include shares of restricted
stock. At May 31, 2009, 2,016,285 options were issuable under the Plan and
31,413,806 options were outstanding at exercise prices ranging from $0.19 to
$1.60 per common share.

|        |                                                  
|------- | -------------------------------------------------
|ITEM 7. | MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS

Major Shareholders

As at May 31,
2009 and to the Companys knowledge, it is not directly or indirectly owned or controlled
by another corporation or by any foreign government and no registered
shareholder owns more than 5% of the Companys common stock

The Company
knows of no arrangements which may, at a subsequent date, result in a change of
control.

Computershare
Trust Company of Canada (Computershare) is the Companys registrar and transfer
agent for the Companys shares. Computershares records as of May 31, 2009
indicate 222,867,272 shares of common stock issued and outstanding as follows:

|                         |  |                   |                     |             |  |        |  
|------------------------ |  | ----------------- | ------------------- | ----------- |  | ------ | -
|Residence of Shareholder |  | Number of Holders | Number of Shares(1) | Percent    
|                         |  |                   |                     |            
|Canada                   |  | 56                |                     | 87,972,180  |  | 39.47  | %
|U.S.A.                   |  | 201               |                     | 122,362,699 |  | 54.90  | %
|Other                    |  | 108               |                     | 12,532,393  |  | 5.63   | %
|Total                    |  | 365               |                     | 222,867,272 |  | 100.00 | %

|    |                                                                                      
|--- | -------------------------------------------------------------------------------------
|(1) | Includes the
  total number of shares held by registered and beneficial shareholders.

Related Party Transactions

Except as
disclosed herein, the Company has not, since the beginning of its last fiscal
year ended December 31, 2008, and does not propose to, entered into any
material transactions with related parties.

The following transactions
with related parties are in the normal course of operations and are recorded at
amounts established and agreed between the related parties. The Company had the
following transactions with related parties since December 31, 2008:

37

---



Consulting fees and salaries
of $1,640,232 for the year ended December 31, 2008 (2007 - $1,931,783; 2006 -
$1,763,575) have been paid to Directors (or companies controlled by Directors)
of the Company. Included in the amount above, is $407,573 (2007 - $207,827;
2006 - $543,122) paid by stock based compensation.

As of December 31, 2008, the
Company entered into loan agreements with directors and officers for $1,187,289
(2007 - $nil). The loans are due on demand and bear interest at 8% p.a. annum. This
amount along with $70,000 from an unrelated party, comprises the total
$1,257,289 of short-term loans. One
of the major loan agreements was secured by a General Security Agreement as a
floating charge over the Companys assets.

The Company recorded a gain
on reduction in bonus and vacation accrual of $1,070,930 in 2008 ($nil in 2007;
$nil in 2006). In 2008 the Companys Compensation Committee approved the motion
of certain Company executives to forgive their entitlement to these amounts and
to make this reduction in the accrual. These amounts were previously accrued as
at December 31, 2007 and included in results to that time.

The Company incurred
relocation expenses of $120,000 on behalf of an officer.

The amount due to directors
and officers of $1,187,289 as of December 31, 2008 included: (a) $1,028,909 due
to Richard C.H. Lin, Chairman of the Company. The loan is due on demand and
bear interest at 8% p.a. annum. The loan agreement with Mr. Lin was secured by
a General Security Agreement as a floating charge over the Companys assets;
(b) $15,000 due to Cape
Fear Limited, an Isle of Man company of which all shares are held by an arms
length trustee of a discretionary trust of which Mr. R. Andrew Kingston, President and CEO of the Company, is a beneficiary. The loan
is unsecured due on demand and bear
interest at 8% p.a. annum; (c) $143,380 due to Chih Lin Chu, a director of the
Company, under the name of Zhen Quo Zhang. The loan is unsecured
due on demand and bear interest at 8% p.a. annum.

Interest of Experts and Counsel

Not
applicable.

|        |                      
|------- | ---------------------
|ITEM 8. | FINANCIAL INFORMATION

Consolidated Statements and Other Financial
Information

The Companys annual audited
consolidated financial statements for the years ended December 31, 2008, 2007
and 2006 are included in this Annual Report and are incorporated by reference
herein.

Significant Changes

There have been no significant changes in the Companys business since
December 31, 2008 except as disclosed in this Annual Report.

|        |                      
|------- | ---------------------
|ITEM 9. | THE OFFER AND LISTING

The Companys
common stock is traded on the Over-the-Counter Bulletin Board (OTCBB) under the
symbol DYMTF.OB. As at December 31, 2008, the closing sales price on the OTCBB
for the Companys common shares was $0.235 per share. The following
table shows
the high and low market prices for the Companys shares on the OTCBB for the
periods indicated:

38

---



|                     |  |  |      |  |  |      | 
|-------------------- |  |  | ---- |  |  | ---- | 
|Year Ended           |  |  | High |  |  | Low  | 
|                     |  |  |      |  |  |      | 
|                     |  |  |      |  |  |      | 
|2004                 |  |  | 0.80 |  |  | 0.41 | 
|2005                 |  |  | 1.00 |  |  | 0.43 | 
|2006                 |  |  | 1.76 |  |  | 0.76 | 
|2007                 |  |  | 1.36 |  |  | 0.60 | 
|2008                 |  |  | 0.82 |  |  | 0.10 | 
|                     |  |  |      |  |  |      | 
|Quarter Ended        |  |  | High |  |  | Low  | 
|                     |  |  |      |  |  |      | 
|                     |  |  |      |  |  |      | 
|June 30,
  2007      |  |  | 1.34 |  |  | 1.00 | 
|September
  30, 2007 |  |  | 1.36 |  |  | 0.91 | 
|December 31,
  2007  |  |  | 1.00 |  |  | 0.60 | 
|                     |  |  |      |  |  |      | 
|March 31,
  2008     |  |  | 0.82 |  |  | 0.45 | 
|June 30,
  2008      |  |  | 0.65 |  |  | 0.29 | 
|September 30,
  2008 |  |  | 0.45 |  |  | 0.18 | 
|December 31,
  2008  |  |  | 0.35 |  |  | 0.10 | 
|                     |  |  |      |  |  |      | 
|March 31,
  2009     |  |  | 0.24 |  |  | 0.15 | 
|                     |  |  |      |  |  |      | 
|Month Ended          |  |  | High |  |  | Low  | 
|                     |  |  |      |  |  |      | 
|                     |  |  |      |  |  |      | 
|November 30,
  2008  |  |  | 0.19 |  |  | 0.11 | 
|December 31,
  2008  |  |  | 0.35 |  |  | 0.16 | 
|                     |  |  |      |  |  |      | 
|January 31,
  2009   |  |  | 0.24 |  |  | 0.18 | 
|February 29,
  2009  |  |  | 0.20 |  |  | 0.16 | 
|March 31,
  2009     |  |  | 0.18 |  |  | 0.15 | 
|April 30,
  2009     |  |  | 0.30 |  |  | 0.17 | 
|May 31, 2009         |  |  | 0.34 |  |  | 0.25 | 

The Company
has never declared or paid cash dividends on its common shares. The Company
currently intends to retain its earnings, if any, to provide funds for the
operation and expansion of its business and, therefore, does not anticipate
declaring or paying cash dividends in the foreseeable future.

|         |                       
|-------- | ----------------------
|ITEM 10. | ADDITIONAL INFORMATION

A. SHARE CAPITAL

Not
applicable.

B. MEMORANDUM AND ARTICLES OF INCORPORATION

Articles of
Association

The Company
was incorporated on April 11, 1991 pursuant to the Companies Act (British
Columbia), later the Company Act. The Companys corporate
constituting documents were then comprised of its Notice of Articles and its
Articles of Association (Articles).

The Business
Corporations Act (British Columbia) (BCA) was adopted in British Columbia in
2004 and is now in effect. The Business Corporations Act replaces the Company
Act (British Columbia) and adopts many provisions similar to those contained in
corporate legislation elsewhere in Canada. There was a mandatory transition
process under the Business Corporations Act, so that all companies had to
comply with the new regulations. As part of its transition, the Company adopted
new Articles in June 2005.

39

---



Under the
Business Corporations Act, every pre-existing company remained subject to
certain Pre-existing Company Provisions contained in the Company Act (British
Columbia) unless such provisions are removed with the approval of shareholders
by way of a special resolution. Such Pre-existing Company Provisions include
the following provisions that were relevant to the Company:

|  |                                                                                                                                                                                                                                        
|- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | The majority
  required to pass a special resolution is three-quarters of those votes cast
  at a properly constituted meeting of shareholders. Under the BCA, a special
  resolution may be passed with a minimum two-thirds vote; and
|  |                                                                                                                                                                                                                                        
| | A repurchase
  or redemption of shares can only be offered pro-rata to all shareholders.
  This provision has been removed under the BCA.                                                                                              

In order to
take full advantage of the flexibility offered by the BCA, the Companys board
of directors proposed removal of the Pre-existing Company Provisions in
connection with the adoption by the Company of a new form of Articles that
incorporates provisions permitted under the BCA. The removal of the
Pre-existing Company Provisions required the affirmative vote of not less than
three-quarters of the votes cast at a meeting of the shareholders of the Company,
present in person or by proxy. This approval of the shareholders by special
resolution was obtained at the annual general meeting of the shareholders of
the Company held on June 27, 2005. The removal of the Pre-existing Company
Provisions became effective upon the filing of a Notice of Alteration to the
Companys Articles with the British Columbia Registrar of Companies on October
5, 2005. The Companys
shareholders also approved by special resolution the adoption of a new form of
Articles (the Articles). The Articles were adopted by the Company with a view
to updating its charter documents to bring them into line with the Business
Corporations Act and incorporating some of the new provisions of the
Business
Corporations Act. These Articles were filed with the
Registrar of Companies on October 5, 2005.

The following is a summary
of certain material provisions of (i) the Companys Notice of Articles, as
amended by the Notice of Alteration approved by shareholders, (ii) the
Companys new Articles, as adopted by shareholders, and (iii) certain
provisions of the Business Corporations Act and related laws applicable to the
Company:

1. Objects and Purposes

The Companys
Memorandum and Articles do not specify objects or purposes. The Company is
entitled under the Business Corporations Act to carry on all
lawful businesses which can be carried on by a natural person.

2. Directors

Generally

The Directors
of the Company are generally empowered, by majority vote, to manage the
business and to bind the Company to all manners of agreements and transactions
as they see fit, acting in the best interests of the Company. So long as the
Preferred Shares are outstanding, the Company directors are restricted from
effecting certain kinds of dividends and distributions on the common shares.

Directors power to vote on a proposal,
arrangement or contract in which the director is interested.

According to
the Business
Corporations Act, a director holds a disclosable interest in a
contract or transaction if:

|   |                                                                                        |                                                                                                                                                         
|-- | -------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | the contract
  or transaction is material to the company;                             
|   |                                                                                        |                                                                                                                                                         
|2. | the company
  has entered, or proposes to enter, into the contract or transaction, and
|   |                                                                                        |                                                                                                                                                         
|3. | either of
  the following applies to the director:                                    
|   |                                                                                        |                                                                                                                                                         
|   | a.                                                                                     | the director
  has a material interest in the contract or transaction;                                                                                  
|   |                                                                                        |                                                                                                                                                         
|   | b.                                                                                     | the director
  is a director or senior officer of, or has a material interest in, a person
  who has a material interest in the contract or transaction.

40

---



However, the Business
Corporations Act also provides that in the following circumstances,
a director does not hold a disclosable interest in a contract or transaction
if:

|                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                           |                                                                                        
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------
|1.                                                                                                                                                                                                                                              | the
  situation that would otherwise constitute a disclosable interest arose before
  the coming into force of the Business Corporations Act or, if the
  company was recognized under the Business Corporations Act, before that
  recognition, and was disclosed and approved under, or was not required to be
  disclosed under, the legislation that:
|                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                | a.                                                                                                                                                                                                                                                                                                                                                        | applied to
  the company on or after the date on which the situation arose; and        
|                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                           |                                                                                        
|                                                                                                                                                                                                                                                | b.                                                                                                                                                                                                                                                                                                                                                        | is
  comparable in scope and intent to the provisions of the Business Corporations Act;
|                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                           |                                                                                        
|2.                                                                                                                                                                                                                                              | both the
  company and the other party to the contract or transaction are wholly-owned
  subsidiaries of the same corporation;                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                          
|3.                                                                                                                                                                                                                                              | the company
  is a wholly-owned subsidiary of the other party to the contract or
  transaction;                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                          
|4.                                                                                                                                                                                                                                              | the other
  party to the contract or transaction is a wholly-owned subsidiary of the
  company; or                                                                                                                                                                                                                                                       
|                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                          
|5.                                                                                                                                                                                                                                              | where the
  director or senior officer is the sole shareholder of the company or of a
  corporation of which the company is a wholly-owned subsidiary.                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                          
|The Business
  Corporations Act further provides that a director of a company
  does not hold a disclosable interest in a contract or transaction merely
  because:                                                                            
|                                                                                                                                                                                                                                               
|1.                                                                                                                                                                                                                                              | the contract
  or transaction is an arrangement by way of security granted by the company
  for money loaned to, or obligations undertaken by, the director or senior
  officer, or a person in whom the director or senior officer has a material
  interest, for the benefit of the company or an affiliate of the company;                            
|                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                          
|2.                                                                                                                                                                                                                                              | the contract
  or transaction relates to an indemnity or insurance;                                                                                                                                                                                                                                                                                      
|                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                          
|3.                                                                                                                                                                                                                                              | the contract
  or transaction relates to the remuneration of the director or senior officer
  in that persons capacity as director, officer, employee or agent of the
  company or of an affiliate of the company;                                                                                                                                      
|                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                          
|4.                                                                                                                                                                                                                                              | the contract
  or transaction relates to a loan to the company, and the director or senior
  officer, or a person in whom the director or senior officer has a material
  interest, is or is to be a guarantor of some or all of the loan; or                                                                                                            
|                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                          
|5.                                                                                                                                                                                                                                              | the contract
  or transaction has been or will be made with or for the benefit of a
  corporation that is affiliated with the company and the director or senior
  officer is also a director or senior officer of that corporation or an
  affiliate of that corporation.                                                                               
|                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                          
|Under the
  Companys Articles, a director or senior officer who holds a disclosable
  interest (as that term is used in the Business Corporations Act) in a contract
  or transaction into which the Company has entered or proposes to enter:
|                                                                                                                                                                                                                                               
|1.                                                                                                                                                                                                                                              | is liable to
  account to the Company for any profit that accrues to the director or senior
  officer under or as a result of the contract or transaction only if and to
  the extent provided in the Act;                                                                                                                                               
|                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                          
|2.                                                                                                                                                                                                                                              | is not
  entitled to vote on any directors resolution to approve that contract or
  transaction, unless all the directors have a disclosable interest in that
  contract or transaction, in which case any or all of those directors may vote
  on such resolution;                                                                                     
|                                                                                                                                                                                                                                                |                                                                                                                                                                                                                                                                                                                                                          
|3.                                                                                                                                                                                                                                              | and who is
  present at the meeting of directors at which the contract or transaction is
  considered for approval may be counted in the quorum at the meeting whether
  or not the director votes on any or all of the resolutions considered at the
  meeting.                                                                                         

41

---



A director or
senior officer who holds any office or possesses any property, right or
interest that could result, directly or indirectly, in the creation of a duty
or interest that materially conflicts with that individuals duty or interest
as a director or senior officer, must disclose the nature and extent of the
conflict as required by the Business Corporations Act. No director or
intended director is disqualified by his or her office from contracting with
the Company either with regard to the holding of any office or place of profit
the director holds with the Company or as vendor, purchaser or otherwise, and
no contract or transaction entered into by or on behalf of the Company in which
a director is in any way interested is liable to be voided for that reason

Directors power, in
the absence of an independent quorum, to vote compensation to themselves or any
members of their body.

The
compensation of the directors is decided by the directors unless the board of
directors requests approval to the compensation from the shareholders by
ordinary resolution. The Business Corporations Act provides that a
director of a company does not hold a disclosable interest in a contract or
transaction merely because the contract or transaction relates to the remuneration
of the director or senior officer in that persons capacity as director,
officer, employee or agent of the Company or of an affiliate of the Company.

Borrowing powers
exercisable by the directors.

Under the
Articles, the directors may, on behalf of the Company:

|   |                                                                                                                                                                                                                                                      
|-- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | Borrow money
  in such manner and amount, on such security, from such sources and upon such
  terms, and conditions as they consider appropriate;                                                                                                    
|   |                                                                                                                                                                                                                                                      
|2. | Issue bonds,
  debentures, and other debt obligations either outright or as a security for
  any liability or obligation of the Company or any other person and at such
  discounts or premiums and on such other terms as they consider appropriate;
|   |                                                                                                                                                                                                                                                      
|3. | guarantee
  the repayment of money by any other person or the performance of any
  obligation of any other person; and                                                                                                                               
|   |                                                                                                                                                                                                                                                      
|4. | mortgage,
  charge, whether by way of specific or floating charge, grant a security
  interest in, or give other security on, the whole or any part of the present
  and future assets and undertaking of the Company.                               

Retirement and non-retirement
of directors under an age limit requirement.

There are no
such provisions applicable to the Company under its Memorandum or its Articles
or the Business
Corporations Act.

Number of shares required for a directors
qualification.

Directors need
not own any shares of the Company in order to qualify as directors.

3. Rights, Preferences and Restrictions
Attaching to Each Class of Shares

Classes of Shares

The Company
has two classes of shares, namely common without par value and Class A
Preferred Shares (the Preferred Shares) with special rights and restrictions.
The common shares and preferred shares are unlimited in number. Notice of
Alteration of the Companys Articles of Incorporation to cancel the existing
special rights and restrictions attached to the Class A Preferred shares and
to adopt a new special rights and restrictions attached to the Class A
Preferred shares as approved at the Companys Special Meeting of Shareholders
on November 21, 2005. The Companys Articles was altered to change all of the
unissued Class A Preferred shares each with a par value of $5.00 into Class
A Preferred with no par value; to delete the existing Article 26 which sets
out the special rights and restrictions attached to the Class A Preferred shares;
and to add to the Articles of the Company, revised

42

---



Article 26,
which will govern the Class A Preferred shares and authorizes directors in
the future to issue them in series and attach specific rights and restrictions
to each such series within the requirements of Article 26.

Dividends

Dividends may
be declared by the board out of available assets and are paid rateably to
holders of common shares subject to the rights attached to the Preferred
Shares. No dividend may be paid if the Company is, or would thereby become,
insolvent.

Voting Rights

Subject to the
special rights and restrictions of the Preferred Shares, as set out in Article
26, shares are entitled to one vote on matters to which shares ordinarily vote
including the annual election of directors, appointment of auditors and
approval of corporate changes. Directors automatically retire at each annual
meeting, and may be elected thereat. There are no staggered directorships among
the Companys directors. There are no cumulative voting rights applicable to
the Company.

Rights to Profits and Liquidation Rights

The holders of Class A
Preferred shares shall be entitled, on the liquidation or dissolution of the
Company, whether voluntary or involuntary, or on any other distribution of its
assets among its shareholders for the purpose of winding up its affairs, to
receive, before any distribution is made to the holders of Common shares or any
other shares of the Company ranking junior to the Class A Preferred shares
with respect to repayment of capital on the liquidation or dissolution of the
Company, whether voluntary or involuntary, or on any other distribution of its
assets among its shareholders for the purpose of winding up its affairs, the
amount paid up with respect to each Class A Preferred share held by them,
together with any liquidation or other applicable premium (if any) thereon, all
accrued and unpaid cumulative dividends (if any and if preferential) thereon,
which for such purpose shall be calculated as if such dividends were accruing
on a day-to-day basis up to the date of such distribution, and all declared and
unpaid non-cumulative dividends (if any and if preferential) thereon. After
payment to the holders of Class A Preferred shares of the amounts so payable
to them, they shall not, as such, be entitled to share in any further
distribution of the property or assets of the Company except as specifically
provided in the special rights and restrictions attached to any particular
series.

Redemption

Sinking Fund Provisions

The Company
has no sinking fund provisions or similar obligations which require it to,
restrict its assets except for as set out in Article 26 of the Articles.

Shares Fully Paid

All the
Company shares must, by applicable law, be issued as fully paid for cash, property
or services. They are therefore non-assessable and not subject to further calls
for payment.

Pre-emptive Rights

There are no
pre-emptive rights as a consequence of the Companys Articles or the BCA which
provide a right to any person to participate in offerings of the Companys
equity or other securities, except as noted below.

With respect

to the rights, preferences and restrictions attaching to the Companys common
shares, there are generally no significant differences between Canadian and
United States law as the shareholders, or the applicable corporate statute,
will determine the rights, preferences and restrictions attaching to each class
of the Companys shares.

43

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4. Changes to Rights and Restrictions to
Shares

The Business
Corporations Act provides that a company may, by the type of
shareholders resolution specified by the articles, or, if the articles do not
specify the type of resolution, by a special resolution:

|                                                                                                                           |     |                                                                                                                                                                                                                                                                                                           |                                                                                                                  
|-------------------------------------------------------------------------------------------------------------------------- | --- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | -----------------------------------------------------------------------------------------------------------------
|                                                                                                                           | i)  | create
  special rights or restrictions for, and attach those special rights or
  restrictions to, the shares of any class or series of shares, whether or not
  any or all of those shares have been issued; or                                                                                         
|                                                                                                                           |     |                                                                                                                                                                                                                                                                                                          
|                                                                                                                           | ii) | vary or
  delete any special rights or restrictions attached to the shares of any class
  or series of shares, whether or not any or all of those shares have been
  issued.                                                                                                                             
|                                                                                                                           |     |                                                                                                                                                                                                                                                                                                          
|The
  Companys Articles provide that, subject to the Business Corporations Act,
  the Company may by ordinary resolution:
|                                                                                                                          
|                                                                                                                           | (a) | create one
  or more classes or series of shares or, if none of the shares of a class or
  series of shares are allotted or issued, eliminate that class or series of
  shares;                                                                                                                          
|                                                                                                                           |     |                                                                                                                                                                                                                                                                                                          
|                                                                                                                           | (b) | increase,
  reduce or eliminate the maximum number of shares that the Company is
  authorized to issue out of any class or series of shares or establish a
  maximum number of shares that the Company is authorized to issue out of any
  class or series of shares for which no maximum is established;
|                                                                                                                           |     |                                                                                                                                                                                                                                                                                                          
|                                                                                                                           | (c) | subdivide or
  consolidate all or any of its unissued, or fully paid, issued, shares;                                                                                                                                                                                                                    
|                                                                                                                           |     |                                                                                                                                                                                                                                                                                                          
|                                                                                                                           | (d) | if the
  Company is authorized to issue shares of a class of shares with par value:                                                                                                                                                                                                                      
|                                                                                                                           |     |                                                                                                                                                                                                                                                                                                          
|                                                                                                                           |     | (i)                                                                                                                                                                                                                                                                                                       | decrease the
  par value of those shares; or                                                                     
|                                                                                                                           |     |                                                                                                                                                                                                                                                                                                           |                                                                                                                  
|                                                                                                                           |     | (ii)                                                                                                                                                                                                                                                                                                      | if none of
  the shares of that class of shares are allotted or issued, increase the par
  value of those shares;
|                                                                                                                           |     |                                                                                                                                                                                                                                                                                                           |                                                                                                                  
|                                                                                                                           | (e) | change all
  or any of its unissued, or fully paid issued, shares with par value into
  shares without par value or any of its unissued shares without par value into
  shares with par value;                                                                                                           
|                                                                                                                           |     |                                                                                                                                                                                                                                                                                                          
|                                                                                                                           | (f) | alter the
  identifying name of any of its shares; or                                                                                                                                                                                                                                                    
|                                                                                                                           |     |                                                                                                                                                                                                                                                                                                          
|                                                                                                                           | (g) | otherwise
  alter its shares or authorized share structure when required or permitted to
  do so by the Act where it does not specify a special resolution.                                                                                                                                              

An ordinary resolution is a
resolution of shareholders that is approved by a majority of those votes cast
at a properly constituted meeting of shareholders.

If special
rights and restrictions are altered and any right or special right attached to
issued shares is prejudiced or interfered with, then the consent of the holders
of shares of that class by a special separate resolution will be required.

The Business
Corporations Act also provides that a company may reduce its capital
if it is authorized to do so by a court order, or, if the capital is reduced to
an amount that is not less than the realizable value of the companys assets
less its liabilities, by a special resolution or court order.

Generally,
there are no significant differences between British Columbia and United States
law with respect to changing the rights of shareholders as most state
corporation statutes require shareholder approval (usually a majority) for any
such changes that affect the rights of shareholders.

44

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5. Meetings of Shareholders

The Articles provide that the
Company must hold its annual
general meeting once in every calendar year (and being a date not more than 15
months from the last annual general meeting) at such time and place to be
determined by the directors of the Company. Shareholders meetings are governed by the Articles of the Company but
many important shareholder protections are also contained in the Securities
Act (British Columbia) (the Securities Act) and the British
Columbia Corporations Act. The Articles provide that the Company
will provide at least 21 days advance written notice if the Company is a public
company, and 10 days otherwise, of any meeting of shareholders and will provide
for certain procedural matters and rules of order with respect to conduct of
the meeting. The directors may fix in advance a date, which is no fewer than 21
days if the company is a public company, and 10 days otherwise, prior to the
date of the meeting for the purpose of determining shareholders entitled to
receive notice of and to attend and vote at a general meeting.

The Securities
Act and the British Columbia Corporations Actsuperimpose
requirements provide that shareholders meetings generally require about a 60
day notice period from initial public notice and that The Company makes a
thorough advanced search of intermediary and brokerage registered shareholdings
to facilitate communication with beneficial shareholders so that meeting proxy
and information materials can be sent via the brokerages to unregistered but
beneficial shareholders. The form and content of information circulars and
proxies and like matters are governed by the Securities Actand the British
Columbia Corporations Act. This legislation specifies the disclosure
requirements for the proxy materials and various corporate actions, background
information on the nominees for election for director, executive compensation
paid in the previous year and full details of any unusual matters or related
party transactions. The Company must hold an annual shareholders meeting open
to all shareholders for personal attendance or by proxy at each shareholders
determination.

Most state
corporation statutes require a public company to hold an annual meeting for the
election of directors and for the consideration of other appropriate matters.
The state statutes also include general provisions relating to shareholder
voting and meetings. Apart from the timing of when an annual meeting must be
held and the percentage of shareholders required to call an annual meeting or
an extraordinary meeting, there are generally no material differences between
Canadian and United States law respecting annual meetings and extraordinary
meetings.

6. Rights to Own Securities

There are no
limitations under the Companys Articles or in the Business Corporations Act on
the right of persons who are not citizens of Canada to hold or vote common
shares.

7. Restrictions on Changes in Control,
Mergers, Acquisitions or Corporate Restructuring of the Company

The Companys
Articles do not contain any provisions that would have the effect of delaying,
deferring or preventing a change of control of the Company. The Company has not
implemented any shareholders rights or other poison pill protection against
possible take-overs. The Company does not have any agreements which are
triggered by a take-over or other change of control. There are no provisions in
its Articles triggered by or affected by a change in outstanding shares which
gives rise to a change in control. There are no provisions in the Companys
material agreements giving special rights to any person on a change in control.

The Business
Corporations Act does not contain any provisions that would have the
effect of delaying, deferring or preventing a change of control of a company.
Securities legislation and stock exchange policies applicable to the Company
however do require shareholders approvals for change of control transactions.

Generally,
there are no significant differences between British Columbia and United States
law in this regard, as many state corporation statutes also do not contain such
provisions and only empower a companys board of directors to adopt such
provisions.

8. Ownership Threshold Requiring Public
Disclosure

The Articles
of the Company do not require disclosure of share ownership. Share ownership of
director nominees must be reported annually in proxy materials sent to the
Companys shareholders. There are no requirements under

45

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British
Columbia corporate law to report ownership of shares of the Company but the Securities
Act requires disclosure of trading by insiders (generally officers,
directors and holders of 10% of voting shares) within 10 days of the trade.
Controlling shareholders (generally those in excess of 20% of outstanding
shares) must provide seven days advance notice of share sales. All insider
trading reports filed by the Companys insiders pursuant to Canadian securities
legislation are available on the internet at www.sedi.ca.

Most state
corporation statutes do not contain provisions governing the threshold above
which shareholder ownership must be disclosed. United States federal securities
laws require a company that is subject to the reporting requirements of the
Securities Exchange Act of 1934 to disclose, in its annual reports filed with
the Securities and Exchange Commission those shareholders who own more than 5%
of a corporations issued and outstanding shares.

9. Differences in Law between the US and
British Columbia

Differences in
the law between United States and British Columbia, where applicable, have been
explained above within each category.

10. Changes in the Capital of the Company

There are no
conditions imposed by the Companys Notice of Articles or Articles which are
more stringent than those required by the Business Corporations Act.

C. MATERIAL CONTRACTS

The following
are the material contracts entered into during the period January 1, 2008 to
date (included as exhibits):

|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Demand Loan
  Agreement between between Dynamotive Energy Systems Corp. and Richard Lin
  (Lender) dated December 31, 2008. The Demand Loan is up to US$2 million
  payable within 10 days of demand by the Lenders, made anytime from the date
  of the Companys completion of current funding and receipt of such relevant
  funds. The Demand Loan interest is 8% simple interest per annum and secured
  by a General Security Agreement.
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | Share
  Purchase Agreement among Pendana Limited (Pendana) and Dynamotive Energy
  Systems Corp. dated October 24, 2008. Pendana is the beneficial owner of 1
  share representing 20% of Dynamotive Europe Limited and has agreed to sell
  the share to the Company at GBP 1.                                                                                                                                                               
|  |                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | Minutes of Settlement
  and Full and Final Mutual Release between Process Group Inc and Dynamotive
  Energy Systems Corp. dated June 20, 2008.                                                                                                                                                                                                                                                                                                  

D. EXCHANGE CONTROLS

There is no
law or governmental decree or regulation in Canada that restricts the export or
import of capital, or affects the remittance of dividends, interest or other
payments to a non-resident holder of common shares of the Company, other than
withholding tax requirements. See Taxation.

There is no
limitation imposed by Canadian law or by the charter or other constituent
documents of the Company on the right of a non-resident to hold or vote common
shares of the Company, other than as provided in the Investment Canada Act
(Canada) (the Investment Act).

The following
discussion summarizes the principal features of the Investment Act for a
non-resident who proposes to acquire common shares of the Company. It is
general only, it is not a substitute for independent advice from an investors
own advisor, and it does not anticipate statutory or regulatory amendments.

The Investment
Act is a federal statute of broad application regulating the establishment and
acquisition of Canadian businesses by non-Canadians, including individuals,
governments or agencies thereof, corporations, partnerships, trusts or joint ventures
(each an entity). Investments by non-Canadians to acquire control over
existing Canadian businesses or to establish new ones are either reviewable or
notifiable under the Investment Act. If an investment by a non-Canadian to
acquire control over an existing Canadian business is reviewable under the
Investment Act, the

46

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Investment Act
prohibits implementation of the investment unless after review the Director of
Investments, who is appointed by the Minster of Industry, is satisfied that the
investment is likely to be of net benefit to Canada.

A non-Canadian
would acquire control of the Company for the purposes of the Investment Act
through acquisition of common shares if the non-Canadian acquired a majority of
the common shares of the Company. Further, the acquisition of less than a
majority but one third or more of the common shares of the Company would be
presumed to be an acquisition of control of the Company unless it could be
established that, on the acquisition, the Company was not controlled in fact by
the acquirer through the ownership of common shares.

For a direct
acquisition that would result in an acquisition of control of the Company,
subject to the exception for WTO-investors that are controlled by persons who
are resident in World Trade Organization (WTO) member nations, a proposed
investment would be reviewable where the value of the acquired assets is CAD $5
million or more, or if an order for review was made by the federal cabinet on
the grounds that the investment related to Canadas cultural heritage or
national identity, regardless of the value of the assets of the Company.

For a proposed
indirect acquisition that would result in an acquisition of control of the
Company through the acquisition of a non-Canadian parent entity, the investment
would be reviewable where (a) the value of the Canadian assets acquired in the
transaction is CAD $50 million or more, or (b) the value of the Canadian assets
is greater than 50% of the value of all of the assets acquired in the transaction
and the value of the Canadian assets is CAD $5 million or more.

In the case of
a direct acquisition by or from a WTO investor, the threshold is
significantly higher, and is adjusted for inflation each year. The 2008
threshold is CAD $295 million. Other than the exception noted below, an
indirect acquisition involving a WTO investor is not reviewable under the
Investment Act.

The higher WTO
threshold for direct investments and the exemption for indirect investments do
not apply where the relevant Canadian business is carrying on the following
businesses that have been deemed to be sensitive: (i) the production of uranium
and the ownership of an interest in a producing uranium property in Canada;
(ii) the provision of any financial service; (iii) the provision of any
transportation service; or (iv) a cultural business.

Certain
transactions relating to common shares of the Company would be exempt from the
Investment Act, including

|    |                                                                                                                                                                                                                                                                          
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | acquisition
  of common shares of the Company by a person in the ordinary course of that
  persons business as a trader or dealer in securities,                                                                                                                        
|    |                                                                                                                                                                                                                                                                          
|(b) | acquisition
  of control of the Company in connection with the realization of security
  granted for a loan or other financial assistance and not for a purpose
  related to the provisions on the Investment Act, and                                                   
|    |                                                                                                                                                                                                                                                                          
|(c) | acquisition
  of control of the Company by reason of an amalgamation, merger, consolidation
  or corporate reorganization following which the ultimate direct or indirect
  control in fact of the Company, through the ownership of common shares,
  remained unchanged.

E. TAXATION

ALL PROSPECTIVE INVESTORS ARE ADVISED TO
CONSULT THEIR OWN TAX ADVISORS WITH RESPECT TO THE SPECIFIC TAX CONSEQUENCES OF
PURCHASING THE COMMON SHARES.

Material Canadian Federal Income Tax Consequences
for United States Residents

The following
summarizes the material Canadian federal income tax consequences generally
applicable to the holding and disposition of Common Shares by a holder who, (a)
for the purposes of the Income Tax Act (Canada) (the Tax Act), is not
resident in Canada, deals at arms length with Dynamotive, holds the Common
Shares as capital property and does not use or hold the Common Shares in the
course of carrying on, or otherwise in connection with, a business in Canada, and
(b) for the purposes of the Canada-United States Income Tax Convention, 1980
(the Treaty), is a resident solely of the United States, has never been a
resident of Canada, has not held or used (and does not hold or use) Common
Shares in connection with a permanent establishment or fixed

47

---



base in
Canada, and is entitled to the benefits of the Treaty. A holder meeting all of
the foregoing requirements is referred to in this summary as a U.S. Holder,
and this summary only addresses such U.S. Holders. This summary does not apply
to traders or dealers in securities, limited liability companies, tax-exempt
entities, insurers, financial institutions (including those to which the
mark-to-market provisions of the Tax Act apply), or any other U.S. Holder to which
special considerations apply.

This summary
is based on the current provisions of the Tax Act including all regulations
thereunder, the Treaty, all proposed amendments to the Tax Act and the
regulations publicly announced by the Minister of Finance to the date hereof,
and the current administrative practice of the Canada Revenue Agency. It has
been assumed that all currently proposed amendments will be enacted as proposed
and that there will be no other relevant change in any governing law, judicial interpretation
or administrative practice, although no assurances can be given in these
respects. The summary does not take into account Canadian provincial, U.S.
federal (which follows further below under the heading Material United States
Tax Consequences), state or other foreign income tax law or practice. The tax
consequences to any particular U.S. Holder will vary according to the status of
that holder as an individual, trust, corporation, partnership or other entity,
the jurisdictions in which that U.S. Holder is subject to taxation, and
generally according to that holders particular circumstances. Accordingly,
this summary is not, and is not to be construed as, Canadian tax advice to any
particular U.S. Holder. All holders or prospective holders should consult with
their own tax and legal advisors regarding their particular circumstances. The
discussion below is qualified accordingly.

Dividends

Dividends paid
or credited, or deemed to be paid or credited, to a U.S. Holder by Dynamotive
will be subject to Canadian withholding tax. Under the Treaty, the rate of
withholding tax on dividends paid to a U.S. Holder is generally limited to 15%
of the gross amount of the dividend (or 5% if the U.S. Holder is a corporation
and beneficially owns at least 10% of Dynamotives voting shares). Dynamotive
will be required to withhold the applicable withholding tax from any such
dividend and remit it to the Canadian government.

Disposition

A U.S. Holder
is subject to tax under the Tax Act in respect of a capital gain realized on
the disposition or deemed disposition of a Common Share unless the U.S. Holder
is entitled to relief under the Treaty. For this purpose, the U.S. Holders
capital gain (or loss) from a disposition or deemed disposition of a Common
Share is the amount by which the proceeds of disposition exceed (or are
exceeded by) the aggregate of the U.S. Holders adjusted cost base of the
Common Share for purposes of the Tax Act and any reasonable expenses of
disposition. Absent Treaty relief, one-half of any capital gain so realized is
included in computing the U.S. Holders income for purposes of the Tax Act.

A qualifying
U.S. Holder may generally qualify for relief under the Treaty in respect of
such tax on such capital gain if and provided that the value of shares of
Dynamotive is not derived principally from real property situated in Canada at
the relevant time. Management believes that the value of Dynamotives common
shares is not currently derived principally from real property situated in
Canada. A U.S. Holder wishing to claim any such applicable Treaty relief should
consult with the U.S. Holders own tax advisors in advance regarding the
procedure for claiming the relief in a relevant Canadian tax return reporting
the disposition or deemed disposition. In addition, notwithstanding any
potentially applicable Treaty relief, a disposition or deemed disposition of
Common Shares is subject to certain tax clearance certificate and withholding
procedures that should also be discussed with the U.S. Holders own tax
advisors in advance of a disposition.

United States Tax Consequences

United States
Federal Income Tax Consequences

The following
is a discussion of all material United States federal income tax
consequences, under current law, generally applicable to a U.S. Holder (as
hereinafter defined) of common shares of Dynamotive. This discussion does not
address all potentially relevant federal income tax matters and it does not
address consequences peculiar to persons subject to special provisions of
federal income tax law, such as those described below as excluded from the
definition of a U.S. Holder. In addition, this discussion does not cover any
state, local or foreign tax consequences.

48

---



(see
Taxation - Canadian Federal Income Tax Consequences above). Accordingly,
we urge holders and prospective holders of common shares of Dynamotive to
consult their own tax advisors about the specific federal, state, local, and
foreign tax consequences to them of purchasing, owning and disposing of common
shares of Dynamotive, based upon their individual circumstances.

The following
discussion is based upon the sections of the Internal Revenue Code of 1986, as
amended (the Code), Treasury Regulations, published Internal Revenue Service
(IRS) rulings, published administrative positions of the IRS and court
decisions that are currently applicable, any or all of which could be
materially and adversely changed, possibly on a retroactive basis, at any time
and which are subject to differing interpretations. This discussion does not
consider the potential effects, both adverse and beneficial, of any proposed
legislation which, if enacted, could be applied, possibly on a retroactive
basis, at any time.

U.S. Holders

As used
herein, a U.S. Holder means a holder of common shares of Dynamotive who is a
citizen or individual resident of the United States, a corporation or
partnership created or organized in or under the laws of the United States or
of any political subdivision thereof, an estate whose income is taxable in the
United States irrespective of source or a trust subject to the primary
supervision of a court within the United States and control of a United States
fiduciary as described Section 7701(a)(30) of the Code. This summary does not
address the tax consequences to, and U.S. Holder does not include, persons
subject to specific provisions of federal income tax law, such as tax-exempt
organizations, qualified retirement plans, individual retirement accounts and
other tax-deferred accounts, financial institutions, insurance companies, real
estate investment trusts, regulated investment companies, broker-dealers,
non-resident alien individuals, persons or entities that have a functional
currency other than the U.S. dollar, shareholders subject to the alternative
minimum tax, shareholders who hold common shares as part of a straddle, hedging
or conversion transaction, and shareholders who acquired their common shares
through the exercise of employee stock options or otherwise as compensation for
services. This summary is limited to U.S. Holders who own common shares as
capital assets and thesummary
does not address the consequences to a person or entity holding an interest in
a shareholder or the consequences to a person of the ownership, exercise or
disposition of any options, warrants or other rights to acquire common shares.
In addition, this summary does not address special rules applicable to United
States persons (as defined in Section 7701(a)(30) of the Code) holding common
shares through a foreign partnership or to foreign persons holding common
shares through a domestic partnership.

Distribution on Common Shares of Dynamotive

In general,
U.S. Holders receiving dividend distributions (including constructive
dividends) with respect to common shares of Dynamotive are required to include
in gross income for United States federal income tax purposes the gross amount
of such distributions, equal to the U.S. dollar value of such distributions on
the date of receipt (based on the exchange rate on such date), to the extent that
Dynamotive has current or accumulated earnings and profits, without reduction
for any Canadian income tax withheld from such distributions. Such Canadian tax
withheld may be credited, subject to certain limitations, against the U.S.
Holders federal income tax liability or, alternatively, may be deducted in
computing the U.S. Holders federal taxable income by those who itemize
deductions. (See more detailed discussion at Foreign Tax Credit below). To
the extent that distributions exceed current or accumulated earnings and
profits of Dynamotive, they will be treated first as a return of capital up to
the U.S. Holders adjusted basis in the common shares and thereafter as gain
from the sale or exchange of property. Preferential tax rates for long-term capital
gains are applicable to a U.S. Holder which is an individual, estate or trust.
There are currently no preferential tax rates for long-term capital gains for a
U.S. Holder which is a corporation.

In the case of
foreign currency received as a dividend that is not converted by the recipient
into U.S. dollars on the date of receipt, a U.S. Holder will have a tax basis
in the foreign currency equal to its U.S. dollar value on the date of receipt.
Generally any gain or loss recognized upon a subsequent sale or other
disposition of the foreign currency, including the exchange for U.S. dollars,
will be ordinary income or loss. However, an individual whose realized gain
does not exceed $200 will not recognize that gain, provided that there are no
expenses associated with the transaction that meet the requirements for
deductibility as a trade or business expense (other than travel expenses in
connection with a business trip) or as an expense for the production of income.

Dividends paid
on the common shares of Dynamotive generally will not be eligible for the
dividends received deduction provided to corporations receiving dividends from
certain United States corporations. A U.S. Holder

49

---



which is a
corporation and which owns shares representing at least 10% of the voting power
and value of Dynamotive may, under certain circumstances, be entitled to a 70%
(or 80% if the U.S. Holder owns shares representing at least 20% of the voting
power and value of Dynamotive) deduction of the United States source portion of
dividends received from Dynamotive (unless Dynamotive qualifies as a passive
foreign investment company, as defined below). Dynamotive does not anticipate
that it will earn any United States income, however, and therefore does not
anticipate that any U.S. Holder will be eligible for the dividends received
deduction.

Under current
Treasury Regulations, dividends paid on Dynamotives common shares, if any,
generally will not be subject to information reporting and generally will not
be subject to U.S. backup withholding tax. However, dividends and the proceeds
from a sale of Dynamotives common shares paid in the U.S. through a U.S. or
U.S. related paying agent (including a broker) will be subject to U.S.
information reporting requirements and may also be subject to the 31% U.S.
backup withholding tax, unless the paying agent is furnished with a duly
completed and signed Form W-9. Any amounts withheld under the U.S. backup
withholding tax rules will be allowed as a refund or a credit against the U.S.
Holders U.S. federal income tax liability, provided the required information
is furnished to the IRS.

Foreign Tax Credit

A U.S. Holder
who pays (or has withheld from distributions) Canadian income tax with respect
to the ownership of common shares of Dynamotive may be entitled, at the option
of the U.S. Holder, to either receive a deduction or a tax credit for such
foreign tax paid or withheld. Generally, it will be more advantageous to claim
a credit because a credit reduces United States federal income taxes on a
dollar-for-dollar basis, while a deduction merely reduces the taxpayers income
subject to tax. This election is made on a year-by-year basis and generally
applies to all foreign taxes paid by (or withheld from) the U.S. Holder during
that year. There are significant and complex limitations which apply to the
credit, among which is the general limitation that the credit cannot exceed the
proportionate share of the U.S. Holders United States income tax liability
that the U.S. Holders foreign source income bears to his or its worldwide
taxable income. In the determination of the application of this limitation, the
various items of income and deduction must be classified into foreign and
domestic sources. Complex rules govern this classification process. In
addition, this limitation is calculated separately with respect to two
categories of income: (1) passive income, and (2) general category income.
Dividends distributed by Dynamotive will generally constitute passive income
for these purposes. The availability of the foreign tax credit and the
application of the limitations on the credit are fact specific, and U.S.
Holders of common shares of Dynamotive should consult their own tax advisors
regarding their individual circumstances.

Disposition of Common Shares of Dynamotive

In general,
U.S. Holders will recognize gain or loss upon the sale of common shares of
Dynamotive equal to the difference, if any, between (i) the amount of cash
plus the fair market value of any property received, and (ii) the shareholders
tax basis in the common shares of Dynamotive. Preferential tax rates apply to
long-term capital gains of U.S. Holders which are individuals, estates or
trusts. In general, gain or loss on the sale of common shares of Dynamotive
will be long-term capital gain or loss if the common shares are a capital asset
in the hands of the U.S. Holder and are held for more than one year. Deductions
for net capital losses are subject to significant limitations. For U.S. Holders
which are not corporations, any unused portion of such net capital loss may be
carried over to be used in later tax years until such net capital loss is
thereby exhausted.

For U.S.
Holders that are corporations (other than corporations subject to Subchapter S
of the Code), an unused net capital loss may be carried back three years and
carried forward five years from the loss year to be offset against capital
gains until such net capital loss is thereby exhausted.

Other Considerations

Set forth
below are certain material exceptions to the above-described general rules
describing the United States federal income tax consequences resulting from the
holding and disposition of common shares:

The Foreign
Personal Holding Company and Foreign Investment Company taxation rules were
repealed for all tax years beginning after December 31, 2004.

50

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Passive Foreign Investment Company

United States
income tax law contains rules governing passive foreign investment companies
(PFIC) which can have significant tax effects on U.S. Holders of foreign
corporations. These rules do not apply to non-U.S. Holders. Section 1297 of the
Code defines a PFIC as a corporation that is not formed in the United States
if, for any taxable year, either (i) 75% or more of its gross income is
passive income, which includes interest, dividends and certain rents and royalties
or (ii) the average percentage, by fair market value (or, if the corporation is
not publicly traded and either is a controlled foreign corporation or makes an
election, by adjusted tax basis), of its assets that produce or are held for
the production of passive income is 50% or more. Dynamotive appears to have
been a PFIC for the fiscal year ended December 31,2003, and at least certain prior
fiscal years. In addition, Dynamotive expects to qualify as a PFIC for the
fiscal year ending December 31, 2008 and may also qualify as a PFIC
in future fiscal years. Each U.S. Holder of Dynamotive is urged to consult a
tax advisor with respect to how the PFIC rules affect such U.S. Holders tax
situation.

Each U.S.
Holder who holds stock in a foreign corporation during any year in which such
corporation qualifies as a PFIC is subject to United States federal income
taxation under one of three alternative tax regimes at the election of such
U.S. Holder. The following is a discussion of such alternative tax regimes
applied to such U.S. Holders of Dynamotive. In addition, special rules apply if
a foreign corporation qualifies as both a PFIC and a controlled foreign
corporation (as defined below) and a U.S. Holder owns, actually or
constructively, 10% or more of the total combined voting power of all classes
of stock entitled to vote of such foreign corporation (See more detailed
discussion at Controlled Foreign Corporation below).

A U.S. Holder
who elects to treat Dynamotive as a qualified electing fund (QEF) will be
subject, under Section 1293 of the Code, to current federal income tax for any
taxable year to which the election applies in which Dynamotive qualifies as a
PFIC on his pro rata share of Dynamotives (i) net capital gain (the excess
of net long-term capital gain over net short-term capital loss), which will be
taxed as long-term capital gain, and (ii) ordinary earnings (the excess of
earnings and profits over net capital gain), which will be taxed as ordinary
income, in each case, for the shareholders taxable year in which (or with
which) Dynamotives taxable year ends, regardless of whether such amounts are
actually distributed. A U.S. Holders tax basis in the common shares will be
increased by any such amount that is included in income but not distributed.

The procedure
a U.S. Holder must comply with in making an effective QEF election, and the
consequences of such election, will depend on whether the year of the election
is the first year in the U.S. Holders holding period in which Dynamotive is a
PFIC. If the U.S. Holder makes a QEF election in such first year, i.e., a
timely QEF election, then the U.S. Holder may make the QEF election by simply
filing the appropriate documents at the time the U.S. Holder files his tax
return for such first year. If, however, Dynamotive qualified as a PFIC in a
prior year during the U.S. Holders holding period, then, in order to avoid the
Section 1291 rules discussed below, in addition to filing documents, the U.S.
Holder must elect to recognize under the rules of Section 1291 of the Code
(discussed herein), (i) any gain that he would otherwise recognize if the
U.S. Holder sold his stock on the qualification date or (ii) if Dynamotive
is a controlled foreign corporation, the U.S. Holders pro rata share of Dynamotives
post-1986 earnings and profits as of the qualification date. The qualification
date is the first day of Dynamotives first tax year in which Dynamotive
qualified as a QEF with respect to such U.S. Holder. For purposes of this
discussion, a U.S. Holder who makes (i) a timely QEF election, or (ii) an
untimely QEF election and either of the above-described gain-recognition
elections under Section 1291 is referred to herein as an Electing U.S.
Holder. A U.S. Holder who holds common shares at any time during a year of
Dynamotive in which Dynamotive is a PFIC and who is not an Electing U.S. Holder
(including a U.S. Holder who makes an untimely QEF election and makes neither
of the above-described gain-recognition elections) is referred to herein as a Non-Electing
U.S. Holder. An Electing U.S. Holder (i) generally treats any gain
realized on the disposition of his Dynamotive common shares as capital gain;
and (ii) may either avoid interest charges resulting from PFIC status
altogether, or make an annual election, subject to certain limitations, to
defer payment of current taxes on his share of Dynamotives annual realized net
capital gain and ordinary earnings subject, however, to an interest charge. If
the U.S. Holder is not a corporation, any interest charge imposed under the
PFIC regime would be treated as personal interest that is not deductible.

In order for a
U.S. Holder to make (or maintain) a valid QEF election, Dynamotive must provide
certain information regarding its net capital gains and ordinary earnings and
permit its books and records to be examined to verify such information.
Dynamotive intends to make the necessary information available to U.S. Holders
to permit them

51

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to make (and maintain) QEF elections with
respect to Dynamotive. Dynamotive urges each U.S. Holder to consult a tax
advisor regarding the availability of, and procedure for making, the QEF
election.

A QEF
election, once made with respect to Dynamotive, applies to the tax year for
which it was made and to all subsequent tax years, unless the election is
invalidated or terminated, or the IRS consents to revocation of the election.
If a QEF election is made by a U.S. Holder and Dynamotive ceases to qualify as
a PFIC in a subsequent tax year, the QEF election will remain in effect,
although not applicable, during those tax years in which Dynamotive does not
qualify as a PFIC. Therefore, if Dynamotive again qualifies as a PFIC in a
subsequent tax year, the QEF election will be effective and the U.S. Holder
will be subject to the rules described above for Electing U.S. Holders in such
tax year and any subsequent tax years in which Dynamotive qualifies as a PFIC.
In addition, the QEF election remains in effect, although not applicable, with
respect to an Electing U.S. Holder even after such U.S. Holder disposes of all
of his or its direct and indirect interest in the shares of Dynamotive.
Therefore, if such U.S. Holder reacquires an interest in Dynamotive, that U.S.
Holder will be subject to the rules described above for Electing U.S. Holders
for each tax year in which Dynamotive qualifies as a PFIC.

In the case of
a Non-Electing U.S. Holder, special taxation rules under Section 1291 of the
Code will apply to (i) gains realized on the disposition (or deemed to be
realized by reasons of a pledge) of his Dynamotive common shares and
(ii) certain excess distributions, as defined in Section 1291(b), by
Dynamotive.

A Non-Electing
U.S. Holder generally would be required to pro rate all gains realized on the
disposition of his Dynamotive common shares and all excess distributions on his
Dynamotive common shares over the entire holding period for the common shares.
All gains or excess distributions allocated to prior years of the U.S. Holder
(excluding any portion of the holders period prior to the first day of the
first year of Dynamotive (i) which began after December 31, 1986, and (ii) for
which Dynamotive was a PFIC) would be taxed at the highest tax rate for each
such prior year applicable to ordinary income. The Non-Electing U.S. Holder
also would be liable for interest on the foregoing tax liability for each such
prior year calculated as if such liability had been due with respect to each
such prior year. A Non-Electing U.S. Holder that is not a corporation must
treat this interest charge as personal interest which, as discussed above, is
wholly non-deductible. The balance, if any, of the gain or the excess
distribution will be treated as ordinary income in the year of the disposition
or distribution, and no interest charge will be incurred with respect to such
balance. In certain circumstances, the sum of the tax and the PFIC interest
charge may exceed the amount of the excess distribution received, or the amount
of proceeds of disposition realized, by the U.S. Holder.

If Dynamotive
is a PFIC for any taxable year during which a Non-Electing U.S. Holder holds
Dynamotive common shares, then Dynamotive will continue to be treated as a PFIC
with respect to such Dynamotive common shares, even if it is no longer
definitionally a PFIC. A Non-Electing U.S. Holder may terminate this deemed
PFIC status by electing to recognize gain (which will be taxed under the rules
discussed above for Non-Electing U.S. Holders) as if such Dynamotive common
shares had been sold on the last day of the last taxable year for which it was
a PFIC.

Effective for
tax years of U.S. Holders beginning after December 31, 1997, U.S. Holders who
hold (actually or constructively) marketable stock of a foreign corporation
that qualifies as a PFIC may elect to mark such stock to the market annually (a
mark-to-market election). If such an election is made, such U.S. Holder will
generally not be subject to the special taxation rules of Section 1291
discussed above. However, if the mark-to-market election is made by a Non-Electing
U.S. Holder after the beginning of the holding period for the PFIC stock, then
the Section 1291 rules will apply to certain dispositions of, distributions on
and other amounts taxable with respect to Dynamotive common shares. A U.S.
Holder who makes the mark-to-market election will include in income for each
taxable year for which the election is in effect an amount equal to the excess,
if any, of the fair market value of the common shares of Dynamotive as of the
close of such tax year over such U.S. Holders adjusted basis in such common
shares. In addition, the U.S. Holder is allowed a deduction for the lesser of
(i) the excess, if any, of such U.S. Holders adjusted tax basis in the
common shares over the fair market value of such shares as of the close of the
tax year, or (ii) the excess, if any, of (A) the mark-to-market gains
for the common shares in Dynamotive included by such U.S. Holder for prior tax
years, including any amount which would have been treated as a mark-to-market
gain for any prior tax year but for the Section 1291 rules discussed above with
respect to Non-Electing U.S. Holders, over (B) the mark-to-market losses
for shares that were allowed as deductions for prior tax years. A U.S. Holders
adjusted tax basis in the common shares of Dynamotive will be adjusted to
reflect the amount included in or deducted from income as a result of a
mark-to-market election. A mark-to-market election applies to the taxable year
in which the election is made and to each subsequent taxable year, unless
Dynamotive common shares cease to be marketable, as specifically defined, or
the IRS consents to revocation of the election. Because the IRS has not

52

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established
procedures for making a mark-to-market election, U.S. Holders should consult
their tax advisor regarding the manner of making such an election. No view is
expressed regarding whether common shares of Dynamotive are marketable for
these purposes or whether the election will be available.

Under Section
1291(f) of the Code, the IRS has issued Proposed Treasury Regulations that,
subject to certain exceptions, would treat as taxable certain transfers of PFIC
stock by Non-Electing U.S. Holders that are generally not otherwise taxed, such
as gifts, exchanges pursuant to corporate reorganizations, and transfers at
death. Generally, in such cases the basis of Dynamotive common shares in the
hands of the transferee and the basis of any property received in the exchange
for those common shares would be increased by the amount of gain recognized.
Under the Proposed Treasury Regulations, an Electing U.S. Holder would not be
taxed on certain transfers of PFIC stock, such as gifts, exchanges pursuant to
corporate reorganizations, and transfers at death. The transferees basis in
this case will depend on the manner of the transfer. In the case of a transfer
by an Electing U.S. Holder upon death, for example, the transferees basis is
generally equal to the fair market value of the Electing U.S. Holders common
shares as of the date of death under Section 1014 of the Code. The specific tax
effect to the U.S. Holder and the transferee may vary based on the manner in
which the common shares are transferred. Each U.S. Holder of Dynamotive is
urged to consult a tax advisor with respect to how the PFIC rules affect his or
its tax situation.

Whether or not
a U.S. Holder makes a timely QEF election with respect to common shares of
Dynamotive, certain adverse rules may apply in the event that both Dynamotive
and any foreign corporation in which Dynamotive directly or indirectly holds
shares is a PFIC (a lower-tier PFIC). Pursuant to certain Proposed Treasury
Regulations, a U.S. Holder would be treated as owning his or its proportionate
amount of any lower-tier PFIC shares, and generally would be subject to the
PFIC rules with respect to such indirectly-held PFIC shares unless such U.S.
Holder makes a timely QEF election with respect thereto. Dynamotive intends to
make the necessary information available to U.S. Holders to permit them to make
(and maintain) QEF elections with respect to each subsidiary of Dynamotive that
is a PFIC.

Under the
Proposed Treasury Regulations, a U.S. Holder who does not make a timely QEF
election with respect to a lower-tier PFIC generally would be subject to tax
(and the PFIC interest charge) on (i) any excess distribution deemed to have
been received with respect to his or its lower-tier PFIC shares and (ii) any
gain deemed to arise from a so-called indirect disposition of such shares.
For this purpose, an indirect disposition of lower-tier PFIC shares would
generally include (i) a disposition by Dynamotive (or an intermediate entity)
of lower-tier PFIC shares, and (ii) any other transaction resulting in a
diminution of the U.S. Holders proportionate ownership of the lower-tier PFIC,
including an issuance of additional common shares by Dynamotive (or an
intermediate entity). Accordingly, each prospective U.S. Holder should be aware
that he or it could be subject to tax even if such U.S. Holder receives no
distributions from Dynamotive and does not dispose of its common shares.
Dynamotive strongly urges each prospective U.S. Holder to consult a tax advisor
with respect to the adverse rules applicable, under the Proposed Treasury
Regulations, to U.S. Holders of lower-tier PFIC shares.

Certain special,
generally adverse, rules will apply with respect to Dynamotive common shares
while Dynamotive is a PFIC unless the U.S. Holder makes a timely QEF election.
For example under Section 1298(b)(6) of the Code, a U.S. Holder who uses PFIC
stock as security for a loan (including a margin loan) will, except as may be
provided in regulations, be treated as having made a taxable disposition of
such shares.

Controlled Foreign Corporation

If more than
50% of the total combined voting power of all classes of shares entitled to
vote or the total value of the shares of Dynamotive is owned, actually or
constructively, by citizens or residents of the United States, United States
domestic partnerships or corporation, or estates or trusts other than foreign
estates or trusts (as defined by the Code Section 7701(a)(31)), each of which
own, actually or constructively, 10% or more of the total combined voting power
of all classes of shares entitled to vote of Dynamotive (United States
Shareholder), Dynamotive could be treated as a controlled foreign corporation
(CFC) under Subpart F of the Code. This classification would effect many
complex results, one of which is the inclusion of certain income of a CFC which
is subject to current U.S. tax. The United States generally taxes United States
Shareholders of a CFC currently on their pro rata shares of the Subpart F
income of the CFC. Such United States Shareholders are generally treated as
having received a current distribution out of the CFCs Subpart F income and
are also subject to current U.S. tax on their pro rata shares of increases in
the CFCs earnings invested in U.S. property. The foreign tax credit described
above may reduce the U.S. tax on these amounts. In addition, under Section 1248
of the Code, gain from the sale or exchange of shares by

53

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a U.S. Holder
of common shares of Dynamotive which is or was a United States Shareholder at
any time during the five-year period ending on the date of the sale or exchange
is treated as ordinary income to the extent of earnings and profits of
Dynamotive attributable to the shares sold or exchanged. If a foreign
corporation is both a PFIC and a CFC, the foreign corporation generally will
not be treated as a PFIC with respect to United States Shareholders of the CFC.
This rule generally will be effective for taxable years of United States
Shareholders beginning after 1997 and for taxable years of foreign corporations
ending with or within such taxable years of United States Shareholders. Special
rules apply to United States Shareholders who are subject to the special
taxation rules under Section 1291 discussed above with respect to a PFIC.
Because of the complexity of Subpart F, a more detailed review of these rules
is outside of the scope of this discussion. Dynamotive does not believe that it
currently qualifies as a CFC. However, there can be no assurance that
Dynamotive will not be considered a CFC for the current or any future taxable
year.

F. DIVIDENDS AND PAYING AGENTS

Not
applicable.

G. STATEMENTS BY EXPERTS

Not applicable.

H. DOCUMENTS ON DISPLAY

Documents and
exhibits referred to in this document may be inspected at the offices of the
Company at Suite 140  13091 Vanier Place, Richmond, BC, V6V 2J1. Copies of
documents we file publicly can also be viewed at www.sec.gov or www.sedar.com.

I. SUBSIDIARY INFORMATION

Not
applicable.

|         |                                                             
|-------- | ------------------------------------------------------------
|ITEM 11. | QUANTITATIVE
  AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

FOREIGN
CURRENCY RISK

The Company
has operations primarily in Canada with some activities in the U.S., Argentina
and the United Kingdom, and therefore the Company is subject to some risks
typical of an international business including, but not limited to, differing
economic conditions, changes in political climate, differing tax structures,
other regulations and restrictions and foreign exchange rate volatility.

The Company
can be adversely affected when the Canadian currency appreciates. Management
has the ability, to some extent, to time the exchange and enter into forward
exchange contracts in an attempt to mitigate such risk. The Company has not
entered into any forward exchange contracts during the reporting period. The
Companys financial statements are reported in U.S. currency. The extent of the
Companys exposure depends on the degree of fluctuation in foreign currencies.
Due to the nature of foreign currency exchange, the exact exposure is difficult
to estimate.

The Companys
sales, corresponding receivables and the majority of its expenses are in
Canadian and U.S. dollars. The Company holds cash mainly in U.S., and Canadian
funds and exchanges from U.S. currency to Canadian and other currencies as
necessary. Through operations, the Company incurs research and development and
administrative expenses in Canadian dollars and U.S. dollars and potentially
other foreign currencies. The Company is exposed, in the normal course of
business, to foreign currency risks on any non-Canadian dollar expenditures.
The Company has evaluated its exposure to these risks and has determined that
the only significant foreign currency exposure at this time is to the U.S.
dollar, through receipt of proceeds of U.S. dollar denominated share offerings.
At this time, the Company does not believe the exposure to other currency
fluctuations is material.

54

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Other than
foreign currency risk as discussed above, the Company is currently not subject
to any material market risks.

|         |                                                       
|-------- | ------------------------------------------------------
|ITEM 12. | DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES

Not
applicable.

55

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PART II

|         |                                                
|-------- | -----------------------------------------------
|ITEM 13. | DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES

Not
applicable.

|         |                                                                              
|-------- | -----------------------------------------------------------------------------
|ITEM 14. | MATERIAL MODIFICATIONS TO THE RIGHT OF SECURITY HOLDERS AND USE OF
  PROCEEDS

Not
applicable.

|         |                          
|-------- | -------------------------
|ITEM 15. | CONTROLS
  AND PROCEDURES

Evaluation of Disclosure Controls and
Procedures

The Company maintains
disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended (the Exchange Act) that
are designed to ensure that information required to be disclosed in its reports
filed or submitted under the Exchange Act is processed, recorded, summarized
and reported within the time periods specified in the SECs rules and forms,
and that such information is accumulated and communicated to the Companys
management, including the Companys Chief Executive Officer and Chief Financial
Officer, as appropriate, to allow for timely decisions regarding required
disclosure. In designing and evaluating the disclosure controls and procedures,
management recognizes that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives, and management is required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.

As required by SEC Rule
13a-15(b), the Company carried out an evaluation, under the supervision and
with the participation of management, including the Companys Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of the Companys disclosure controls and procedures as of the end of
the period covered by this Annual Report. Based on this evaluation, our Chief
Executive Officer and Chief Financial Officer concluded that the Companys
disclosure controls and procedures were not effective as December 31, 2008, at
the reasonable assurance level, because of the material weaknesses described in
Managements Report on Internal Control over Financial Reporting.

Notwithstanding the
existence of the material weaknesses described below, management has concluded
that the consolidated financial statements in this Form 20-F fairly present, in
all material respects, the Companys financial position, results of operations
and cash flows for the periods presented.

Managements Annual
Report on Internal Control over Financial Reporting

Management is
responsible for establishing and maintaining adequate internal control over
financial reporting. The Companys internal control over financial reporting is
designed to provide reasonable assurance regarding the preparation and fair
presentation of published consolidated financial statements in accordance with
Canadian Generally Accepted Accounting Principles (Canadian GAAP), including a
reconciliation of net loss to US Generally Accepted Accounting Principles (US
GAAP).

The Companys
internal control over financial reporting includes those policies and
procedures that (a) pertain to the maintenance of records that, in reasonable
detail, accurately and fairly reflect the transactions and dispositions of the
assets of the Company (b) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of consolidated financial
statements in accordance with Canadian generally accepted accounting principles
and that receipts and expenditures of the Company are being made only in
accordance with authorizations of management and directors of the Company (c)
provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the Companys assets that could
have a material effect on the consolidated financial statements.

56

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Internal
controls over financial reporting, no matter how well designed, have inherent
limitations. Therefore, internal control over financial reporting determined to
be effective can provide only reasonable assurance with respect to financial
statement preparation and may not prevent or detect all misstatements.
Moreover, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in
conditions, or that the degree of compliance with the policies or procedures
may deteriorate.

Management
performed an assessment of the effectiveness of the Companys internal control
over financial reporting as of December 31, 2008, based on the criteria set
forth in the Internal Control  Integrated Framework issued by the Committee
of Sponsoring Organizations of the Treadway Commission (COSO). The objective
of this assessment was to determine whether the Companys internal control over
financial reporting was effective as of December 31, 2008.

A material
weakness, as defined by the Securities and Exchange Commission rules, is a
significant deficiency, or combination of significant deficiencies, such that
there is a reasonable possibility that material misstatements of the annual or
interim consolidated financial statements will not be prevented or detected. In
its assessment of the effectiveness of internal control over financial
reporting as of December 31, 2008, management determined that there were
control deficiencies that constituted material weaknesses, as described below.

The Company
does not have sufficient personnel with experience in the application of US
GAAP. Specifically, the Companys entity level controls initially failed to
identify the impact of new accounting pronouncements on the disclosures in the
US GAAP reconciliation note. These errors were corrected by management prior to
the issuance of the Companys December 31, 2008 consolidated financial
statements.

Management performs
an oversight function with regard to meeting the Companys tax obligations.
This includes preparation of tax returns, monitoring of new tax requirements
for changes in the Companys operations and preparation of tax disclosures for
income tax, commodity taxes and other tax-related matters. Staff involved in
the Companys tax function have some knowledge and experience with tax
requirements but are not experts in all the tax regulations to which the
company is subject. External tax experts are engaged by the Company to deal
with tax matters, but there is a reasonable possibility that a material
misstatement could occur in the Companys tax note or regulatory obligations
with regard to tax could arise due to managements limited expertise with regard
to tax requirements.

The Company
did not maintain effective control in preparing financial statement disclosures
in income taxes. Specifically, management initially failed to apply the correct
future enacted tax rate to its future income tax assets in accordance with CICA
HB 3465, Income Taxes. This error was corrected by management prior to the
issuance of the Companys December 31, 2008 consolidated financial statements.

When the
Company has sufficient funds available, it intends to add internal expertise
and to hire consultants as required to address the above noted deficiencies in
US GAAP and taxation capabilities.

Based on our
assessment and because of the material weaknesses described above, management
has concluded that our internal control over financial reporting was not
effective as of December 31, 2008.

Managements
assessment of the effectiveness of the Companys internal control over
financial reporting as of December 31, 2008 has been audited by BDO Dunwoody,
the Companys independent registered public accounting firm, as stated in their
report which appears herein.

Remediation to Address Material
Weakness

The Company
will enhance its staff training and improve controls with regard to US GAAP and
taxation matters. The Company will expand the use of outside consultants with
expertise in the application of US GAAP and requisite knowledge of tax
regulations in the jurisdictions in which the Company operates. Management will
also implement an improved consultation process with external auditors in the
above areas.

57

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Changes in Internal Control over Financial
Reporting

During the
fiscal year ended December 31, 2008, there were no changes in the Companys
internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect, the registrants internal control over
financial reporting.

|          |                                   
|--------- | ----------------------------------
|ITEM 16A. | AUDIT
  COMMITTEE FINANCIAL EXPERT

Our board of
directors has determined that Mr. Shing-Cheng Hong is an independent member of
the board (in accordance with the definition of independence adopted by the
NYSE and AMEX stock exchanges) and is the committee financial expert on our
audit committee. For details on his professional career see Item 6. Directors,
Senior Management and Employees.

|          |               
|--------- | --------------
|ITEM 16B. | CODE OF ETHICS

The Company
has adopted a code of ethics which requires all employees to acknowledge a
responsibility for honest, fair and respectful dealings between the Company and
its employees, customers and suppliers. The Code requires observance of high
standards of respect for the laws applicable to the Companys business
activities and precludes offering or accepting any benefit from a customer or
supplier which could be construed as an improper inducement to do business. The
Companys insiders acknowledge their responsibility for careful compliance with
corporate disclosure and securities trading laws. The Code is available for
review on the Companys website at www.dynamotive.com.

|          |                                       
|--------- | --------------------------------------
|ITEM 16C. | PRINCIPAL ACCOUNTANT FEES AND SERVICES

A summary of
accountant fees and services are provided in a table below:

|                       |  |            |         |      |  |         | 
|---------------------- |  | ---------- | ------- | ---- |  | ------- | 
|                       |  | Total Fees |        
|                       |  |            |        
|                       |  | 2008       |         | 2007 | 
|                       |  |            |         |      | 
|Audit Fees (1)         |  |            | 187,000 |      |  | 256,400 | 
|Audit-Related Fees (2) |  |            |        |      |  |        | 
|Tax Fees (3)           |  |            |        |      |  | 2,405   | 
|All Other Fees (4)     |  |            |        |      |  |        | 
|                       |  |            |         |      |  |         | 
|Total                  |  |            | 187,000 |      |  | 258,805 | 

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Audit Fees
  include fees necessary to perform the annual audit and quarterly reviews of
  the Companys consolidated financial statements. Audit Fees include fees for
  review of tax provisions and for accounting consultations on matters
  reflected in the financial statements. Audit Fees also include audit or other
  attest services required by legislation or regulation, such as comfort
  letters, consents, reviews of securities filings and statutory audits.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(2) | Audit-Related
  Fees include services that are traditionally performed by the auditor. These
  audit-related services include employee benefit audits, due diligence
  assistance, accounting consultations on proposed transactions, internal
  control reviews and audit or attest services not required by legislation or
  regulation.                                                                                                                                      
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(3) | Tax Fees
  include fees for all tax services other than those included in Audit Fees
  and Audit-Related Fees. This category includes fees for tax compliance, tax
  planning and tax advice. Tax planning and tax advice includes assistance with
  tax audits and appeals, tax advice related to mergers and acquisitions, and
  requests for rulings or technical advice from tax authorities.                                                                           
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|(4) | All Other
  Fees include all other non-audit services.                                                                                                                                                                                                                                                                                                                                                                                                                          

Our policy is to pre-approve all audit and permissible non-audit
services performed by the independent accountants. These services may include
audit services, audit-related services, tax services and other services. Under
our audit committees policy, pre-approval is generally provided for particular
services or categories of services, including planned services, project based
services and routine consultations. In addition, we may also pre-approve
particular services on a case-by-case basis. We approved all services that our
independent accountants provided to us in the past two fiscal years.

|          |                                                           
|--------- | ----------------------------------------------------------
|ITEM 16D. | EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES

Not
Applicable.

58

---



|          |                                                                         
|--------- | ------------------------------------------------------------------------
|ITEM 16E. | PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED
  PURCHASERS

Not Applicable.

59

---



PART III

|         |                     
|-------- | --------------------
|ITEM 17. | FINANCIAL STATEMENTS

The following
financial statements are filed with this Annual Report.

Auditors Report

Comments by Auditors for
U.S. Readers on Canada-United States Reporting Difference

Consolidated Balance Sheets
as at December 31, 2008 and December 31, 2007

Consolidated Statements of
Loss and Comprehensive Loss for the years ended December 31, 2008 and December
31, 2007 and Consolidated Statement of Loss for the year ended December 31,
2006

Consolidated Statements of
Changes in Shareholders Equity December 31, 2008, December 31, 2007 and
December 31, 2006

Consolidated Statements of
Cash Flows for the years ended December 31, 2008, December 31, 2007 and
December 31, 2006

Notes to Consolidated
Financial Statements

60

---



Consolidated Financial Statements (in U.S.
dollars)

Dynamotive
Energy Systems Corporation

December 31, 2008 and 2007

61

---



|                      |                               |                         
|--------------------- | ----------------------------- | ------------------------
|(LOGO)                | BDO Dunwoody LLP              | 600 Cathedral Place     
|Chartered Accountants | 925 West Georgia Street      
|                      | Vancouver, BC, Canada V6C 3L2
|                      | Telephone: (604) 688-5421    
|                      |                               | Telefax: (604) 688-5132 
|                      |                               | E-mail: vancouver@bdo.ca
|                      |                               | www.bdo.ca              

INDEPENDENT
AUDITORS REPORT

To the
Shareholders ofDynamotive
Energy Systems Corporation

We have
completed an integrated audit of the consolidated financial statements and
internal control over financial reporting of Dynamotive Energy Systems
Corporation as of December 31, 2008 and 2007 and an audit of its 2007 and 2006
consolidated financial statements. Our opinions, based on our audits, are
presented below.

Consolidated
financial statements

We have
audited the consolidated balance sheets of Dynamotive Energy Systems
Corporation as at December 31, 2008 and 2007 and the consolidated statements of
loss, changes in shareholders equity and cash flows for each of the years in
the three-year period ended December 31, 2008. We have also audited the
consolidated statement of comprehensive loss for the years ended December 31,
2008 and 2007. 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 December 31,
2008 and 2007 and the results of its operations and its cash flows for each of
the years in the three-year period ended December 31, 2008 in accordance with
Canadian generally accepted accounting principles.

Internal control over
financial reporting

We have also
audited Dynamotive Energy System Corporations internal control over financial
reporting as of December 31, 2008 and 2007, based on criteria established in Internal
Control  Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (the COSO criteria). Dynamotive Energy
System Corporations management is responsible for maintaining effective
internal control over financial reporting and for its assessment of the
effectiveness of internal control over financial reporting, included in the
accompanying Managements Report on Internal Control Over Financial Reporting.
Our responsibility is to express an opinion on the companys internal control
over financial reporting based on our audit.

62

---



We conducted
our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audits included obtaining an understanding of internal control
over financial reporting, assessing the risk that a material weakness exists,
and testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk. Our audit also included performing such
other procedures as we considered necessary in the circumstances. We believe
that our audit provides a reasonable basis for our opinion.

A companys
internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A companys internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the
company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition
of the companys assets that could have a material effect on the financial
statements.

Because of its
inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.

A material weakness is a deficiency, or a combination of deficiencies,
in internal control over financial reporting, such that there is a reasonable
possibility that a material misstatement of the Companys annual or interim financial
statements will not be prevented or detected on a timely basis. The following
material weaknesses have been identified and are included in Managements
Report on Internal Control Over Financial Reporting: The Companys finance and
accounting staff do not have sufficient technical accounting and financial
reporting expertise as it relates to specific and complex areas within income
tax and United States generally accepted accounting principles.

We considered these material weaknesses in determining the nature,
timing, and extent of audit tests applied in our audit of the December 31, 2008
and 2007 consolidated financial statements, and our opinion regarding the
effectiveness of the Companys internal control over financial reporting does
not affect our opinion on those consolidated financial statements.

In our
opinion, because of the effect of the aforementioned material weaknesses on the
achievement of the objectives of the control criteria, the Company has not
maintained effective internal control over financial reporting as of December
31, 2008 and 2007, based on criteria established in Internal Control -
Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission.

|                        | 
|----------------------- | 
|/s/ BDO Dunwoody LLP    | 
|                        | 
|Chartered
  Accountants | 
|                        | 
|Vancouver,
  Canada     | 
|June 29,
  2009         | 

63

---



|                      |                               |                         
|--------------------- | ----------------------------- | ------------------------
|(LOGO)                | BDO Dunwoody LLP              | 600 Cathedral Place     
|Chartered Accountants | 925 West Georgia Street      
|                      | Vancouver, BC, Canada V6C 3L2
|                      | Telephone: (604) 688-5421    
|                      |                               | Telefax: (604) 688-5132 
|                      |                               | E-mail: vancouver@bdo.ca
|                      |                               | www.bdo.ca              

Comments by Auditors for U.S. Readers on Canada-United States Reporting
Difference

The reporting
standards of the Public Company Accounting Oversight Board (United States) 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 1 to the financial statements. Public Company
Accounting Oversight Board (United States) reporting standards also require the
addition of an explanatory paragraph when changes in an accounting policy, such
as those described in note 3, have a material effect on the consolidated
financial statements. Although we conducted our audits in accordance with both
Canadian generally accepted auditing standards and the standards of the Public
Company Accounting Oversight Board (United States), our report to the
shareholders on the Consolidated Financial Statements dated June 29, 2009 is
expressed in accordance with Canadian reporting standards which do not permit a
reference to such conditions and events in the auditors report when these are
adequately disclosed in the financial statements.

|                        | 
|----------------------- | 
|/s/ BDO Dunwoody LLP    | 
|                        | 
|Chartered
  Accountants | 
|                        | 
|Vancouver,
  Canada     | 
|June 29,
  2009         | 

64

---



Dynamotive Energy
Systems CorporationIncorporated under the laws of British Columbia,
Canada

CONSOLIDATED
BALANCE SHEETSAs at December 31 (in U.S. dollars)

|                                                         |  |      |              |      |  |             |  
|-------------------------------------------------------- |  | ---- | ------------ | ---- |  | ----------- | -
|                                                         |  | 2008 |              | 2007 | 
|                                                         |  | $    |              | $    | 
|                                                         |  |      |              |      |  |             |  
|                                                         |  |      |              |      |  |             |  
|ASSETS                                                   |  |      |              |      |  |             |  
|Current                                                  |  |      |              |      |  |             |  
|Cash and cash equivalents [note 2]                       |  |      | 39,927       |      |  | 1,796,822   |  
|Receivables [note 4]                                     |  |      | 20,339       |      |  | 151,233     |  
|Government grants receivable [note 21]                   |  |      | 336,265      |      |  | 828,795     |  
|Prepaid expenses and deposits                            |  |      | 321,587      |      |  | 503,268     |  
|Total current assets                                     |  |      | 718,118      |      |  | 3,280,118   |  
|Property, plant and equipment [note 6]                   |  |      | 32,769,583   |      |  | 53,754,874  |  
|Patents [note
  7]                                       |  |      | 193,171      |      |  | 269,568     |  
|Long-term loan receivable [note 5]                       |  |      |             |      |  | 346,666     |  
|Long-term investments [note 10]                          |  |      | 231,098      |      |  | 286,410     |  
|Long-term deferred assets [note 11]                      |  |      | 608,413      |      |  | 998,008     |  
|                                                         |  |      |              |      |  |             |  
|                                                         |  |      | 34,520,383   |      |  | 58,935,644  |  
|                                                         |  |      |              |      |  |             |  
|                                                         |  |      |              |      |  |             |  
|LIABILITIES AND SHAREHOLDERS EQUITY                     |  |      |              |      |  |             |  
|Current                                                  |  |      |              |      |  |             |  
|Accounts payable and accrued liabilities [note 12]       |  |      | 9,866,822    |      |  | 6,268,664   |  
|Short-term and related party debt [Note 13]              |  |      | 1,257,289    |      |  |            |  
|Current portion of long-term debt [note 11]              |  |      | 35,900       |      |  | 35,900      |  
|                                                         |  |      |              |      |  |             |  
|Total current liabilities                                |  |      | 11,160,011   |      |  | 6,304,564   |  
|Long-term debt [note 11]                                 |  |      | 263,267      |      |  | 299,167     |  
|Asset retirement obligation liability [note 14]          |  |      | 229,312      |      |  | 246,939     |  
|Deferred revenue [note 15]                               |  |      | 705,495      |      |  | 920,000     |  
|                                                         |  |      |              |      |  |             |  
|Total liabilities                                        |  |      | 12,358,085   |      |  | 7,770,670   |  
|                                                         |  |      |              |      |  |             |  
|                                                         |  |      |              |      |  |             |  
|Shareholders Equity                                     |  |      |              |      |  |             |  
|Share capital [note 16(b)]                               |  |      | 112,883,411  |      |  | 109,133,395 |  
|Shares to be issued [note 16(c)]                         |  |      | 1,837,398    |      |  | 1,265,070   |  
|Contributed surplus                                      |  |      | 24,729,955   |      |  | 22,663,941  |  
|Accumulated other comprehensive income
  (loss) (note 2) |  |      | (1,612,018   | )    |  | 5,422,751   |  
|Deficit                                                  |  |      | (115,676,448 | )    |  | (87,320,183 | )
|                                                         |  |      |              |      |  |             |  
|Total shareholders equity                               |  |      | 22,162,298   |      |  | 51,164,974  |  
|                                                         |  |      |              |      |  |             |  
|                                                         |  |      | 34,520,383   |      |  | 58,935,644  |  
|                                                         |  |      |              |      |  |             |  

See accompanying notes

On behalf of
the Board:

| |                 |                   | 
| | --------------- | ----------------- | 
| | Richard
  Lin | Andrew Kingston | 
| | Director        | Director          | 

65

---



Dynamotive Energy Systems CorporationIncorporated under the laws of British Columbia,
Canada

CONSOLIDATED STATEMENTS OF LOSS AND 
COMPREHENSIVE LOSS For the Year
Ended December 31 (in U.S. dollars)

|                                                                 |  |  |             |   |  |             |   |  |             |  
|---------------------------------------------------------------- |  |  | ----------- | - |  | ----------- | - |  | ----------- | -
|                                                                 |  |  | 2008        |   |  | 2007        |   |  | 2006        |  
|                                                                 |  |  | $           |   |  | $           |   |  | $           |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|REVENUES                                                         |  |  |             |   |  |             |   |  |             |  
|License revenue [note 15]                                        |  |  | 178,106     |   |  |            |   |  |            |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|Total revenues                                                   |  |  | 178,106     |   |  |            |   |  |            |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|COST OF SALES                                                    |  |  |             |   |  |             |   |  |             |  
|Royalty Fees[note 21]                                            |  |  | 4,876       |   |  |            |   |  |            |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|Total cost of sales                                              |  |  | 4,876       |   |  |            |   |  |            |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|Gross margin                                                     |  |  | 173,230     |   |  |            |   |  |            |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|EXPENSES                                                         |  |  |             |   |  |             |   |  |             |  
|Marketing and business development [note
  16(h)]                |  |  | 828,368     |   |  | 1,601,723   |   |  | 1,768,063   |  
|Research and development[notes 16(h) and 22]                     |  |  | 1,354,556   |   |  | 2,040,003   |   |  | 4,247,784   |  
|General and administrative [notes 16(h) and 18(a)]               |  |  | 9,650,644   |   |  | 11,026,616  |   |  | 7,763,275   |  
|Amortization and depreciation                                    |  |  | 169,914     |   |  | 144,168     |   |  | 124,067     |  
|Interest expense [note 16(h)]                                    |  |  | 333,477     |   |  | 22,207      |   |  | 505,340     |  
|Foreign exchange loss (gain)                                     |  |  | 1,115,596   |   |  | (418,868    | ) |  | (88,888     | )
|                                                                 |  |  |             |   |  |             |   |  |             |  
|Total operating expenses                                         |  |  | 13,452,555  |   |  | 14,415,849  |   |  | 14,319,641  |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|Loss from operations                                             |  |  | (13,279,325 | ) |  | (14,415,849 | ) |  | (14,319,641 | )
|                                                                 |  |  |             |   |  |             |   |  |             |  
|OTHER INCOME AND EXPENSES                                        |  |  |             |   |  |             |   |  |             |  
|Interest and other income                                        |  |  | 5,349       |   |  | 207,099     |   |  | 493,610     |  
|Loss on settlement of accounts payable [note
  16(h)]            |  |  |            |   |  | (111,108    | ) |  | (98,189     | )
|Loss on sale of interest in subsidiary [note 9]                  |  |  |            |   |  |            |   |  | (420,400    | )
|Loss on return of services deposit [note 6]                      |  |  | (125,073    | ) |  |             |   |  |             |  
|Gain on reduction in bonus and vacation
  accrual [note 18c]     |  |  | 1,070,930   |   |  |            |   |  |            |  
|Capital taxes                                                    |  |  | (9,411      | ) |  |            |   |  |            |  
|Write-down of property, plant &
  equipment [note6]              |  |  | (16,018,735 | ) |  |            |   |  |            |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|                                                                 |  |  | (15,076,940 | ) |  | 95,991      |   |  | (24,979     | )
|                                                                 |  |  |             |   |  |             |   |  |             |  
|Loss
  before non-controlling interest                           |  |  | (28,356,265 | ) |  | (14,319,858 | ) |  | (14,344,620 | )
|                                                                 |  |  |             |   |  |             |   |  |             |  
|Non-controlling
  interest[note 8]                               |  |  |            |   |  | 99,454      |   |  | 92,238      |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|Net loss
  for the year                                          |  |  | (28,356,265 | ) |  | (14,220,404 | ) |  | (14,252,382 | )
|                                                                 |  |  |             |   |  |             |   |  |             |  
|Other
  comprehensive income (loss)                              |  |  |             |   |  |             |   |  |             |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|Foreign currency translation adjustment                          |  |  | (7,034,769  | ) |  | 6,212,222   |   |  |             |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|Comprehensive
  loss                                             |  |  | (35,391,034 | ) |  | (8,008,182  | ) |  |             |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|Weighted average number of common shares outstanding[note
16[i]] |  |  | 211,448,521 |   |  | 189,573,764 |   |  | 153,685,553 |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|                                                                 |  |  |             |   |  |             |   |  |             |  
|Basic and diluted loss per common share                          |  |  | (0.13       | ) |  | (0.08       | ) |  | (0.09       | )
|                                                                 |  |  |             |   |  |             |   |  |             |  

See accompanying notes

66

---



Dynamotive Energy
Systems CorporationIncorporated under the laws of British Columbia,
Canada

CONSOLIDATED
STATEMENTS OF CHANGES IN SHAREHOLDERS EQUITYAs at December 31 (in U.S. dollars)

|                                                     |  |                 |             |                         |  |                       |   |                                       |            |                                                     |  |          |   |       |            |   |  |              |   |  |             |  
|---------------------------------------------------- |  | --------------- | ----------- | ----------------------- |  | --------------------- | - | ------------------------------------- | ---------- | --------------------------------------------------- |  | -------- | - | ----- | ---------- | - |  | ------------ | - |  | ----------- | -
|                                                     |  | Share
  Capital |             | Shares
  To be
  Issued |  | Contributed
  Surplus |   | Cumulative
  Translation
  Adjustment |            | Accumulated
  Other
  Comprehensive
  Income (loss) |  | Deficit  |   | Total |           
|                                                     |  |                 |             |                         |  |                       |   |                                       |            |                                                     |  |          |   |       |           
|                                                     |  | $               |             | $                       |  | $                     |   | $                                     |            | $                                                   |  | $        |   | $     |           
|Balance,
  January 1, 2006                           |  |                 | 51,849,476  |                         |  | 2,677,832             |   |                                       | 13,047,158 |                                                     |  | (434,661 | ) |       |           |   |  | (58,847,397  | ) |  | 8,292,408   |  
|Issued for cash and proceeds received in prior
year  |  |                 |             |                         |  |                       |   |                                       |            |                                                     |  |          |   |       |            |   |  |              |   |  |             |  
|Pursuant to private placement, net of issuance
costs |  |                 | 18,670,368  |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 18,670,368  |  
|Pursuant to exercise of stock options                |  |                 | 642,098     |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 642,098     |  
|Pursuant to exercise of warrants                     |  |                 | 7,936,096   |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 7,936,096   |  
|Issued for settlement of fees payable                |  |                 | 3,036,562   |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 3,036,562   |  
|Issued for services                                  |  |                 | 2,514,585   |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 2,514,585   |  
|Issued on conversion of convertible
debentures       |  |                 | 726,056     |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 726,056     |  
|Cancellation of Escrow Shares                        |  |                 | (247,368    | )                       |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | (247,368    | )
|Net change in shares to be issued                    |  |                 |            |                         |  | (936,493              | ) |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | (936,493    | )
|Escrow shares cancelled/forfeited                    |  |                 |            |                         |  |                      |   |                                       | 247,368    |                                                     |  |         |   |       |           |   |  |             |   |  | 247,368     |  
|Loss on sale of subsidiary                           |  |                 |            |                         |  |                      |   |                                       | 420,400    |                                                     |  |         |   |       |           |   |  |             |   |  | 420,400     |  
|Stock-based compensation expense                     |  |                 |            |                         |  |                      |   |                                       | 3,085,601  |                                                     |  |         |   |       |           |   |  |             |   |  | 3,085,601   |  
|Net loss                                             |  |                 |            |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  | (14,252,382  | ) |  | (14,252,382 | )
|Foreign exchange adjustment                          |  |                 |            |                         |  |                      |   |                                       |           |                                                     |  | (354,810 | ) |       |           |   |  |             |   |  | (354,810    | )
|                                                     |  |                 |             |                         |  |                       |   |                                       |            |                                                     |  |          |   |       |            |   |  |              |   |  |             |  
|Balance, December 31, 2006                           |  |                 | 85,127,873  |                         |  | 1,741,339             |   |                                       | 16,800,527 |                                                     |  | (789,471 | ) |       |           |   |  | (73,099,779  | ) |  | 29,780,489  |  
|Change in accounting policy [note 3]                 |  |                 |            |                         |  |                      |   |                                       |           |                                                     |  | 789,471  |   |       | (789,471   | ) |  |             |   |  |            |  
|                                                     |  |                 |             |                         |  |                       |   |                                       |            |                                                     |  |          |   |       |            |   |  |              |   |  |             |  
|                                                     |  |                 | 85,127,873  |                         |  | 1,741,339             |   |                                       | 16,800,527 |                                                     |  |         |   |       | (789,471   | ) |  | (73,099,779  | ) |  | 29,780,489  |  
|Balance, January 1, 2007                             |  |                 |             |                         |  |                       |   |                                       |            |                                                     |  |          |   |       |            |   |  |              |   |  |             |  
|Issued for cash and proceeds received in prior
year  |  |                 |             |                         |  |                       |   |                                       |            |                                                     |  |          |   |       |            |   |  |              |   |  |             |  
|Pursuant to private placement, net of issuance
costs |  |                 | 11,557,657  |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 11,557,657  |  
|Pursuant to exercise of stock options                |  |                 | 672,483     |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 672,483     |  
|Pursuant to exercise of warrants                     |  |                 | 7,111,610   |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 7,111,610   |  
|Issued for settlement of fees payable                |  |                 | 1,565,152   |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 1,565,152   |  
|Issued for services                                  |  |                 | 1,058,620   |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 1,058,620   |  
|Issued on purchase of interest in
subsidiary         |  |                 | 2,040,000   |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 2,040,000   |  
|Net change in shares to be issued                    |  |                 |            |                         |  | (476,269              | ) |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | (476,269    | )
|Warrant allocation for private placement             |  |                 |            |                         |  |                      |   |                                       | 2,744,520  |                                                     |  |         |   |       |           |   |  |             |   |  | 2,744,520   |  
|Stock-based compensation expense                     |  |                 |            |                         |  |                      |   |                                       | 3,118,894  |                                                     |  |         |   |       |           |   |  |             |   |  | 3,118,894   |  
|Net loss                                             |  |                 |            |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  | (14,220,404  | ) |  | (14,220,404 | )
|Foreign currency translation adjustment              |  |                 |            |                         |  |                      |   |                                       |           |                                                     |  |         |   |       | 6,212,222  |   |  |             |   |  | 6,212,222   |  
|                                                     |  |                 |             |                         |  |                       |   |                                       |            |                                                     |  |          |   |       |            |   |  |              |   |  |             |  
|Balance, December 31, 2007                           |  |                 | 109,133,395 |                         |  | 1,265,070             |   |                                       | 22,663,941 |                                                     |  |         |   |       | 5,422,751  |   |  | (87,320,183  | ) |  | 51,164,974  |  
|Issued for cash and proceeds received in prior
year  |  |                 |             |                         |  |                       |   |                                       |            |                                                     |  |          |   |       |            |   |  |              |   |  |             |  
|Pursuant to private placement, net of issuance costs |  |                 | 3,273,027   |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 3,273,027   |  
|Pursuant to exercise of stock options                |  |                 | 126,780     |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 126,780     |  
|Pursuant to exercise of warrants                     |  |                 | 127,340     |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 127,340     |  
|Issued for settlement of fees payable                |  |                 |            |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  |            |  
|Issued for services                                  |  |                 | 222,869     |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 222,869     |  
|Issued on purchase of interest in
subsidiary         |  |                 |            |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  |            |  
|Net change in shares to be issued                    |  |                 |            |                         |  | 572,328               |   |                                       |           |                                                     |  |         |   |       |           |   |  |             |   |  | 572,328     |  
|Warrant allocation for private placement             |  |                 |            |                         |  |                      |   |                                       | 413,173    |                                                     |  |         |   |       |           |   |  |             |   |  | 413,173     |  
|Stock-based compensation expense                     |  |                 |            |                         |  |                      |   |                                       | 1,652,841  |                                                     |  |         |   |       |           |   |  |             |   |  | 1,652,841   |  
|Net loss                                             |  |                 |            |                         |  |                      |   |                                       |           |                                                     |  |         |   |       |           |   |  | (28,356,265  | ) |  | (28,356,265 | )
|Foreign currency translation adjustment              |  |                 |            |                         |  |                      |   |                                       |           |                                                     |  |         |   |       | (7,034,769 | ) |  |             |   |  | (7,034,769  | )
|                                                     |  |                 |             |                         |  |                       |   |                                       |            |                                                     |  |          |   |       |            |   |  |              |   |  |             |  
|Balance, December 31, 2008                           |  |                 | 112,883,411 |                         |  | 1,837,398             |   |                                       | 24,729,955 |                                                     |  |         |   |       | (1,612,018 | ) |  | (115,676,448 | ) |  | 22,162,298  |  
|                                                     |  |                 |             |                         |  |                       |   |                                       |            |                                                     |  |          |   |       |            |   |  |              |   |  |             |  

See accompanying notes

67

---



Dynamotive Energy
Systems CorporationIncorporated under the laws of British Columbia,
Canada

CONSOLIDATED
STATEMENTS OF CASH FLOWSAs at December 31 (in U.S. dollars)

|                                                                                  |  |  |             |   |  |             |   |  |             |  
|--------------------------------------------------------------------------------- |  |  | ----------- | - |  | ----------- | - |  | ----------- | -
|                                                                                  |  |  | 2008        |   |  | 2007        |   |  | 2006        |  
|                                                                                  |  |  | $           |   |  | $           |   |  | $           |  
|                                                                                  |  |  |             |   |  |             |   |  |             |  
|                                                                                  |  |  |             |   |  |             |   |  |             |  
|OPERATING ACTIVITIES                                                              |  |  |             |   |  |             |   |  |             |  
|Net loss for the year                                                             |  |  | (28,356,265 | ) |  | (14,220,404 | ) |  | (14,252,382 | )
|Add items not involving cash:                                                     |  |  |             |   |  |             |   |  |             |  
|Amortization and depreciation                                                     |  |  | 169,914     |   |  | 144,168     |   |  | 124,067     |  
|Accretion expense                                                                 |  |  | 34,488      |   |  |            |   |  | 208,022     |  
|Non-controlling interest                                                          |  |  |            |   |  | (99,454     | ) |  | (92,238     | )
|Interest expense non-cash                                                         |  |  | 34,148      |   |  |            |   |  | 14,408      |  
|Write-down of property, plant &
equipment                                         |  |  | 16,018,735  |   |  |            |   |  |            |  
|Recognition of deferred revenue                                                   |  |  | (178,106    | ) |  |            |   |  |            |  
|Loss on settlement of accounts payable                                            |  |  |            |   |  | 111,108     |   |  | 98,189      |  
|Loss on purchase/sale of interest in
  subsidiary                                 |  |  |            |   |  | 238,346     |   |  | 420,400     |  
|Loss on return of services deposit                                                |  |  | 125,073     |   |  |            |   |  |            |  
|Stock based compensation [note
16(h)]                                             |  |  | 2,524,138   |   |  | 3,632,561   |   |  | 4,337,590   |  
|Foreign exchange
loss (gain)                                                      |  |  | 1,115,596   |   |  | (418,868    | ) |  | (88,888     | )
|Net change in non-cash working capital
  balances related to operations [note 20] |  |  | 5,326,051   |   |  | (197,227    | ) |  | (171,912    | )
|                                                                                  |  |  |             |   |  |             |   |  |             |  
|Cash used in operating activities                                                 |  |  | (3,186,228  | ) |  | (10,809,770 | ) |  | (9,402,744  | )
|                                                                                  |  |  |             |   |  |             |   |  |             |  
|                                                                                  |  |  |             |   |  |             |   |  |             |  
|FINANCING ACTIVITIES                                                              |  |  |             |   |  |             |   |  |             |  
|Contribution received from joint venture [note 9]                                 |  |  |            |   |  | 500,000     |   |  | 1,500,000   |  
|Increase in short- term loan                                                      |  |  | 2,762,870   |   |  |            |   |  |            |  
|Repayment of short- term loan                                                     |  |  | (1,505,581  | ) |  |            |   |  |            |  
|Increase (decrease) in long-term debt                                             |  |  |            |   |  |            |   |  | (899,184    | )
|Repayment of loan                                                                 |  |  | (35,900     | ) |  | (23,933     | ) |  |            |  
|(Increase) decrease in government grant
  receivables                             |  |  | 381,398     |   |  | 419,351     |   |  | (473,451    | )
|Share capital issued                                                              |  |  | 3,816,579   |   |  | 22,983,149  |   |  | 27,495,575  |  
|Shares to be issued                                                               |  |  |            |   |  | 130,000     |   |  | 18,091      |  
|                                                                                  |  |  |             |   |  |             |   |  |             |  
|Cash provided by financing activities                                             |  |  | 5,419,366   |   |  | 24,008,567  |   |  | 27,641,031  |  
|                                                                                  |  |  |             |   |  |             |   |  |             |  
|                                                                                  |  |  |             |   |  |             |   |  |             |  
|INVESTING ACTIVITIES                                                              |  |  |             |   |  |             |   |  |             |  
|Increase in other long term deferred assets                                       |  |  |            |   |  | (500,000    | ) |  |            |  
|(Increase)/decrease in long term loan
  receivable                                |  |  | 346,666     |   |  | (346,666    | ) |  |            |  
|Increase in patent costs                                                          |  |  |            |   |  |            |   |  | (21,016     | )
|Purchase of property, plant and equipment
  (net of government grants received)   |  |  | (3,963,628  | ) |  | (20,172,180 | ) |  | (10,496,423 | )
|Decrease in restricted cash                                                       |  |  |            |   |  |            |   |  | 177,596     |  
|                                                                                  |  |  |             |   |  |             |   |  |             |  
|Cash used in investing activities                                                 |  |  | (3,616,962  | ) |  | (21,018,846 | ) |  | (10,339,843 | )
|                                                                                  |  |  |             |   |  |             |   |  |             |  
|                                                                                  |  |  |             |   |  |             |   |  |             |  
|Increase (decrease) in cash and cash
  equivalents                                |  |  | (1,383,824  | ) |  | (7,820,049  | ) |  | 7,898,444   |  
|Effects of foreign exchange rate changes on
  cash                                |  |  | (373,071    | ) |  | 270,337     |   |  | 19,622      |  
|                                                                                  |  |  |             |   |  |             |   |  |             |  
|Increase (decrease) in cash and cash
  equivalents during year                    |  |  | (1,756,895  | ) |  | (7,549,712  | ) |  | 7,918,066   |  
|Cash and cash equivalents, beginning of
  year                                    |  |  | 1,796,822   |   |  | 9,346,534   |   |  | 1,428,468   |  
|                                                                                  |  |  |             |   |  |             |   |  |             |  
|Cash and cash equivalents, end of year                                            |  |  | 39,927      |   |  | 1,796,822   |   |  | 9,346,534   |  
|                                                                                  |  |  |             |   |  |             |   |  |             |  

Supplemental
cash flow information [notes 16(b) and 20]See
accompanying notes

68

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

1. NATURE OF BUSINESS
AND ABILITY TO CONTINUE AS A GOING CONCERN

Dynamotive Energy Systems Corporation (the
Company or Dynamotive) was incorporated on April 11, 1991 under the laws of
the Province of British Columbia. Dynamotive is focused on the development of
innovative energy solutions based on its patented fast pyrolysis system. The
Companys focus is to commercialize its patented BioOil production technology
and establish this technology for production of BioOil clean fuels.

These financial statements have been prepared
in accordance with Canadian generally accepted accounting principles on a going
concern basis, which presumes the Company will be able to realize its assets
and discharge its liabilities and commitments in the normal course of operations
for the foreseeable future. As at December 31, 2008, the Company has a working
capital deficiency of $10,441,893 (2007 - $3,024,446), and has incurred a loss
of $28,356,265 (2007 - $14,220,404; 2006 - $14,252,382) for the year ended
December 31, 2008.

The ability of the Company to continue as a
going concern is in substantial doubt and is dependent on achieving profitable
operations, commercializing its BioOil production technology and obtaining the
necessary financing in order to develop this technology. The outcome of these
matters cannot be predicted at this time. The Companys future operations are
dependent on the markets acceptance of its products in order to ultimately
generate future profitable operations, and the Companys ability to secure
sufficient financing to fund future operations. There can be no assurance that
the Companys products will be able to secure market acceptance. Management
plans to raise additional equity financing to enable the Company to complete
its development plans. These financial statements do not include any
adjustments that might result from the outcome of these uncertainties.

Management is of the opinion that expected
future financing along with expected sales will provide sufficient working
capital to meet the Companys liabilities and commitments as they become due.

2. SIGNIFICANT
ACCOUNTING POLICIES

The consolidated financial statements have
been prepared by management in accordance with Canadian generally accepted
accounting principles.

The following is a summary of significant
accounting policies used in the preparation of these consolidated financial
statements:

Principles of
consolidation

These consolidated financial statements
include the accounts of the Company and its wholly-owned subsidiaries
Dynamotive Canada Inc., federally incorporated under the laws of Canada;
Dynamotive USA Inc. incorporated under the laws of Delaware, U.S.A.; Dynamotive
Latinoamericana S.A., incorporated under the laws of Buenos Aires, Argentina;
and First Resources Corporation, incorporated under the laws of British
Columbia.

69

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

2. SIGNIFICANT
ACCOUNTING POLICIES (CONTD)

Dynamotive Corporation, incorporated under
the laws of Rhode Island, U.S.A. has been inactive, has a nominal Balance
Sheet, and was wholly owned until December 12, 2008 when a 51% interest was
sold to an officer of the Company for nominal consideration. Prior to this
date, Dynamotive Corporation was consolidated. Subsequent to that date, results
are accounted for using the equity method.

In September 2006, the Company entered into
an agreement to sell-off a 20% interest of its then wholly owned subsidiary
Dynamotive Europe Limited (DEL) (note 9). The Company maintained the
remaining 80% ownership interest in DEL. In October 2008, the Company and
Pendana Limited (Pendana) entered into a share purchase agreement where
Pendana (the beneficial owner of one share representing 20% of DEL) sold the
one share of DEL to the Company for £1 and DEL again became a wholly owned
subsidiary of the Company. The Company continues to consolidate DEL for each of
the years presented.

The Company
also owns 100% shares of Dynamotive Biomass Resource Corporation (DBRC),
incorporated under the laws of British Columbia, Canada. In July 2007, the
Company entered into a share exchange agreement with Pendana, whereby Pendana
agreed to sell 49% (490,000 common shares) of DBRC in consideration of the
issuance of 2,000,000 common shares of the Company. 2,000,000 common shares
having a fair value of $1.02 per share were issued to Pendana in August 2007.
In addition, the Company owns 99.98% of the West Lorne BioOil Co-Generation LP
formed under the laws of Ontario and has accounted for its proportionate share
of the partnership.

All inter-company balances and transactions
have been eliminated on consolidation.

Use of estimates

The preparation of financial statements in
conformity with Canadian generally accepted accounting principles requires
management to make estimates and assumptions that affect the amounts reported
in the financial statements and accompanying notes. Significant areas requiring
the use of management estimates relate to the determination of recoverability of
property, plant and equipment costs, patents, long-term investments and
long-term deferred assets, the useful lives for amortization, determination of
asset retirement obligations, determination of future income tax valuation
allowances and assumptions used in determining the fair value of non-cash
stock-based compensation. Actual results could differ from these estimates.

Foreign currency translation

The accounts of the Company and its
consolidated subsidiaries are measured using the Canadian dollar as the
functional currency. Monetary items denominated in foreign currencies are
translated into Canadian dollars using exchange rates in effect at the balance
sheet date and non-monetary items are translated using historical exchange
rates. Exchange gains or losses arising on the transaction or settlement of
foreign currency denominated monetary items are included in the determination
of net loss.

70

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

2. SIGNIFICANT
ACCOUNTING POLICIES (CONTD)

The Company uses the U.S. dollar as the
reporting currency for its consolidated financial statements. Assets and
liabilities are translated into U.S. dollars using current exchange rates in
effect at the balance sheet date and revenue and expense accounts are
translated using the average exchange rate during the period. Gains and losses
resulting from this translation are recorded in shareholders equity as an
adjustment to accumulated other comprehensive income.

Revenue recognition

[a] Product
Sales

The Company recognizes revenue from the sale
of products, including BioOil, char, and other by-products, upon shipment of
the product when the risk and reward of ownership has been transferred to the
customer, provided that the amount is fixed or determinable and collection is
reasonably assured.

[b]
Licenses and royalties

Revenue from license agreements may include
multiple elements within a single contract. Payments received under license
agreements may include the following: non-refundable fees at inception of the
contract, fees for services to be performed, milestone payments for specific
achievements, and royalty payments based upon resulting sales of products.
Agreements with multiple elements are separated into significant discrete units
of accounting based on the relative fair value of each element. Revenue is
recognized for each element when all significant acts have been completed and
delivery has occurred with no substantial risk of return and collectability is
reasonably assured. When the fair value cannot be determined, revenue is
deferred until objective evidence exists or recognized as the final elements
are delivered. Any non-refundable amounts not yet recognized during the term of
the license term are recognized at the time of license expiry.

Deferred revenue is comprised of amounts
received prior to the satisfaction of the revenue recognition criteria
described above and includes non-refundable amounts related to sales of master
license and plant license agreements. Master license agreements grant the
licensee the exclusive right and license to use and commercially exploit the
Companys BioOil technology including the rights to manufacture, market,
distribute, and sub-license the technology for the production of BioOil within
a specific territory. Plant license agreements grant a licensee the right to
use and commercially exploit the Companys BioOil technology for the
development of one or more pyrolysis plant facilities.

71

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

2. SIGNIFICANT
ACCOUNTING POLICIES (CONTD)

Government assistance and investment tax
credits

Government assistance towards current
expenses is included in the determination of income for the period as a
reduction of the expenses to which it relates. Amounts received for future
expenditures are recorded as a current liability. Government assistance towards
the acquisition and construction of property, plant and equipment is deducted
from the cost of the related property, plant and equipment. Government grants
receivable are recorded when the Company has incurred the qualifying
expenditure and there is reasonable assurance the receipts will be recovered.

Repayment of contribution is contingent
solely upon the Companys ability to generate revenue from the sale of
specified products or technology. Accordingly, liability of repayment will only
be accrued when sales of the products or technology have been generated. Any
such repayment is recorded as Royalty Fees under Cost of Goods Sold.

Investment tax credits are accounted for
under the cost reduction method whereby they are netted against the expense or
capital asset to which they relate. Investment tax credits are recorded when
the Company has incurred the qualifying expenditures and there is reasonable
assurance the tax credits will be realized. As at December 31, 2008 and 2007,
no investment tax credits have been recognized.

Research and development costs

Research costs are expensed in the period
incurred. Development costs are expensed in the period incurred unless the
Company believes the development project meets Canadian generally accepted
accounting criteria for deferral and amortization. In evaluating these criteria
the Company considers technological feasibility to be established only when a
product demonstrates that it operates under conditions which are acceptable to
target customers. If management determines that the development of products to
which such costs have been capitalized is not reasonably certain, or that costs
exceed recoverable value, such costs are charged to operations. The Company has
not capitalized any development costs for any of the year ends presented.

During the year ended December 31, 2008, the
Company netted $151,657 (2007 - $13,911; 2006 - $154,560) of product sales
against research and development expenses, which are considered incidental
sales of BioOil, char and electricity until such time as the Companys plants
have reached commercial production levels (note 22).

Patents

Patents are recorded at cost, including
related legal costs, and are amortized on a straight-line basis over the lesser
of the estimated useful life of the related technology and the life of the
patent. If management determines that development of products to which patent
costs relate is not reasonably certain, or that costs exceed recoverable value,
such costs are charged to operations. Due to the long-term nature of estimates
inherent in determining future cash flows, it is possible that the future cash
flows or the estimated useful life of such assets could be reduced in the
future.

72

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

2. SIGNIFICANT
ACCOUNTING POLICIES (CONTD)

Property, plant and equipment

Property, plant and equipment are recorded at
cost, net of government assistance, and amortized using the following methods
and annual rates:

|                           |                                         
|-------------------------- | ----------------------------------------
|Furniture and fixtures     | 20% declining balance                   
|Computer equipment         | 30% declining balance                   
|Computer software          | 100% declining balance                  
|Equipment                  | 20% declining balance                   
|Leasehold improvements     | Straight line over the term of the lease
|                           | (which approximates its estimated life) 
|Projects under development | See below                               

Annually, or whenever events and
circumstances indicate that the carrying value of the assets might be impaired
and the carrying value may not be recoverable, the Company performs evaluations
to assess the recoverability of its property, plant and equipment. When the
carrying value of property, plant and equipment is determined to exceed its
recoverable amount, an impairment loss is recorded to reduce the carrying value
of the capital asset to its fair value.

Projects under development

The Company expenses all preliminary stage
costs incurred with respect to a potential capital project, including costs
related to the consideration of alternatives, feasibility studies, and
activities occurring prior to the decision to proceed with the project until
the capital project meets the Companys capitalization policy and is considered
a project under development. The Company begins to capitalize costs for
projects under development when it has determined that it is more likely than
not that the financing for the capital project is available and it is more
likely than not that the Company will be able to meet the requisite local and
other governmental regulations to develop the capital project.

For those capital projects that meet the
Companys capitalization policy, the Company capitalizes incremental costs that
are directly identifiable with the specific capital project until the capital
project is substantially complete and ready for its intended use. Financing
costs, including interest, are capitalized when they arise from indebtedness
incurred, directly or indirectly, to finance the construction of the capital
project. Capitalization of financing costs will cease when a capital project is
considered to be substantially complete and ready for its intended use.

73

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

2. SIGNIFICANT
ACCOUNTING POLICIES (CONTD)

Annually, or whenever events and circumstances
indicate that the carrying value of the assets might be impaired and the
carrying value may not be recoverable, the Company performs evaluations to
assess the recoverability of its projects under development. When the carrying
value of projects under development is determined to exceed its recoverable
amount, an impairment loss is recorded to reduce the carrying value of the
projects under development to its fair value. During the year ended December
31, 2008, the Company recorded an impairment loss of $16,018,735 (2007 - $nil;
2006 - $nil) related to projects under development (note 6).

As at December 31, 2008, no amortization is
recorded on projects under development as assets are not yet available for use.

Income taxes

The Company accounts for income taxes using
the asset and liability method of tax allocation. Future income taxes are
recognized for the future income tax consequences attributable to differences
between the carrying values of assets and liabilities and their respective
income tax bases. Future income tax assets and liabilities are measured using
substantively enacted income tax rates expected to apply to taxable income in
the periods in which temporary differences are expected to be recovered or
settled. The effect on future income tax assets and liabilities of a change in
rates is included in earnings in the period that includes the substantial
enactment date. Future income tax assets are recorded in the consolidated
financial statements if realization is considered more likely than not.A valuation allowance is recorded to reduce future income tax
assets
recognized by the amount of any future income tax benefits that, based on
available evidence, are not expected to be realized.

Stock based compensation

The Company has two stock based compensation
plans - a stock appreciation rights (SA Rights) plan and a stock option plan
for directors and employees, which are described in note 16. Under the terms of
the stock option plan the Company may grant fixed options or options whose vesting
is contingent on future performance. Compensation is recognized under the fair
value based method when fixed or performance based stock options are granted to
employees and directors. Compensation for SA Rights to be settled in cash are
accrued at their fair value at the date of grant and re-measured at each
financial statement date until they are exercised. Compensation for SA Rights
to be settled in shares are accrued at their fair value at the date of grant
but are not re-measured at each financial statement date.

The Company may also issue stock options and
warrants to employees or as consideration for services rendered by
non-employees. Such equity awards are recorded at their fair value using the
Black Scholes option pricing model, as compensation expense or capitalized to
long-term assets under construction when the Company receives the related
services and the equity awards vest. No compensation is recognized in
connection with options and warrants awarded in connection with private
placements, since the share issue costs are netted against the proceeds raised.
All unvested or modified options for non-employees are re-measured on each
balance sheet date until such options vest.

74

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

2. SIGNIFICANT
ACCOUNTING POLICIES (CONTD)

Loss per common share

Basic loss per common share is based on the
weighted average number of shares outstanding for the period excluding
contingently issuable shares and excluding escrowed shares. The Company uses
the treasury stock method for calculating diluted loss per share. The treasury
stock method assumes that for purposes of determining the weighted average
shares outstanding for the calculation of dilutive per share amounts, the
proceeds to be received on the exercise of dilutive share options and warrants
are used to repurchase common shares at the average market price for the
period.

However, in the Companys
case, diluted loss per share does not differ from basic loss per share as the
effect of the exercise of the 25,841,218 (2007  19,119,367; 2006  16,889,533)
options and 13,527,078 (2007  15,899,525; 2006  26,277,714) warrants that are
outstanding at December 31, 2008 would be anti-dilutive.

Leases

Leases are classified as either capital or
operating leases. Leases which transfer substantially all the benefits and
risks of ownership of the property to the Company are accounted for as capital
leases. Capital lease obligations reflect the present value of future minimum
lease payments, discounted at the appropriate interest rate. All other leases
are accounted for as operating leases wherein rental payments are expensed as
incurred.

Cash and cash equivalents

Cash and cash equivalents consist of cash on
hand and balances invested in short-term money market deposits with an original
maturity less than 90 days from the date of purchase. For the year ended
December 31, 2008, the weighted average interest rate earned on cash equivalent
balances was 3.65% (2007  4.83%). As at December 31, 2008, the Company had
$39,927 (2007 - $1,796,822) in cash, which includes $30,031 (2007  Cash balance
$Nil) in Canadian currency (converted to US dollars based on the year end
foreign exchange rate), $Nil (2007 - $1,000,000) in short-term US dollar money
market deposits.

75

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

2. SIGNIFICANT
ACCOUNTING POLICIES (CONTD)

Asset retirement
obligations

The Company records the fair value of an
asset retirement obligation as a liability in the period in which it incurred a
legal obligation associated with the retirement of tangible long-lived assets
that result from the acquisition, construction, development, and/or normal use
of the assets and when a reasonable estimate of the fair value can be made. The
obligation is measured initially at fair value using present value methodology,
and the resulting costs capitalized into the carrying amount of the related
asset. In subsequent periods, the liability will be adjusted for any changes in
the amount or timing of the underlying future cash flows. Capitalized asset
retirement costs will be depreciated on the same basis as the related asset and
the discount accretion of the liability is included in determining the results
of operations. As at December 31, 2008, the estimated fair value of the asset
retirement obligations was $229,312 (2007 - $246,939).

Long-term
investment

The Companys long-term investment in equity
instruments that do not have a quoted market price in an active market is
accounted for on a cost basis. The investment is written-down to its estimated
net realizable value when there is evidence of a decline in value below carried
cost that is other than temporary.

Comprehensive
loss

Comprehensive loss comprises the Companys
net loss and other comprehensive loss. Comprehensive loss represents changes in
shareholders equity during a period arising from non-owner sources and, for the
Company, other comprehensive loss includes gains and losses on
available-for-sale securities and gains and losses arising from the translation
from the Companys functional currency (Canadian dollars) to its reporting
currency (U.S. dollars). Cumulative changes in other comprehensive loss are
included in accumulated other comprehensive income (loss).

Derivatives
and hedge accounting

The Company does not hold any financial
instruments designated for hedge accounting and accordingly is not impacted by
CICA Handbook Section 3865, Hedges

Financial
instruments

Effective
January 1, 2007, the Company adopted the Canadian Institute of Chartered
Accountants (CICA) Handbook Section 3855, Financial Instruments Recognition
and Measurement; and Section 3861, Financial Instruments  Disclosure and
Presentation (the Financial Instrument Standards).

The Financial
Instrument Standards require that adjustments to the carrying value of
financial assets and liabilities be recorded within retained earnings or, in
the case of available-for-sale assets, accumulated other comprehensive income.

76

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

2. SIGNIFICANT
ACCOUNTING POLICIES (CONTD)

Under these
standards, financial assets and liabilities are initially recognized at fair
value and are subsequently measured based on their classification as
held-to-maturity, loans and receivables, available-for-sale, held-for-trading,
or other financial liabilities as described below. The classification is not
changed subsequent to initial recognition.

Held-to-maturity and Loans and Receivables

Financial
instruments that have a fixed maturity date, where the Company intends and has
the ability to hold to maturity are classified as held-to-maturity and measured
at amortized cost using the effective interest rate method. Loans and
receivables are measured at amortized cost using the effective interest method.

Available-for-sale

Financial

assets classified as available-for-sale are carried at fair value (where
determinable based on market prices of actively traded securities) with changes
in fair value recorded in other comprehensive income. Available-for-sale
securities are written down to fair value through earnings whenever it is
necessary to reflect an other-than-temporary impairment.

Held-for-trading

Financial
assets and financial liabilities that are purchased and incurred with the
intention of generating profits in the near term are classified as
held-for-trading. These instruments are measured at fair value with the change
in the fair value recognized in income.

Other financial liabilities

Other
financial liabilities are initially measured at fair value and subsequently
measured at amortized cost, with any resulting premium or discount from the
face value being amortized to income or expense using the effective interest
method.

The Company
has chosen to recognize all transaction costs to net income on all financial
liabilities that have been designated as other than held for trading.

The following
is a summary of the accounting model the Company has elected to apply to each
of its significant categories of financial instruments outstanding:

|                               |                              
|------------------------------ | -----------------------------
|Cash and
  cash equivalents    | Held-for-trading             
|Receivables                    | Loans and
  receivables      
|Government
  grants receivable | Loans and
  receivables      
|Long-term
  loan receivable    | Loans and
  receivables      
|Long-term
  investments        | Available
  for Sale         
|Accounts
  payable             | Other
  financial liabilities
|Short-term
  debt              | Other
  financial liabilities
|Long-term debt                 | Other
  financial liabilities

Included in
long-term investments is an investment in the common shares of Renewable Energy
Corp (note 10) which is classified as available-for-sale. As at December 31,
2008, the fair value of this investment approximated its carrying value.

77

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

2. SIGNIFICANT
ACCOUNTING POLICIES (CONTD)

Future accounting changes

Goodwill and Intangible Assets

In February
2008, the CICA issued a new Section 3064, Goodwill and Intangible Assets,
replacing Section 3062, Goodwill and Intangible Assets, as well as Section
3450, Research and Development Costs.

The new Section 3064 states
that upon their initial identification, intangible assets are to be
recognized as assets only if they meet the definition of an intangible asset
and the recognition criteria. Section 3064 also provides further information on
the recognition of internally generated intangible assets, including research
and development costs. As for subsequent measurement of intangible assets,
goodwill, and disclosure, Section 3064 carries forward the requirements of the
old Section 3062.

The new

Section applies to annual and interim financial statements relating to fiscal
years beginning on or after October 1, 2008. The Company is currently
evaluating the effect of this new standard on the Companys financial
statements.

Financial Statement Concepts

In February
2008, the CICA issued amendments to Section 1000, Financial Statement
Concepts, to clarify the criteria for recognition of an asset and the timing
of expense recognition, specifically, deleting the guidance permitting the
deferral of costs. The new requirements are effective for interim and annual
financial statements relating to fiscal years beginning on or after October 1,
2008. The Company is currently evaluating the effect of this new standard on
the Companys financial statements.

International Financial Reporting Standards
(IFRS)

In 2006, the
Canadian Accounting Standards Board (AcSB) published a new strategic plan
that will significantly affect financial reporting requirements for Canadian
companies. The AcSB strategic plan outlines the convergence of Canadian
GAAP with IFRS over an expected five year transitional period. In February
2008, the AcSB announced that 2011 is the changeover date for publicly-listed
companies to use IFRS, replacing Canadas own GAAP. The date is for interim and
annual financial statements relating to fiscal years beginning on or after
January 1, 2011. The transition date of January 1, 2011 will require the
restatement for comparative purposes of amounts reported by the Company for the
year ended December 31, 2010. While the Company has begun assessing the adoption
of IFRS for 2011, the financial reporting impact of the transition to IFRS
cannot be reasonably estimated at this time.

78

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

3. CHANGE IN
ACCOUNTING POLICY

(a) Effective January 1, 2008, the Company
adopted the amended CICA guidelines of Section 1400, Assessing going concern,
which includes requirements for management to assess and disclose an entitys
ability to continue as a going concern. When financial statements are not
prepared on a going-concern basis that fact shall be disclosed together with
the basis on which the financial statements are prepared and the reason why the
company is not considered a going-concern. The adoption of this standard did
not have a material effect on the Companys financial statements.

(b) Effective
March 1, 2008 the Company adopted the CICA Handbook Section 1535, Capital
Disclosures. This section of the CICA Handbook establishes the new standards
for disclosing an entitys objectives, policies, and processes for managing
capital. These disclosures include a description of what the company manages as
capital, the nature of externally imposed capital requirements, how the
requirements are incorporated into the companys management of capital, whether
the requirements have been complied with, or consequences of non-compliance and
an explanation of how the company is meeting its objectives for managing
capital. In addition, quantitative data about capital and whether the company
has complied with all capital requirements are also required. Other than the
additional disclosure (see note 23), the adoption of this section did not have
a material effect on the Companys financial statements.

(c) Effective
January 1, 2008, the Company adopted the CICA guidelines of Section 3862,
Financial Instruments  Disclosures, and Section 3863, Financial Instruments 
Presentation. These standards replace CICA 3861, Financial Instruments 
Disclosure and Presentation.

These
standards increase the disclosures currently required, which will enable users
to evaluate the significance of financial instruments for an entitys financial
position and performance, including disclosures about fair value. In addition,
disclosure is required of qualitative and quantitative information about
exposure to risks arising from financial instruments, including specified
minimum disclosures about credit risk, liquidity risk, and market risk. The
quantitative disclosures must provide information about the extent to which the
company is exposed to such risk, based on information provided internally to
the entitys key management personnel.

79

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

3. CHANGE IN
ACCOUNTING POLICY (CONTD)

(i) Fair value

The fair
values of cash and cash equivalents, receivables, government grants receivable,
accounts payable and short-term debt approximate carrying value because of the
short term nature of these instruments. The fair value for the long-term loan
receivable represents the balance outstanding as the full repayment was
received in July 2008 (see note 5). Long-term investments are written-down to
their estimated net realizable value when there is evidence of a decline in
value below carried cost that is other than temporary. Long-term debt is
recorded at its fair value. There are no differences between the carrying
values and the fair values of any financial assets or liabilities.

(ii) Financial
Instrument Risk Exposure and Risk Management

The Company is
exposed in varying degrees to a variety of financial instrument related risks.
The Board approves and monitors the risk management process. The type of risk
exposure and the way in which such exposure is managed is provided as follows:

Credit Risk:

Credit risk is
the risk that arises when a party to a financial instrument will be unable to
discharge its obligations. The Companys financial assets exposed to credit
risk are cash and cash equivalents, receivables, government grants receivable,
long-term loan receivable and long-term investments.

Cash is placed
with major financial institutions. Amounts receivable, government grants
receivable, loans receivable and long-term investments are assessed for
impairment based on the individual characteristics (credit history, ability to
repay) of each counterparty.

Liquidity
Risk:

Liquidity risk
is the risk that the Company will encounter difficulty in meeting obligations
associated with its financial liabilities. The Company has no operating income
and relies on equity fund-raising to support its commercialization projects.
Management prepares budgets and ensures funds are available prior to
commencement of any such projects. However, without further equity financing,
it is unlikely that the Company will be able to meet the obligations associated
with its financial liabilities in the upcoming year.

Market Risk:

The
significant market risk exposures to which the Company is exposed are foreign
currency risk, interest rate risk, and commodity price risk.

80

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

3. CHANGE IN
ACCOUNTING POLICY (CONTD)

Foreign Currency
Risk - The Companys operations are primarily in Canada with some activities in
the USA, Argentina and the United Kingdom, which makes it subject to foreign
currency fluctuations. The Companys operating expenses are incurred in
Canadian dollars, United States dollars (US dollars), Argentine pesos and
British Pounds, and the fluctuation of the Canadian dollar in relation to these
currencies will have an impact upon the profitability of the Company and may
also affect the value of the Companys assets and the amount of shareholders
equity. The Company has not entered into any agreements or purchased any
instruments to hedge possible currency risks.

Interest Rate
Risk - The Company has minimal debt and virtually no floating rate debt and so
exposure to interest rate risk is minimal at this time.

Commodity
Price Risk  The Companys BioOil and Char outputs may be sold at various
prices, some of which may be at prices directly or indirectly tied to fossil
fuel commodity prices such as heating oil #2, natural gas, diesel oil and
others. To date the Companys sales have been on fixed price contracts and so
currently, the Company has little or no exposure to commodity price risk.

4. RECEIVABLES

|                                          |  |  |        |  |  |         | 
|----------------------------------------- |  |  | ------ |  |  | ------- | 
|                                          |  |  | 2008   |  |  | 2007    | 
|                                          |  |  | $      |  |  | $       | 
|                                          |  |  |        |  |  |         | 
|                                          |  |  |        |  |  |         | 
|Receivables from sales of BioOil and char |  |  | 9,004  |  |  | 6,579   | 
|Government taxes recoverable              |  |  | 11,335 |  |  | 113,337 | 
|Sundry receivables                        |  |  |       |  |  | 31,317  | 
|                                          |  |  |        |  |  |         | 
|                                          |  |  | 20,339 |  |  | 151,233 | 
|                                          |  |  |        |  |  |         | 

81

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

5. LOAN RECEIVABLE

On November 14, 2007, the Company and Biomass Worldwide Limited
(Biomass) and Anthony Pius Noll (Guarantor) entered into a negotiation
commitment and loan agreement where the Company would loan Biomass up to
$720,000 in five tranches (to be completed by April 12, 2008) on the
understanding that if the parties were able to reach a definitive agreement in
respect of an equity investment by the Company in Biomass, all the loan would
be converted into not less than 30% of the equity of Biomass. The due date for
repayment of the loan was on demand any time on or after March 7, 2008. The
loan was secured by a pledge of all of the assets of Biomass and by an unconditional
guarantee of the Guarantor. A total of $520,000 was advanced to Biomass under
the loan and in July 2008, the loan of $520,000 was repaid in full to the
Company. As at December 31, 2008, $nil (2007 - $346,666) was due to the Company
from Biomass.

6. PROPERTY, PLANT
AND EQUIPMENT

|                                     |  |      |            |                            |  |            |  |                            |            |  |  |         | 
|------------------------------------ |  | ---- | ---------- | -------------------------- |  | ---------- |  | -------------------------- | ---------- |  |  | ------- | 
|                                     |  | 2008 |            | 2007                       | 
|                                     |  |      |            |                            | 
|                                     |  | Cost |            | Accumulated
  Amortization |  | Cost       |  | Accumulated
  Amortization |           
|                                     |  |      |            |                            |  |            |  |                            |           
|                                     |  | $    |            | $                          |  | $          |  | $                          |           
|                                     |  |      |            |                            |  |            |  |                            |           
|Furniture and fixtures               |  |      | 161,958    |                            |  | 135,979    |  |                            | 201,127    |  |  | 160,516 | 
|Computer equipment and software      |  |      | 548,673    |                            |  | 482,742    |  |                            | 670,109    |  |  | 560,859 | 
|Equipment                            |  |      | 135,539    |                            |  | 68,178     |  |                            | 160,570    |  |  | 60,430  | 
|Projects under development:          |  |      |            |                            |  |            |  |                            |            |  |  |         | 
|West Lorne                           |  |      | 20,248,176 |                            |  |           |  |                            | 22,150,711 |  |  |        | 
|Less: Impairment provision           |  |      | (4,947,682 | )                          |  |            |  |                            |            |  |  |         | 
|Guelph                               |  |      | 26,058,242 |                            |  |           |  |                            | 30,580,258 |  |  |        | 
|Less: Impairment provision           |  |      | (8,819,206 | )                          |  |            |  |                            |            |  |  |         | 
|Deposits on equipment  200tpd plant |  |      | 43,636     |                            |  |           |  |                            | 661,199    |  |  |        | 
|Leasehold improvements               |  |      | 246,868    |                            |  | 219,722    |  |                            | 301,787    |  |  | 189,082 | 
|                                     |  |      |            |                            |  |            |  |                            |            |  |  |         | 
|                                     |  |      | 33,676,204 |                            |  | 906,621    |  |                            | 54,725,761 |  |  | 970,887 | 
|                                     |  |      |            |                            |  |            |  |                            |            |  |  |         | 
|Net book value                       |  |      | 32,769,583 |                            |  | 53,754,874 | 
|                                     |  |      |            |                            |  |            | 

At December 31, 2008, the Company has recorded
$26,058,242 (2007 -
$30,580,258) as plant and equipment representing construction costs on a 200
TPD plant at Guelph, Ontario and $20,248,176 (2007 - $22,150,711) as plant and
equipment representing construction costs on a 120 TPD plant at West Lorne,
Ontario. All of the construction payments were paid in cash or shares.

During 2006 the Company began construction of a 200 tpd Bio Oil
production facility in Guelph, Ontario, Canada. The Company owns the plant and
intends to lease it to Evolution BioFuels Inc., the entity that will operate
the plant. Construction of the plant was completed in 2007 and has been
commissioned. The plant is currently in shut down mode due to feedstock issues
and due to financial limitations. The Company is currently in discussions with
Evolution BioFuels Inc. about possibly changing the business relationship
governing the plant.

During 2008 the Company conducted a review of realizable value from its
property plant and equipment in West Lorne and Guelph and as a result has
recorded an impairment provision totaling $13,963,743 of which $196,855 was
allocated to long-term deferred assets (note 11). This amount, plus related
foreign exchange effect of $2,054,992 totaling $16,018,735, was written down
and expensed during the year. The impairment provision for the West Lorne plant
was determined by discounting managements best estimate of future cash flow of
the plant. There is significant measurement uncertainty in determining this
estimate, particularly in relation to estimated revenue and certain costs.

The Company is currently assessing a number of scenarios including the
possibility of moving the plant in Guelph to another location. The impairment
provision determined by management represents managements best estimate of the
realizable value of the plant under these scenarios. Note, there is significant
measurement uncertainty in determining the amount of the impairment provision
for the Guelph plant, as management used significant estimates that related to
the determination of recoverability of property, plant and equipment costs.

82

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

6. PROPERTY, PLANT
AND EQUIPMENT (CONTD)

A small fire in an isolated area of the West Lorne Plant occurred on
April 10th 2008. There were no injuries and there was no need to evacuate the
plant. No significant damage to the plant was reported, and product storage
areas were not affected. Repairs took approximately three months and cost
approximately $300,000, the large majority of which was covered by insurance.

The deposits on equipment  200tpd plant are payments made for
equipment to be used in a future 200tpd plant. These amounts decreased during
2008 as services, in the amount of $184,493, were received by the Company and due
to the termination of a service agreement which resulted in the return of cash
of $31,054 and shares $129,292 from a supplier as it was determined that the
services were not going to be required. A loss of $125,073 was recorded in
relation to cancellation of this service agreement.

7. PATENTS

|               |  |      |         |                            |  |         |  |                            |         |  |  |         | 
|-------------- |  | ---- | ------- | -------------------------- |  | ------- |  | -------------------------- | ------- |  |  | ------- | 
|               |  | 2008 |         | 2007                       | 
|               |  |      |         |                            | 
|               |  | Cost |         | Accumulated
  Amortization |  | Cost    |  | Accumulated
  Amortization |        
|               |  |      |         |                            |  |         |  |                            |        
|               |  | $    |         | $                          |  | $       |  | $                          |        
|               |  |      |         |                            |  |         |  |                            |        
|               |  |      |         |                            |  |         |  |                            |         |  |  |         | 
|Patents        |  |      | 391,019 |                            |  | 197,848 |  |                            | 484,609 |  |  | 215,041 | 
|               |  |      |         |                            |  |         |  |                            |         |  |  |         | 
|Net book value |  |      | 193,171 |                            |  | 269,568 | 
|               |  |      |         |                            |  |         | 

Patents are recorded at cost, including related legal costs, and are
amortized on a straight-line basis over the lesser of the estimated useful life
of the related technology and the life of the patent. The annual amortization
expense of these patents for the next five years is estimated to be
approximately $25,000 per annum. Fluctuations to the cost of patents compared
to the prior year resulted from foreign exchange translation.

8. BIOMASS JOINT
VENTURE

In September 2006, the Company and Pendana Limited BVI (Pendana)
entered into a 10 year joint venture agreement to establish DBRC (a company
incorporated federally in Canada) with the purpose of securing biomass and to
source project development opportunities and additional biofuel and green
credit pipeline opportunities.

Pursuant to terms of the agreement, the Company earned a 51% interest
in DBRC by contributing cash of $500,000 and granting DBRC certain rights
(Rights) associated with specific biomass development opportunities in
Canada, South America, and Europe. In return for a 49% ownership in DBRC,
Pendanas contribution amounted to cash payments of $2,000,000 ($1.5 million
was received in DBRC as at December 31, 2006 and $500,000 received in 2007). In
addition to the above, the Company agreed to lend DBRC up to $1 million.
Pendana further agreed to provide a $20 million revolving line of credit to
DBRC. Any sums advanced under this credit facility would be at Pendanas sole
discretion. No funds were advanced by Pendana under this credit facility.

83

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

8. Biomass JOINT VENTURE
(CONTD)

In July 2007, the Company entered into a share exchange agreement with
Pendana, whereby Pendana agreed to sell 49% (490,000 common shares) of DBRC in
exchange for 2,000,000 common shares of the Company. 2,000,000 common shares
having a fair value, based on the market price for a period before and after
the date of the share issuance, of $1.02 per share were issued to Pendana in
early August 2007. The difference between the fair value and the carrying value
of the net assets of DBRC was unchanged from the date of its inception
(September 2006) through the date of acquisition of the 490,000 common shares
of DBRC from Pendana. The excess of the consideration paid over the fair value
of the net assets acquired has been adjusted to general and administrative
expense in 2007.

9. DYNAMOTIVE EUROPE
LIMITED

In September 2006, the Company and Pendana Limited BVI (Pendana)
entered into an agreement in connection with the Companys then wholly-owned
subsidiary DEL. The agreement was made in an effort to establish DEL as a
permanent presence in Europe to develop European projects. Under the terms of
the agreement, Pendana completed a private placement with the Company, whereby
the Company issued 2,332,361 common shares and 583,090 share purchase warrants
for gross cash proceeds of $2,000,000. The warrants were exercisable at $1.26
and expired on August 2, 2008. In addition, the Company issued a total of
3,000,000 warrants, with an exercise price of $1.2375 to Pendana, 2,000,000 of
these warrants expired on February 28, 2007 and the remaining 1,000,000
warrants expired on April 24, 2007. The additional warrants were valued using
the Black-Scholes option pricing model using the following assumptions: risk
free interest rate of 4.17%; dividend yield of 0%, volatility factors of
35.23%; and an expected life of 0.5 years. Pendana also received a 20% interest
in DEL, with Dynamotive maintaining the remaining 80% interest. The Company
further agreed to loan DEL $2,000,000 on commercial terms.

At the date of acquisition, DEL was substantially inactive and no
non-controlling interest was recorded as a result of this transaction, as the
net asset value at that date was in a deficit position and DEL had not yet
obtained profitable operations. As a result of the sale of this 20% interest in
DEL, the Company recorded a loss on sale of $420,400 in its operations for the
year ended December 31, 2006. The Company continued to consolidate the accounts
of DEL as the Company maintains its remaining 80% ownership interest for the years
ended December 31, 2006 and 2007.

On October 24, 2008, the Company and Pendana entered into a share
purchase agreement where Pendana agreed to sell its 20% share of DEL to the
Company. The Company purchased the share for £1. DEL was substantially inactive
and became a wholly owned subsidiary of the Company upon execution of the
agreement.

84

---



Dynamotive Energy
Systems Corporation

NOTES
TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

10. LONG TERM
INVESTMENTS

As at December 31, 2008, Dynamotive holds 3,874,139 (2007  3,874,139)
common shares of Renewable Energy Corp (ROC) incorporated in Victoria,
Australia, a subsidiary of Enecon Pyrolysis Pty Limited. It represents an 8.02%
(2007  8.02%) interest in the entity.

11. LONG TERM
DEFERRED ASSET

In April 2007, the Company entered into amended agreements with Erie
Flooring and Wood Products (Erie) regarding the supply by Erie of wood chips
to the West Lorne BioOil plant over the next 12 years at no charge and the
provision of char from the BioOil plant to Erie at no charge. In relation to
these agreements, Dynamotive has paid for the purchase and installation of a
char based boiler system and related char delivery infrastructure at Erie. The
asset will be amortized evenly over the remaining life of the wood supply
contract commencing when the Company begins to amortize the West Lorne plant.
During 2008 the Company conducted a review of realizable value from its
property plant and equipment in West Lorne and Guelph and as a result has
recorded an impairment provision of which $196,855 was allocated to the long
term deferred asset (note 6).

To facilitate the purchase of the boiler system, the Company borrowed
$359,000 from Erie. This amount is being repaid to Erie in equal monthly
payments plus 8% interest over a 10-year period. The first payment was made in
May 2007. As at December 31, 2008, the Company owed Erie $299,167 [2007 -
$335,067].

Long-term debt repayment schedule:

|               |  |  |         | 
|-------------- |  |  | ------- | 
|               |  |  | 2008    | 
|               |  |  | $       | 
|               |  |  |         | 
|2009 (Current) |  |  | 35,900  | 
|2010           |  |  | 35,900  | 
|2011           |  |  | 35,900  | 
|2012           |  |  | 35,900  | 
|2013           |  |  | 35,900  | 
|Thereafter     |  |  | 119,667 | 
|               |  |  |         | 
|               |  |  | 299,167 | 
|               |  |  |         | 

12. ACCOUNTS PAYABLE
AND ACCRUED LIABILITIES

|                                 |  |  |           |  |  |           | 
|-------------------------------- |  |  | --------- |  |  | --------- | 
|                                 |  |  | 2008      |  |  | 2007      | 
|                                 |  |  | $         |  |  | $         | 
|                                 |  |  |           |  |  |           | 
|                                 |  |  |           |  |  |           | 
|Trade accounts payable           |  |  | 5,614,872 |  |  | 2,582,981 | 
|Accrued compensation             |  |  | 1,416,207 |  |  | 349,957   | 
|Accrued liabilities [note 18(c)] |  |  | 2,543,468 |  |  | 2,939,005 | 
|Bank guarantee(i)                |  |  | 292,275   |  |  | 396,721   | 
|                                 |  |  |           |  |  |           | 
|                                 |  |  | 9,866,822 |  |  | 6,268,664 | 
|                                 |  |  |           |  |  |           | 

85

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

12. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
(CONTD)

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(i) | In 2001,
  Border Biofuels Ltd. (BBL, a company in liquidation which was 75% owned by
  the Company) entered into a credit facility with a UK Bank (the Bank) for a
  maximum of $292,280 (2007 - $396,721) (£200,000). The credit facility is
  denominated in British Pounds Sterling and is guaranteed by the Company.
  During 2002, BBL became insolvent. If the Bank is unable to realize on its
  collateral with BBL, it has the right to seek settlement from the Company for
  payment. Although there is currently no indication that the Bank will pursue
  the Company, the Company in 2002 recognized the full amount of the guarantee
  as a current liability. BBL remains in liquidation at December 31, 2008,
  there has been no change in status regarding the settlement of the credit
  facility.

13. SHORT TERM AND RELATED PARTY DEBT

During the
year, the Company entered into loan agreements with directors, officers and
shareholders for $1,257,289 (2007 - $nil). The loans are due on demand and bear
interest at 8% per annum. The Company has provided one of the lenders (a
director of the Company with an outstanding amount as of December 31, 2008 of
$1,028,909) with a general security agreement (GSA) in regard to the loan.
This GSA provides the lender a floating charge over the Companys assets.

14. ASSET RETIREMENT OBLIGATION

The Company expects that at the end of the life of its production
plants, there will be residual obligations to remediate the sites and remove
equipment. Although the timing and amount of the future obligations are
uncertain, the Company has estimated the present value of these future
obligations arising from its activities to December 31, 2008 to be $229,312
(2007 - $246,939), being $114,656 for West Lorne and $114,656 for Guelph. The
present value of the future obligations assumes a discount rate of 15%, an
inflation rate of 2% and the commencement of reclamation activities in 15 years
from January 1, 2007. The total undiscounted amount of the future obligation is
$2,000,000. For the year ended December 31, 2008, the Company recorded $34,488
(2007 - $nil) in accretion expense which was charged to the Consolidated
statement of loss.

The Company is currently reviewing scenarios including the possibility
of relocating one of its plants within the next year. Although the likelihood
of relocation cannot be determined at this time, the total undiscounted amount
of future obligations associated with a relocation within the next year would
be $745,760 and had been included in the asset retirement obligation at its
discounted value

86

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

15. DEFERRED REVENUE

In 2006, the Company received a total of $950,000 in non-refundable
payments from three unrelated companies as licensing fees. $500,000 from Rika
Ltd. as payment for a Master License to develop project opportunities in the
Ukraine and the Baltic republics using Dynamotives patented pyrolysis
technology; $150,000 from Classic Power Inc. as an initial payment on a Plant
License for Guelph, Ontario, Canada; $200,000 from Renewable Oil Corporation
Pty Ltd. (ROC) for a Master License to develop project opportunities in
Australia and $100,000 from ROC as a deposit on an initial Plant License.

In the first quarter of 2008, the Company recognized Rika Ltd. master
license fee of $500,000 at the end of the agreement term, less the related loan
to entities controlled by Rika of $330,000 for revenue recognition of $170,000.
This amount has been removed from the deferred revenue balance. In 2007,
deferred revenue was net of the $330,000 loan to entities controlled by Rika
Ltd.

In 2007, the Company received common shares of ROC with a fair value of
$300,000 as compensation for engineering services performed. The Company
subsequently transferred common shares of ROC with a fair value of $150,000 to
a sub-contractor as partial settlement for services provided to ROC by the
sub-contractor on behalf of the Company. These amounts are included in deferred
revenue.

Differences between the amounts described above and deferred revenue
per the Balance Sheet result from the Companys foreign exchange translation
policy.

87

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

16. SHARE CAPITAL

[a] Authorized share
capital

The Companys authorized capital consists of an unlimited number of
common shares with no par value and unlimited Class A preferred shares with no
par value with each having attached special rights and restrictions. No
preferred shares were issued and outstanding at December 31, 2008 and 2007.

[b] Issued and
outstanding common shares

|                                                             |  |  |             |   |  |             |  
|------------------------------------------------------------ |  |  | ----------- | - |  | ----------- | -
|                                                             |  |  | Issued      |  
|                                                             |  |  | #           |   |  | $           |  
|                                                             |  |  |             |   |  |             |  
|Balance, December 31, 2005                                   |  |  | 123,211,875 |   |  | 51,849,476  |  
|Issued for cash and proceeds received in
  prior year        |  |  |             |   |  |             |  
|Pursuant to private placement, net of
  issuance costs (iii) |  |  | 24,001,562  |   |  | 18,670,368  |  
|Pursuant to exercise of stock options                        |  |  | 1,411,716   |   |  | 642,098     |  
|Pursuant to exercise of warrants                             |  |  | 17,574,713  |   |  | 7,936,096   |  
|Issued for settlement of fees payable (iii)                  |  |  | 2,394,907   |   |  | 3,036,562   |  
|Issued for services (i)                                      |  |  | 2,003,664   |   |  | 2,514,585   |  
|Issued on conversion of convertible
  debentures             |  |  | 1,723,339   |   |  | 726,056     |  
|Cancellation of Escrow Shares                                |  |  | (556,000    | ) |  | (247,368    | )
|                                                             |  |  |             |   |  |             |  
|Balance, December 31, 2006                                   |  |  | 171,765,776 |   |  | 85,127,873  |  
|Issued for cash and proceeds received in
  prior year        |  |  |             |   |  |             |  
|Pursuant to private placement, net of
  issuance costs (iii) |  |  | 16,871,989  |   |  | 11,557,657  |  
|Pursuant to exercise of stock options                        |  |  | 1,434,166   |   |  | 672,483     |  
|Pursuant to exercise of warrants                             |  |  | 13,198,261  |   |  | 7,111,610   |  
|Issued for settlement of fees payable (iii)                  |  |  | 1,553,840   |   |  | 1,565,152   |  
|Issued for services (i)                                      |  |  | 925,641     |   |  | 1,058,620   |  
|Issued on purchase of interest in
  subsidiary (note 8)      |  |  | 2,000,000   |   |  | 2,040,000   |  
|                                                             |  |  |             |   |  |             |  
|Balance, December 31, 2007                                   |  |  | 207,749,673 |   |  | 109,133,395 |  
|Issued for cash and proceeds received in
  prior year        |  |  |             |   |  |             |  
|Pursuant to private placement, net of
  issuance costs (iii) |  |  | 12,210,646  |   |  | 3,273,027   |  
|Pursuant to exercise of stock options                        |  |  | 598,899     |   |  | 126,780     |  
|Pursuant to exercise of warrants                             |  |  | 559,203     |   |  | 127,340     |  
|Issued for services (i)                                      |  |  | 193,780     |   |  | 222,869     |  
|                                                             |  |  |             |   |  |             |  
|Balance, December 31, 2008                                   |  |  | 221,312,201 |   |  | 112,883,411 |  
|                                                             |  |  |             |   |  |             |  

88

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

16. SHARE CAPITAL (CONTD)

|    |                                                                                                                                                                                                                                                                                                                                                                                                            
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|[i] | The Company has entered into various agreements for services with its
  employees, directors and non-employees to be settled with various stock
  awards. For awards issued to employees and directors, the fair value is
  determined using the market price on the date of grant and for non-employees
  the fair value is determined using the market value on the date of completion
  of the services.

The Company issued shares for services as described below:

|                                         |  |  |           |   |  |           |  
|---------------------------------------- |  |  | --------- | - |  | --------- | -
|                                         |  |  | Issued    |  
|                                         |  |  | #         |   |  | $         |  
|                                         |  |  |           |   |  |           |  
|For the year end December 31,
  2006     |  |  |           |   |  |           |  
|Shares issued for services:              |  |  |           |   |  |           |  
|Consulting services                      |  |  | 1,270,258 |   |  | 1,667,292 |  
|Share issuance costs                     |  |  | 676,533   |   |  | 799,574   |  
|Employees, directors and officers        |  |  | 56,873    |   |  | 47,719    |  
|Total shares issued for services in 2006 |  |  | 2,003,664 |   |  | 2,514,585 |  
|                                         |  |  |           |   |  |           |  
|                                         |  |  |           |   |  |           |  
|For the year end December 31,
  2007     |  |  |           |   |  |           |  
|Shares issued for services:              |  |  |           |   |  |           |  
|Consulting services                      |  |  | 397,317   |   |  | 430,083   |  
|Share issuance costs                     |  |  | 495,047   |   |  | 591,876   |  
|Employees, directors and officers        |  |  | 33,277    |   |  | 36,661    |  
|Total shares issued for services in 2007 |  |  | 925,641   |   |  | 1,058,620 |  
|                                         |  |  |           |   |  |           |  
|                                         |  |  |           |   |  |           |  
|For the year end December 31,
  2008     |  |  |           |   |  |           |  
|Shares issued for services:              |  |  |           |   |  |           |  
|Consulting services                      |  |  | 328,138   |   |  | 208,825   |  
|Refund of services deposit (note 6)      |  |  | (538,716  | ) |  | (129,292  | )
|Share issuance costs                     |  |  | 298,250   |   |  | 104,388   |  
|Employees, directors and officers        |  |  | 106,108   |   |  | 38,948    |  
|Total shares issued for services in 2008 |  |  | 193,780   |   |  | 222,869   |  
|                                         |  |  |           |   |  |           |  

In 2008 the Company entered into subscription agreements under a
private placement including warrants to be issued with an exercise price of
$0.20. Due to existing agreements, this resulted in a re-pricing of the
4,998,372 Series V Warrants from an exercise price of $1.06 to an exercise
price of $0.20.

89

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

16. SHARE CAPITAL (CONTD)

|                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|----------------------------------------------------------------------------------------------------------------------- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|[ii]                                                                                                                    | During the year ended December 31, 2008, the Company completed
  private placements for gross proceeds of $3,394,066 (2007 - $13,291,580; 2006
  - $21,072,712). Share issuance costs related to these private placements
  totaled $120,542 (2007 - $1,733,923; 2006 - $2,402,344), of which $nil (2007
  - $822,500; 2006 - $232,722) was paid in cash and $120,542 (2007 - $911,422;
  2006 - $2,169,622) was paid in shares and warrants. Share issuance costs paid
  in shares were valued based on the quoted market price on the date of private
  placements. The fair value of the warrants was estimated using the
  Black-Scholes option pricing model with the following weighted average
  assumptions: risk free interest rate of 2.65% (2007  4.25%; 2006  4.06%);
  dividend yield of 0% (2007  0%; 2006  0%); volatility factors of 56.8%
  (2007  62.2%; 2006  54.5%); and weighted average expected life of 3.7 years
  (2007  4.8 years; 2006  2 years). Pursuant to the private placement
  agreements in 2008, 5,390,217 Series S warrants 56,430 Series V warrants
  (2007  1,720,354 Series S warrants and 4,492,674 Series V warrants; 2006 
  9,082,305 series S warrants) were issued in 2008 (note 16f).
|                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|                                                                                                                        | In 2008, the Company also issued nil (2007  1,553,840; 2006 
  2,394,907) fully vested shares for settlement of fees payable with a total
  fair value of $nil (2007 - $1,565,152; 2006 - $3,036,562). These shares were
  valued based on the quoted market price on the date of the settlement
  agreement. This resulted in a loss on settlement of accounts payable of $nil
  (2007 - $111,108; 2006 - $98,189).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|[c] Shares to be issued                                                                                                
|                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|At December 31, 2008, the Company has 2,918,674 (2007  1,429,785)
  common shares to be issued which are comprised of:
|                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|[i]                                                                                                                     | 2,080,470 (2007  450,506) common shares which are to be issued to
  senior management, directors and non-employees for services rendered under
  compensation arrangements in 2008 with a fair value of $1,136,868 (2007 -
  $434,540).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
|                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|[ii]                                                                                                                    | 838,204 (2007  838,204) common shares which are to be issued to directors
  and officers as bonuses for the previous years with a fair value of $700,530
  (2007 - $700,530).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|                                                                                                                        |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|[iii]                                                                                                                   | Nil common shares relating to a private placement commenced during
  the year ended December 31, 2008 (2007  141,075). At December 31, 2008, the
  Company had received $nil (2007 - $130,000) in cash for these shares to be
  issued.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

90

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

16. SHARE CAPITAL (CONTD)

[d] Escrow agreement

Prior to March 2006, the Company held certain shares in escrow to be
released from such escrow agreement as the Company achieves certain milestones.
In March 2006, 556,000 common shares were cancelled and returned to the
Treasury as the remaining milestone expired without being reached. Accordingly,
the Company reduced common share capital by $247,368 in 2006, based on the
average per-share amount of the common shares at the date of cancellation, with
a corresponding increase to contributed surplus.

As at December 31, 2008, nil (2007 - nil) common shares are held in
escrow.

[e] Stock options

At December 31, 2008, the following stock options to directors,
employees and non-employees were outstanding:

|                              |  |                                               |            |                                                    |  |                                        |  |                                               |      |                                     |  |            |  |   |      | 
|----------------------------- |  | --------------------------------------------- | ---------- | -------------------------------------------------- |  | -------------------------------------- |  | --------------------------------------------- | ---- | ----------------------------------- |  | ---------- |  | - | ---- | 
|                              |  |                                               |            | Options
  Outstanding                              |  | Options
  Exercisable                  | 
|                              |  |                                               |            |                                                    |  |                                        | 
|Range of 
  Exercise
  Prices |  | Number
  Outstanding at
  December 31,
  2008 |            | Weighted-
  Average
  Remaining
  Contractual Life |  | Weighted-
  Average
  Exercise
  Price |  | Number
  Exercisable at
  December 31,
  2008 |      | Weighted-Average
  Exercise
  Price | 
|                              |  |                                               |            |                                                    |  |                                        |  |                                               |      |                                     | 
|                              |  |                                               |            |                                                    |  |                                        |  |                                               |      |                                     | 
|$0.20 - $0.23                 |  |                                               | 4,161,718  |                                                    |  | 4.43 years                             |  | $                                             | 0.22 |                                     |  | 4,161,718  |  | $ | 0.22 | 
|$0.33 - $0.48                 |  |                                               | 9,302,500  |                                                    |  | 4.36 years                             |  | $                                             | 0.46 |                                     |  | 8,902,500  |  | $ | 0.46 | 
|$0.50 - $0.88                 |  |                                               | 5,780,000  |                                                    |  | 3.29 years                             |  | $                                             | 0.61 |                                     |  | 2,430,000  |  | $ | 0.53 | 
|$1.00 - $1.35                 |  |                                               | 5,809,500  |                                                    |  | 2.26 years                             |  | $                                             | 1.21 |                                     |  | 4,459,500  |  | $ | 1.20 | 
|$1.50 - $1.60                 |  |                                               | 787,500    |                                                    |  | 0.65 years                             |  | $                                             | 1.59 |                                     |  | 787,500    |  | $ | 1.59 | 
|                              |  |                                               |            |                                                    |  |                                        |  |                                               |      |                                     |  |            |  |   |      | 
|                              |  |                                               | 25,841,218 |                                                    |  | 3.55 years                             |  | $                                             | 0.66 |                                     |  | 20,741,218 |  | $ | 0.62 | 
|                              |  |                                               |            |                                                    |  |                                        |  |                                               |      |                                     |  |            |  |   |      | 

91

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

16. SHARE CAPITAL (CONTD)

From time to time, the Company has provided incentives in the form of
stock options to the Companys directors, officers, employees and others. The
Company has reserved 33,196,830 (2007 - 31,162,451) (15%) of its common shares
for issuance upon the exercise of stock options of which at December 31, 2008,
7,355,612 (2007  4,643,084) are available to be granted. The exercise price
and the vesting terms of the options are determined by the Compensation
Committee of the Companys Board of Directors. The exercise price will
generally be at least equal to the market price of the common shares at the date
of the grant.

Stock option transactions for the respective periods and the number of
stock options outstanding are summarized as follows:

|                               |  |                               |            |                                 |  |      | 
|------------------------------ |  | ----------------------------- | ---------- | ------------------------------- |  | ---- | 
|                               |  | No. of Common Shares Issuable |            | Weighted Average Exercise Price | 
|                               |  |                               |            |                                 | 
|                               |  | #                             |            | $                               | 
|                               |  |                               |            |                                 | 
|Balance, December 31, 2005     |  |                               | 21,713,250 |                                 |  | 0.44 | 
|Options
  granted              |  |                               | 3,715,999  |                                 |  | 1.02 | 
|Options
  forfeited or expired |  |                               | (278,000   | )                               |  | 0.66 | 
|Options
  exercised            |  |                               | (1,411,716 | )                               |  | 0.45 | 
|                               |  |                               |            |                                 |  |      | 
|Balance, December 31, 2006     |  |                               | 23,739,533 |                                 |  | 0.52 | 
|Options
  granted              |  |                               | 5,584,000  |                                 |  | 1.22 | 
|Options
  forfeited or expired |  |                               | (1,370,000 | )                               |  | 1.04 | 
|Options
  exercised            |  |                               | (1,434,166 | )                               |  | 0.47 | 
|                               |  |                               |            |                                 |  |      | 
|Balance, December 31, 2007     |  |                               | 26,519,367 |                                 |  | 0.65 | 
|Options
  granted              |  |                               | 1,361,500  |                                 |  | 0.91 | 
|Options
  forfeited or expired |  |                               | (1,440,750 | )                               |  | 0.88 | 
|Options
  exercised            |  |                               | (598,899   | )                               |  | 0.21 | 
|                               |  |                               |            |                                 |  |      | 
|Balance, December 31, 2008     |  |                               | 25,841,218 |                                 |  | 0.66 | 
|                               |  |                               |            |                                 |  |      | 

During 2007, the Company extended the expiry date for eight months of
225,000 options issued to an employee from the original expiry date.

In December 2008, the Compensation Committee approved a program
regarding the treatment of salary deferral and income reduction of the
Companys officers. Subsequent to the year end, 6,632,588 stock options were
allotted and granted to such officers for salaries deferred and income
reduction. Compensation expense for these options was accrued in 2008 in the
amount of $499,654.

92

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

16. SHARE CAPITAL (CONTD)

The weighted-average fair value of options granted or revalued in 2008
where the stock price is equal to the exercise price of the options, greater
than the exercise price of the options and less than the exercise of the
options was $0.88, $nil, and $0.81 respectively (2007 - $1.16, $nil, and $1.15;
2006 - $0.58, $0.54, and $0.97).

Compensation expense recognized for options granted or modified in 2008
or prior periods was $1,682,923 (2007 - $2,827,976; 2006 - $1,933,233).
Included in the options granted in 2008, was nil (2007  533,000; 2006 
200,000) options to non-employees for services rendered recorded at a fair
value of $nil (2007 - $190,948; 2006  $nil). The fair value of stock options
issued in 2008 is estimated at the measurement date using the Black Scholes
option pricing model with the following weighted average assumptions: Risk free
interest rate of 3.59% (2007  4.16%; 2006  4.12%); dividend yields of 0%
(2007  0%; 2006  0%); volatility factors of the expected market price of the
Companys common stock of 62.5% (2007  58.7%; 2006  60.5%); and weighted
average expected life of the option of 3.9 years (2007  3.9 years; 2006  3.8
years).

Expected volatilities are based on historical volatility of the
Companys stock using available data and other factors. The risk-free interest
rate is based on Canadian Treasury Instruments. As the Company does not
currently pay cash dividends on common stock and does not anticipate doing so
in the foreseeable future, the expected dividend yield is zero. The Company
uses historical data to estimate option exercise, forfeiture and employee
termination within the valuation model. For non-employees, the expected life of
the options approximates the full term of the options.

[f] Common
share purchase warrants

At December 31, 2008 the common share purchase warrants outstanding
were as follows:



|                  |                 |  |                |                                      
|----------------- | --------------- |  | -------------- | -------------------------------------
|                  | No. of Common   |  | Exercise       |                                      
|                  | Shares Issuable |  | Price          | Expiration
  Date                    
|                  |                 |  |                |                                      
|                  |                 |  |                |                                      
|Series S Warrants | 8,289,610       |  | $0.01 to $1.70 | January 09, 2009 to December 31, 2011
|Series U Warrants | 239,096         |  | $0.46 to $0.53 | January 20, 2009 to June 21, 2009    
|Series V Warrants | 4,998,372       |  | $0.20          | October 03, 2012 to January 18, 2013 
|                  |                 |  |                |                                      
|Total             | 13,527,078      |  |                |                                      
|                  |                 |  |                |                                      

Subsequent to year end, 1,291,621 Series S Warrants and 239,096 Series
U Warrants expired unexercised as the exercise prices exceeded the market price
at the time of expiry.

93

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

16. SHARE CAPITAL (CONTD)

Summary
of warrants exercised and issued during the year end:



|           |  |                                    |            |                                       |  |                                          |  |                                                     |          |                        |  |                  |   |  |            |  |  |                | 
|---------- |  | ---------------------------------- | ---------- | ------------------------------------- |  | ---------------------------------------- |  | --------------------------------------------------- | -------- | ---------------------- |  | ---------------- | - |  | ---------- |  |  | -------------- | 
|           |  | Number of
  Common Shares Issuable |            |                                       | 
|           |  |                                    |            |                                       | 
|Series     |  | at
  December 31, 2007             |            | via
  Warrants Issued during the year |  | via
  Warrants exercised during the year |  | via
  Warrants cancelled or expired during the year |          | at
  December 31, 2008 |  | Exercise
  Price |  
|           |  |                                    |            |                                       |  |                                          |  |                                                     |          |                        |  |                  |  
|Q Warrants |  |                                    | 374,195    |                                       |  |                                         |  |                                                     | (374,195 | )                      |  |                 |   |  |           |  |  | $0.20          | 
|R Warrants |  |                                    | 500,000    |                                       |  |                                         |  |                                                     | (110,008 | )                      |  | (389,992         | ) |  |           |  |  | $0.20          | 
|S Warrants |  |                                    | 9,137,040  |                                       |  | 5,716,199                                |  |                                                     | (75,000  | )                      |  | (6,488,629       | ) |  | 8,289,610  |  |  | $0.01 to $2.00 | 
|U Warrants |  |                                    | 946,348    |                                       |  |                                         |  |                                                     |         |                        |  | (707,252         | ) |  | 239,096    |  |  | $0.46 to $0.53 | 
|V Warrants |  |                                    | 4,941,942  |                                       |  | 56,430                                   |  |                                                     |         |                        |  |                 |   |  | 4,998,372  |  |  | $0.20          | 
|           |  |                                    |            |                                       |  |                                          |  |                                                     |          |                        |  |                  |   |  |            |  |  |                | 
|           |  |                                    | 15,899,525 |                                       |  | 5,772,629                                |  |                                                     | (559,203 | )                      |  | (7,585,873       | ) |  | 13,527,078 |  |  |                | 
|           |  |                                    |            |                                       |  |                                          |  |                                                     |          |                        |  |                  |   |  |            |  |  |                | 

Of 13,527,078 outstanding warrants, 13,527,078 warrants are vested.

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | The Series Q warrants were issued as part of a private placement for
  cash and services. These warrants vested upon successful completion of the
  private placement and as services were performed. In 2002, 818,418 Series Q
  warrants were issued as part of a loan agreement to certain directors of the
  Company. In 2008, 374,195 (2007 - 3,108,266) warrants were exercised at a
  weighted average price of $0.20 (2007 - $0.60) per share.                                                                                                                                                                                                                                                                                                          
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|(2) | The 2,500,000 Series R warrants were issued as part of a loan
  financing in 2003 at an exercise price of $0.20 per share. In accordance with
  the Series R warrant agreement, these warrants were exercisable on a
  cashless basis whereby the in the money value (the market price at the
  time of exercise less the $0.20) of the warrants could be used to satisfy the
  $0.20 per share exercise price. As at December 31, 2008, 110,008 (2007 
  1,680,000) shares were issued in satisfaction of the cashless exercise of
  500,000 (2007  2,000,000) warrants.                                                                                                                                                                                 
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|(3) | The Series S warrants were issued as part of a private placement for
  cash and services. Of the 5,716,199 (2007  2,063,411) warrants issued,
  5,390,217 (2007  2,031,411) were issued in relation to private placements
  which had a fair value of $395,680. 155,555 warrants (2007  nil) were issued
  in lieu of cash recruitment fees for the placement of an officer. Of these
  155,555 warrants, 100,000 warrants were at $0.01 per share. The remainder of
  the warrants were issued for issuance costs. These warrants vested upon
  successful completion of the private placement and as services were
  performed. In 2008, 75,000 (2007  8,409,995) warrants were exercised at a
  weighted average price of $0.70 (2007 - $0.63) per share.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|(4) | In 2008, nil (2007  nil) Series U warrants were issued as a part of
  a conversion of convertible debentures. These warrants vested immediately
  upon issue with a weighted average exercise price of $nil (2007  $nil).                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|(5) | The Series V warrants were issued as part of a private placement for
  cash and services. Of the 56,430 (2007  4,941,942) warrants issued, 56,430
  (2007  4,507,867) were issued in relation to private placements which had a
  fair value of $17,493. The remainder of the warrants were issued for issuance
  costs. These warrants vested upon successful completion of the private
  placement and as services were performed.                                                                                                                                                                                                                                                                                                                          

94

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

16. SHARE CAPITAL (CONTD)

Compensation
expense recognized for warrants issued during 2008 was $ 67,243 (2007 -
$298,935; 2006  $1,152,368).

[g] Stock appreciation rights

In 1998, the
Company established a stock appreciation rights (SA Rights) plan whereby the
participants were entitled to require the Company to redeem the SA Rights for
an amount equal to the excess of the market value of the underlying common
shares over the initial value of the SA Right at the date of grant. The SA
Rights vested as the Company achieved stock value targets as defined in the
agreement. The Company also had the right to redeem the SA Rights at its option
under certain circumstances. The Company had the sole exclusive election to
redeem the SA Rights in cash, shares or in a combination of cash and shares.
The number of SA Rights that could be granted under the plan until December 31,
2008 were not to exceed 2,500,000.

At December
31, 2008, nil (December 2007 - 300,000) SA Rights were outstanding and nil
(December 2007 - 300,000) were vested. These 300,000 SA Rights, with an initial
value of $0.40, expired on December 31, 2008. There were no SA Rights issued,
redeemed or forfeited during the past three year period.

95

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

16. SHARE CAPITAL (CONTD)

[h] Stock based compensation and payment

The Company has recorded stock based compensation and payment as
follows:

|                                             |  |      |           |      |  |           |  |  |           | 
|-------------------------------------------- |  | ---- | --------- | ---- |  | --------- |  |  | --------- | 
|                                             |  | 2008 |           | 2007 |  | 2006      | 
|                                             |  | $    |           | $    |  | $         | 
|                                             |  |      |           |      |  |           | 
|Balance sheet items                          |  |      |           |      |  |           |  |  |           | 
|Property, plant and equipment                |  |      | 62,154    |      |  | 593,538   |  |  | 1,941,324 | 
|Share issue costs                            |  |      | 121,038   |      |  | 911,422   |  |  | 2,169,622 | 
|Accounts payable                             |  |      |          |      |  |          |  |  | 969,261   | 
|Other assets                                 |  |      |          |      |  |          |  |  | 100,637   | 
|                                             |  |      |           |      |  |           |  |  |           | 
|                                             |  |      | 183,192   |      |  | 1,504,960 |  |  | 5,180,844 | 
|                                             |  |      |           |      |  |           |  |  |           | 
|Income statement items                       |  |      |           |      |  |           |  |  |           | 
|Marketing and business development           |  |      | 313,961   |      |  |          |  |  | 179,917   | 
|General and administrative                   |  |      | 2,204,343 |      |  | 3,310,752 |  |  | 2,571,175 | 
|Loss on settlement of accounts payable       |  |      |          |      |  | 111,108   |  |  | 98,189    | 
|Research and development                     |  |      | 5,834     |      |  | 321,809   |  |  | 1,586,498 | 
|Interest expense and other                   |  |      |          |      |  |          |  |  | 14,408    | 
|                                             |  |      |           |      |  |           |  |  |           | 
|                                             |  |      | 2,524,138 |      |  | 3,743,669 |  |  | 4,450,187 | 
|                                             |  |      |           |      |  |           |  |  |           | 
|                                             |  |      |           |      |  |           |  |  |           | 
|Total stock based compensation
  and payment |  |      | 2,707,330 |      |  | 5,248,629 |  |  | 9,631,031 | 
|                                             |  |      |           |      |  |           |  |  |           | 

[i] Basic and diluted loss per common share

|                                                       |  |      |             |      |   |             |   |   |             |  
|------------------------------------------------------ |  | ---- | ----------- | ---- | - | ----------- | - | - | ----------- | -
|                                                       |  | 2008 |             | 2007 |   | 2006        |  
|                                                       |  |      |             |      |   |             |   |   |             |  
|                                                       |  |      |             |      |   |             |   |   |             |  
|Numerator                                              |  |      |             |      |   |             |   |   |             |  
|                                                       |  |      |             |      |   |             |   |   |             |  
|Net loss                                               |  | $    | (28,356,265 | )    | $ | (14,220,404 | ) | $ | (14,252,382 | )
|                                                       |  |      |             |      |   |             |   |   |             |  
|                                                       |  |      |             |      |   |             |   |   |             |  
|Denominator                                            |  |      |             |      |   |             |   |   |             |  
|                                                       |  |      |             |      |   |             |   |   |             |  
|Weighted average number of
  common shares outstanding |  |      | 211,448,521 |      |   | 189,573,764 |   |   | 153,685,553 |  
|                                                       |  |      |             |      |   |             |   |   |             |  
|                                                       |  |      |             |      |   |             |   |   |             |  
|Basic and diluted loss per common share                |  | $    | (0.13       | )    | $ | (0.08       | ) | $ | (0.09       | )
|                                                       |  |      |             |      |   |             |   |   |             |  

96

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

17. COMMITMENTS AND CONTINGENCIES

Commitments

The Company has the following future minimum
annual lease commitments for premises and equipment:



|                 |  |  |         | 
|---------------- |  |  | ------- | 
|                 |  |  | $       | 
|                 |  |  |         | 
|2009             |  |  | 271,000 | 
|2010             |  |  | 129,000 | 
|2011             |  |  | 92,000  | 
|2012             |  |  | 48,000  | 
|2013 and
  after |  |  | 156,000 | 
|                 |  |  |         | 
|                 |  |  | 696,000 | 
|                 |  |  |         | 

Pursuant to employment agreements with certain officers of the Company,
which expire between September 30, 2009 and July 31, 2011, the Company is
obligated to pay the full term of contract or severance in the event of the
officers termination. As at December 31, 2008, the compensation obligation
potentially payable over the next four years amounts to $5,607,764 (2007 -
$9,001,918).

In April, 2009 the Company entered into a lease for a new head office
in Richmond, British Columbia, Canada for a total commitment of $140,000
(C$174,000) over the 2009-2011 period.

In connection with the Companys West Lorne project upgrade and
construction advances related to the 200 TPD plants (see note 6), the Company
has outstanding construction commitments of approximately $0.6 million.

Contingencies

In the ordinary course of business activities, the Company may be
contingently liable for litigation and claims with customers, suppliers and
former employees. Management believes that adequate provisions have been
recorded in the accounts where required. Although it is not possible to
estimate the extent of potential costs and losses, if any, management believes
that the ultimate resolution of such contingencies will not have a material
adverse effect on the consolidated financial position of the Company.

97

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

18. RELATED PARTY TRANSACTIONS

The transactions with related parties are recorded at amounts
established and agreed between the related parties. In addition to the
transactions described in note 16, the Company had the following transactions
with related parties:

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|[a] | Consulting fees and salaries of $1,640,232 for the year ended
  December 31, 2008 (2007 - $1,931,783; 2006 - $1,763,575) have been paid to
  Directors (or companies controlled by Directors) of the Company. Included in
  the amount above, is $407,573 (2007 - $207,827; 2006 - $543,122) paid by
  stock based compensation [note 16(b)(i)].                                                                                                                                                                                                                               
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|[b] | As of December 31, 2008, the Company entered into loan agreements
  with directors and officers for $1,187,289 (2007 - $nil). This amount along
  with $70,000 from an unrelated party, comprises the total $1,257,289 of
  short-term loans. The loans are due on demand and bear interest at 8% p.a.
  annum. One of the major loan agreements to a director of the Company (note
  13) was secured by a General Security Agreement as a floating charge over the
  Companys assets. This loan bore interest at 23% per annum for the period
  from April to September 2008.
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|[c] | The amounts due from/to related parties, which are non-interest
  bearing, unsecured and due on demand, are comprised of the following:                                                                                                                                                                                                                                                                                                                                                                                                                                        

|                                                                     |  |  |           |  |  |           | 
|-------------------------------------------------------------------- |  |  | --------- |  |  | --------- | 
|                                                                     |  |  | 2008      |  |  | 2007      | 
|                                                                     |  |  | $         |  |  | $         | 
|                                                                     |  |  |           |  |  |           | 
|Receivable                                                           |  |  |           |  |  |           | 
|Due from directors and officers                                      |  |  |          |  |  | 7,215     | 
|                                                                     |  |  |           |  |  |           | 
|                                                                     |  |  |           |  |  |           | 
|Payable                                                              |  |  |           |  |  |           | 
|Due to directors and officers, principally
  accrued bonuses payable |  |  | 1,866,540 |  |  | 2,022,366 | 
|                                                                     |  |  |           |  |  |           | 

Note: Of the total amount $1,866,540 (2007 -
$2,022,366) due to directors and officers, $780,260 (2007 - $969,899) was
recorded in the shares to be issued account and $1,086,280 (2007 - $1,052,467)
was recorded as accrued liabilities.

The Company recorded a gain on reduction in bonus and vacation accrual
of $1,070,930 in 2008 ($nil in 2007; $nil in 2006). In 2008 the Companys
Compensation Committee approved the motion of certain Company executives to
forgive their entitlement to these amounts and to make this reduction in the
accrual. These amounts were previously accrued as at December 31, 2007 and
included in results to that time.

The Company incurred relocation expenses of $120,000 on behalf of an
officer.

98

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                  |                            
|----------------- | ---------------------------
|December 31, 2008 | (expressed in U.S. dollars)

19. LOSSES AND UNUSED DEDUCTIONS CARRIED
FORWARD FOR INCOME TAX PURPOSES

As at December 31, 2008, the Company has loss carryforwards of
approximately $50,625,000 to apply against future taxable income in Canada
($46,391,000) and the United Kingdom ($4,234,000). The United Kingdom loss
carryforwards can be carried forward indefinitely. The loss carryforwards in
various jurisdictions expire between 2009 and 2028.

In addition, the Company has scientific research and experimental
development expenditures of approximately $6,000,000 (2007 - $7,500,000) that
can be carried forward indefinitely to apply against future taxable income in
Canada.

Future income taxes reflect the net tax effects of temporary
differences between the carrying amounts of assets and liabilities for
financial reporting purposes and the amounts used for income tax purposes. The
Company has recognized a valuation allowance for those future tax assets for
which it is more likely than not that realization will not occur. Significant
components of the Companys future tax assets as of December 31, 2008 and
December 31, 2007 are as follows:

|                                                  |  |  |             |   |  |             |  
|------------------------------------------------- |  |  | ----------- | - |  | ----------- | -
|                                                  |  |  | 2008        |   |  | 2007        |  
|                                                  |  |  | $           |   |  | $           |  
|                                                  |  |  |             |   |  |             |  
|Loss
  carryforwards                              |  |  | 13,310,000  |   |  | 16,650,000  |  
|Research and
  development deductions and credits |  |  | 2,750,000   |   |  | 3,500,000   |  
|Property,
  plant and equipment                   |  |  | 5,060,000   |   |  | 1,200,000   |  
|Financing
  costs                                 |  |  | 450,000     |   |  | 830,000     |  
|Asset
  Retirement Obligation                     |  |  | 10,000      |   |  |            |  
|Reserves                                          |  |  | 250,000     |   |  | 390,000     |  
|Total future
  tax assets                         |  |  | 21,830,000  |   |  | 22,570,000  |  
|Valuation
  allowance                             |  |  | (21,830,000 | ) |  | (22,570,000 | )
|                                                  |  |  |             |   |  |             |  
|Net future
  tax assets                           |  |  |            |   |  |            |  
|                                                  |  |  |             |   |  |             |  

99

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                    |                            
|------------------- | ---------------------------
|December 31,
  2008 | (expressed in U.S. dollars)

19. LOSSES AND UNUSED DEDUCTIONS CARRIED
FORWARD FOR INCOME TAX PURPOSES (CONTD)

The provision for income taxes differs from the amount established
using the statutory income tax rate for British Columbia residents corporations
not eligible for the small business deduction as follows:

|                                                   |  |      |            |      |  |            |   |  |            |  
|-------------------------------------------------- |  | ---- | ---------- | ---- |  | ---------- | - |  | ---------- | -
|                                                   |  | 2008 |            | 2007 |  | 2006       |  
|                                                   |  | $    |            | $    |  | $          |  
|                                                   |  |      |            |      |  |            |  
|Provision (benefit) at Canadian statutory rate     |  |      | (8,970,000 | )    |  | (5,050,000 | ) |  | (5,150,000 | )
|Permanent differences                              |  |      | 10,000     |      |  | 190,000    |   |  | 60,000     |  
|Non-deductible stock option compensation           |  |      | 540,000    |      |  | 1,090,000  |   |  | 920,000    |  
|Effect of reduction in statutory rate              |  |      | 1,160,000  |      |  | 5,810,000  |   |  |           |  
|FX (gains)
  losses on revaluation on FIT balances |  |      | 4,530,000  |      |  | (3,290,000 | ) |  | (330,000   | )
|Increase (decrease) in valuation allowance         |  |      | 2,730,000  |      |  | 1,250,000  |   |  | 4,500,000  |  
|Future income tax recovery                         |  |      |           |      |  |           |   |  |           |  

The valuation
allowance as at December 31, 2008 was reduced by $3,470,000 (2007 - $1,070,000;
2006 - $1,040,000) representing tax effected losses carried forward that
expired during the period.

The potential
income tax benefits relating to these future tax assets have not been
recognized in the consolidated financial statements as their realization did
not meet the requirements of more likely than not under the asset and
liability method of tax allocation. Accordingly, no future tax assets have been
recognized as at December 31, 2008 and 2007 and no income tax provision or
benefit has been provided for any of the periods presented. Had a tax benefit
been provided, the Companys future expected effective tax rate for the
reversal of the tax benefit would be 25.13%, 26.3% and 34.18% in 2008, 2007 and
2006, respectively.

The Companys
future tax assets include approximately $450,000 (2007 - $830,000; 2006 -
$896,000) related to deductions for share issuance costs, in excess of amounts
deducted for financial reporting purposes. If and when the valuation allowance
related to these amounts is reversed, the Company will recognize this benefit
as an adjustment to share capital as opposed to income tax expense in the
Consolidated Statement of Loss. The valuation allowance as at December 31, 2008
was increased by $nil (2007 - $360,000; 2006 - $nil) representing the tax
effect of share issuance costs incurred in the period.

100

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                    |                            
|------------------- | ---------------------------
|December 31,
  2008 | (expressed in U.S. dollars)

20. SUPPLEMENTAL CASH FLOW INFORMATION

|                                           |  |      |           |      |  |          |   |  |          |  
|------------------------------------------ |  | ---- | --------- | ---- |  | -------- | - |  | -------- | -
|                                           |  | 2008 |           | 2007 |  | 2006     |  
|Net change in non-cash working capital     |  | $    |           | $    |  | $        |  
|                                           |  |      |           |      |  |          |  
|                                           |  |      |           |      |  |          |   |  |          |  
|Receivables                                |  |      | 117,804   |      |  | 367,891  |   |  | (442,216 | )
|Prepaid
  expenses and deposits            |  |      | 113,107   |      |  | 29,952   |   |  | (237,452 | )
|Accounts
  payable and accrued liabilities |  |      | 5,095,140 |      |  | (895,070 | ) |  | (12,244  | )
|Deferred
  revenue                         |  |      |          |      |  | 300,000  |   |  | 520,000  |  
|                                           |  |      |           |      |  |          |   |  |          |  
|                                           |  |      | 5,326,051 |      |  | (197,227 | ) |  | (171,912 | )
|                                           |  |      |           |      |  |          |   |  |          |  
|                                           |  |      |           |      |  |          |   |  |          |  
|Interest paid                              |  |      |           |      |  |          |   |  |          |  
|Short-term
  interest paid                 |  |      | 273,687   |      |  |         |   |  | 174,257  |  
|                                           |  |      |           |      |  |          |   |  |          |  

For stock based non-cash investing and
financing activities, see note 16(b).

21. GOVERNMENT ASSISTANCE

Government
assistance claimed during the year ended December 31, 2008 in the amount of
$nil (2007 - $nil; 2006 - $1,559,085) has been recorded as a reduction of
expenditures.

|                                          |  |      |   |      |  |      |  |  |           | 
|----------------------------------------- |  | ---- | - | ---- |  | ---- |  |  | --------- | 
|Government assistance applied to:         |  | 2008 |   | 2007 |  | 2006 | 
|                                          |  | $    |   | $    |  | $    | 
|                                          |  |      |   |      |  |      | 
|                                          |  |      |   |      |  |      |  |  |           | 
|Property,
  plant and equipment and other |  |      |  |      |  |     |  |  | 1,331,964 | 
|Research and
  development                |  |      |  |      |  |     |  |  | 227,121   | 
|                                          |  |      |   |      |  |      |  |  |           | 
|Total                                     |  |      |  |      |  |     |  |  | 1,559,085 | 
|                                          |  |      |   |      |  |      |  |  |           | 



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|[a] | Industrial Technologies Office During 1997, the Company entered into a
  contribution agreement with Industrial Technologies Office (ITO) (formerly
  known as Industry Canada-Technology Partnerships Canada (TPC)) whereby the
  Company is entitled to receive a maximum of approximately $6.7million
  (Cdn$8.2 million) or 37% of eligible expenditures, as defined in the
  agreement. The agreement, as amended, specifies that in the event commercial
  viability is achieved, then the assistance is repayable, commencing January
  1, 2005 based on a 2.5% royalty from sales of specified products resulting
  from the project, to a maximum of $13.1 million (Cdn$16 million) or until the
  expiration of contract on December 31, 2016. Royalty amounts will be recorded
  as a cost of sales. As at December 31, 2008, the Company has received $6.4
  million (Cdn$7.8 million) under these agreements. In 2008, the Company
  received $385,752 (2007 - $419,352; 2006 - $640,852) from ITO. As at December
  31, 2008, $336,265 (2007 - $828,795; 2006 - $1,087,910) is included in
  government grants receivable. Although the Company has not achieved
  commercial viability, some revenues have been recorded from the project. As a
  result, a $4,876 repayment has been accrued as a royalty fee during 2008. No
  amount is accrued for ITO assistance as at year end.

101

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                    |                            
|------------------- | ---------------------------
|December 31,
  2008 | (expressed in U.S. dollars)

22. RESEARCH AND DEVELOPMENT

The breakdown
of the research and development is as follows:

|                                      |  |      |           |      |  |           |   |  |           |  
|------------------------------------- |  | ---- | --------- | ---- |  | --------- | - |  | --------- | -
|                                      |  | 2008 |           | 2007 |  | 2006      |  
|                                      |  | $    |           | $    |  | $         |  
|                                      |  |      |           |      |  |           |  
|Research
  & development expenditures |  |      | 1,506,213 |      |  | 2,053,914 |   |  | 4,629,465 |  
|Less:
  Government assistance         |  |      |          |      |  |          |   |  | (227,121  | )
|Product sales - BioOil                |  |      | (63,976   | )    |  | (13,802   | ) |  | (123,594  | )
|Product sales - Char                  |  |      | (12,146   | )    |  |          |   |  |          |  
|Product sales - Electricity           |  |      | (594      | )    |  | (109      | ) |  | (30,966   | )
|Service sales                         |  |      | (74,941   | )    |  |          |   |  |          |  
|                                      |  |      |           |      |  |           |   |  |           |  
|Total                                 |  |      | 1,354,556 |      |  | 2,040,003 |   |  | 4,247,784 |  
|                                      |  |      |           |      |  |           |   |  |           |  

23. CAPITAL MANAGEMENT

The Companys
objective when managing capital is to safeguard the Companys ability to
continue as a going concern so that it can continue to provide returns for
shareholders and benefits for other stakeholders.

The Company
considers its working capital and the items included in the consolidated
statement of changes in shareholders equity as components of its capital base.
The Company manages the capital structure and makes adjustments to it in light
of changes in economic conditions and the risk characteristics of the
underlying assets. In order to maintain or adjust the capital structure, the
Company may issue new shares through private placements, sell assets to reduce
debt or return capital to shareholders. The Company is not subject to
externally imposed capital requirements.

102

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                    |                            
|------------------- | ---------------------------
|December 31,
  2008 | (expressed in U.S. dollars)

23. Capital Management (CONTD)

The Companys
capital under management includes:

|                                           |  |                   |             |                   |   |             |  
|------------------------------------------ |  | ----------------- | ----------- | ----------------- | - | ----------- | -
|                                           |  | December 31, 2008 |             | December 31, 2007 |  
|Working
  Capital                          |  |                   |             |                   |   |             |  
|Cash and
  cash equivalents                |  | $                 | 39,927      |                   | $ | 1,796,822   |  
|Receivables                                |  |                   | 20,339      |                   |   | 151,233     |  
|Government
  grants receivable             |  |                   | 336,265     |                   |   | 828,795     |  
|Prepaid
  expenses and deposits            |  |                   | 321,587     |                   |   | 503,268     |  
|Accounts
  payable and accrued liabilities |  |                   | (9,866,822  | )                 |   | (6,268,664  | )
|                                           |  |                   |             |                   |   |             |  
|Short-term
  debt                          |  |                   | (1,257,289  | )                 |   |            |  
|                                           |  |                   |             |                   |   |             |  
|Current
  portion of long-term debt        |  |                   | (35,900     | )                 |   | (35,900     | )
|                                           |  |                   |             |                   |   |             |  
|                                           |  |                   |             |                   |   |             |  
|                                           |  | $                 | (10,441,893 | )                 | $ | (3,024,446  | )
|Shareholders
  Equity                     |  |                   |             |                   |   |             |  
|Share
  capital                            |  | $                 | 112,883,411 |                   | $ | 109,133,395 |  
|Shares to be
  issued                      |  |                   | 1,837,398   |                   |   | 1,265,070   |  
|Contributed
  surplus                      |  |                   | 24,729,955  |                   |   | 22,663,941  |  
|                                           |  |                   |             |                   |   |             |  
|                                           |  |                   |             |                   |   |             |  
|                                           |  | $                 | 139,450,764 |                   | $ | 133,062,406 |  
|                                           |  |                   |             |                   |   |             |  

There were no
changes in the Companys approach to capital management during the period.

24. SEGMENTED INFORMATION

In 2008 the Company has one reportable segment, BioOil Power
Generation. The BioOil Power Generation segment relates to the
biomass-to-energy technology. Substantially all of the Companys assets and the
large majority of its operations are in Canada and are solely focused on the
development and commercialization of its technology. BioOil Power Generation is
biomass-to-energy technology that converts low value forest residues and
agricultural by-products into BioOil for use in power generation or other
industrial energy purposes.

For the year ended December 31, 2008, the Company recorded revenue of
$178,106 (2007 - $nil; 2006 - $nil).

103

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                    |                            
|------------------- | ---------------------------
|December 31,
  2008 | (expressed in U.S. dollars)

25.RECONCILIATION OF GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES

The Company prepares its consolidated financial statements in
accordance with Canadian generally accepted accounting principles (Canadian
GAAP), which conform in all material respects to those in the United States
(U.S. GAAP), except as follows:

|     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|---- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|[i]  | Under U.S. GAAP, the excess, if any, between the fair value of the
  shares in escrow and the carrying value, will be recorded as compensation
  expense upon release from escrow. Under Canadian GAAP, shares released from
  escrow do not give rise to compensation expense.                                                                                                                                                                                                                                                                                                                                                                                                  
|     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|[ii] | Under
  Canadian GAAP, prior
  to the accounting change in 2004 the Company accounted for all stock-based
  compensation issued on or after January 1, 2002 to non-employees using the
  fair value based method and recognized no compensation expense for
  stock-based awards to employees.                                                                                                                                                                                                                                                                                                                                                                                   
|     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|     | Beginning January 1, 2006, the Company
  adopted the recommendations of the Statement of Financial Accounting
  Standards No. 123R, Accounting for Stock-based Compensation (SFAS 123R),
  and has applied the recommendations of this standard using the modified
  prospective method. Under this application, the Company is required to record
  compensation expense for all awards granted or modified after the date of
  adoption and for the unvested portion of previously granted awards that
  remain outstanding at the date of adoption. Accordingly, no prior periods
  were restated or cumulative adjustments recorded upon the adoption of this
  standard.
|     |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|     | Prior to the adoption of SFAS 123R, the
  Company accounted for stock-based compensation plans under the intrinsic
  value method of accounting as defined by Accounting Principles Board (APB)
  Opinion No. 25, Accounting for Stock Issued to Employees and applied the
  disclosure provisions of Statement No. 123, Accounting for Stock-based
  Compensation, as amended.                                                                                                                                                                                                                                                                                            

104

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                    |                            
|------------------- | ---------------------------
|December 31,
  2008 | (expressed in U.S. dollars)

25. RECONCILIATION OF GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES (CONTD)

|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|----- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      | For years ending prior to December 31,
  2006, 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,
  compensation arising from changes in the market price is included in the
  measurement of loss.
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|[iii] | Under US GAAP, the conversion feature of the convertible debt issued
  by the Company meets the criteria to be classified as equity. As a result,
  the Company follows Emerging Issue Task Force (EITF) No. 00-27 and records
  the proceeds of the convertible debts based on the relative fair value of the
  convertible debt, the contingent warrants issuable upon conversion and any
  detachable warrants. In accordance with Issue 15 of EITF 00-27, at the time
  of conversion, the contingent warrants that were issued upon conversion of
  the convertible debenture should be recognized.    
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|      | During the year ended December 31, 2006, the Company settled
  convertible debentures. As a result, the Company accreted the remaining debt
  discount, which under US GAAP, resulted in an additional accretion expense of
  $81,560, which includes the recognition of the contingent warrants issuable
  upon conversion of the debenture. The Company has determined there was no
  additional beneficial conversion feature on the convertible instruments
  related to the paid-in-kind accrued interest for the convertible debentures
  that were converted during the fiscal year 2006.              

105

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                    |                            
|------------------- | ---------------------------
|December 31,
  2008 | (expressed in U.S. dollars)

25. RECONCILIATION OF GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES (CONTD)

|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|----- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|[iv]  | Under Canadian GAAP, the Company can capitalize start-up or
  pre-operating costs until commercial production is established. Under US
  GAAP, any pre-operating costs or deferred expenses related to start-up
  operations are expensed as incurred. For the year ended December 31, 2006,
  this difference resulted in write-off of $100,637 under US GAAP. For the year
  ended December 31, 2007, under Canadian GAAP, the amount was recorded in
  Shareholders equity as a share issuance cost.                                                                                               
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|[v]   | Under Canadian GAAP, the Company has included interest expense in
  loss from operations and loss on write-down of long-term assets as other
  expenditure. Under US GAAP, interest expense is recorded as other
  expenditure, and the loss on write-down of long-term assets of $16,018,735
  (2007  Nil) is included in loss from operations. Under Canadian GAAP, the
  loss from operations is $13,279,325. Under US GAAP, the loss from operations
  is $28,964,583.                                                                                                                            
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|[vi]  | Under Canadian GAAP, the Company has included a long-term deferred
  asset on the Balance Sheet totaling $608,413 (2007: $998,008). As the
  recovery of the amount was not probable it was expensed under US GAAP in
  2007. During 2008 under Canadian GAAP the Company recognized a foreign
  currency translation difference of $192,740 and an impairment loss of
  $196,855 (note 6) relating to the long-term deferred asset, which must be
  reversed for US GAAP.                                                                                                                           
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|      | For the
  purposes of accounting under Canadian GAAP, the Company showed the net
  increase in long-term deferred assets as an investing activity in the
  Statement of Cash Flows. Under US GAAP the amounts are shown at their gross amounts
  as separate operating and financing activities.                                                                                                                                                                                                                                                                                                       
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|[vii] | New Accounting Pronouncements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|      | Fair Value
  Measurements (SFAS 157)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|      | In September
  2006, FASB issued SFAS No. 157, Fair Value Measurement to define fair
  value, establish a framework for measuring fair value and to expand
  disclosures about fair value measurements. The statement only applies to fair
  value measurements that are already required or permitted under current
  accounting standards and is effective for fiscal years beginning after
  November 15, 2007. The adoption of SFAS 157 for financial instruments as
  required at January 1, 2008 did not have a material effect on the companys
  results of operations or financial position.
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|      | SFAS 157
  establishes a three-tier fair value hierarchy, which prioritizes the inputs
  used in measuring fair value. These tiers include: Level 1, defined as
  observable inputs such as quoted prices in active markets; Level 2, defined
  as inputs other than quoted prices in active markets that are either directly
  or indirectly observable; and Level 3, defined as unobservable inputs in
  which little or no market data exists, therefore requiring an entity to
  develop its own assumptions.                                                                                      

106

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                    |                            
|------------------- | ---------------------------
|December 31,
  2008 | (expressed in U.S. dollars)

25. RECONCILIATION OF GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES (CONTD)

|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|----- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|      | Fair Value Option for Financial Assets and Financial Liabilities
  (SFAS 159)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|      | In February
  2007, FASB issued SFAS No. 159, Fair Value Option For Financial Assets and
  Liabilities, which permits entities to choose to measure various financial
  instruments and certain other items at fair value. The adoption of SFAS 159
  on January 1, 2008 did not have a material effect on the companys results of
  operations or financial position.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|[vii] | Future Accounting Pronouncements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|      | Business Combinations (SFAS 141R)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|      | In December
  2007, the FASB revised Statement of Financial Accounting Standards No. 141,
  Business Combinations (SFAS 141R). This Statement has been slightly
  modified in order to converge the standard with International Financial
  Reporting Standard 3 Business Combinations. SFAS 141R applies prospectively
  to business combinations for which the acquisition date is on or after the
  beginning of the first annual reporting period beginning on or after December
  15, 2008. The Company expects that adoption of SFAS 141R will not have a
  material impact on its consolidated financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|      | Non-Controlling Interests in Consolidated Financial Statements (SFAS
  160)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|      |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|      | In December
  2007, FASB issued SFAS-160 Non-controlling Interests in Consolidated
  Financial Statements  an amendment of ARB No 51, which clarifies that
  non-controlling interests (minority interests) are to be treated as a
  separate component of equity and any changes in the ownership interest (in
  which control is retained) are to be accounted for as capital transactions.
  However, a change in ownership of a consolidated subsidiary that results in a
  loss of control is considered a significant event that triggers a gain or
  loss recognition, with the establishment of a new fair value basis in any
  remaining ownership interest. SFAS-160 also provides additional disclosure
  requirements for each reporting period. SFAS-160 applies to fiscal years
  beginning on or after December 15, 2008, with early adoption prohibited. This
  statement is required to be adopted prospectively, except for the following
  provisions, which are expected to be applied retrospectively: (i) the reclassification
  of non-controlling interests to equity in the consolidated balance sheets;
  and (ii) the adjustment to consolidated net income to include net income
  attributable to both the controlling and non-controlling interests. The
  Company does not expect the adoption of this standard for US GAAP purposes
  will have a material effect on its consolidated financial statements.

107

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                    |                            
|------------------- | ---------------------------
|December 31,
  2008 | (expressed in U.S. dollars)

25. RECONCILIATION OF GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES (CONTD)

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Disclosures about Derivative Instruments and Hedging Activities (SFAS
  161)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | In March
  2008, FASB issued SFAS-161 Disclosures about Derivative Instruments and
  Hedging Activities  an amendment of FASB Statement No 133. SFAS-161 amends
  the disclosure requirements for derivative instruments and hedging activities
  contained in SFAS-133 Accounting for Derivative Instruments and Hedging
  Activities. Under SFAS-161, entities are required to provide enhanced
  disclosures about (i) how and why an entity uses derivative instruments, (ii)
  how derivative instruments are related to hedged items and accounted for
  under SFAS-133 and related interpretations, and (iii) how derivative instruments
  and related hedged items affect an entitys financial position, financial
  performance and cash flows. SFAS-161 is effective for fiscal years and
  interim period beginning after November 15, 2008, with early adoption
  encouraged. Disclosure for earlier periods presented fro comparative period
  are not required. The Company does not expect that the adoption of this
  standard for US GAAP purposes will have a material impact on its consolidated
  financial statements.                                                              
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | The Hierarchy of Generally Accepted Accounting Principles (SFAS 162)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | In May 2008,
  FASB issued SFAS-162 The Hierarchy of Generally Accepted Accounting
  Principles, which identifies the sources of accounting and the framework for
  selecting principles to be used in the preparation of financial statements of
  nongovernmental entities that are presented in conformity with US GAAP.
  SFAS-162 was effective November 15, 2008. The Company does not expect that
  the adoption of this standard will have a material effect on its consolidated
  financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | Accounting for Convertible Debt Instruments that May be Settled in
  Cash upon Conversion (FSP APB 14-1)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | In May 2008,
  FASB issues FSP-APB-14-1 Accounting for Convertible Debt Instruments that
  May be Settled in Cash upon Conversion (Including Partial Cash Settlement),
  which change the accounting treatment for convertible debt securities that
  the issuer may settled fully or partially in cash. FSP-APB-14-1 requires
  bifurcation of convertible debt instruments into a debt component that is initially
  recorded at fair value and an equity component that represents the difference
  between the initial proceeds from issuance of the instrument and the fair
  value allocated to the debt component. The debt component is subsequently
  accreted (as a component of interest expense) to par value over its expected
  life. FSP-APB-14-1 is effective for fiscal years and interim periods
  beginning after December 15, 2008 and must be retrospectively applied to all
  prior periods presented, event if an instrument has matured, converted, or
  otherwise been extinguished as of the FSPs effective date. The Company does
  not expect that the adoption of this standard for US GAAP purposes will have
  a material effective on its consolidated financial statements.

108

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                    |                            
|------------------- | ---------------------------
|December 31,
  2008 | (expressed in U.S. dollars)

25. RECONCILIATION OF GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES (CONTD)

| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Determining the Fair Value of a Financial Asset when the Market for
  that Asset is Not Active (FSP FAS 157-3)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | In October
  2008, FASB issued FSP-FAS-157-3 Determining the Fair Value of a Financial
  Asset when the Market for That Asset is Not Active, which clarifies the
  application of SFAS-157 in a market that is not active and provides key
  considerations in determining the fair value of the financial asset..
  FSP-FAS-157-3 is effective upon issuance, including prior periods for which
  financial statements have not been issued. Revisions resulting from a change
  in the valuation technique or its application shall be accounted for as a
  change in accounting estimate. The Company does not expect that the adoption
  of this standard will have a material impact on its consolidated financial
  statements.
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | Employers Disclosures about Post-Retirement Benefit Plan Assets (FSP
  FAS 132R)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | In December
  2008, FASB issued FSP-FAS-132(R)-1 Employers Disclosures about
  Post-Retirement Benefit Plan Assets, which provides enhanced guidance on
  disclosures after FASB determined that fair value measurements for
  post-retirement plans were not within the scope of SFAS-157. The disclosures
  about the plan assets required are effective for fiscal years ending after
  December 15, 2009, with early adoption permitted. Upon initial adoption disclosures
  are not required for earlier periods that are presented for comparative
  periods. The Company does not expect that the adoption of this standard will
  have a material effect on its consolidated financial statements.                          
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | EITF 07-05  Whether an Instrument or Embedded Feature is Indexed to
  an Entitys own Stock (EITF 07-05)                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
| | This new
  standard states that a Company is required to assess whether an equity
  instrument, denominated in a currency other than its own measurement
  currency, is a derivative financial instrument or an embedded derivative.
  This standard is effective for interim and annual financial statements for
  periods beginning on or after December 15, 2008. Early adoption is
  prohibited. The Company will adopt EITF 07-05 for US GAAP purposes on January
  1, 2009 as required and is currently evaluating the impact of this standard.                                                                                                                                                                                  

109

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                    |                            
|------------------- | ---------------------------
|December 31,
  2008 | (expressed in U.S. dollars)

25. RECONCILIATION OF GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES (CONTD)

If US GAAP were followed, the significant variations on the
consolidated statements of loss and comprehensive loss would be as summarized
in the table below.

|                                                                |  |      |             |      |  |             |   |  |             |  
|--------------------------------------------------------------- |  | ---- | ----------- | ---- |  | ----------- | - |  | ----------- | -
|                                                                |  | 2008 |             | 2007 |  | 2006        |  
|                                                                |  | $    |             | $    |  | $           |  
|                                                                |  |      |             |      |  |             |  
|                                                                |  |      |             |      |  |             |   |  |             |  
|Loss for the
  year, Canadian GAAP                              |  |      | (28,356,265 | )    |  | (14,220,404 | ) |  | (14,252,382 | )
|Adjustment
  for release of escrow shares (i)                   |  |      |            |      |  |            |   |  | (235,068    | )
|Adjustment
  for stock based compensation (ii)                  |  |      |            |      |  |            |   |  |            |  
|Adjustment
  to accretion of interest expense (iii)             |  |      |            |      |  |            |   |  | (81,560     | )
|Adjustment
  for other assets (iv)                              |  |      |            |      |  |            |   |  | (100,637    | )
|Adjustment
  for long-term deferred asset (vi)                  |  |      | 196,855     |      |  | (998,008    | ) |  |            |  
|                                                                |  |      |             |      |  |             |   |  |             |  
|Loss for the
  year, US GAAP                                    |  |      | (28,159,410 | )    |  | (15,218,412 | ) |  | (14,669,647 | )
|                                                                |  |      |             |      |  |             |   |  |             |  
|                                                                |  |      |             |      |  |             |   |  |             |  
|Unrealized
  gain/(losses) on foreign currency translation (vi) |  |      | (6,842,029  | )    |  | 6,212,222   |   |  | (354,810    | )
|                                                                |  |      |             |      |  |             |   |  |             |  
|Comprehensive
  loss for the year, US GAAP                      |  |      | (35,001,439 | )    |  | (9,006,190  | ) |  | (15,024,457 | )
|                                                                |  |      |             |      |  |             |   |  |             |  
|                                                                |  |      |             |      |  |             |   |  |             |  
|Weighted
  average number of common shares outstanding          |  |      | 211,448,521 |      |  | 189,573,764 |   |  | 153,685,553 |  
|                                                                |  |      |             |      |  |             |   |  |             |  
|                                                                |  |      |             |      |  |             |   |  |             |  
|Basic and
  diluted loss per common share, U.S. GAAP            |  |      | (0.13       | )    |  | (0.08       | ) |  | (0.10       | )
|                                                                |  |      |             |      |  |             |   |  |             |  

|                                             |  |      |            |      |  |            |  
|-------------------------------------------- |  | ---- | ---------- | ---- |  | ---------- | -
|                                             |  | 2008 |            | 2007 | 
|                                             |  | $    |            | $    | 
|                                             |  |      |            |      | 
|Total
  assets, Canadian GAAP                |  |      | 34,520,383 |      |  | 58,935,644 |  
|Adjustment for other assets (iv)             |  |      |           |      |  |           |  
|Adjustment for long-term deferred asset (vi) |  |      | (608,413   | )    |  | (998,008   | )
|                                             |  |      |            |      |  |            |  
|                                             |  |      |            |      |  |            |  
|Total assets, US GAAP                        |  |      | 33,911,970 |      |  | 57,937,636 |  
|                                             |  |      |            |      |  |            |  

110

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                    |                            
|------------------- | ---------------------------
|December 31,
  2008 | (expressed in U.S. dollars)

25. RECONCILIATION OF GENERALLY ACCEPTED
ACCOUNTING PRINCIPLES (CONTD)

|                                                               |  |      |            |      |  |            |  
|-------------------------------------------------------------- |  | ---- | ---------- | ---- |  | ---------- | -
|                                                               |  | 2008 |            | 2007 | 
|                                                               |  | $    |            | $    | 
|Total
  shareholders equity, Canadian GAAP                    |  |      | 22,162,298 |      |  | 51,164,974 |  
|Adjustment for allocation of proceeds of convertible debt (iv) |  |      |           |      |  |           |  
|Adjustment for long-term deferred asset (vi)                   |  |      | (608,413   | )    |  | (998,008   | )
|                                                               |  |      |            |      |  |            |  
|Total shareholders equity, US GAAP                            |  |      | 21,553,885 |      |  | 50,166,966 |  
|                                                               |  |      |            |      |  |            |  

|                                                            |  |      |            |      |  |             |   |  |             |  
|----------------------------------------------------------- |  | ---- | ---------- | ---- |  | ----------- | - |  | ----------- | -
|                                                            |  | 2008 |            | 2007 |  | 2006        |  
|                                                            |  | $    |            | $    |  | $           |  
|                                                            |  |      |            |      |  |             |  
|Cash flows
  used in operating activities per Canadian GAAP |  |      | (3,186,228 | )    |  | (10,809,770 | ) |  | (9,402,744  | )
|Adjustment
  for long-term deferred assets (vi)             |  |      |           |      |  | (859,000    | ) |  |            |  
|                                                            |  |      |            |      |  |             |   |  |             |  
|Cash flows
  used in operating activities per US GAAP       |  |      | (3,186,228 | )    |  | (11,668,770 | ) |  | (9,402,744  | )
|                                                            |  |      |            |      |  |             |   |  |             |  
|Cash flows
  used in financing activities per Canadian GAAP |  |      | 5,419,366  |      |  | 24,008,567  |   |  | 27,641,031  |  
|Adjustment
  for long-term deferred assets (vi)             |  |      |           |      |  | 359,000     |   |  |            |  
|                                                            |  |      |            |      |  |             |   |  |             |  
|Cash flows
  used in financing activities per US GAAP       |  |      | 5,419,366  |      |  | 24,367,567  |   |  | 27,641,031  |  
|                                                            |  |      |            |      |  |             |   |  |             |  
|                                                            |  |      |            |      |  |             |   |  |             |  
|Cash flows
  used in investing activities per Canadian GAAP |  |      | (3,616,962 | )    |  | (21,018,846 | ) |  | (10,399,843 | )
|Adjustment
  for long-term deferred asset (vi)              |  |      |           |      |  | 500,000     |   |  |            |  
|                                                            |  |      |            |      |  |             |   |  |             |  
|Cash flows
  used in investing activities per US GAAP       |  |      | (3,616,962 | )    |  | (20,518,846 | ) |  | (10,399,843 | )
|                                                            |  |      |            |      |  |             |   |  |             |  

The non-controlling interest under accounting principles generally
accepted in Canada is the same as the non-controlling interest under the
accounting principles generally accepted in the United States.

111

---



Dynamotive Energy Systems Corporation

NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS

|                    |                            
|------------------- | ---------------------------
|December 31,
  2008 | (expressed in U.S. dollars)

26. SUBSEQUENT EVENTS

Subsequent to
the year end, during the period from January 1 to June 29, 2009, the Company agreed
to issue 18,756,605 common shares for total proceeds of $3,751,321 ($1,280,026
in cash, $500,000 from short-term debt due to a director of the Company and
$1,971,295 in settlement of outstanding accounts payable), relating to a
private placement commencing during the fourth quarter of 2008. The proceeds
were received and the issuance of the related shares is expected to occur in
July, 2009 after the Companys statutory filings are brought up-to-date and a
regulatory order restricting share issuances imposed on the Company on account
of the late filings has been lifted.

27. COMPARATIVE FIGURES

Certain comparative figures have been reclassified in order to conform
with the presentation adopted in the current year.

112

---



ITEM 18. FINANCIAL STATEMENTS

Not
applicable.

ITEM 19. EXHIBITS

|        |  |                                                                                                                                                                                                                                                                                            
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Exhibit Description                                                                                                                                                                                                                                                                        
|        |  |                                                                                                                                                                                                                                                                                            
|1.1     |  | Memorandum
  of Dynamotive Technologies Corporation, as amended to August 15, 2000 (filed
  as Exhibit 3.1 to the Companys Quarterly Report on Form 10-QSB filed on
  August 15, 2000 and incorporated herein by reference.)                                                              
|        |  |                                                                                                                                                                                                                                                                                            
|1.2     |  | Amendment to
  the Memorandum of Dynamotive Energy Systems Corporation, dated July 3, 2001
  (filed as Exhibit 3.1(b) to the Companys Quarterly Report on Form 10-Q filed
  on August 14, 2001 and incorporated herein by reference.)                                                     
|        |  |                                                                                                                                                                                                                                                                                            
|1.3     |  | Articles of
  Dynamotive Technologies Corporation, as amended to date (filed as Exhibit 3.2
  to the Companys Quarterly Report on Form 10-QSB filed on August 15, 2000 and
  incorporated herein by reference.)                                                                           
|        |  |                                                                                                                                                                                                                                                                                            
|1.4     |  | Notice of
  Alteration to the authorized share structure of the Company as filed with the
  British Columbia Corporate and Personal Property Registries on October 28,
  2004 (filed as an exhibit to the Companys Form 20-F filed on May 30, 2005
  and incorporated herein by reference)
|        |  |                                                                                                                                                                                                                                                                                            
|1.5     |  | Notice of
  Alteration to the Articles of the Company as filed with the British Columbia
  Corporate and Personal Property Registries on November 24, 2005 (filed as an
  exhibit to the Companys Form 20-F filed on June 29, 2006 and incorporated
  herein by reference)                
|        |  |                                                                                                                                                                                                                                                                                            
|1.6     |  | Copy of the
  Limited partnership Agreement establishing the West Lorne BioOil
  Co-Generation LP referred to the Consortium Master Agreement filed under 4.6
  below                                                                                                                      
|        |  |                                                                                                                                                                                                                                                                                            
|4.1     |  | Sustainable
  Development Technology Canada Contribution Agreement dated as of March 5,
  2004 (filed as an exhibit to the Companys Form 20-F filed on June 1, 2004
  and incorporated herein by reference)                                                                               
|        |  |                                                                                                                                                                                                                                                                                            
|4.2     |  | Modification
  No. M1 to the Sustainable Development Technology Canada Contribution
  Agreement dated as of April 6, 2004 (filed as an exhibit to the Companys
  Form 20-F filed on June 1, 2004 and incorporated herein by reference)                                                    
|        |  |                                                                                                                                                                                                                                                                                            
|4.3     |  | Loan
  Agreement between Memorial Gift Trust, James Acheson and the Company dated
  June 3, 2003 (filed as an exhibit to the Companys Form 20-F filed on June 1,
  2004 and incorporated herein by reference)                                                                             
|        |  |                                                                                                                                                                                                                                                                                            
|4.4     |  | Technology
  Partnerships Canada Agreement dated July 29, 1997 including amendments dated
  February 2, 1998 to August 29, 2003 (filed as an exhibit to the Companys
  Form 20-F filed on June 1, 2004 and incorporated herein by reference)                                              
|        |  |                                                                                                                                                                                                                                                                                            
|4.5     |  | Amendment to
  the Technology Partnerships Canada Agreement dated November 23, 2004 (filed
  as an exhibit to the Companys Form 20-F filed on May 30, 2005 and
  incorporated herein by reference)                                                                                        
|        |  |                                                                                                                                                                                                                                                                                            
|4.6     |  | Consortium
  Master Agreement dated February 11, 2004 (filed as an exhibit to the
  Companys Form 20-F filed on May 30, 2005 and incorporated herein by
  reference)                                                                                                                      
|        |  |                                                                                                                                                                                                                                                                                            
|4.7     |  | Alliance
  Agreement with UMA Engineering Ltd. dated January 29, 2004 (filed as an
  exhibit to the Companys Form 20-F filed on May 30, 2005 and incorporated
  herein by reference)                                                                                                      

113

---



|        |  |                                                                                                                                                                                                                                                                                                   
|------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Exhibit Description                                                                                                                                                                                                                                                                               
|        |  |                                                                                                                                                                                                                                                                                                   
|        |  |                                                                                                                                                                                                                                                                                                   
|4.8     |  | Loan
  Agreement between Environmental Engineering & Consultants Limited and the
  Company dated November 3, 2004 (filed as an exhibit to the Companys Form
  20-F filed on May 30, 2005 and incorporated herein by reference)                                                                   
|        |  |                                                                                                                                                                                                                                                                                                   
|4.9     |  | Settlement
  Agreement between Magellan Aerospace Limited, West Lorne BioOil Co-Generation
  LP and the Company dated December 10, 2004 (filed as an exhibit to the
  Companys Form 20-F filed on May 30, 2005 and incorporated herein by
  reference)                                           
|        |  |                                                                                                                                                                                                                                                                                                   
|4.10    |  | Convertible
  Note Agreement between Paul Hughes, COO and the Company dated May 31, 2005
  (filed as an exhibit to the Companys Form 20-F filed on June 29, 2006 and
  incorporated herein by reference)                                                                                         
|        |  |                                                                                                                                                                                                                                                                                                   
|4.11    |  | Executive
  Services Agreement with Andrew Kingston dated August 1, 2004 and Amended
  Executive Services Agreement with Andrew Kingston dated September 29, 2004
  (filed as an exhibit to the Companys Form 20-F filed on June 29, 2006 and
  incorporated herein by reference)                
|        |  |                                                                                                                                                                                                                                                                                                   
|4.12    |  | Executive
  Services Agreement with Richard Lin dated August 1, 2004 and Amended
  Executive Services Agreement with Richard Lin dated September 29, 2004 (filed
  as an exhibit to the Companys Form 20-F filed on June 29, 2006 and
  incorporated herein by reference)                        
|        |  |                                                                                                                                                                                                                                                                                                   
|4.13    |  | Executive
  Services Agreement with Brian Richardson dated October 1, 2005 (filed as an
  exhibit to the Companys Form 20-F filed on June 29, 2006 and incorporated
  herein by reference)                                                                                                       
|        |  |                                                                                                                                                                                                                                                                                                   
|4.14    |  | Executive
  Services Agreement with Jan Barynin dated May 17, 2004 (filed as an exhibit
  to the Companys Form 20-F filed on June 29, 2006 and incorporated herein by
  reference)                                                                                                               
|        |  |                                                                                                                                                                                                                                                                                                   
|4.15    |  | Shareholder
  Agreement with Pendana Limited BVI and Dynamotive Biomass Resource
  Corporation dated September 22, 2006 (filed as an exhibit to the Companys
  Form 20-F filed on June 29, 2007 and incorporated herein by reference)                                                            
|        |  |                                                                                                                                                                                                                                                                                                   
|4.16    |  | Joint
  Venture Agreement with Pendana Limited BVI and Dynamotive Europe Limited
  dated September 22, 2006 (filed as an exhibit to the Companys Form 20-F
  filed on June 29, 2007 and incorporated herein by reference)                                                                        
|        |  |                                                                                                                                                                                                                                                                                                   
|4.17    |  | Consulting
  Agreement with Desmond Radlein, Ph. D dated December 8, 2006 (filed as an
  exhibit to the Companys Form 20-F filed on June 29, 2007 and incorporated
  herein by reference)                                                                                                        
|        |  |                                                                                                                                                                                                                                                                                                   
|4.18    |  | Executive
  Services Agreement with Anton Kuipers dated January 16, 2007 (filed as an
  exhibit to the Companys Form 20-F filed on June 29, 2007 and incorporated
  herein by reference)                                                                                                         
|        |  |                                                                                                                                                                                                                                                                                                   
|4.19    |  | Loan
  Agreement with Dynamotive Biomass Resource Corporation dated September 30,
  2006 (filed as an exhibit to the Companys Form 20-F filed on June 29, 2007
  and incorporated herein by reference)                                                                                           
|        |  |                                                                                                                                                                                                                                                                                                   
|4.20    |  | Loan
  Agreement with Dynamotive Europe Limited dated September 30, 2006 (filed as
  an exhibit to the Companys Form 20-F filed on June 29, 2007 and incorporated
  herein by reference)                                                                                                         
|        |  |                                                                                                                                                                                                                                                                                                   
|4.21    |  | Umberlla
  Amending Agreement by and amongst Erie Flooring & Wood Products and West
  Lorne BioOil Co-generation LP and Dynamotive Energy Systems Corporation dated
  April 5, 2007 (filed as an exhibit to the Companys Form 20-F filed on June
  29, 2007 and incorporated herein by reference)
|        |  |                                                                                                                                                                                                                                                                                                   
|4.22    |  | Engineering,
  and Construction Management Agreements with Tecna S.A. dated July 7, 2006
  (filed as an exhibit to the Companys Form 20-F filed on June 29, 2007 and
  incorporated herein by reference)                                                                                         
|        |  |                                                                                                                                                                                                                                                                                                   
|4.23    |  | DT2
  Engineering, Development Agreements with Tecna S.A. dated July 7, 2006 (filed
  as an exhibit to the Companys Form 20-F filed on June 29, 2007 and
  incorporated herein by reference)                                                                                                     

114

---



|        |  |                                                                                                                                                                                                                                                                                                              
|------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |  | Exhibit Description                                                                                                                                                                                                                                                                                          
|        |  |                                                                                                                                                                                                                                                                                                              
|        |  |                                                                                                                                                                                                                                                                                                              
|4.24    |  | Escrow
  Agreement, dated January 10, 1995, by and among the Company, Montreal Trust
  Company of Canada and the holders of the 3,140,900 escrowed shares (filed as
  Exhibit 10.21 to the Companys Registration Statement on Form SB-2,
  Registration No. 33-98622, and incorporated herein by reference.)
|        |  |                                                                                                                                                                                                                                                                                                              
|4.25    |  | February 9,
  2000 Agreement to Purchase Patents and Rights between Dynamotive Technologies
  Corporation and RTI Resource Transforms International, Ltd., (filed as
  Exhibit 10.28 to the Companys Form 10-QSB filed on May 15, 2000, and
  incorporated herein by reference.)                            
|        |  |                                                                                                                                                                                                                                                                                                              
|4.26    |  | Heads of
  Agreement with Consensus Business Group and Joint Venture Proposal for
  Consensus Business Group dated February 20, 2006 (filed as Exhibit 10.29 to
  the Companys Form 20-F filed on June 29, 2006 and incorporated herein by
  reference)                                                     
|        |  |                                                                                                                                                                                                                                                                                                              
|4.27    |  | Share
  Purchase Agreement with Pendana Limited dated July 25, 2007*                                                                                                                                                                                                                                         
|        |  |                                                                                                                                                                                                                                                                                                              
|4.28    |  | Financial
  Advisory Agreement with Ardour Capital Investments, LLC dated September 28,
  2007*                                                                                                                                                                                                              
|        |  |                                                                                                                                                                                                                                                                                                              
|4.29    |  | Negotiation
  Commitment and Loan Agreement with Biomass Worldwide Limited and Anthony Pius
  Noll dated November 14, 2007*                                                                                                                                                                                  
|        |  |                                                                                                                                                                                                                                                                                                              
|4.30    |  | Executive
  Employment Agreement with David McMillan dated November 19, 2007*                                                                                                                                                                                                                                
|        |  |                                                                                                                                                                                                                                                                                                              
|4.31    |  | Executive
  Employment Agreement with Tom Bouchard dated December 3, 2007*                                                                                                                                                                                                                                   
|        |  |                                                                                                                                                                                                                                                                                                              
|4.32    |  | Demand Loan
  Agreement between between Dynamotive Energy Systems Corp. and Richard Lin
  (Lender) dated December 31, 2008                                                                                                                                                                                 
|        |  |                                                                                                                                                                                                                                                                                                              
|4.33    |  | Share
  Purchase Agreement among Pendana Limited (Pendana) and Dynamotive Energy
  Systems Corp. dated October 24, 2008                                                                                                                                                                                    
|        |  |                                                                                                                                                                                                                                                                                                              
|4.34    |  | Minutes of
  Settlement and Full and Final Mutual Release between Process Group Inc and
  Dynamotive Energy Systems Corp. dated June 20, 2008.                                                                                                                                                               
|        |  |                                                                                                                                                                                                                                                                                                              
|12.1    |  | Certification of chief executive officer                                                                                                                                                                                                                                                                     
|        |  |                                                                                                                                                                                                                                                                                                              
|12.2    |  | Certification of chief financial officer                                                                                                                                                                                                                                                                     
|        |  |                                                                                                                                                                                                                                                                                                              
|13.1    |  | Certification of chief executive officer  Section 906 of the
  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                   
|        |  |                                                                                                                                                                                                                                                                                                              
|13.2    |  | Certification of chief financial officer  Section 906 of the
  Sarbanes-Oxley Act of 2002                                                                                                                                                                                                                   
|        |  |                                                                                                                                                                                                                                                                                                              
|15.1    |  | Audit Committee Charter                                                                                                                                                                                                                                                                                      

115

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*Filed as an exhibit
to our Annual Report on Form 20-F for the period ended December 31, 2007.

SIGNATURES

The registrant hereby
certifies that it meets all of the requirements for filing on Form 20-F and
that it has duly caused and authorized the undersigned to sign this annual
report on its behalf.

|                    |     |                                        
|------------------- | --- | ---------------------------------------
|                    |     | DYNAMOTIVE
  ENERGY SYSTEMS CORPORATION
|Date: July 6, 2009. |     |                                        
|                    | By: | /s/ R. Andrew Kingston                 
|                    |     |                                        
|                    |     | R. Andrew Kingston                     
|                    |     | President and Chief
  Executive Officer

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