While most people don’t often think about what’s happening at the Tax Court of Canada, taking the time to read through their website can yield some gold nuggets of useful SR&ED eligibility information. Throughout the SREDucation.ca Gold Nugget series, I’ll dig up some of the most informative hearings and judgements from the Tax Court of Canada, as they can help answer some of the most frequently asked questions regarding the SR&ED program.
A frequent question we hear at The InGenuity Group is:
“Someone else has already built a similar product, is my work still eligible?”
The answer is a resounding yes!
There are a few assumptions to clear up. First, I’m going to assume that you are doing SR&ED-eligible work–namely, you’ve met the other eligibility criteria regarding Uncertainty, Advancements, Systematic Investigation, etc. The only issue is that the company next door has a product that does exactly the same thing.
For all its faults, the Canada Revenue Agency was savvy enough to take ‘business context‘ into account when developing the SR&ED program. They recognize that, while someone else may have a similar product, the information regarding how the product achieves its goal (i.e., the process) is proprietary. Consequently, two organizations may be next door to each other developing a product that produces the same result, but each organization will do so in a different way.
CRA Documents Re: Business Context
In the CRA’s IC86-4R3, which used to serve as the primary document for determining SR&ED eligibility, the specific wording is as follows:
Scientific research and experimental development varies in content as well as complexity in a given field. The technical uncertainties encountered by one taxpayer may well be looked upon as facts easily obtained by another. The judgment as to eligibility should be made within the context of a single company and its field of business. Specifically, the activities undertaken to resolve technical uncertainties are eligible if the taxpayer cannot obtain the solutions through commonly available sources of knowledge and experience in the business context of the firm. We expect that any firm claiming expenditures for scientific research and experimental development activities will have or will access the expertise necessary to carry out a viable program. [Emphasis added]
In the IC86-4R3’s modern equivalent, Eligibility of Work for SR&ED Investment Tax Credits Policy, the wording focuses on the scientific or technological advancement achieved by a particular company to address a corresponding uncertainty:
Scientific or technological uncertainty means whether a given result or objective can be achieved or how to achieve it, is not known or determined on the basis of generally available scientific or technological knowledge or experience.
Technological advancement moves the scientific or technological knowledge base of a company to a higher level through an increase in the understanding of technology. In other words, it is a discovery or gain in understanding of technological principles, techniques, and concepts beyond the existing scientific or technological knowledge base. [Emphasis added]
In plain language, the CRA:
- Understands that what is perceived as a “technical uncertainty” varies by organization;
- Considers technical uncertainties to be eligible if you have exhausted publicly available sources of information both external (ex. searchers in journals, online, etc.) and internal (ex. knowledge and experience of team);
- Expects you will hire / contract appropriate individuals if the expertise is not available in-house; and
- Will consider the eligibility only within the context of a single company and its field of business
Wait, but my reviewer said…?
Scientific Research and Experimental development activities need to be assessed for eligibility in the context of what technical information was available to the taxpayers at the time the SR&ED occurred. The determination of what is and what is not SR&ED work in any industry is a context dependent subjective decision. Without any specific science audit guidelines to follow, each decision will be based on the reviewer’s experience, standards, work ethics, and training. Even with guidelines, without a process to implement the guidelines, people revert back to their own standards base, which may or may not be appropriate for the review under consideration. [Emphasis added]
Court Cases Regarding Business Context in SR&ED
To further illustrate that this is a point of contention, there are many Tax Court of Canada rulings regarding the “business context”. The earliest we found was Northwest Hydraulic Consultants Ltd. v. The Queen, 1998 3 C.T.C. 2520, 98 D.T.C. 1839 (TCC) ruling:
[a] technological advance in Canada does not cease to be one merely because there is a theoretical possibility that a researcher in, say, China, may have made the same advancement but his or her work is not generally known.
More recently, in the 2008 ruling on Logitek Technology Ltd. v. M.N.R., 2008 TCC 331 (read more about the case in our Logitek Part One and Part Two posts), the judge specifically commented on this point:
 If a taxpayer undertakes SR&ED activities to solve a technological problem, the activities should qualify, even if those SR&ED activities were not necessary because there was an existing solution in the marketplace that the taxpayer was not aware of. I think the wording of the definition of SR&ED in the statute supports this view, and I quote from the relevant definition in the statute: “work undertaken for the purpose of achieving technological advance.” The emphasis in the statute on the purpose of the work suggests that the SR&ED activity should qualify based on what the taxpayer was trying to achieve, and the means that the taxpayer used to do so. It should not be disqualified merely because there was a solution available in the marketplace if the taxpayer was unaware of it. [Emphasis added]
Even better, in the same case the judge took great pains to highlight this point in his summary, almost reprimanding Mr. Dutch, who wrote the science report for the CRA:
 […] I would comment briefly that I have some difficulty with some of the reasoning in Mr. Dutch’s report. Specifically, it appears that Mr. Dutch may have approached the problem on the basis that activities would not qualify as SR&ED if there was an existing computer program in the market that solved the technological problem that was identified by Logitek. It is not entirely clear to me that Mr. Dutch took this approach, but if he did, I have some difficulty with it because I do not think that the statutory provisions are so restrictive.
While this comment is cause for optimism, it should also be viewed with caution as the taxpayer must clearly demonstrate that they have done their due diligence.
How can I demonstrate that I met the requirements of SR&ED Eligibility?
When starting any business or research project, one (theoretically) begins by seeing what is publicly available that could be used in order to reduce wasted effort and to avoid duplication. The same holds true in all potential SR&ED-eligible projects. Be sure to regularly perform and document your searches in the following areas:
- Internet searches, incl. blogs, discussion forums, whitepapers, etc.
- Professional journals, publications, events and presentations
- Industry-specific associations & their resources
- Government reports, regulations, and technical papers
- Recognized sources of techniques and methods specific to your industry
- Any other sources of information regarding processes, methods, techniques, etc. that you can publicly access.
The burden of proof will lie with the taxpayer. Consequently, it’s encouraged that you regularly consult these (and other) sources to see if there are any updates. Remember as well, that it’s important to have the right employees/contractors at your disposal, as originally outlined in the IC97-1–Administrative Guidelines for Software Development–(para 3.2):
A technological uncertainty arises when the solution is not readily apparent to appropriately skilled and experienced software developers. Uncertainties that arise from lack of diligence or lack of appropriate expertise, such as the failure to use commonly available information, or lack of programming knowledge are not technological uncertainties and relevant to eligibility. As well, the tax credits are not to serve as incentives simply for training or learning on the job but for efforts to develop new or improved technologies through experimental development or research. [Emphasis added]
This is echoed in the Eligibility of Work for SR&ED Investment Tax Credits Policy, which states:
It is expected that the work will be performed or directed by qualified individuals who are knowledgeable in the field and have relevant experience in science, technology, or engineering. Note that qualification is not necessarily limited to formal training, but includes skills and knowledge gained through experience. [Emphasis added]
To summarize, even if your neighbour is devloping the same product as you, it shouldn’t matter when the CRA assesses the eligibility of your project–unless your neighbour’s is an open-source product! That being said, having a binder of documentation that provides evidence of your due diligence and the experience of your team will help reduce the risk of this becoming an issue.
This article is presented only for informational purposes and does not constitute legal advice. You should retain legal counsel if you require legal advice regarding your individual situation.