Updated to Reflect New Policies (2022)
*** Some of the policies referenced were updated 2021-08-13. This article has been updated and is accurate as of 2022. ***
Does accidental SR&ED exist?
Would a new process, or product discovered entirely by accident qualify for the SR&ED tax incentive program?
Throughout the years, new innovations or inventions have been created sometimes as the result of an accidental discovery. Penicillin, a life-saving anti-bacteria medicine, was discovered when a scientist found a new substance growing in their Petrie dish by chance. The audio cassette player also took recording engineers decades to perfect through a series of serendipitous events.1
This article will look at the question of whether or not an accidental discovery or research that is serendipitous in nature could qualify for an SR&ED tax incentive and what else the federal government has done to encourage scientific and technological advances that are a result of pure luck.
Can Accidental Discoveries in Science and Technology Qualify for SR&ED?
Whether work related to an accidental discovery in science and technology can qualify for SR&ED depends on how the work that resulted in the discovery was carried out. The now archived Eligibility of Work for SR&ED Investment Tax Credits Policy provided an example of accidental discovery. The principle of the transistor was an accidental discovery, but because it of how it was developed it was SR&ED eligible:
One example of experimental development is the work that came about from the discovery of the principle of the transistor. It resulted in the development of devices that used this principle to create solid-state amplifiers and other devices. The development of technology to make devices and eventually products using this discovery was done through experimental development. The applied research was rapidly followed by the development of working prototypes and eventually by practical techniques to make a new product—the transistor. Developing a transistor after discovering the principle of the transistor did not advance scientific knowledge. It did, however, advance technology (the practical application of scientific knowledge and principles).2
In this circumstance, the devices developed from the principle of the transistor would qualify for SR&ED for two reasons. First of all, they were developed using the process of experimental development, which is “work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto.”3 Secondly, systematic investigation or search was conducted to develop these devices. systematic investigation or search is defined as “an approach that includes defining a problem, advancing a hypothesis towards resolving that problem, planning and testing the hypothesis by experiment or analysis, and developing logical conclusions based on the results.”4 However, would a discovery that came about by accident alone qualify for the SR&ED tax credit?
Karl Lavoie, a media spokesperson for the Canada Revenue Agency (CRA), confirmed that no, entirely accidental discoveries would not be eligible for SR&ED. Lavoie points to subsection 248(1) of the Income Tax Act to explain that “SR&ED is defined as systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis. Non-systematic research would not be eligible for the SR&ED Tax Incentive Program.” 5 That means if you discovered a new substance in a Petrie dish, and did not carry out a systematic investigation with the intent to discover something else as a part of a larger experimental development effort, the accidental discovery in and of itself would not qualify for the SR&ED tax credit. Therefore as an accidental discovery would not involve systematic research, it would not be eligible for SR&ED; however, if a new discovery was made in the process of performing systematic investigation, this would qualify for SR&ED.
Avoiding “Trial and Error”
What the CRA is hoping to avoid is having companies develop new products or processes through “trial and error”. However, in developing a new product or process, if you have an idea that results from your intuition, you can still use it in your SR&ED work. As Lavoie stated, referencing the Eligibility of Work for SR&ED Investment Tax Credits Policy, “the need for a systematic investigation or search does not preclude ideas that result from intuitive processes. These ideas can lead to hypotheses for testing that are [a] part of experimental development.” 6
This means that within a systematic investigation or search, creativity and intuition can lead to the formulation of a hypothesis. This hypothesis must still be tested within the framework of experimental development as defined in the Income Tax Act. It is also important to note that the results of experimental development can be unexpected. However, the work leading to these results must be a systematic investigation or search, and not trial and error.7
“Trial and error” was defined in the Eligibility of Work for SR&ED Investment Tax Credits Policy as follows:
Trial and error involves executing a series of tests in no particular order and not part of a systematic plan. The objective in such a case is to resolve a functional problem rather than to address a problem in the underlying technology that may have caused this functional problem. The lesson learned in each attempt of trial and error is simply that “an option did not work.” There is no further analysis of the reason why it did not work to make the lesson applicable in a broader sense. The test conditions that are judged to be the most effective in resolving the immediate problem are chosen for the next attempt, and the process simply moves from attempt to attempt without trying to understand or address the problem associated with the underlying technology. Solving problems by trial and error is not experiment or analysis within the framework of a systematic investigation or search. 8
Even though the Eligibility of Work for SR&ED Investment Tax Credits Policy was archived and replaced by the Guidelines on the eligibility of work for scientific research and experimental development (SR&ED) tax incentives in August of 2021, the policy document is still an important source of information and is still reference in the courts during legal proceedings. A recent example since the change is the case of National R&D Inc. v. The Queen (2022), in which the Appellant argued that since the SR&ED Eligibility Policy has been archived, the content in it should not be admissible in court, however the Judge disagreed stating “a misunderstanding of the relationship between the courts and legislation” and that “Parliament and the legislatures rely on the courts to give definition, amplitude and precision to statutory language as required by the circumstances of the case. The resulting understanding of legislation as expressed in the jurisprudence is not an improper exercise of judicial legislation, rather it is precisely what courts are required to do.”9
Are There Examples of Accidental Discoveries That Have Qualified for SR&ED Work?
The transistor was an accidental discovery that would have been eligible for SR&ED;10 but have there been any other accidental discoveries that would have qualified for the SR&ED tax credit in Canada? Unfortunately, the CRA did not wish to answer this question, citing confidentiality provisions in the Income Tax Act that prohibit them from providing any details about taxpayers that have claimed the SR&ED tax credit or any information that could possibly identify such taxpayers.11 However, any new, accidental processes or products would have been developed under the context of experimental development and systematic research, and not just pure serendipity.
Has the Federal Government Funded Serendipitous Research in the Past?
The federal government has previously funded serendipitous research. During the early 2000s, the Canada Council for the Arts (CCA) and the National Research Council Canada (NRC) jointly created an artist-in-residence pilot program called AIRes that paired artists and NRC facility researchers together.12 The program was meant to increase creativity in research, artistic or otherwise, and there were no expectations that anything would ever be created – either a new piece of artwork or a new product or process. As Katherine Watson, who ran the program at the Canada Council for the Arts, noted at the time, “I wanted to open up the possibilities for just about anything. I wanted to be sure that whatever the outcomes were, they were outcomes that came out of collaboration.” 13
The AIRes program, which in a sense was designed to foster accidental artistic or scientific discoveries, was controversial and was undertaken as the federal government was confronted with the “Sponsorship Scandal” that uncovered corruption in how money was being spent on government contracts, which played a large role in the defeat of the Liberal party in the 2006 election.14 Walter Robinson, who was the federal director of Ottawa’s Canadian Taxpayers Federation (CTF), said that “innovation is not necessarily the result of accidental discovery” and that the hundreds of thousands of dollars spent on the AIRes program “could be better spent funding pure and applied research. From [the] point of view [of the CTF], this is just a colossal waste.” 15 Claude Schryer, who helped design the AIRes program at the Canada Council, stated that the program was cancelled in 2004 “due to budgetary restrictions by the [CCA and NRC].” 16
Summary – Accidental SR&ED: When it’s Eligible, and When it’s Not.
In conclusion, an unexpected discovery may qualify for the SR&ED tax incentive program if it was uncovered as the result of experimental development, including a systematic search, possibly while meaning to uncover something else. Intuition or another creative process can also be used to create a hypothesis that may lead to a surprising result that was not intended. If you use a systematic method of research and test your hypotheses in the context of experimental development, your new product or process is likely to qualify for SR&ED. However, discovering a new process or product simply by chance, outside of experimental development without conducting any systematic research, or through what is known as “trial and error,” would not be considered as scientific research and experimental development, and would lead to an SR&ED claim being rejected.