Analysis of 2019 SR&ED Legal Rulings
In 2019, there were sixteen legal rulings that dealt with scientific research and experimental development (SR&ED). In this post we will do an analysis of the legal rulings and how lessons learned from others can help you with your future SR&ED claims.
Out of sixteen rulings, only five were successful or partially successful for the claimant. These rulings are as follows: A & D Precision Limited v. The Queen (2019), CRL Engineering Ltd. v. The Queen (2019), PCI Géomatics Entreprises inc. c. Agence du Revenu du Québec (2019), Deans Knight Income Corporation v. The Queen (2019), and Béton Mobile du Québec Inc. c. The Queen (2019). The last case, Beton Mobile, was only partially successful.
Common Issues
Our analysis of the 2019 SR&ED legal rulings showed a few main themes:
- Technological uncertainty. This concept was the biggest challenge faced by taxpayers and appeared in four rulings.
- General anti-avoidance rule (GAAR). This concept was an issue in three separate cases.
- Technological advancement. This concept was an issue in three cases.
- Documentation. This concept was an issue in two cases.
- Fraud. This concept was an issue in two cases.
- “Trial and error”. This concept was an issue in two cases.
Technological Uncertainty
The CRA defines technological uncertainty as:
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.1
Additionally, the CRA explains:
Technological uncertainties may arise from shortcomings or limitations of the current state of technology that prevent a new or improved capability from being developed. In other words, the current state of technology may be insufficient to resolve a problem.2
Technological uncertainty is the most common theme among the 2019 SR&ED legal rulings. In 2019, three of the rulings dealing with technological uncertainty were unsuccessful and one was only partially successful. The appellants were unable to prove they had identified a technological uncertainty and sought to reduce or eliminate that uncertainty through experimentation or analysis in all of their projects.
In one of the losing cases, Dock Edge + Inc. v. The Queen (2019), the judge stated that there was a lack of evidence to show a technological uncertainty which could not be resolved through routine engineering or standard practice:
I have found in this matter that there was lack of evidence as to whether there were technical risks or uncertainties, essentially due to lack of evidence as to what constituted routine engineering and standard procedures for the relevant technologies.3
Another losing case, Clevor Technologies Inc. v. The Queen (2019), the judge ruled that:
Thus, I do not find here evidence sufficient to permit the conclusion that in dealing with the API issue, SR&ED was engaged in. The Appellant had not identified any technological uncertainty, which requires a testing procedure other than a standard process or routine engineering. The procedure the Appellant chose to follow was the technique of trial and error, a procedure undoubtedly known by professionals competent in the field. As well there was a dearth of evidence as to any testing results.4
In one of the winning cases, A & D Precision Limited v. The Queen (2019), the judge stated:
In my view, considering the evidence as a whole and as well the submissions of the respective parties and experts, A&D in determining to manufacture the 80 ton Matteo did face a technological uncertainty, being system uncertainty.5
For those who are not familiar with the term, this is what the judge means by system uncertainty:
can arise from or during the integration of technologies, the components of which are generally well known. This is due to unpredictable interactions between the individual components or sub-systems. It may be difficult or impossible to predict how the integrated system will perform due to unforeseeable adverse interactions. The uncertainty here is not in the individual modules or components, but in the modules or components acting as an integrated system.2
Technological Advancement
The CRA defines technological advancement as:
Scientific or technological advancement is the generation of information or the discovery of knowledge that advances the understanding of scientific relations or technology.7
Additionally, the CRA states:
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.2
Technological advancement was an issue in three cases in 2019. Out of these three cases, one was successful, one partially successful, and one was unsuccessful. The work performed must also increase the overall industry’s knowledge base through scientific or technological advancement. Please see the Eligibility of Work for SR&ED Investment Tax Credits Policy for more information.
In CRL Engineering Ltd. v. The Queen (2019), the judge states:
There is necessarily a fine line between a “technological advancement” or “incremental improvements” to existing materials, devices, products or processes. This suggests that the Appellant need not prove that its activities were novel, but rather that there were incremental improvements to existing technology.9
In Dock Edge + Inc. v. The Queen (2019), the judge ruled:
a technological advancement is achieved actually when general knowledge has been advanced through application of the scientific method.3
In Béton Mobile du Québec Inc. c. La Reine (2020), the judge ruled:
I am not convinced that, on a balance of probabilities, BMQ has attempted to resolve scientific uncertainties using a systematic investigation to achieve advancement or scientific progress.11
General Anti-Avoidance Rule (GAAR)
The General Anti-Avoidance Rule (GAAR) is set out in Section 245 in the Income Tax Act.
The CRA states:
Subsection 245(2) states that where a transaction is an avoidance transaction, the tax consequences to a person shall be determined as is reasonable in the circumstances in order to deny a tax benefit that would result from that transaction or from a series of transactions that includes that transaction.
An avoidance transaction is defined in subsection 245(3) as a single transaction or one that is a part of a series of transactions where the single transaction or the series results directly or indirectly in a tax benefit, unless the transaction is carried out primarily for bona fide purposes other than to obtain the tax benefit.12
In the cases where the GAAR was determined to be the issue, the appellants were perceived to have intentionally avoided the payment of taxes under Section 245 of the Income Tax Act. Two appeals were dismissed and one was a win. Deans Knight Income Corporation v. The Queen (2019) was a win but the other two appeals, Madison Pacific Properties Inc. v. Canada (2019) and Total Energy Services Inc. v. The Queen (2019) were both losses.
Key Rulings Cited as Precedence
Northwest Hydraulic Consultants v. The Queen (1998)
In eight of the sixteen cases last year, the judges used Northwest Hydraulic Consultants v. The Queen (1998) as legal precedence. In all eight of these cases the judges cited the Five Questions of Eligibility which Justice Bowman had laid out his ruling:
1. Is there a technical risk or uncertainty?
2. Did the person claiming to be doing SRED formulate hypotheses specifically aimed at reducing or eliminating that technological uncertainty?
3. Did the procedures adopted accord with established and objective principles of scientific method, characterized by trained and systematic observation, measurement and experiment, and the formulation, testing and modification of hypotheses?
4. Did the process result in a technological advance, that is to say an advancement in the general understanding?
5. Although the Income Tax Act and the Regulations do not say so explicitly, it seems self-evident that a detailed record of the hypotheses, tests and results be kept, and that it be kept as the work progresses.13
The judges ran through these five questions in regard to the evidence presented to see if the work conducted met all five criteria. If the work failed just one, it is considered to be ineligible for SR&ED investment tax credits. These five questions have been incorporated into the current Eligibility of Work for SR&ED Investment Tax Credits Policy. We have written a blog post on the evolution of those five questions, which can be found here.
Two additional rulings were used legal precedence three times each, C W Agencies Inc. v. Canada (2001) and Zeuter Development Corporation v. The Queen (2006). These rulings were used by the judges to show how Northwest Hydraulic Consultants v. The Queen (1998) and the five questions were implemented in prior cases. In A & D Precision Limited v. The Queen (2019), Dock Edge + Inc. v. The Queen (2019), and Concept Danat Inc. v. The Queen (2019) the judges cited the five questions using C W Agencies Inc. v. Canada (2001) to show further precedence than Northwest Hydraulic Consultants v. The Queen (1998). In the three rulings which Zeuter Development Corporation v. The Queen (2006) was cited, one citation was used in two rulings.
In CRL Engineering Ltd. v. The Queen (2019), the judge cited from Zeuter Development Corporation v. The Queen (2006):
The first step is to determine whether the activities meet the definition of SRED. If they do not, the appeal must be dismissed but if it is determined that the project as a whole is eligible, then the specific expenditures and activities must be vetted against the objectives of the project.14
This concept was also used in Concept Danat Inc. v. The Queen (2019) as precedence:
If the projects do not meet the criteria that they have to in order to be considered SR&ED activities, the examination will end at that stage. However, if it is determined that the activities do meet the definition of SR&ED activities, then it will be necessary to assess the eligibility of an SR&ED expenditure with respect to the specific facts of each project (subsection 37(1)) (Zeuter Development Corporation v. The Queen, 2006 TCC 597 at para. 20, 2007 DTC 41 [Zeuter Development]).15
Full List of Legal Ruling Summaries
(Note: The Legal Rulings Database is available to SR&ED Education and Resources Master Members.)
- Dock Edge + Inc. v. The Queen (2019)
- Madison Pacific Properties Inc. v. Canada (2019)
- Concept Danat Inc. v. The Queen (2019)
- A & D Precision Limited v. The Queen (2019)
- Laforest Marketing Internationals Inc. v. The Queen (2019)
- CRL Engineering Ltd. v. The Queen (2019)
- PCI Geomatics Enterprises Inc. v. Quebec Revenue Agency (2019)
- Deans Knight Income Corporation v. The Queen (2019)
- Exxonmobil Canada Ltd. v. The Queen (2019)
- Total Energy Services Inc. v. The Queen (2019)
- Accurso v. The Queen (2019)
- Gordon v. Canada (2019)
- Clevor Technologies Inc. v. The Queen (2019)
- Kam-Press Metal Products Ltd. v. The Queen (2019)
- Béton Mobile du Québec Inc. c. La Reine (2020)
- CO2 Solution Technologies Inc. vs. The Queen (2019)
Conclusion
In 2019, SR&ED legal rulings were successful 31% of the time. It is a costly and lengthy process to take an issue to trial. If one is able to come to an agreement or arrangement with the CRA versus going to trial it may be more advantageous for all parties involved.