The Canada Revenue Agency (CRA), as per the specifications under the Income Tax Act (ITA), defines Scientific Research and Experimental Development (SR&ED) as a “systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that either falls under the purview of basic research, applied research, or experimental development.” 1

However, neither the SR&ED Glossary nor any other CRA-released information explains the CRA’s understanding of the term “due diligence,” even though it plays a critical role in every step from the inception of your project to the successful resolution of your claim to tax credits.

This article succinctly addresses this issue, in order to promote a deeper understanding of the role played by “due diligence” in SR&ED claims, as well as to give a glimpse of its overwhelming legal advantages.

What is Due Diligence Within the Scope of the SR&ED Tax Incentive?

While this term is never brought up in official material from the CRA or in the ITA, due diligence is nonetheless one of the most important parts of the process during audits (or reviews) by the CRA, meetings with Research and Technology Advisors (RTAs), or in the explanation of uncertainty in the claimant’s forms. Simply put, due diligence is everything that you do between a) encountering a scientific or technological obstacle and b) embarking on systematic experimental research and development (R&D) in order to overcome said obstacle, which then results in a scientific and technological advancement.

Therefore, as it pertains to the SR&ED process, due diligence is the process of comprehensively researching available prospective solutions for the scientific or technological obstacle (STO). These obstacles have been identified during the routine work of the SR&ED claimant from the available knowledge in the scientific or technological public domain as well as the knowledge base of the claimant’s organization. The organization then pursues a systematic investigation into possible solutions in order to ascertain whether or not the STO can be resolved using the technological or intellectual tools and resources already available at hand.

In short, due diligence is the documented elimination of all possible, existing, scientific or technological expertise and knowledge in order to prove that the hypothesis which formed the core of your SR&ED project could not have been resolved using routine engineering methods or commonly known scientific processes.

The thorough documentation of the “due diligence” process allows the claimant to establish the “standard practices” of the relevant fields involved with the STO, as well as prove why those practices wouldn’t work for their particular problem. In this manner, it allows the claimant to systematically prove the existence of the scientific or technological uncertainties which form the core of their SR&ED hypotheses.

Role of Scientific or Technological Knowledge Base in Due Diligence

One of the foremost reasons the CRA insists upon complete and transparent declaration of the claiming organization’s knowledge base for their SR&ED claim is to ensure that all publicly available resources which could have been used by the claimant to pursue thorough “due diligence” have been unearthed, researched, and duly eliminated.

As such, the scientific or technological knowledge base of an organization refers to “the existing level of technology and scientific knowledge, and consists of the knowledge of the resources within the company and sources available publicly.” 2

The internal resources of the company include:

  • The technical knowledge, education, training, and experience of its personnel; and,
  • The technical capabilities of the organization as exemplified by its current products, techniques, practices, and methodologies.

On the other hand, resources and knowledge available in the public domain include:

  • Scientific papers, journals, and other credible publications;
  • Online information sources; and,
  • Expertise which can be hired by the company – academics, consultants, contractors, etc.

Understanding the scope of this definition is vital to the process of due diligence since it specifies resources and resolutions that could possibly be openly available to the claimant organization. Thus, if another organization has encountered a similar obstacle, performed their own R&D, and created patented intellectual property which would be capable of resolving this STO faced by the claimant organization, that isn’t included in publicly available knowledge or expertise. Thus, the claimant organization is still eligible for SR&ED to resolve the identified scientific or technological uncertainty which arose from the STO.

Moreover, if another SR&ED organization has come up with a patented solution for this obstacle and only makes it available to other firms at costs which would be far too expensive for the claiming organization’s needs, the claimant’s R&D efforts into unearthing cheaper alternatives using different processes altogether would still count as SR&ED. This because “a technological uncertainty might arise from the need to meet the cost target, even though a more costly process in known to work.” 3

However, even in such a case, to prove to the CRA that your technological uncertainty arose from the inability of present solutions to meet cost targets, you need to have researched and unearthed said solution, and attempted to resolve your STO through it to first figure out that it would make the end-result far too expensive for you to begin with. Thus, ignoring any aspect of the “due diligence” process can be disastrous, as it could lead to your entire SR&ED claim being invalidated by the CRA.

Legal Advantages of Comprehensive Due Diligence

Les Abeilles Service de Conditionnement Inc. v. The Queen in 2014 stands as a recent and excellent example of the benefits of undergoing comprehensive due diligence.4

Four out of six projects submitted by Les Abeilles for SR&ED credits were geared towards increasing efficiency and cost-effectiveness of the process while retaining quality benchmarks. As such the work was labeled standard practice and routine engineering.

The CRA rejected all claims on the four projects on the grounds that the work involved did not denote a technological uncertainty, and that there wasn’t enough contemporaneous documented evidence of due diligence and SR&ED procedures submitted by the taxpayer to prove otherwise.

The case ended in victory for the taxpayer, on the grounds that tackling system uncertainties in order to meet cost targets did indeed qualify as eligible for SR&ED. However, this case was only won because the taxpayer conducted thorough due diligence which allowed the expert witness (owing to the lack of sufficient documentation) to list the failures of standard practices to resolve the obstacles faced by the organization in their efforts to increase the efficiency of the process. This allowed the presiding judge to establish the inherent technical uncertainty, rather than a simple technical problem, which ultimately resulted in the taxpayer’s victory.

Due Diligence in SR&ED: Final Verdict

Much of the SR&ED work which is undertaken often represents small and infinitesimally gradual progress in scientific or technological advancement – and as such can easily be mistaken for routine engineering or standard processes. This point is especially important since the CRA can declare some or all of SR&ED expenses as ineligible without needing to provide any documented or comprehensive proof of the “routine engineering” or “standard processes” to which it refers in the rejection of the claim. This differs from the American Internal Review Service (IRS), which needs to disclose full information on the standard processes and routine engineering to which it is referring while rejecting an R&D claim.

In order to establish the scope of knowledge provided by “standard processes,” as well as to thoroughly and indisputably prove why those processes were unqualified to resolve the uncertainties inherent in the STO, “due diligence” becomes an indispensable part of the work undertaken before eligible SR&ED can begin. Ignore it at the cost of your business’ future in the field of R&D.

This article is based on CRA policy documents available at the date of publication. Please consult the CRA website for the most recent versions of these documents.

For access to further SR&ED policy compliance aid from industry experts, as well as a library of case studies, join The Comprehensive Guide to SR&ED today!

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Show 4 footnotes

  1. Government of Canada. (July 15,2015. ) SR&ED Glossary – Scientific research and experimental development (SR&ED). (Accessed: October 2, 2017.) Retrieved from: https://www.canada.ca/en/revenue-agency/services/scientific-research-experimental-development-tax-incentive-program/glossary.html#g19.
  2. Government of Canada. (July 15, 2015.) SR&ED Glossary – Scientific or technological base. (Accessed: October 2, 2017.) Retrieved from: https://www.canada.ca/en/revenue-agency/services/scientific-research-experimental-development-tax-incentive-program/glossary.html#tbslvl.
  3. Government of Canada. (April 24, 2015.) Eligibility of Work for SR&ED Investment Tax Credits Policy – 2.1.1 Was there a scientific or a technological uncertainty? (Accessed: October 2, 2017.) Retrieved from: https://www.canada.ca/en/revenue-agency/services/scientific-research-experimental-development-tax-incentive-program/eligibility-work-investment-tax-credits.html#s2_1_1.
  4. Tax Court of Canada. (October 23, 2014.) Abeilles Service de Conditionnement Inc. v. The Queen. (Accessed: October 2, 2017.) Retrieved from: http://decision.tcc-cci.gc.ca/tcc-cci/decisions/en/item/98243/index.do?r=AAAAAQA5TGVzIEFiZWlsbGVzIFNlcnZpY2UgZGUgQ29uZGl0aW9ubmVtZW50IEluYy4gdi4gVGhlIFF1ZWVuAQ.

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