Canafric Inc. v. The King (2023)
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Canafric Inc. v. The King (2023)
Key Lessons / Points
- To be eligible for SR&ED Investment Tax Credits (ITCs), work must be approached through a systematic investigation where hypotheses formed using the existing knowledge base are tested through experimentation and analysis. Hypotheses are tested and the results are analyzed to determine what can be learned to improve future attempts. This process seeks to address an uncertainty to achieve scientific and technological advancement.
- A project must meet all the criteria laid out in the “five questions” to be eligible for SR&ED.
- In this case, the Appellant was able to prove their work did meet the criteria laid out in the “five questions” and the judge allowed their appeal.
- Providing an expert in the field of SR&ED conducted can be crucial for projects to be seen as SR&ED versus routine engineering.
- In this case, the Appellant’s expert witness was involved at every stage of the review process for all the Taxation Years, spoke to specific technical challenges encountered in every project, had a good recollection of the various meetings with CRA representatives during the review process as well as the specifics of the technical discussions which took place during those meetings. The expert witness’s credible and reliable demeanour allowed them to successfully establish that the work performed was SR&ED eligible.
- Interestingly, the judge called out the CRA for not “addressing the Appellant’s evidence in a forthright manner, especially the documentation provided to the CRA and the detailed technical discussions […] other than by denying the claim.” This is a positive statement, reiterating the right of taxpayers to have their evidence considered at the time of any review.
Fiscal Years in Question
2013, 2014, 2015, 2016
Court Heard In
Tax Court of Canada (Hamilton, Ontario)
Dates Heard
September 20, 21, 22, 2022 and December 13, 2022
Length of Process
10 years
Neutral Citation
TCC 2023 108
Docket
2018-677(IT)G
2019-3835(IT)G
2020-1571(IT)G
2020-1574(IT)G
Amount Under Dispute
F2013 ($22,183), F2014 (not specified), F2015 ($15,476), F2016 ($23,304)
Decision
[116] I am more than satisfied the Appellant discharged its burden. The appeal is allowed.
[117] Each party is requested to make written submissions on costs within 60 days as to:
- a) Entitlement of costs; and
- b) Quantum of costs, if any.
Summary
The Appellant (Canafric Inc.) is a food manufacturing business specializing in developing frozen pies. During the 2013-2016 taxation years, the Appellant carried on various projects and activities aimed at developing new or advancing pre-existing products. The Appellants’ SR&ED claim was reassessed by the Minister of National Revenue (‘Minister’) and the expenditures related to projects 1304, 1306, 1401, 1402, 1501, 1502 and 1602 were denied. In this case, the Appellant appealed the Minister’s decisions arguing the work done in these projects did constitute as SR&ED within the meaning of subsection 248(1) of the Act.
The Judge made note that the appellant’s expert witness, Mr. Suvrut Pandya, was credible and reliable. Mr. Pandya was involved at every stage of the review process for all the Taxation Years and he spoke to the specific technical challenges encountered in every project. The Judge was impressed with Mr. Pandya’s good recollection of the various meetings with CRA representatives during the review process as well as the specifics of the technical discussions that took place during those meetings. In contrast, the Judge also stated that the Respondent failed to address the Appellant’s evidence in a forthright manner, especially the documentation provided to the CRA and the detailed technical discussions, which took place during the on-site meetings.
The Judge used the definition of SR&ED as written in the Income Tax Act, and the five-factor test first posed by Judge Bowman within the case of Northwest Hydraulic Consultants Ltd. vs. The Queen (1998), to determine if the Appellant’s research activities within each of the denied projects met the definition of SR&ED activities and that the expenses it incurred were deductible expenses for SR&ED and therefore eligible expenses for the calculation of the ITC.
Based upon the evidence, which the Judge stated was “most compelling and met the burden put forth upon them by the pleadings”, the Appellant was able to successfully establish that the 2013, 2015, 2015 and 2016 SR&ED Claims met all five criteria established in Northwest Hydraulics:
- There was a technological risk or uncertainty, which could not be removed by routine engineering or standard procedures.
- Canafric formulated hypotheses specifically aimed at reducing or eliminating that technological uncertainty.
- The procedure adopted accord with the total discipline of the scientific method including the formulation testing and modification of hypotheses.
- The process resulted in a technological advancement.
- A detailed record of the hypotheses tested, and results were kept as the work progressed.
The appeal was allowed with costs.
Key Excerpts
[2] Canafric operates a food manufacturing business specialized in developing frozen pies mainly for the Canadian and the United States markets. During the Taxation Years, Canafric carried on various projects and activities aimed at developing new or advancing pre-existing products.
[3] For the 2013 taxation year, Canafric claimed SR&ED expenditures and ITCs in respect of the following five projects (the “2013 SR&ED Claim”):
i.1302: Mortimer’s brand Saffron Garden
ii.1303: Loblaw’s PC Scotch beef pie
iii.1304: Metro Irresistible Asian Style dinners
iv.1306: Costco deli chicken pie fill
v.1307: Costco crustless quiche
[4] Projects 1304 and 1306 were selected for a joint technical and financial review by the Minister. By Notice of Reassessment dated May 13, 2016, the Minister disallowed SR&ED expenditures in the aggregate amount of $90,682 and corresponding ITCs in the aggregate amount of $22,183 in relation to these two projects.
[5] For the 2014 taxation year, Canafric claimed SR&ED expenditures and ITCs in respect of the following three projects (the “2014 SR&ED Claim”):
i.1306: Costco deli chicken pie fill
ii.1401: Costco and Metro Irresistible Shepard’s Pies
iii.1402: Loblaw’s Free from Chicken & Beef Pot Pies
[6] By Notice of Reassessment dated July 28, 2017, the Minister disallowed the entirety of the claimed SR&ED expenditures and corresponding ITCs in relation to Project 1306, Project 1401 and Project 1402.
[7] For the 2015 taxation year, Canafric claimed SR&ED expenditures and ITCs in respect of the following seven projects (the “2015 SR&ED Claim”):
i.1303: Loblaw’s PC Scotch beef pie
ii.1307: Costco crustless quiche.
iii.1401: Costco and Metro Irresistible Shepard’s Pies
iv.1501: Mortimer’s Hand Held Pies “On the Go”
v.1502: Mortimer’s Halal Kitchen Frozen Entrée
vi.1503: National Foods Frozen Dinner Entrée
vii.1504: Swiss Chalet & Cara Foods Frozen Entrée
[8] By Notice of Reassessment dated August 9, 2019, the Minister disallowed SR&ED expenditures totalling $97,895 and the corresponding ITCs totalling $15,476 in relation to projects 1401, 1501 and 1502.
[9] For the 2016 taxation year, Canafric claimed SR&ED expenditures and ITCs in respect of the following six projects (the “2016 SR&ED Claim”):
i.1501: Mortimer’s Hand Held Pies “On the Go”
ii.1502: Mortimer’s Halal Kitchen Frozen Entrée
iii.1503: National Foods Frozen Dinner Entrée
iv.1504: Swiss Chalet & Cara Foods Frozen Entrée
v.1601: Alimentation Couche-tard Chilled Pies
vi.1602: Longo’s Savoury Pies
[10] By Notice of Reassessment dated August 9, 2019 The Minister disallowed SR&ED expenditures totalling $154,872 and the corresponding ITCs totalling $23,304 in relation to projects 1501, 1502 and 1602.
[11] The issue in these appeals is whether the work Canafric had undertaken with respect to projects 1304, 1306, 1401, 1402, 1501, 1502 and 1602 constitutes SR&ED within the meaning of subsection 248(1) of the Act.
III. FACTS
[12] George Papadopoulos, Azza Hassanein and David Zhou, three Canada Revenue Agency (“CRA”) employees involved at various degrees in the reviews of the projects, testified for the Respondent. Suvrut Pandya, the Chief Executive Officer of Canafric, testified for the Appellant.
(1) Suvrut Pandya
[13] I found Mr. Pandya’s testimony to be credible and reliable. He was involved at every stage of the review process for all the Taxation Years and he spoke to the specific technical challenges encountered in every project. He had a good recollection of the various meetings with CRA representatives during the review process as well as the specifics of the technical discussions which took place during those meetings.
[14] Mr. Pandya described Canafric’s business as developing new or different products, mainly frozen pies, in accordance with customer demand, evolving taste profile of consumers and regulations regarding fat, salt and sugar contents of products. At all relevant times, his role was to oversee the development work without conducting it himself.
[15] He summarized the product development process for all projects as follows:
i. A customer requests a product with specific targets in terms of content, shelf life, taste acceptability, texture et cetera;
ii. Canafric develops and elaborates a recipe that addresses customer targets;
iii. The product is tested to ensure it meets the client’s requirements.
[16] Mr. Pandya explained that plant trials and product development are two distinct stages of the process. While, development work mainly consists of developing, elaborating and testing a recipe that meet the client’s requirements, plant trials are conducted to verify that the same success is achievable on a larger scale. Canafric would only proceed with plant trials once the product meets all customer requirements.
[17] In developing new products, Canafric had to balance “health” and “taste” requirements. Higher salt and fat contents generally lead to better tasting but unhealthier products. Throughout the Taxation Years and for every project, Canafric sought to reduce salt and fat contents in its products, while maintaining good taste. According to Mr. Pandya, even if the ultimate goal was the same, the nature of this challenge varied from one product to the other because different ingredients do not interact the same way with fat and salt. This was a major source of disagreement with David Zhou, the CRA’s research and technology advisor.
2013 Taxation Year
(1) Project 1306
[19] Project 1306 was a pie filling developed for Costco, which was meant to follow a specific cooking process. Canafric would boil the filling to 165 degrees Fahrenheit to eliminate all bacteria. Canafric would then freeze the filling and pack it in 10 pound bags which were sent to Costco. Costco would make its own pies using the filling and bake it in the oven before displaying it in its refrigerator.
[20] In addition to the usual fat and salt reduction requirements, Costco wanted a pie filling that could achieve a 10-day shelf life including transportation time without using artificial or chemical preservatives. The challenges were to maintain product integrity and taste after three bakes, one freeze and two filling phases, achieve the targeted shelf life without artificial preservatives and increase protein levels in the filling by 35%.
(2) Project 1304
[22] Mr. Pandya testified that “Metro Irresistibles Asian Style dinner” was not a new product. The customer simply wanted improvements to an existing product.
[23] Mr. Pandya described the main challenges as reducing salt and fat contents while preserving the taste profile of the items, maintaining the freeze / thaw credibility as well as maintaining shelf life without using artificial preservatives. According to Mr. Pandya, these improvements made the product “as good as new”.
2014 Taxation Year
(1) Project 1401
[31] In project 1401, the main challenges were to replace potato flakes with “real potatoes”, use leaner beef (from 75% muscle and 25% fat to 85% muscle and 15% fat) as well as the usual fat and salt reduction. Project 1401 was successful.
(2) Project 1402
[32] Regarding project 1402, he described the main challenges as using “free from antibiotics” animals and reducing cooking time by 20 to 50%. Mr. Pandya explained that the elimination of antibiotics created challenges with the “quality of the protein”. Since each animal has different immunity levels, chickens and whole cattle beef differed in quality and in texture. As for the cooking time, it led to microbiology concerns since it was not sufficient to reach the usual 165 degrees Fahrenheit, which ensures elimination of bacteria.
2015 and 2016 Taxation Years
(1) Project 1501
[34] Project 1501 aimed to develop twelve pocket-sized frozen pies that could be safely consumed after being heated in a microwave or an oven.
[35] The main challenges were to conceive a thicker filling, use a flaky pie crust that is compatible with all the fillings, reduce fat and salt contents and achieve a 21-day shelf life without any artificial preservatives.
[36] Mr. Pandya also outlined the challenges relating to the packaging of the product. He explained that Canafric had to use paper coated with chemicals to ensure the product could be microwaved in a minute. The lamination inside the paper allowed the microwave heat to be transferred 100 times faster than it would have been with normal paper.
[37] Mr. Pandya explained that project 1501 was not successful because the product was not firm enough to be hand-held. This was mainly due to the filling leaking moisture into the pastry. Canafric was also unable to achieve the required shelf life.
(2) Project 1502
[38] Project 1502 involved the development of a series of halal products. In cross-examination, Mr. Pandya admitted that this was not their first experience with halal products since Project 1501 also involved some halal products. Mr. Pandya explained that the halal requirement created challenges regarding the raw materials which had to be halal-based and the shortenings which could not be animal based.
(3) Project 1602
[39] Project 1602 aimed to develop nine meat and vegetable pies for Longo’s. The customer specified the pastry should not contain lard. At least 10% of the shortening had to be made of real butter. The customer also wanted the pies to come in two sizes, which meant Canafric had to elaborate a different heating process for each pie. Salt and fat content reduction was not a requirement for this project.
[40] Mr. Pandya testified that David Zhou rejected the claim regarding project 1602 saying, “a pie is a pie what is the big deal about it”.
(2) George Papadopoulos
[45] George Papadopoulos was the financial reviewer for the 2013 and 2014 SR&ED Claims. He testified as to the CRA’s review process of SR&ED Claims.
(3) Azza Hassanein
[62] Azza Hassanein was the RTM for the 2013 and 2014 SR&ED Claims.
(4) David Zhou
[67] David Zhou was RTA in charge of the technical review of the projects for the Taxation Years.
[91] The 2013 SR&ED Claim included five projects, two of which, projects 1304 and 1306, were selected for a joint technical and financial review. These two projects were discussed at length during the September 14, 2015, on-site meeting. Canafric’s customers outlined specific targets which included a higher shelf life without artificial preservatives, reducing salt and fat contents, increasing protein levels, maintaining product integrity during the freeze / thaw process. These targets were to be achieved without affecting the taste of the product. During his examination in chief, Mr. Zhou acknowledged that projects 1304 and 1306 posed a technological uncertainty.
[92] The 2014 SR&ED Claim included projects 1306, 1401 and 1402. Projects 1401 and 1402 were new products with specific requirements including salt and fat reduction, the replacement of potato flakes with “real potatoes”, using free from antibiotics meat, reducing cooking time. Mr. Zhou did not specify whether he believed projects 1401 and 1402 posed a technological uncertainty since no meeting took place regarding the 2014 SR&ED Claim.
[93] The 2015-2016 SR&ED Claim included seven projects, two of which, projects 1501 and 1502, were discussed during the March 8, 2018, meeting. The main challenges were to conceive a thicker filling, use a flaky pie crust that is compatible with all the fillings, reduce fat and salt contents, achieve a 21-day shelf life without any artificial preservatives and use halal products while preserving the taste profile of the products.
[94] Based on the challenges described by Mr. Pandya, projects 1304, 1306, 1401, 1402, 1501 and 1502 posed a technological uncertainty which could not be resolved by routine engineering or standard procedures. Canafric attempted to create recipes in order to meet client objectives for their products. Each project consisted of a new or improved product which meant there was no information available on how to achieve these goals. A major source of disagreement for all SR&ED Claims was David Zhou’s position that each breakthrough was transferrable from one product to the other. For example, Mr. Zhou said that salt and fat reduction techniques could be replicated in different products. Mr. Pandya clearly demonstrated that this was not the case because the ingredients will react differently when used in different products. Canafric was unable to achieve all of its targets. Nonetheless, the elimination of certain recipes which did not work constituted a technological advancement.
[95] I found Mr. Pandya to be a very impressive witness. He demonstrated a deep knowledge of the area under research and had excellent communication skills. He was very well spoken and factual in his evidence and was obviously very experienced in the area of the research being conducted. Mr. Zhou on the other hand, although factual, was very much a generalist without support or backups. He was rigid in his evidence and his approach lacked the understanding necessary to property evaluate the operations in question. This is not surprising given his lack of knowledge in the area under research and his newness to the position he occupied.
[103] Mr. Pandya described Canafric’s development process as follows:
- The client requests a product with specific features.
- Canafric elaborates a recipe designed to meet the client’s requirements.
- The recipe is tested to ensure it meets the requirements.
- The product is sent to a “taste panel” to evaluate its taste.
[104] This process meets the second criterion. Canafric formulated hypothesis specifically aimed at achieving its various goals. As for the third criterion, whether the process accorded with the scientific method, the CRA’s position was that Canafric relied on a “trial and error” approach by trying various recipes to reach its targets and without attempting to explain or analyze the reason why each recipe did not work. I disagree with this position. When it found a recipe could not meet client requirements, Canafric’s main takeaway was not simply that it did not work. Canafric conducted analyses in order to understand which requirement was not met and modified specific parts of the recipe in order to address the issue. In doing so, Canafric was limited by its clients’ demands regarding which ingredients to use.
[110] The documentation requirement was another source of disagreement in these appeals. For example, David Zhou testified that projects 1304 and 1306 had elements of technological uncertainty but did not have sufficient supporting documentation. Documentary evidence is not mandatory. Testimonial evidence may be presented in support of a claim. In this case, Canafric provided both documentary and testimonial evidence in support of its various claims.
[111] On September 14, 2015, an on-site meeting took place regarding the 2013 SR&ED Claim and specifically projects 1304 and 1306. Mr. Pandya testified that all the technical information regarding these projects was explained orally to Mr. Zhou during the meeting. This was corroborated by Mr. Zhou himself. Mr. Papadopoulos and Mrs. Hassanein, while they could not speak to the specifics of the discussion, confirmed that a “lengthy technical discussion” took place between Canafric’s representatives and Mr. Zhou. After the meeting, Canafric sent documentation supporting the various costs of the projects to Mr. Papadopoulos on October 29, 2015. At the Appeal stage, Canafric communicated a 120-page document to the CRA which included a detailed description of the projects and the development process on July 27, 2018.
[112] As for the 2014 SR&ED Claim, the meeting which was initially scheduled for September 9, 2016, never took place. Consequently, no information, whether oral or documentary, was communicated at the audit stage. However, documents supporting the 2014 SR&ED Claim were produced at the appeal stage as part of the 120-page document sent to CRA appeals on July 27, 2017.
[113] An on-site meeting took place on March 8, 2018, regarding projects 1501 and 1502. Similar to the 2015 meeting, Canafric’s representatives explained the work relating to these projects to Mr. Zhou who was accompanied by Kevin Kells (RTM) and Reagan Blancfield (FR). Mr. Zhou acknowledged that Canafric provided sufficient information about project 1501 to make a determination. A conference call scheduled to take place on July 27, 2018, regarding the other projects never took place because Canafric’s technical consultant had a medical issue. Once again, documentation was provided to Reagan Blanchfield after the meeting which included a project summary and a description of the project costs.
V. CONCLUSION
[114] Based upon the evidence, Appellant’s evidence was most compelling and met the burden put forth upon them by the pleadings. The Respondent failed to address the Appellant’s evidence in a forthright manner, especially the documentation provided to the CRA and the detailed technical discussions, which took place during the on-site meetings. This was never addressed by the Respondent other than by denying the claim.
[115] The Appellant successfully established that the 2013, 2015, 2015 and 2016 SR&ED Claims met all five criteria established in Northwest Hydraulics:
- There was a technological risk or uncertainty, which could not be removed by routine engineering or standard procedures.
- Canafric formulated hypotheses specifically aimed at reducing or eliminating that technological uncertainty.
- The procedure adopted accord with the total discipline of the scientific method including the formulation testing and modification of hypotheses.
- The process resulted in a technological advancement.
- A detailed record of the hypotheses tested, and results were kept as the work progressed.
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Related Ruling
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