CS Communication v. Quebec Revenue Agency (2022)
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CS Communication v. Quebec Revenue Agency (2022)
Key Lessons / Points
- Key lessons from ruling.
- SR&ED Tax Credits Must Be Claimed by a Single Eligible Party: Salaries paid for SR&ED activities can only be claimed by one entity, either the payer or the performing party, as per the accumulation rule1. The claiming party must clearly demonstrate that the work was carried out on its own behalf.
- Contract Payments2 and Eligibility: For SR&ED credits to be claimed by the payer, there must be a contract explicitly stipulating that the work is conducted on behalf of the payer. The agreement should meet the requirements for an arm’s length transaction and clearly establish the payer’s rights to the SR&ED. Ownership and licensing of IP must be explicitly addressed in contracts, particularly when the IP is developed during SR&ED activities. Evaluations of eligibility for SR&ED credits should consider the full scope of the contractual relationship, including IP rights, financial risk allocation, and technical responsibilities.
Fiscal Years in Question
2011 and 2012
Court Heard In
Court of Quebec (Montreal, Quebec)
Dates Heard
March 24, 2022
Length of Process
10 years
Neutral Citation
2022 QCCQ 1175
Docket
500-80-038412-194
Amount Under Dispute
(ASI) $167,010, (Salaries) $954,343 (2011) and (Salaries) $834,479, (ASI) $146,034 (2012)
Decision
[ 102 ] The SR&ED credit therefore reverts to the applicant and the contributions issued by Revenue Québec must be canceled.
Summary
CS Communications, a company specializing in real-time software development for systems such as turbine engines, entered into a contact with Pratt & Whitney (P&W) in 2009 to develop Application Software Interface (ASI). For the tax years 2011 and 2012, both CS Communications and P&W claimed Scientific Research and Experimental Development (SR&ED) tax credits for salaries and wages related to the same work. According to the accumulation rule3, two taxpayers cannot benefit from the same SR&ED tax credit for the same work. Revenue Quebec denied CS Communications’ claims, asserting that the payments from P&W were “contract payments” under Quebec’s Taxation Act, making P&W-Not CS Communications-eligible for the credits. CS Communications challenged this denial, asserting the the credits rightfully belonged to them.
The 2009 contact outlined the responsibilities of both parties, with CS Communications retaining ownership of the intellectual property (IP) developed during the SR&ED work. P&W was granted license to use the developed IP, but CS Communications maintained full control over the innovation. The court found the the critical factors in determining eligibility for the tax credit was the nature of the contract obligations between the parties.
Under the contract, P&W specified the desired outcome though detailed purchase orders that outlined technical requirements for integrating the ASI into their systems. However, P&W did not direct or supervise the SR&ED activities, moreover P&W lacked the expertise and human resources to do so. In 2011 and amendment was introduced into the contract help between CS Communications and P&W, that outlined penalties in the event that delays were incurred. CS Communications independently determined how to meet these technical requirements, assuming all financial risks and responsibilities, including penalties for delays.
The court analysis focused on several factors, including the contractual relationship, ownership of the IP, and financial responsibility. While P&W defined the technical requirements via purchase orders, the work itself, including the research and development, the work itself was conducted entirely by CS Communications. P&W, lacking the expertise to complete the SR&ED work, did not oversee or control the activities carried out by CS Communications. With CS Communications assuming the financial risk, including potential penalties for delays, and retaining ownership of the resulting IP; this underscores its position that the SR&ED activities were performed on its behalf.
The court concluded that the payments received from P&W were not “contract payments”4and that the SR&ED activities were carried out by CS Communications. Consequently, CS Communications was entitles to the claim for the SR&ED tax credits for the 2011 and 2012 tax years. The assessments issued by Revenue Quebec were canceled, and costs were awarded in favour of CS Communications, the original ruling from Revenue Quebec is therefore invalid.
The court also acknowledged the potential administrative implications for P&W’s previous claimed SR&ED tax credits, suggesting a possible “domino effect”. It emphasized that it would be up to the tax authorities to address this issue in accordance with the Tribunal’s decision.
Key Excerpts
[3] CS Canada operates a business developing and verifying real-time and critical software, particularly in the context of certifications of application systems in the aeronautics sector. In this case, this specifically involves work carried out on computer control systems for turbine engines, propulsion, and power supply systems for aircraft.
[5] On June 22, 2009, CS Canada signed a contract with P&W called the “Long-term purchase agreement: Engine software product” [2] (Contract). It is this contract which is, for the years in dispute, the contractual and consensual framework which defines between P&W and CS Canada the commercial and legal elements of their business relationship.
[6] The contract is for the purchase by P&W of the product described as follows:
“1.3 “Product” means control system software, including Source Code and Object Code, for the control of the Engine within a software process, and includes but is not limited to, the results of testing, application software interface (ASI) software design, architecture, creation, and system verification as well as all related Documentation, specifications and schematics. »
[7] The contract sets out how P&W purchases the product sold by CS Canada and the various rights and obligations of each, including product warranty, the impact of lead times, audits and inspections, invoicing terms, intellectual property, etc.
[9] Following the issuance of the production order, CS Canada formulates a technical proposal and a commercial proposal based on a fixed price. This price is set according to costs, plus a profit margin. The technical and commercial proposal is intended to meet P&W’s request [4].
[12] The contract imposes several qualifying constraints that arise from certifications that must be obtained from Transport Canada depending on the nature of the projects concerned, which gives rise to a right of review on the part of P&W [5].
[14] It is within the framework of these contractual relations that CS Canada designs the software covered by the contract, which is called ASI (Application Software Surface). This software is then integrated and certified following the purchase orders issued by P&W over the years following the various projects.
[15] CS Canada remains the owner of the intellectual property of the ASI that it developed [7].
[16] CS claimed the portion of the salaries that would qualify as eligible expenses for SR&ED credits under the L.I. [8].
[19] It is in this context of the execution of the contract that CS Canada carries out SR&ED activities for which it has paid its employees. It has set up a system of timesheets and task codes that are completed daily by its employees and validated each week by the project manager. Thus, CS Canada knows exactly how many hours of SR&ED work are carried out.
[21] On May 21, 2014, Revenue Québec began an audit of CS Canada’s affairs for the years in dispute.
[22] Following the audit, Revenue Québec denies the SR&ED credits. It believes that P&W made a contractual payment to CS Canada for the years in dispute. Part of this payment is considered an eligible expenditure in favour of P&W, made to a subcontractor (CS Canada). However, P&W claimed and obtained the SR&ED tax credit.
23] Furthermore, according to Revenue Québec, article 1029.6.0.1 L.I., which sets out the rules for the accumulation of SR&ED tax credit claims, applies. Briefly, these rules provide that two taxpayers cannot benefit from the same SR&ED credit for the same work. Revenue Québec raises a second ground for refusal through this rule.
[24] On October 10, 2016, CS Canada waived the limitation period for the year 2011 only concerning the application of section article 1029.6.0.1 L.I. for an amount not exceeding $167,010 [9].
[25] On March 30 and May 1, 2017, Revenue Québec issued assessments to CS Canada in which it denied the SR&ED tax credits claimed for the development of the ASI software for $167,010 for the 2011 taxation year and in the amount of $146,034 for the 2012 taxation year [10]. .
[26] For the year 2011, Revenue Québec refused 32,548 hours of work devoted by CS Canada employees to the completion of P&W projects, which is equivalent, considering the waiver of the limitation period for the year 2011, to an amount in refused salary of $954,343 [11].
[27] For the year 2012, 23,830 hours of work were carried out by CS Canada employees and devoted to the completion of P&W projects, which Revenue Québec refused for a sum in salaries of $834,479 [12].
[30] Consequently, the five criteria for determining whether this work constitutes SR&ED activities are met here [13] and this aspect is not in dispute.
ISSUES IN DISPUTE
1) Are the amounts paid by P&W a “contract payment” within the meaning of article 1029.8.17 (c)(ii) L.I.?
2) Does the mere fact that P&W obtained the SR&ED tax credit deduction prevent CS Canada from obtaining it?
[34] This case therefore raises a question of law. The Court must determine, having regard to the contract and the conduct of the parties, whether the sums paid are a “contractual payment” within the meaning of the LI
[48] It emerges from these legislative provisions that, in principle, CS Canada, which operates a business in Quebec, can claim a tax credit for current expenses such as salaries when these generate SR&ED activities. [48] It emerges from these legislative provisions that, in principle, CS Canada, which operates a business in Quebec, can claim a tax credit for current expenses such as salaries when these generate SR&ED activities.
[49] When a taxpayer has SR&ED carried out on their behalf by a subcontractor, he can also claim the SR&ED tax credit.
[51] Consequently, in the presence of a commercial contract between two parties, it is necessary to determine whether there is a transfer of SR&ED carried out. In other words, it is necessary to identify who owns the right to the SR&ED credit by analyzing the legal framework established by the parties to the contract [22].
[ 52 ] In the absence of a clear contractual clause to this effect, the Tribunal must determine whether CS Canada received a “contractual payment” from P&W within the meaning of the law.
[59] There is no single criterion for concluding that a contractual payment has been made, and these criteria are not exhaustive. The objective is to establish whether or not there has been a transfer of SR&ED activities or, in other words, whether the contractual relationship between the two parties provides that this SR&ED is carried out on behalf of the other [28].
[60] The analysis and application of these criteria to the particular facts of this case lead to the conclusion that CS Canada does not receive a contractual payment from P&W within the meaning of article 1029.8.17 (c) (ii) L.I. for the SR&ED activities.
[65] What emerges from the study of the contract is that significant collaborative work is being put in place between P&W and CS Canada.
[68] The evidence shows that these technical elements are primarily required for engine certification by Transport Canada. The monitoring of the work performed by CS Canada is useful for documenting the processes followed during the development of the software to obtain certifications. There is no supervision of the work that would allow us to conclude that CS Canada is performing work under the supervision of P&W.
[69] Furthermore, P&W does not have the skills and human resources required to design the product sold [32]. P&W does not tell CS Canada how to proceed, but it asks it for results, which is entirely understandable.
[70] Furthermore, P&W does not formulate any assumptions or technological uncertainties and does not indicate to CS Canada the scientific path to reach the result. P&W cannot assist, much less control, over how CS Canada carries out its tasks since it does not have the expertise to do so [33].
[ 72 ] The criterion of financial risks associated with the performance of the work also leads to the conclusion that CS Canada is entitled to the SR&ED tax credit.
[73] The contract implies high financial responsibilities for CS Canada such as: a product warranty in the event of a defect for two years [34]; CS Canada assuming the costs if the product is not compliant, deadlines must be respected [35]; maintaining high levels of competence and expertise at all times [36].
[74] All costs associated with the development of the product described in the purchase order are assumed by CS Canada [37], which is entirely responsible for the product [38].
[75] Furthermore, the agreement specifically provides that P&W may refuse any payment if the product does not meet the stated requirements [39].
[76] The price is fixed as a lump sum and cannot be changed except in exceptional circumstances. Thus, it is CS Canada that bears the financial risk of any loss in the execution [40].
[77] The fixed price may certainly be modified, but only if P&W requests a technical modification or an addition of another nature, which allows for a renegotiation of the price. But this element is not conclusive or does not lead to a contrary conclusion.
[78] Furthermore, Mr. Giroux explained to the Tribunal that when problems are encountered in the development of the ASI, such problems are resolved at CS Canada’s expense.
[79] The relationship between the parties demonstrates that when there was a significant cost overrun, CS Canada requested P&W, which resulted in a partially amicable settlement. Then, the parties put in place a new control process requiring CS Canada to request a purchase order if it anticipates work not initially planned and additional costs [41]. These facts demonstrate that it is CS Canada that bears the financial risks.
[80] Finally, the contract was amended in 2011 to add a penalty element against CS Canada in the event that delays were incurred [42].
[81] The financial risks are assumed by CS Canada and the second criterion is therefore met.
[88] Consequently, under the contract, CS Canada retains ownership of its ASI software, which constitutes the cornerstone of all the SR&ED work in dispute as well as the developments that it makes to its ASI software.
[89] CS Canada claims tax credits for SR&ED activities that it carried out itself and for which it owns the intellectual property. There is no contractual payment within the meaning of the LIA for intellectual property arising from SR&ED. Consequently, the third criterion is met.
[94] To qualify as a contract payment within the meaning of section article 1029.8.17 (c) L.I., the amounts in dispute must constitute an expenditure of a current nature, which are paid by P&W in relation to SR&ED activities carried out by it.
[96] The SR&ED work is carried out on behalf of CS Canada, which bears the majority of the risks. In addition, the intellectual property relating to the SR&ED work remains that of CS Canada. Finally, the evidence allows us to conclude that there is a contract for the sale of software and not SR&ED.
[102] The SR&ED credit therefore goes to the applicant and the contributions issued by Revenue Québec must be cancelled.
[103] It is possible that a domino effect will occur on P&W. It will then be up to the tax authority to exercise its administrative role according to the decision of the Tribunal, if applicable.
Link to Full Ruling
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CS Communications v. Quebec Revenue Agency (2022) – Unofficial Translation
Related Ruling
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