Gestion ACBK Inc. v. The King (2022)

*** This information is presented for educational purposes only and does not constitute legal advice. You should retain legal counsel if you require legal advice regarding your individual tax situation. *** 

Gestion ACBK Inc. v. The King (2022)

 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. 
  • To be eligible for the SR&ED tax credit, work performed must address a scientific or technological uncertainty with the goal of increasing your company’s knowledge base relative to its state prior to the project. 
  • Review the CRA’s SR&ED Glossary prior to completing an SR&ED application as the language of the definitions is particular in nature. Familiarity with key terms such as knowledge base, scientific and technological uncertainty, scientific and technological advancement, and experimental development is highly beneficial. 

Fiscal Years in Question 

2012

Court Heard In 

Tax Court of Canada (Montreal, Quebec)

Dates Heard 

November 24 and 25, 2021 & May 3, 2022

Length of Process

10 years

Neutral Citation 

2022 CCI 94

Docket 

2015-3974(IT)G

Amount Under Dispute 

$115,267

Decision 

[41] Since the Court concluded that, on the preponderance of the evidence, the expenses of $115,267 were not incurred for SR&ED activities within the meaning of subsection 248(1) of the ITA, it is correct that the Minister refused the deduction of these expenses in the calculation of the appellant’s income. Consequently, and for the same reason, the Minister was right to refuse Hydro LMR SR&ED ITCs of $37,945.

[42] For these reasons, the appeal is dismissed with costs.

Summary 

The Appellant, Gestion ACBK Inc. (“ACBK Management”), formerly named Hydro LMR Inc. (“Hydro LMR”) before a merger, sought to appeal the reassessments of their 2012 taxation years made by the Minister of National Revenue (the “Minister”). The Minister denied the Appellant a deduction of $115,267 claimed as scientific research and experimental development (“SR&ED”) expenditures, as well as the corresponding investment tax credit (“ITC”) of $37,945. The Appellant incurred these expenditures during the installation of a hydrodynamic energy-efficient assistance system in a residential building. The Appellant’s objective for the project was to install an upgraded version of a hydrodynamic system, originally patented by Mr. Laperle, into a residential triplex. The Appellant utilized Mr. Laperle’s handwritten notes as a reference to design and implement a second prototype of the hydrodynamic system at the triplex.

During the hearing, the Appellant acknowledged that certain expenses incurred by Hydro LMR during the construction and installation of the system, and related to the purchase of intellectual property did not qualify as eligible SR&ED. Consequently, the Appellant declared a total of $106,051 as SR&ED expenses as opposed to the originally claimed deductions of $115,267.

The Judge used the definition of SR&ED as written in the Income Tax Act, and the five-factor test first posed by in the case of Northwest Hydraulic Consultants Ltd. vs. The Queen (1998), to determine if the Appellant’s work met the definition of SR&ED and if the associated expenses incurred were eligible expenses for the calculation of the SR&ED ITC.

The Judge determined that the Appellant used common techniques to try to resolve the technological uncertainties they faced during their project. The Judge also noted that the Appellant did not describe the techniques used in order to try to overcome these uncertainties, neither during the design nor the construction of the system. Additionally, an analysis of Mr. Laperle’s original patent, revealed references to other previous patents relating to thermal storage since the 1980s, indicating that there were already systems similar to that designed.

Consequently, the Judge concluded that the activities of the Appellant during the design and installation of the hydrodynamic system at the triplex did not constitute SR&ED activities within the meaning of the ITA and the appeal was dismissed with costs.

Key Excerpts 

[1] Gestion ACBK Inc. (“ACBK Management”) is appealing a notice of reassessment issued on June 18, 2013, by the Minister of National Revenue (the “Minister”). This contribution concerns the tax year of the company Hydro LMR Inc. (“Hydro LMR”) ended July 31, 2012 (“the year in question”). In this reassessment, the Minister denied Hydro LMR the deduction of scientific research and experimental development (“SR&ED”) expenditures totalling $115,267 in its income calculation. Hydro LMR incurred these expenditures during the installation of a hydrodynamic energy-efficient assistance system in a residential building. The Minister concluded that these expenses were not incurred for SR&ED activities and, therefore, were not deductible in calculating Hydro LMR’s income for the year in question. The expenses for which Hydro LMR claimed the deduction are as follows:

Salary or Wages

 $4,580

Materials consumed

 $67,425
Subcontractors

$43,262
Total

$115,267

[2] For the same reason, the Minister also refused Hydro LMR an SR&ED investment tax credit (“ITC”) of $37,945. The ITC was claimed for the same expenses.

[5] The issues in dispute are as follows:

  1. Was the Minister right to refuse Hydro LMR a deduction of $115,267 in the calculation of its income for SR&ED expenses?
  2. Was the minister right to refuse Hydro LMR SR&ED ITCs of $37,945?
  1. FACTS

[8] André Roy (“Mr. Roy”) was the president and sole director of Hydro LMR during the period in question. He is an electromechanic by training and specializes in automation[1]. During this period, Mr. Roy’s work mainly consisted of designing, installing, and programming automated systems in the agri‑food industry.

[9] On an unspecified date before the year in question, Dominic Laperle (“Mr. Laperle”) had installed a system named “hydrodynamic system for the energy‑efficient assistance of a building, construction processes and corresponding uses” in a residence in Saint‑Césaire, in the province of Quebec. Mr. Laperle obtained a patent for this system. According to Mr. Roy’s testimony, Mr. Laperle’s system makes it possible to reduce the effect of a building on the environment by making it energy-autonomous.

[10] After the completion of the construction of the residence and the installation of the hydrodynamic system, Marc Brunet (“Mr. Brunet”), from the Quebec Industrial Research Center (“CRIQ”), contacted Mr. Roy to ask him if he was able to improve Mr. Laperle’s system. Mr. Brunet asked him to accompany him on a visit to the residence in Saint‑Césaire. Following the visit, Mr. Roy became interested in Mr. Laperle, and he decided, through Hydro LMR, to buy land in Saint‑Alphonse de Granby, in the province of Quebec, in order to build a triplex and install an improved version of Mr. Lapierre’s system.

[11] To this end, Hydro LMR created a project called “Study and analysis of a thermal storage system”, for which it claimed the deduction of expenses for SR&ED activities and an ITC for the year in question[4]. Hydro LMR has chosen the proxy method for calculating SR&ED expenditures[5].

[12] The expenses for which the Minister refused to deduct were incurred by Hydro LMR during the construction and installation of an improved version of Mr. Laperle’s system at the triplex.

[13] On October 1, 2017, Hydro LMR merged with three other companies under the Business Corporations Act[6] (“BCSA”). At the end of this merger, Gestion ACBK was incorporated, and Hydro LMR was automatically deregistered on October 1, 2017. The respondent submits that pursuant to subsection 286(2) of the LSA, Gestion ACBK retains the rights to ‘Hydro LMR and that, therefore, it can be a party to legal proceedings to which Hydro LMR was a party[7]. Article 286 of the LSA is worded as follows:

The merger certificate, issued by the company registrar in accordance with the provisions of Chapter XVIII, certifies the merger of the companies on the date and, where applicable, at the time appearing on this certificate.

From that moment on, the merging companies continue their existence in the company resulting from the merger and their assets then form only one, which is that of the company resulting from the merger. The rights and obligations of the merging companies become those of the company resulting from the merger and the latter becomes a party to any judicial or administrative procedure to which the merging companies were parties.

[Emphasis added.]

[15] Having regard to the observations of the parties, the Court accepts the respondent’s request. The initial title will therefore be replaced by the following: Gestion ACBK Inc. (the company which replaced Hydro LMR Inc. following a merger) v. His Majesty the King.

  1. Total amount of SR&ED expenditures under dispute

[16] During the hearing, Mr. Roy acknowledged that certain expenses incurred by Hydro LMR during the construction and installation of the system did not qualify as eligible SR&ED (Scientific Research and Experimental Development) expenses. Specifically, Mr. Roy chose not to dispute the rejection of deductions totalling $667 and $59, which were initially claimed for materials consumed[11]. Furthermore, Mr. Roy also decided not to contest the disallowance of an $8,490 deduction related to the purchase of Mr. Laperle’s intellectual property[12]. Consequently, the appellant has declared a total of $106,051 as SR&ED expenses. These expenses are as follows:

Wages $4,580
Materials consumed $66,699
Entrepreneurs $34,772
Total $106,051

Was the Minister right to refuse Hydro LMR a deduction of $106,051 in the calculation of its income for SR&ED expenses?

[24] In the Northwest Hydraulic decision, this Court explained the meaning of the expression “technological uncertainty” when applying the relevant provisions of the ITA as follows:

(a) Implicit in the term “technical risk or uncertainty” in this context is the requirement that it be a type of uncertainty that cannot be removed by routine engineering or standard procedures. I am not talking about the fact that whenever a problem is identified there may be some doubt concerning the way in which it will be solved. If the resolution of the problem is reasonably predictable using standard procedure or routine engineering, there is no technological uncertainty as used in this context.

(b) What is “routine engineering”? It is this question, (as well as that relating to technological advancement) that appears to have divided the experts more than any other. Briefly, it describes techniques, procedures and data that are generally accessible to competent professionals in the field [19].

[Emphasis Added.]

[25] Therefore, in order to demonstrate that Hydro LMR’s expenses relate to SR&ED activities within the meaning of the ITA, the appellant must demonstrate, on the preponderance of the evidence, that there was a technological risk or uncertainty that could not be eliminated by current techniques or usual procedures[20].

[26] In this particular case, Mr. Roy took the necessary steps to install an upgraded version of Mr. Laperle’s hydrodynamic system in the triplex. Initially, he acquired Mr. Laperle’s patent for the system. Additionally, he utilized Mr. Laperle’s handwritten notes as a reference to design and implement the second prototype of the hydrodynamic system at the triplex. Prior to commencing the construction of the triplex, Mr. Roy met with Daniel Rousse (referred to as “Mr. Rousse”), a researcher holding the Industrial Research Chair in energy and efficiency at the École de technologie supérieure (“ÉTS”). This meeting aimed to conduct a digital simulation of the system. Following the meeting, Mr. Roy received the simulation results report from ÉTS. Subsequently, he made the decision to construct a full-scale prototype of his system, which was then integrated into the triplex.

[27] The system designed by Mr. Roy included, among other things, solar panels installed on the roof of the building, concrete water tanks filled with gravel buried under the concrete floor of the building’s basement, a heat pump, a radiant floor system, a control panel (computer) and probes to measure the water temperature in the tanks.

[28] Mr. Roy reported that when creating his full-scale prototype, he relied on Mr. Laperle’s notes and patent as reference materials. However, during this process, he identified a significant design issue in Mr. Laperle’s system. According to Mr. Roy, the water temperature within the tanks was insufficient, reaching extremely cold temperatures that caused freezing. This, in turn, hindered the proper operation of the water pump responsible for conveying water to the solar panels installed on the building’s roof. Mr. Roy attributed the problem to several factors, including the tank size, the absence of a temperature measurement probe, and issues with the control panel programming.

[29] Mr. Roy testified that when designing his system, he faced two technological uncertainties, specifically related to the size of the water tanks and the temperature of the water within them[21]. To resolve these problems, Mr. Roy utilized the data contained in the ÉTS report as a basis for making modifications. He modified the size of the basins and installed probes to measure the temperature as well as additional valves. This involved altering the size of the basins originally used by Mr. Laperle, with the smaller basin placed inside the larger one. Additionally, he installed a third basin (a conventional water heater) outside the building and connected it to the system. Finally, he also proceeded to install and program the control panel which controls the water pump. According to Mr. Roy, these uncertainties could not be eliminated using usual procedures or current techniques.

[30] The evidence shows that Mr. Roy used common techniques to try to resolve the two technological uncertainties he faced. During his testimony, Mr. Roy did not describe precisely the techniques that he used in order to try to overcome these uncertainties, neither during the design nor the construction of his system. The evidence does not demonstrate that the modification of the sizes of the basins, the installation of probes to measure the temperature, the installation of valves and the design and installation of the control panel required the use of practices that were not commonly used at the time.

[31] Furthermore, according to the testimony of Mr. Desmarais, Mr. Roy used known thermodynamic principles to measure energy exchanges in a system. Mr. Desmarais also testified that it was possible to measure the thermal exchanges between the basins and to model the envisaged system using mathematical equations and concepts known at the time in order to estimate the appropriate dimensions of the basins. A scale model could also have been used to test it.

[32] Finally, Mr. Desmarais also indicated that Mr. Laperle’s patent made reference to other previous patents relating to thermal storage, which allowed him to conclude that there were systems similar to that designed by Hydro LMR since the 1980s.

[34] Consequently, the Court concluded that the activities of Hydro LMR during the design and installation of the hydrodynamic system at the triplex do not constitute SR&ED activities within the meaning of the ITA.

[37] As the Court determined that the activities associated with the design and installation of the hydrodynamic system at the triplex did not qualify as SR&ED activities, the initial requirement for Hydro LMR’s expenses to be deductible in income calculations remains unmet. Consequently, there is no need for the Court to address the matter of expense deduction under section 37 of the ITA (Income Tax Act). These expenses were not incurred by Hydro LMR for SR&ED activities, and therefore, they do not qualify as eligible SR&ED expenses.

[39] Eligible expenditures, as defined in subsection 127(9) of the ITA, include expenditures related to SR&ED activities that are assigned to first‑period or second-period multi-purpose equipment, current expenses referred to in paragraph 37(1)(a) of the ITA, and capital expenditures referred to in subparagraph 37(1)(b)(i) of the ITA. In addition, when the taxpayer chooses the “proxy method”, as was the case here, the eligible expenses also include a prescribed replacement amount. The replacement amount is provided for in subsection 2900(4) of the Income Tax Regulations. During the period in question, this amount was equivalent to 65% of the amounts incurred by the taxpayer during the year for the salary or wages of his employee who is directly involved in SR&ED activities carried out in Canada and which can reasonably be considered to relate to these activities.[40] Consequently, when the Court concludes that a taxpayer’s expenses were not incurred for an SR&ED activity, the taxpayer is not entitled to an ITC for these expenses. Since the Court concluded that the expenses for which Hydro LMR claimed the deduction were not incurred for such activities, it is not entitled to an ITC of $37,945.

[40] Consequently, when the Court determines that a taxpayer’s expenses were not expended on SR&ED activities, the taxpayer is not eligible for an Investment Tax Credit (ITC) for those expenses. In light of the Court’s ruling that the expenses claimed by Hydro LMR were not associated with such activities, the company is not eligible for an ITC amounting to $37,945.

Link to Full Ruling 

View the full report here.

Gestion ACBK Inc. v. The King (2022) – Unofficial English Translation

Related Ruling

N/A