Manufacture Kute Knit inc. v. Revenue Quebec (2024)
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Manufacture Kute Knit Inc. v. Revenue Quebec (2024)
Key Lessons / Points
- Burden of Proof
- In proceedings before the Tax Court, including those involving SR&ED claims, the burden of proof rests with the Appellant. The applicable standard is the “balance of probabilities,” meaning the Appellant must demonstrate that their position is more likely than not to be correct. This standard is lower than the “beyond a reasonable doubt” threshold, which applies in criminal cases and is not relevant in the context of tax appeals
- The Court consistently emphasizes that the Appellant must provide sufficient, credible evidence to substantiate their claims, whether related to the eligibility of SR&ED activities, the adequacy of supporting documentation, or the allocation of expenditures. The Appellant’s evidence should establish, on a balance of probabilities, that the requirements under the SR&ED program have been met.
- Documentation
- Maintaining a well-organized and complete collection of documentation is imperative for the success of SR&ED applications.
- The last of the five questions used to determine the eligibility of work for SR&ED Investment Tax Credits pertains to the collection of documentation regarding hypothesis development and testing, and the results thereof.
- Documentation regarding expenditures and time spent on SR&ED is also imperative for SR&ED applications. For more information see SR&ED Salary and Wages Policy as well as Materials for SR&ED Policy.
- Documentation regarding time spent on SR&ED is imperative for SR&ED applications. Hours spent on SR&ED work should not be “rounded-up”.
- Maintaining a well-organized and complete collection of documentation is imperative for the success of SR&ED applications.
Fiscal Years in Question
2011 and 2012
Court Heard In
Court Name (City, Province) (N/A if not mentioned.)
Dates Heard
April 05, 2024
Length of Process
13
Neutral Citation
2024 QCCA 408
Docket
500-09-030056-220
(500-80-038698-198) (500-80-038699-196)
Amount Under Dispute
N/A
Decision
[25] To succeed in “demolishing” the notices of assessment, the appellant was required to demonstrate, on a prima facie basis, that the respondent’s premise — i.e., that the appellant had not shown that the reported portions of each employee’s salary could reasonably be attributed to the prosecution of SR&ED — was false. The judge found that the appellant had not made such a prima facie demonstration, and the appellant had not shown that she committed a palpable and overriding error in this regard.
FOR THESE REASONS, THE COURT:
[26] DISMISSES the appeal, with legal costs.
Summary
Manufacture Kute Knit Inc. is a textile and children’s clothing manufacturer based in Quebec. Kute Knit sought an appeal a judgment for a April 5, 2022 court decision on their 2011 and 2012 Scientific Research and Experimental Development (SR&ED) tax credit assessment which resulted in the denial of salary and wages for the managerial and supervisor staff. In 2011 and 2012 Kute Knit engaged in SR&ED work to stay competitive with manufacturers in China, India, and Bangladesh. Kute Knit applied for SR&ED tax credits for work associated with these projects which included claims for salaries and wages for technician-machine operators and managers/supervisors. Their claim with Revenue Quebec was initially accepted, however, a later audit led to the denial of the credits related to managerial and support staff. Under Quebec’s Taxation Act, tax credits for salaries and wages are only granted for work that is directly related to SR&ED activities. Clear evidence is required to confirm the validity of these expenses, evidence generally consists of thorough documentation. In April of 2022, Kute Knit sought to overturn the denial by Revenue Quebec for salaries and wages for their managerial and supervisor staff. The courts found that Kute Knit did not have enough documented evidence to validate that the salaries for their managerial and supervisory staff qualified for the SR&ED tax credits.
Kute Knit believed that the trial judge erred in failing to recognize the prima facie evidence provided, which included testimony acknowledging supervisory and support staff involvement in SR&ED work. Kute Knit also claimed that the Canada Revenue Agency (CRA) had allowed a similar claim from 2006 audit, which supported their validity. Kute Knit argues that their support staff employees did participate in SR&ED work and that they had the proper documentation for hours worked by their supervisory staff. Kute Knit further argues that the testimony provided by the CRA officer acknowledges that salaries for employees that has been disallowed has performed SR&ED work. This should be sufficient to show that the 0% rate set by the CRA in regards to salaries for these employees is clearly wrong.
The court examined the evidence and used previous case law to consider the arguments. The court noted that though Kute Knit had provided documentation for salaries and wages, it did not provide evidence for the percentages of time these employees spent on SR&ED work. The appellant has submitted a table to the court, which listed the names of employees in the two groups and attributed to each of them a percentage of the total time it stated had been spent on the SR&ED projects. The court concluded this evidence was not satisfactory as no supporting documentation was provided to confirm the accuracy of this information. The respondent gave testimony in the previous case to assert why the claims were denied and it was stated in the testimony that very clear guidelines are in place with the CRA in regards to claims for wages and SR&ED tax credits. The court continues that the burden of proof is to be provided by the appellant, Kute Knit, to confirm the accuracy and validity of their claim. The appellant has not shown that the reported portions of each employee’s salary could reasonably be attributed to carrying out work associated to SR&ED. Furthermore, the court could confirm that an audit by the CRA had taken place in 2006 and the appellant had not provided evidence to this claim. Moreover, nothing suggests that the respondent would have been bound by a decisions rendered in 2006 by the CRA. For these reasons, the court dismissed the appeal.
Key Excerpts
[1] The appellant appeals from a judgment rendered on April 5, 2022, by the Court of Québec, District of Montreal (the Honourable Claudine Alcindor), which dismissed the appeal from two decisions on objections rendered by the respondent.[1] In these two decisions, the respondent had disallowed tax credits for scientific research and experimental development (“SR&ED”) activities, which credits were intended to cover expenditures for the salaries of the supervisory staff and support staff hired by the appellant for the years 2011 and 2012.
[2] The appellant specialized in dyeing, textiles, and children’s clothing. In this context, it carried out SR&ED projects, which qualified it for tax credits (37.5%) calculated on the salaries paid to certain categories of employees who worked on these projects.
[4] The appellant claimed such credits from the respondent for three categories of employees who, according to the appellant, had participated in its SR&ED projects during 2011 and 2012, the two disputed years. After initially disallowing the entire claim, the respondent partially reversed its decision because it was satisfied with the appellant’s demonstration of its method for calculating the involvement of employees in one of the three categories (the machine technicians and operators), which method made it possible to determine the number of hours they had spent on the SR&ED projects (the method being based on the quantities of textiles processed by these employees within the scope of these projects). The respondent therefore accepted the claim for these employees but maintained its refusal for the other two categories — i.e., the supervisory staff and support staff — because the appellant had not shown that the supervisory staff and support staff had actually participated in the SR&ED projects as it had reported. Consequently, the respondent sent the appellant notices of assessment, which were appealed to the Court of Québec and resulted in the judgment under appeal.
[5] The trial judge concluded that the appellant had failed to rebut the presumption of validity of the assessments.
[6] The appellant argues that the trial judge erred by failing to acknowledge that it had discharged its burden of prima facie rebutting the presumption of validity of the assessments; (i) by concluding that the appellant had not presented sufficient prima facie evidence that the percentage of hours worked by its supervisory staff and support staff was reasonable; (ii) by determining that the appellant was required to provide detailed time sheets for the work performed on the SR&ED projects by these two categories of employees; and (iii) by concluding that the appellant had presented tables that contained anomalies.
[7] More specifically, the appellant submits that the testimony of the ARQ officer acknowledging that the employees whose salaries had been disallowed had performed SR&ED work (which, indeed, the judge found to be so based on the evidence[2]) is sufficient to show that the 0% rate set by the respondent was clearly wrong and had the effect of reversing the onus of proving that some of these employees had worked on these projects. Moreover, the appellant argues, the CRA accepted these rates in 2006 and they were never subsequently put into question.
[8] The appellant further alleges that the percentages it reported were accepted by the CRA in 2006 as part of an audit, after discussions and negotiations, which gives the percentages an aura of validity.
[11] The outcome of the present appeal hinges on correctly identifying the element of the assessment that had to be “demolished” in this way. The appellant maintains that it had the burden of proving prima facie that the 0% rate set by the respondent was unreasonable and that it met that burden given the admission by the respondent’s representative that some of the employees in these two categories had worked on SR&ED projects during the disputed years.
[17] Thus, the appellant’s onus was to show with prima facie evidence that the respondent’s assumption in support of the notices of assessment — namely, that the appellant had not presented tangible evidence for the expenditures it had reported for the salary or wages of the supervisory staff and support staff engaged in the pursuit of SR&ED — was wrong.
[18] The appellant, therefore, should have presented the Court of Québec with facts demonstrating, on a prima facie basis, the percentages, as reported by the appellant, of the SR&ED work performed by its supervisory staff and support staff. As the Court has pointed out, these facts had to [translation] “have a certain degree of precision and probability weighing in [the appellant’s] favour, rather than being vague and ambiguous allegations. As a general rule, a simple statement by the taxpayer is not enough; it benefits from being supported by documentary or circumstantial evidence”.[8] Furthermore, as the Federal Court of Appeal pointed out in this regard:
[24] Although it is not conclusive evidence, “the burden of proof put on the taxpayer is not to be lightly, capriciously or casually shifted”, considering that “[i]t is the taxpayer’s business” (Orly Automobiles Inc. v. Canada, 2005 FCA 425, paragraph 20). This Court stated that the taxpayer “knows how and why it is run in a particular fashion rather than in some other ways. He [or she] knows and possesses information that the Minister does not. He [or she] has information within his [or her] reach and under his [or her] control” (ibid.).[9]
[19] The trial judge found that the appellant had presented no such evidence. The appellant has not convinced us that the judge committed a palpable and overriding error in this regard. In any event, even if the appellant had succeeded in reversing the burden of proof, the absence of a palpable and overriding error in the judge’s analysis would lead to the same result — namely, that the evidence clearly does not support the reasonableness of the percentages put forth by the appellant in support of its position.
[20] The only evidence the appellant submitted was a table in which it listed the names of the employees in the two groups and attributed to each of them a percentage of the total time it stated had been spent on the SR&ED projects. Other than this table, the appellant did not file supporting documents regarding the percentages set out therein, be they time sheets, SR&ED progress reports, correspondence, minutes of meetings, internal notes or emails related to these tasks, nor did it file any other document likely to contain an indication that these employees worked on the SR&ED for the percentage of their time listed in the table. It did not call any of the employees from these two groups as witnesses to support these percentages and thereby justify, if only with prima facie evidence, the basis for those percentages. Mr. Weldon, the appellant’s external consultant and principal witness, even admitted on cross-examination that he himself had done nothing to determine whether these percentages were accurate or reasonable.
[22] This so-called admission by the objection officer is no such thing: at most, she admitted that [translation] “perhaps managerial personnel had done some R&D”, but this was conditioned on the appellant demonstrating with [translation] “tangible proof” how it had determined the portions of the salary of its supervisory staff and support staff that it attributed to the SR&ED work. Without such a demonstration, it was not possible to conclude that the percentage reported in respect of each of these employees could reasonably be considered as relating to the prosecution of SR&ED.
[23] As to the argument that the percentages the appellant reported were accepted by the CRA in 2006 as part of an audit, after discussions and negotiations, which gives those percentages an aura of validity, this cannot amount to such a demonstration. First, the appellant did not file any documents showing that the CRA performed such an audit in 2006, or showing the basis on which such a determination, if any, was made. On the contrary, according to the evidence adduced at trial, the verifications carried out by the respondent with the CRA showed that no such audit had taken place in 2006. Moreover, nothing suggests that the respondent would have been bound by such a decision rendered in 2006 by the CRA.
[24] Second, establishing the portion of the expenditures incurred for the salary or wages of each of the appellant’s employees that can reasonably be considered to relate to SR&ED is an annual exercise, whereas the evidence shows that in the matter at hand the same percentages that had been set in 2006 were simply reused year after year without the accuracy of these percentages being verified for each of these years and without regard to employee turnover.
[25] To succeed in “demolishing” the notices of assessment, the appellant was required to demonstrate, on a prima facie basis, that the respondent’s premise — i.e., that the appellant had not shown that the reported portions of each employee’s salary could reasonably be attributed to the prosecution of SR&ED — was false. The judge found that the appellant had not made such a prima facie demonstration, and the appellant has not shown that she committed a palpable and overriding error in this regard.
Link to Full Ruling
View the full report here.
Manufacture Kute Knit Inc. vs. Quebec Revenue Agency (2024) – Unofficial Translation
Related Ruling
Summary for SR&ED: Manufacture Kute Knit Inc. vs. Quebec Revenue Agency (2022)