When applying for tax credits through the Scientific Research and Experimental Development (SR&ED) incentive program, the first hurdle which all projects face is that of determining eligibility.
The confusion often faced over whether or not your work qualifies for SR&ED hasn’t been helped by recent changes in the Canada Revenue Agency (CRA)’s approach to discussions on project qualifications.
Prior to the federal budget and extensive policy updates in 2012, 1 the CRA was more amenable to engaged discussions prior to filing. In particular, the CRA had one program that was excellent: the Account Executive program.
The Account Executive Service gives your business a designated contact person. An account executive from the SR&ED program will provide you with one-stop access to SR&ED information, and help make sure you get maximum benefits from the tax incentives available.
However, visits from account executives are becoming more like the related Pre-Claim Project Review (or “pre-audit”, as they are known informally).
The PCPR Service provides an up-front review and preliminary opinion on the eligibility of projects for SR&ED tax incentives.
There is no “help [to] make sure you get maximum benefits from the tax incentive available” (as with the Account Executive Service). Instead, claimants – whether or not they are part of the Account Executive program – are now required to already have everything ready from the moment they approach the CRA. But how can a company clearly establish their eligibility and minimize their risk of rejection?
Revisiting The Five SR&ED Questions
All neophyte and experienced claimants to the SR&ED tax incentive program are well aware of the integral importance of the “Five Questions”. Yet, while the questions have always been clearly spelt out, the true challenge has always lain in understanding their interpretation from the CRA’s perspective, and not your own. The current and old five questions are listed below:
Five Questions (New) Three Criteria Five Questions (Old) 1. Was there a scientific or a technological uncertainty? Scientific or technological uncertainty 1. Was there a scientific or a technological uncertainty—an uncertainty that could not be removed by standard practice? 2. Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty? Scientific and technical content 2. Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty? 3. Was the overall approach adopted consistent with a systematic investigation or search, including formulating and testing the hypotheses by means of experiment or analysis? Scientific and technical content 3. Was the adopted procedure consistent with the total discipline of the scientific method, including formulating, testing, and modifying the hypotheses? 4. Was the overall approach undertaken for the purpose of achieving a scientific or a technological advancement? Scientific or technological advancement 4. Did the process result in a scientific or a technological advancement? 5. Was a record of the hypotheses tested and the results kept as the work progressed? Scientific and technical content 5. Was a record of the hypotheses tested and the results kept as the work progressed?
The Uncomfortable Link Between Questions
While the five questions may have been updated for the purposes of clarification in the policy documents the current T661(13e) still reflects the old question:
Line 242 of the T661(13e) – “What scientific or technological uncertainties did you attempt to overcome – uncertainties that could not be removed using standard practice?
Moreover, while the five questions may exist to enlighten the claimants on the basic eligibility criteria of their work, it still doesn’t change the fact that the response required by the CRA within Line 242 is actually significantly more complex than one is led to believe. These 350 words must address the following:
Scientific or technological uncertainty means whether a given result or objective can be achieved or how to achieve it, is not known or determined on the basis of generally available scientific or technological knowledge or experience. Specifically, it is uncertain if the goals can be achieved at all or what alternatives (for example, paths, routes, approaches, equipment configurations, system architectures, or circuit techniques) will enable the goals to be met based on the existing scientific or technological knowledge base. There is scientific uncertainty in basic research or applied research. There is technological uncertainty in experimental development. Recognition of the uncertainty is an integral step in the systematic investigation or search and implies recognition of the need for advancement. 2
Did you notice the implied question? If not, it should be more apparent in the directions from the T4088:
Describe the scientific or technological uncertainty you encountered that led you to do the SR&ED.
In responding to this question, we suggest that you include the objective of the project and describe the scientific knowledge or the new or improved capability you were seeking. Your response should indicate the existing technology base or level, or the existing body of scientific knowledge at the onset of the SR&ED project. Describe the shortcomings or limitations of that technology base or body of knowledge that prevented you from overcoming the scientific or technological uncertainties identified. In other words, your response should describe how the uncertainties could not be resolved on the basis of generally available scientific or technological knowledge or experience. 3
If you haven’t noticed it yet, the primary criteria upon which all SR&ED is judged is the ability to establish a clear scientific or technological knowledge base. As a result, much of the confusion surrounding SR&ED is due to this question-within-a-question; the black-and-white nature of a sufficient or insufficient knowledge base is considerably more straightforward to answer and defend when questioned by the CRA.
To that end, I would advise that all companies annotate their version of the five questions and add one more at the beginning. This question should be clearly and completely answered even before the first of the five questions are addressed.
The Missing Precursor & Most Important Question to Demonstrate SR&ED Eligibility
(Question 0) What was your knowledge base and why was it insufficient to meet your objectives?
To begin with, you can’t just say that you couldn’t be bothered to research existing knowledge stores for a pre-existing solution to your problem, and then claim that this represents a technological uncertainty – which is why the CRA looks at the existing scientific or technological knowledge base of the claimant. The definition provided by the CRA is very clear:
Scientific or technological knowledge base 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.
The resources within the company include:
- technical knowledge, education, training, and experience of its personnel; and
- its technical capabilities typified by its current products, techniques, practices, and methodologies (for example, trade secrets and intellectual property).
Publicly available sources generally include scientific papers, journals, textbooks, and internet-based information sources as well as expertise accessible to the company (for example, through recruiting employees or hiring consultants or contractors). The company is expected to have information that is common knowledge at the time the work is performed. Common knowledge is knowledge available to professionals familiar with the specific areas of science or technology in question.
It is recognized that, although the knowledge available publicly is the same for all companies, the scientific or technological knowledge base may vary from company to company because the internal resources can vary from company to company. 4
This can be further broken down into two key sources of information: internal (company) resources and external (publicly available) resources.
Publicly Available Sources is often the easiest to define, as it requires minimal time to review the sources cited in the definition and determine whether the information could be imported through other means (ex. consultants or new employees). There may be instances where a pre-existing answer to your problem may only be available as a trade secret or intellectual property of another company which may not have publicly released its details; consequently, this knowledge will not be included in the knowledge base of the claimant.
Resources Within The Company is often more difficult to define, but it is absolutely critical to determine. The CRA expects “that the work will be performed or directed by qualified individuals who are knowledgeable in the field and have relevant experience in science, technology, or engineering. Note that qualification is not necessarily limited to formal training, but includes skills and knowledge gained through experience.” 5 The CRA defines qualified individuals as follows:
Qualified individuals are personnel who have qualifications and / or experience in science, technology or engineering. The qualifications and experience must be relevant to the science or technology involved in the projects claimed. 6
Put bluntly, your co-op student shouldn’t be listed, but if the project lead is a PhD in the area, it should be mentioned in this section (or made explicit in Line 260/261).
Moreover, there are numerous categories of uncertainty – this initial question helps ascertain the kind of uncertainty involved upon which the project attempts to shed light. For example, if multiple components are already well-researched in their individual forms, and yet no stores of knowledge exist which may predict their behaviour when integrated into a single process, and this gap in knowledge remains unsatisfied by any knowledge base existing within the resources of the company or even publicly available stores of knowledge, then this is described as system uncertainty – which is a form of technological uncertainty.
Finally, uncertainties don’t just arise from a lack of any possible answer. There may even be problems which may be resolved through costly components, but that may result in the final product being too expensive for cost-efficiency. Therefore, if your goal is to come up with a hitherto unknown cost-effective way of achieving the same result, then that may form yet another kind of technological uncertainty.
Importance Of The Missing Precursor – The Verdict
In the end, this query can help your R&D team reflect upon some crucial points are not clearly addressed in the five questions or the three that appear in the T661. If my knowledge base is X, and my objective is Y, how do I get from X to Y? What is the nature of the knowledge gap between X and Y, if that’s even possible to ascertain? Can I obtain that data from pre-existing sources, academic consultants, publications, specialists, etc? Or do I need to perform my own systematic and documented research and experimentation in order to get from X to Y, because no public source has the knowledge I need, or is too expensive for the parameters of my objective, or because no public source knows how the various known components will fit together?
If the answer to this last question is yes, then you’re likely eligible for SR&ED – as long as you follow the quest for that Data Y in a systematic, comprehensively documented fashion.
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.
- Department of Finance. (2012a, March 29). Improving Conditions for Budget Investments. In Archived – Budget 2012 (Chapter 3.2). Retrieved July 8, 2015, from http://www.budget.gc.ca/2012/plan/chap3-2-eng.html#a62 ↩
- CRA. (2012b, October 9). Was there a scientific or technological uncertainty? In Eligibility of Work for SR&ED Investment Tax Credits Policy (Chapter 2.1.1). Retrieved July 7, 2015, from http://www.cra-arc.gc.ca/txcrdt/sred-rsde/clmng/lgbltywrkfrsrdnvstmnttxcrdts-eng.html#N10519 ↩
- CRA. (2015, January 29). How to complete Form T661 – Line-by-line explanations. In T4088 – Scientific Research and Experimental Development (SR&ED) Expenditures Claim – Guide to Form T661. Retrieved July 7, 2015, from http://www.cra-arc.gc.ca/E/pub/tg/t4088/README.html. ↩
- CRA. (2012b, October 23). Scientific or technological knowledge base. In SR&ED Glossary. Retrieved July 7, 2015, from http://www.cra-arc.gc.ca/txcrdt/sred-rsde/clmng/glssry-eng.html. ↩
- CRA. (2012a, October 9). Was the overall approach adopted consistent with a systematic investigation or search, including formulating and testing the hypotheses by means of experiment or analysis? In Eligibility of work for SR&ED investment tax credits (Chapter 2.1.3). Retrieved July 7, 2015, from http://www.cra-arc.gc.ca/txcrdt/sred-rsde/clmng/lgbltywrkfrsrdnvstmnttxcrdts-eng.html#N10519. ↩
- CRA. (2012b, October 23). Qualified individuals. In SR&ED Glossary. Retrieved July 7, 2015, from http://www.cra-arc.gc.ca/txcrdt/sred-rsde/clmng/glssry-eng.html. ↩