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Anne-Marie Chagnon Inc. v. The King (2023)
Key Lessons / Points
- 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 and above the overall industry’s knowledge base through scientific or technological advancement.
- A project must meet all the criteria laid out in the “five questions” to be eligible for SR&ED.
- The Appellant was unable to prove they had identified a technological uncertainty and sought to reduce or eliminate that uncertainty through experimentation or analysis in all of their projects.
- It is preferable to keep marketing components separate from research in supporting documentation, to ensure the research (not commercial) purpose is clear. For more information on market-driven development work, see the SR&ED While Developing an Asset Policy.
- Using existing manufacturing processes in an attempt to build a better product is not SR&ED.
- In the Tax Court, the burden of proof on the Appellant is the “balance of probabilities” and not “beyond a reasonable doubt”.
- In this case, the judge explains “the burden of proof on the Appellant is the balance of probabilities — and not beyond a reasonable doubt, which is a higher standard that does not apply to appeals before this Court.”
Fiscal Years in Question
Court Heard In
Tax Court of Canada (Montreal, Quebec)
May 24 and 25, 2022
Length of Process
2023 CCI 35
Amount Under Dispute
[ 51 ] The Court, therefore, concludes that the appellant’s activities did not constitute SR&ED within the meaning of the definition in paragraph 248(1) of the Act.
[ 52 ] The appeal is dismissed without costs.
The Appellant, Anne-Marie Chagnon Inc., specializes in the jewelry and goldsmith industry, and more specifically in the manufacture and resale of handcrafted jewelry. In this case, the Appellant sought to appeal the reassessments of their 2016 taxation years made by the Minister of National Revenue (the “Minister”). The Minister denied the Appellant a deduction of $117,971 claimed as scientific research and experimental development (“SR&ED”) expenditures, as well as the corresponding investment tax credit (“ITC”) of $37,764, as they concluded, “that the results were qualitative and that there was no scientific or technological uncertainty or technological advancement.”
To begin the Judge reviewed the initial assumption of facts made by the Minister in his reassessment, which included the fact that the Appellant’s first project, “Improvements and development of secondary operations”, was composed of four sub-projects, and the Appellant’s second project, “Development of tools and design of molds”, was composed of ten sub-projects. 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 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.
The Appellant had prepared an expert report, however, because it was not relevant nor necessary to the case, and the qualifications of the expert were deemed to be insufficient. Two individuals testified for the Appellant, and two testified for the Respondent. The Judge determined the Appellant could have solved the problems they encountered through “routine technical studies” or “usual procedures” known to competent specialists in this field as it was logical to conclude that this initial parts supplier used by the Appellant before deciding to switch the internal production would have had the knowledge necessary to manufacture the production molds, they simply need to have inquired.
The Judge determined that there was no technological or scientific uncertainty within the two main projects, nor in any of the 16 sub-projects. As the Appellant did not meet its burden of proof and did not demonstrate, on a balance of probabilities, that there was technological uncertainty or that its activities constituted SR&ED activities, there was no need to review the question of eligible expenses and the appeal was dismissed without costs.
[ 1 ] This is an appeal of a reassessment made under the Income Tax Act (RSC 1985, c.1 (5th Supp .), as amended. This assessment is dated December 20, 2018, and relates to the appellant’s taxation year ending June 30, 2016.
[ 2 ] By this reassessment, the Minister denied the appellant a deduction of $117,971 claimed as scientific research and experimental development (“SR&ED”), as well as the corresponding investment tax credit (“ITC”) of $37,764 for the year in question.
[ 3 ] The appellant specializes in the jewelry and goldsmith industry, and more specifically in the manufacture and resale of handcrafted jewelry. She began her activities with the manufacture of artisanal jewelry and, starting in 2013, added industrial production with the use of molds.
[ 4 ] For the year in question, the appellant claimed SR&ED expenditures related to the following projects:
1. 2015-01 – Improvements and development of secondary operations;
2. 2015-02 – Development of tools and design of molds.
III. Assumptions of facts
[ 8 ] Without repeating all of these assumptions of fact, suffice it to say that the first project entitled “Improvements and development of secondary operations” was a grouping of four sub-projects which aimed to improve the polishing finishing procedures, manual finishing and 3D printing for the components of pewter jewelry and to improve the layout of the workshop.
[ 10 ] Still according to the hypotheses of fact, the second project entitled “Development of tools and design of molds” was a grouping of ten sub-projects which aimed to create or optimize jewelry components and molds and to create or improve tools. The Minister also concluded that the results were qualitative and that there was no scientific or technological uncertainty or technological advancement.
[ 17 ] According to well-established case law, it is up to the appellant to demonstrate, on a balance of probabilities, that the factual assumptions are incorrect. The appellant must satisfy the Court that its research activities meet the definition of SR&ED activities and that the expenses it incurred are deductible expenses for SR&ED activities under section 37 of the Act and eligible expenses for the calculation of the ITC.
V. The Evidence
[ 18 ] Before the start of the hearing, the respondent objected to the admissibility of the expert report produced by the appellant, on the grounds that it did not meet the criteria established by case law, namely relevance, necessity and sufficient qualification of the expert. After a voir dire was held, the Court concluded that it should declare the report inadmissible. The reasons were delivered orally.
[ 19 ] Mr. Denis Chagnon and Ms. Dulce Gutierrez testified for the appellant and Ms. Julie Bernier and Ms. Heather Filiatrault testified for the respondent.
Mr. Denis Chagnon
[ 23 ] According to Mr. Chagnon, some parts are difficult to reproduce, and it is in the manufacture of the molds into which the pewter is poured for the reproduction of the said parts that they encounter difficulties. Each “collection” of jewelry contains “new pieces” hence the need to make several molds. These molds are made of organic rubber and must be able to reproduce a part identical to the master part and to “respond to a certain number of factors determined by Ms. Chagnon in the mold part”. In particular, they must be reproducible and capable of withstanding heat at a high temperature and rotation at high speed to allow the tin to fill the cavities.
[ 24 ] In cross-examination, Mr. Chagnon acknowledged that the manufacture of the main pewter parts was subcontracted to a pewter foundry until 2013 and that, subsequently, the appellant made investments to be able to do it internally. However, they encountered challenges given the lack of expertise.
[ 25 ] Mr. Chagnon admits that all the steps in the manufacture of the jewelry are carried out in the same factory, that the appellant has “a single workshop for the manufacture of castings” including the polishing or finishing of the jewellery, and that the same employees work on all the stages of the production of the factory, including “the activities claimed” in this proceeding. Mr. Chagnon explains that to determine which work can be claimed as SR&ED, it is only at the end of a given period that they review their notes to identify everything that is ” ostensibly R&D”, in particular with “the consultant”.
[ 26 ] In re-examination, Mr. Chagnon explained that in the broad field of jewellery, there are “the jewelry jewels” which are the subject of several study programs at high school or CEGEP and which are not subject to large-scale replication. However, for the appellant, it is “costume jewels” which are “made in thousands of copies, on an assembly line, in an industrial way(…)” and therefore the technicians who have studied jewelry have not necessarily learned “how production machines work (…) or mold manufacturing”. He explains that there was “a transfer of knowledge from craftsman to craftsman”, but that the pewter manufacturing industry is dead today as it has been moved to Asia, so local expertise no longer exists or ‘is hard to acquire’.
Ms. Dulce Gutierrez
[ 29 ] Ms. Gutierrez recounts her collaboration with the creative work of Ms. Chagnon’s, stating that the reproduction of the wax sculpture by the lost wax process is carried out by an external supplier. They receive “a single prototype in bronze or silver” and this is the master piece or “master”.
[ 30 ] She must then ensure the reproduction of the master piece, without damaging it, by a process of “spin casting” by creating “a master mold”. She must produce an identical piece taking into account shape, texture, appearance and weight. Once successful, she must create “a production mold” which is given to the production workshop for the mass reproduction of the part in question. The production mold is made of rubber that needs to be vulcanized to harden. In this whole process, it must take into account, among other things, centrifugal and centripetal force, gravity, heat, time, rotational speed, the flow of tin in liquid form and the hardening in metal. She explains that she has to do this analysis at the beginning and that is when she formulates her hypotheses.
[ 33 ] She adds that she must satisfy “the expectations of the designer”, in particular, “her needs, her desires, what she wants to project”. If Ms. Chagnon is not satisfied, she must start the process again, redo the tests and “formulate new hypotheses” both at the level of the part and at the level of the finish.
[ 35 ] Ms. Gutierrez also explains that she had prepared an Excel table to record the “technological problem to be solved”, ” the technological objective”, “the hypothesis related to the activity”, the “result of the activity carried out” and the hours spent per employee followed by the applicable expenses. According to her, there were “technological uncertainties”, but some were rather a “challenge, something that we had not done before” for which she had “no knowledge” or even when there had been a lack of “knowledge transfer”.
Mrs. Julie Bernier
[ 38 ] Ms. Bernier concluded that there was “a mixture of activities” without “systematic investigation” carried out “by trial and error to see if it worked or not” and therefore there was no systematic investigation. In addition, she concluded that the appellant “used techniques known in the molding industry” where it is often necessary to “make a few iterations and then sometimes start the mold again” and therefore there was no scientific or technological uncertainty. Ultimately, she saw no connection between research and development and the mass production of jewelry where the primary focus was the aesthetic or visual aspect of the piece.
[ 39 ] In cross-examination, Ms. Bernier acknowledged that she carried out about twenty SR&ED audits per year, including about five in the area of molds, but none in the area of jewellery. She acknowledged that depending on the context of the business, it was possible that “qualitative” elements were important in SR&ED, but that it was more at the level of precision.
Ms. Heather Filiatrault
[ 43 ] She reiterated her understanding that Ms. Bernier took a holistic approach to determine if there was any technological uncertainty and then reviewed the various sub-projects. She came to the same conclusion.
VI. Analysis and conclusion
[ 44 ] First, the Court agrees with the respondent that notwithstanding the guides on the eligibility of SR&ED projects published by the Agency, the applicable law is still that of the Northwest Hydraulic decision which was repeated and confirmed in many decisions of the Federal Court of Appeal.
[ 46 ] In Northwest Hydraulic, Judge Bowman explained that there is “technological risk or uncertainty” when a problem cannot be “removed by routine engineering or standard procedures (…) generally accessible to competent professionals in the field”, otherwise there is no technological uncertainty (para. 16). This knowledge must “really not exist in the base of scientific or technological knowledge, not simply be unknown to the claimant.”: Formadrain Inc. c. The Queen, 2017 ICC 42 (para. 93). In other words,” the creation of a new product through the application of techniques, procedures and data generally accessible to competent specialists in the field will not constitute an SR&ED activity, even if there is doubt as to how the objective will be achieved”: Béton Mobile du Québec Inc. c. The Queen, 2019 ICC 278, para. 43. The Respondent summarizes this in its written pleadings by stating that there is “no resolution of technological uncertainty if competent specialists in the field can solve problems in a predictable way using common and established techniques”.
[ 49 ] The Court is of the opinion that the appellant could have solved the problems related to the manufacture of the molds and the finishing of the parts by “routine technical studies” or “usual procedures” known to “competent specialists in this field” and that the evidence as a whole demonstrates that there was no technological or scientific uncertainty. The same is true for the other sub-projects, including 3D printing and the improvement of the workshop.
[ 50 ] In the end, the Court is of the opinion that the appellant has not met its burden of proof and has not demonstrated, on a balance of probabilities, that there was technological uncertainty or that its activities constituted SR&ED activities. There is therefore no need to review the question of eligible expenses.
Link to Full Ruling
View the full report here.