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Dave’s Diesel Inc. v. The Queen (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 knowledge can be generated or discovered to improve future attempts. This process seeks to address an uncertainty to achieve scientific and technological advancement.
  • Providing an expert in the field of SR&ED conducted can be crucial for projects to be seen as SR&ED versus routine engineering.
    • In this case, the judge observed that the Appellants lone witness “did not study mechanical engineering and has no degree, certificate or designation in the field”, and “none of the individuals involved in the project in 2013 or 2014 were engineers or mechanics.” The fact that all the individuals involved were non-specialized in the work at hand, and that there was an absence of experts in the related field greatly weakened the Appellants case.
    • While non-specialized employees’ salaries or wages may be claimed in regard to an SR&ED project, the SR&ED Salary or Wages Policy states that “The non-specialized employee’s work must be supervised by staff with scientific or technological qualifications.”
  • Maintaining a well-organized and complete collection of documentation is imperative for the success of SR&ED applications.
    • In this case, the judge noted the evidence presented by the Appellant was minimal with concise entries. The lack of measurable or quantified indicators, to support the scientific or technological advancement achieved through the project made it impossible for the Appellant to prove SR&ED occurred.
    • See the article Why do I need contemporaneous documentation for SR&ED? for more information.

Fiscal Years in Question 

2013, 2014

Court Heard In 

Tax Court of Canada (Hamilton, Ontario)

Dates Heard 

May 10, 2022

Length of Process

9 years

Neutral Citation 

2022 TCC 62

Docket 

2018-1618(IT)G

Amount Under Dispute 

$26,865 and $31,134

Decision 

[46] The Appellant has failed to meet its onus to show, on a balance of probabilities, that its work on the project in 2013 or 2014 qualifies as “experimental development” within the meaning of “SR&ED” in subsection 248(1) of the Act. Accordingly, the appeals must be dismissed.

[47] At the conclusion of the hearing, I asked each party for their position on costs. The Appellant requested an opportunity to make submissions on costs. The Respondent requested costs in accordance with the Tariff. The appeals for the Appellant’s 2013 and 2014 taxation years will, therefore, be dismissed with costs in accordance with the Tariff.

Summary 

The Appellant, Dave’s Diesel Inc., is a fuel injection shop for the diesel engine industry. As the manufacturers of the mechanical fuel injection systems would no longer pay the Appellant to remanufacture components of their used fuel injection systems, they began the related projects in an effort to find a way to remanufacture injectors on their own. In this case, the Appellant sought to appeal the reassessments of their scientific research and experimental development (SR&ED) claims and the investment tax credits for the 2013 and 2014 taxation years. The related investment tax credit amounts included $26,865 for the 2013 taxation year and $31,134 for the 2014 taxation year.

The Minister of National Revenue (the “Minister”) disallowed all of the Appellant’s SR&ED Claims on the grounds that the work carried out in connection with the projects did not constitute as SR&ED as defined in subsection 248(1) of the Income Tax Act, Canada (the “ITA”).

In this case, the judge used the definition of SR&ED as it is written within subsection 248(1) of the ITA, the 5 questions of eligibility as they were posed within the case of Northwest Hydraulic Consultants Ltd. v The Queen (1998) to determine whether the Appellant’s activities constituted as SR&ED.

The judge noted that the Appellants only witness, Mr. Rushi Dave, was not an expert in the related field of technology to which the SR&ED project was related, and neither were any of the other individuals involved. The judge reviewed the documentary evidence provided by the Appellant which consisted of short, non-descriptive handwritten diaries for both the 2013 and the 2014 projects, and a series of colour photographs illustrating the machines and tools used in the project.

After examining each project within the framework of the ITA and the 5 questions the judge determined that the Appellant failed to prove their work on the project in both the 2013 and 2014 taxation years qualified as experimental development within the meaning of SR&ED. The judge noted that the evidence presented contained no quantifiable metrics which could have been used to create a hypothesis within the meaning of SR&ED. The judge stated he could not to overturn the minister’s original ruling because the Appellant failed to show the formulation of a hypothesis, the testing of that hypothesis, nor the modification of that hypothesis in light of the results of the testing. The appeal was dismissed with costs in accordance with the Tariff.

Key Excerpts 

[1] In trying to find a way to remanufacture used fuel injectors for diesel engines (the “project”), did the Appellant engage in “experimental development” during its 2013 and 2014 taxation years within the meaning of the phrase “scientific research and experimental development” (“SR&ED”) in subsection 248(1) of the Income Tax Act (the “Act”)? The Appellant says that it did. The Respondent argues it did not. For the reasons that follow, I agree with the Respondent.

[2] In computing tax for its 2013 and 2014 taxation years, the Appellant deducted investment tax credits of $26,865 and $31,134, respectively, on the basis that its work on the project during those years constituted “experimental development”. [1] On assessment, the Minister of National Revenue (the “Minister”) disallowed the deduction of those credits. These are the appeals of those assessments.

[5] Northwest Hydraulic teaches that if work is to qualify as “SR&ED” under subsection 248(1) of the Act, the following questions should be answered in the affirmative:

1. Was there a technological risk or uncertainty that could not be removed by routine engineering or standard procedures? The phrase “routine engineering” describes techniques, procedures and data that are generally accessible to competent professionals in the field.

2. Did the person claiming to be doing SR&ED formulate hypotheses specifically aimed at reducing or eliminating that technological uncertainty?

3. Did the procedures adopted accord with established and objective principles of scientific method, characterized by trained and systematic observation, measurement and experiment, and the formulation, testing and modification of hypotheses?

4. Did the process result in a technological advance?

5. Was a detailed record of the hypotheses, tests, and results kept as the work progressed?

[6] The Appellant called Mr. Rushi Dave as its only witness. Mr. Dave was General Manager of the Appellant in 2013 and 2014. He was one of four individuals who worked on the project.

[7] Mr. Dave did not study mechanical engineering and has no degree, certificate or designation in the field. However, he did study business and marketing and worked for a large advertising, marketing, and public relations firm before joining the Appellant 15 years ago.

[8] Mr. Dave’s father established the Appellant’s business in Brampton, Ontario a decade before starting the project. Although Mr. Dave described the Appellant as a fuel injection shop for the diesel engine industry, it was not a mechanic shop as no mechanics worked there.

[9] Before starting the project, the Appellant remanufactured components of used mechanical fuel injection systems for dealers under warranty programs offered by the manufacturers of the injectors. The Appellant went about remanufacturing components of used mechanical fuel injectors in the following way:

The process was to receive the component from an engine shop, like the dealership, then we would disassemble it, do an assessment of its failures, and then reassemble it with brand new components, and put it on a test stand to recalibrate [it] to [the] provided manufacturer specifications. [3]

[10] By 2007 or 2008, electronic fuel injection systems began to replace mechanical fuel injection systems in diesel engines. The Appellant found itself in difficulty as manufacturers would no longer pay the Appellant to remanufacture components of their used fuel injection systems. Presumably, they wanted their customers to purchase new units as replacements. In any event, the Appellant needed a new source of income.

[11] The Appellant, therefore, set out to find a way to remanufacture injectors on its own. Those injectors were found in diesel-powered trucks, generators, marine equipment, and construction and farm equipment. The Appellant studied three types of injectors as part of the project:

(a) Delphi 4 Pin (an electronic fuel injector used in certain Volvo diesel engines);

(b) C7 (an electronic fuel injector used in certain Caterpillar diesel engines); and

(c) ISX (a mechanical fuel injector used in certain Cummins diesel engines).

[12] Four individuals worked on the project in 2013 and 2014: Mr. Dave, his father, and two unskilled labourers employed by the Appellant. Mr. Dave testified that the Appellant “would hire unskilled labourers, train them, and build them into technicians, and we would get them to do this work with myself and my father.” [4] It was never made clear exactly what training was given to these unskilled labourers. What is clear, however, is that none of the individuals involved in the project in 2013 or 2014 were engineers or mechanics.

[13] At trial, Mr. Dave produced a fully-assembled fuel injector as well as a disassembled fuel injector of each type (Exhibits AP-1 to AP-6). He described certain technical differences between each of the three types. None of those differences is material as the process employed by the Appellant was the same for each type. The Appellant appears to have followed a four-step process. The following steps were taken by the Appellant in respect of each type of injector:

Step 1: Taking apart the injector to understand how it worked
[14] The Appellant did not understand how the injectors worked, so it needed to take them apart first. This required the use of tools allowing it to take the injectors apart without breaking them. The Appellant had to fabricate some of its own tools to accomplish this task. After a particular type of injector was taken apart, the Appellant inspected it with a view to understanding exactly how it worked.

Step 2: Simulating the operation of the injector and determining which parts of the injector were likely to fail
[15] The Appellant would place the injector in one of its machines to simulate its operation with a view to ascertaining which of its parts were likely to fail.

Step 3: Purchasing or modifying parts designed to prevent those failures
[16] The Appellant would purchase or modify parts that it thought were likely to fail with a view to meeting, or improving on, the manufacturer’s original specifications.

Step 4: Incorporating those parts into used injectors to be remanufactured by the Appellant
[17] The final step would be the assembly of a remanufactured used fuel injector that met or exceeded the specifications of a new one. The Appellant hoped to remanufacture all three types of injectors with used injectors as “cores”. It hoped to sell the remanufactured injectors at a price below that charged by manufacturers for new ones.

[18] The Appellant did not remanufacture any of the three types of injectors during its 2013 or 2014 taxation years.

[20] Mr. Dave produced a handwritten diary for each of 2013 and 2014 (Exhibits A-3 and A-4). This is how he described the diaries (which he called “notebooks”):

So essentially I keep a notebook for the purposes of SR&ED. And what I do is at the end of every day, if we’ve done any SR&ED work, that I just go and write it down quickly; what was done and what we did, and who did it. [6]

[21] Most of the diary entries are rather concise. The following are some of the more descriptive ones (square brackets indicate the type of injector tested):

January 4, 2013

Broke [Delphi 4 Pin] injector trying to understand how it comes apart.

January 23, 2013

Purchased and tested 12 [C7] cores and found all to be operating differently and having leaks from different sections of injector.

February 25, 2013

Received prototype [C7 adapter] from machine shop and installed. The thinner O‐ring would not stand up to the pressure and kept breaking.

March 6, 2013

Continued [ISX] trials and documenting results. Not ideal and still not operating as expected. No atomization.

March 15, 2013

Used a thin steel punch and applied pressure from the top of the [Delphi 4 Pin] injector and popped out the terminal insulating sleeve and seal.

March 21, 2013

Ran trials using [C7] cores based on Ray’s findings. [7]

May 14, 2013

Diesel in oil leaks at top of [ISX] injector; trial test to better understand faults.

July 17, 2013

Continued to run trials [ISX]; Still trying to determine how it comes apart.

September 12, 2013

Run [Delphi 4 Pin] trials with different shim thicknesses.

September 25, 2013

Spring pressure trials [Delphi 4 Pin].

October 12, 2013

Test 4 [C7] injectors with rebuilt control valves and all leaked badly. There were no leaks before.

October 18, 2013

Created a spring cage pressure test to define a different shim for every [Delphi 4 Pin] injector.

October 23, 2013

Tested again and [Delphi 4 Pin] valve and spool still leaked.

November 15, 2013

Test [C7] injectors; Everything inside seems to always be worn and full of filings.

November 26, 2013

Test [C7] injector with oversized piston and still had internal leaks.

January 13, 2014

Test [C7] valve and still leaking.

April 14, 2014

Test [ISX] injectors with prototype springs.

April 15, 2014

All [ISX] springs failed test and no solution to date.

July 21, 2014

Tried different materials and tested [ISX].

July 22, 2014

Test proved successful after a number of trials [ISX]; Not repeatable.

November 4, 2014

All [ISX] tests failed.

November 24, 2014

Test results proving to work [Delphi 4 Pin].

December 3, 4, 5, 6, 2014

Test and record results [C7]. [8]

December 19, 2014

Analyze [C7] results; No consistency.

December 20, 2014

No consistency in [C7] results.

December 23, 2014

Unable to build valve or rebuild [C7] injector at this time.

[22] The Appellant also produced a partial record of a single test performed on a C7 injector in 2013 (Exhibit A-2 reproduced at Appendix “A”) and a partial record of a single test performed on the same type of injector in 2014 (Exhibit A‐1 reproduced at Appendix “B”).

[23] As Mr. Dave presented his oral evidence, he showed the Court a series of colour photographs illustrating the machines and tools used in the project. Counsel for the Respondent objected to their admission on the basis that none of the usual notice requirements in subsection 89(1) of the Tax Court of Canada Rules (General Procedure) (the “Rules”) had been followed. [9] As Mr. Dave offered each photograph to illustrate his evidence, I identified it for the record and reserved my ruling on its admissibility.

[24] I have now decided that each of those photographs should be admitted into evidence as they satisfy the usual conditions for the admissibility of photographs, namely:

(a) accuracy in representing the facts;

(b) fairness and absence of any intention to mislead; and

(c) verification on oath by a person capable of doing so.

[26] The Appellant says that the relevant “technological uncertainty” was whether it could successfully develop a process to remanufacture the three different types of injectors. [11] [27] The fact that a small group of non-engineers and non-mechanics, including two unskilled labourers, did not know whether they could remanufacture three types of used fuel injectors tells us nothing about whether it was “technologically uncertain” that those fuel used injectors could have been remanufactured by a competent professional in the field.

[28] The Appellant rests its case on the subjective knowledge of the four non‐engineers and non-mechanics who worked on the project. To them, every aspect of the project was a “technological uncertainty”. The “technological uncertainty” standard, however, is not subjective. If it were subjective, a grade school student trying to build a simple electric motor would meet the test. When she was a member of this Court, Justice Monaghan noted that “technological uncertainty”:

. . . does not arise simply because the Appellant does not have the requisite knowledge. The question is whether the uncertainty identified by the Appellant is an uncertainty to those knowledgeable and experienced in the relevant field. [12] [29] The onus was on the Appellant to demonstrate that it was “technologically uncertain” that the used fuel injectors could have been remanufactured by a competent professional in the field – a mechanical engineer, for example. [13] [30] But even if I had found the requisite “technological uncertainty”, I would still have no basis on which to decide whether the steps taken by the Appellant were anything other than “routine engineering” for a competent professional in the field. There was no evidence that taking a fuel injector apart without breaking it was anything other than “routine engineering” for such a professional. Similarly, there was no evidence that understanding how the fuel injectors worked was anything but “standard procedure” for a competent professional in the field.

[31] Mr. Dave testified that the Appellant’s hypothesis was:

. . . whether we could develop a remanufacturing procedure and be able to remanufacture these injectors, and that’s the hypothesis. [14]

[32] As noted above, the Appellant also claims that the “technological uncertainty” was whether it could successfully develop a process to remanufacture the fuel injectors. Only in Alice’s Adventures in Wonderland could it be argued that one’s hypothesis is the “technological uncertainty” and that the “technological uncertainty” is one’s hypothesis. [15] [33] The Appellant faces two other challenges. First, as noted above, the Appellant has not adduced any evidence demonstrating that it was “technologically uncertain” that the fuel injectors could have been remanufactured by a competent professional in the field. Second, the Appellant’s single, overarching “hypothesis” is not the type of hypothesis contemplated by the second criterion in Northwest Hydraulic.

[34] In Northwest Hydraulic, Justice Bowman describes a five-stage process to determine whether the person claiming to have done SR&ED formulated hypotheses specifically aimed at reducing or eliminating the technological uncertainty. According to Justice Bowman, such a person would have engaged in:

a. the observation of the subject matter of the problem;

b. the formulation of a clear objective;

c. the identification and articulation of the technological uncertainty;

d. the formulation of an hypothesis or hypotheses designed to reduce or eliminate the uncertainty; and

e. the methodical and systematic testing of the hypotheses.

[35] Justice Bowman uses the plural “hypotheses” throughout Northwest Hydraulic, particularly in the second, third, and fifth criteria. The Northwest Hydraulic criteria do not contemplate a single, overarching hypothesis, as the Appellant contends, but a discrete hypothesis that precedes each test and that is subject to modification in light of the results of that particular test.

[40] As noted above, there is no evidence that in respect of any particular test the Appellant formulated a particular hypothesis, tested that hypothesis, and modified that hypothesis in light of the results of that test.

[41] There is no evidence that any of the four individuals involved in the project used “established and objective principles of scientific method” in their testing. Even a cursory review of the diary entries at paragraph 21 above suggests that the project had more in common with “tinkering” or “simple trial and error” than it did with the scientific method. [17] [42] The process might have resulted in an “environmental advance” as used fuel injectors would be remanufactured rather than dumped in landfills. It might have resulted in a “financial advance” for the Appellant as it could fill the hole in income left by the withdrawal of the warranty programs. But, after hearing all the evidence, I still have no idea whether the project resulted in a “technological advance”.

[43] The Appellant has not satisfied its onus to demonstrate that it recorded, in respect of any particular test performed in 2013 and 2014:

(a) the formulation of a hypothesis;

(b) the testing of that hypothesis; and

(c) the modification of that hypothesis in light of the results of the test.

[45] The problem is not only the Appellant’s lack of documentation. The problem is that the Appellant’s lack of documentation makes it almost impossible for it to meet its onus in respect of the second and third criteria in Northwest Hydraulic. A partial record of a single test performed on a C7 injector in 2013 (Exhibit A-2 reproduced at Appendix “A”) and a partial record of a single test performed on the same type of injector in 2014 (Exhibit A-1 reproduced at Appendix “B”) are insufficient to discharge that onus.

Link to Full Ruling 

View the full report here.

Related Ruling

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