What happened with SR&ED in the third quarter (July to September) in 2022? Here, we discuss the updates.
This post outlines Scientific Research and Experimental Development (SR&ED) program updates from July-September 2022, including administrative, policy, tax law, and court cases. SR&ED Education and Resources was busy in the third quarter of 2022 keeping our readers up to date, including summarizing four legal rulings on the subject of SR&ED, examining the relevance and evolution of the Five Questions of eligibility, and sharing knowledge concerning some lesser understood topics within the SR&ED program.
SR&ED Policy and Program Updates
Throughout July to September of 2022, there were no new SR&ED Policy or Program changes. The What’s new – SR&ED Program page is an important source of information for SR&ED taxpayers as it is where the CRA lists any changes or updates to the SR&ED program by order of date.
SR&ED Education and Resources Articles
SR&ED Education and Resources was busy in the third quarter of 2022 educating our readers on a variety of SR&ED topics, including taking a closer look at the Five Questions of SR&ED, and examining how a change in company control may affect your SR&ED claim, in the hopes of further illuminating the world of SR&ED.
- On July 5, 2022, we discussed the pool of deductible SR&ED expenditures and how it is affected by a change in company control in Carryover amounts for SR&ED after a Change in Company Control.
- On July 19, 2022, we discussed how the SR&ED refund is calculated at the provincial level and if there is a maximum amount a claimant may receive per year in the Maximum SR&ED refund: Provincial level.
- On August 23, 2022, we examined the Five Questions initially posed by Justice Bowman in Northwest Hydraulics v The Queen (1998) and how these questions are utilized and viewed in the current judicial environment in Are the Five Questions still the SR&ED standard?
- On September 20, 2022, we examined the initial intent of the Five Questions posed by Justice Bowman in Northwest Hydraulics v The Queen (1998) and how these questions have evolved since their conception in 1998 in The 5 Questions For SR&ED – Intent and Evolution.
- On September 20, 2022, we published a new page “SR&ED Procedures and Guidelines, Summarized” for the convenience of our readers containing a complete list and brief descriptions of all the CRA’s current SR&ED Procedures and Guideline documents.
We did not publish any articles regarding the T661 – Scientific Research and Experimental Development (SR&ED) Expenditures Claim Form from July-September 2022. Keep an eye on our posts as we enter the next quarter of 2022. We will continue to delve into topics of interest and demystify the SR&ED application process for prospective claimants.
Administrative, Policy, and Legislative
In the third quarter of 2022 we published two articles in regards to SR&ED news and information updates from CRA:
- On April 28, 2022, the Canada Revenue Agency (CRA) announced updates to the Prescribed Proxy Amount Policy, the SR&ED Claims for Partnerships Policy, and the SR&ED Investment Tax Credit Policy. We have detailed these updates in our article CRA Updates to Select SR&ED Program Policies – April 28, 2022.
- On June 29, 2022, the Canada Revenue Agency (CRA) released two Notices to the Public and the Profession concerning the use of electronic signatures and initials on Notices of Discontinuance, Notices of Withdrawal, Consents to Judgment and Affidavits. We have detailed these notices in our article Tax Court of Canada Update: Notice to the Public and the Profession, June 29, 2022.
The third quarter of 2022 was busy with regard to judicial proceedings. We analyzed four SR&ED court rulings for our readers.
National R&D Inc. v. The Queen (2022)
Topic: Technical Eligibility – specifically, Scientific Method & Use of Five Questions
The Appellant, National Research & Development Inc., a Canadian-controlled private corporation (CCPC), provided consulting services to clients in the areas of engineering, information technology, scientific research and experimental development tax credits and Ontario interactive digital media tax credits. They filed an appeal to the assessment of their F2011 SR&ED ITC assessment which was denied in 2020 on the basis that their work did not meet the five questions of eligibility, particularly following the scientific method and thereby achieving a technological advancement.
The Appellant appealed the decision on the basis that the scientific method is no longer a requirement for SR&ED eligibility based on the August 2021 “Guidelines on the eligibility of work for scientific research and experimental development (SR&ED) tax incentives”. The Appellant argued that the five questions of eligibility are guidance and not requirements.
The judge did not agree with the Appellant. First, the judge stated that his argument had been tried in Kam-Press Metal Products Ltd. v. Canada (2021) and failed. Further, the judge explained:
While the new CRA guidance no longer uses the precise language of the “scientific method”, the “The ‘How’ requirement” section of the CRA guidance still speaks to the requirement of an underlying rigour or discipline in the experimental process. In any event, while the CRA guidance is useful context in understanding the purpose and intent of a particular provision, it is not binding on the court.
Additionally, the judge stated that the Appellant misunderstands the relationship between the courts and legislation:
The criteria relied on by the judge are not ultra vires subsection 248(1), rather they reflect the court’s understanding of what Parliament intended by subsection 248(1) (Kam-Press at para. 6; see also Justice Robert Sharpe, Good Judgment: Making Judicial Decisions, “The Generality of Law” (Toronto: University of Toronto Press, 2018) at 54). Parliament and the legislatures rely on the courts to give definition, amplitude and precision to statutory language as required by the circumstances of the case. The resulting understanding of the legislation as expressed in the jurisprudence is not an improper exercise of judicial legislation, rather it is precisely what courts are required to do: “Generality gives the law its objective, rational, and systematic quality. It is what distinguishes the law from the judicial decision applying it” (Sharpe at 54).
Third, the judge explained that the original judge did not take a restrictive approach in their interpretation of the scientific method. The judge stated, “The Tax Court has found that activities in the applied sciences constituted SR&ED in the context of technological as opposed to pure scientific development [i.e. computer software, algorithms, databases]”. The judge also explained that a definition in a scientific journal does not equate to a matter of evidence in a trial; however, facts presented by expert witnesses who can be cross-examined and the evidence tested are credible. Additionally, regarding the scientific method, the judge stated, “The judge acknowledged that she must apply the criteria ‘within the context of National’s business environment’ “.
The Appellant argued that the judge did not correctly apply the burden of proof at their first trial. The judge argued that the original judge correctly applied the burden of proof by requiring the Appellant to establish, at trial, that its activities qualified as SR&ED under the Income Tax Act. The Appellant had the burden to prove its case.
Additionally, the Appellant argued that without the expert witness report the original judge “did not appreciate or understand the evidence and was not in a position to assess whether it conformed to the requirements”. The judge ruled that the first judge demonstrated careful regard for the evidence and that the Appellant did not work in a methodical manner or keep accurate records as their work was performed. The judge stated:
To the extent that the appellant kept records, she found them “vague”, “unclear”, and not reflecting a logical progression between the premise of an experiment and the result. The recorded entries were conclusionary and there was no indication that any of the hypotheses advanced were modified as a result of any analysis or testing (Reasons at paras. 52-55). The viva voce testimony of the one witness called by National did not make up for the inadequacy of the documentary evidence
The judge ruled that there was no error in the judge’s finding regarding evidence.
Regarding the decision of the first judge to exclude the expert witness testimony, the judge used the criteria from White Burgess Langille Inman v. Abbott and Haliburton Co., 2015 and applied section 145 of the Tax Court of Canada Rules (General Procedure), S.O.R./90-688a to determine its admissibility. The first judge ruled that it was not admissible as it did not comply with section 145(2) of the Tax Court Rules nor paragraphs 3(d),(e), (g) and (h) of the Code of Conduct for Experts. The report also did not identify the source of facts or source material.
For the substance of the report, the judge stated that “expert opinion evidence must meet the threshold requirements of admissibility: relevance, necessity, the absence of an exclusionary rule and a properly qualified expert”. If this threshold is met, there is a second step, “trial judge must decide whether the expert evidence is sufficiently beneficial to the trial process to warrant its admission despite the potential harm to the trial process”. The original judge ruled that “the report did not satisfy the threshold criteria for admissibility” and Justice Rennie agreed with their decision. Additionally, Justice Rennie explained, “a court does not need an expert opinion on how to apply the law”.
The appeal was dismissed with costs.
For more details and analysis, please view our complete analysis of National R&D Inc. v. The Queen (2022).
Formadrain Inc. v. The Queen (2017)
Topic: Technical & Financial Eligibility – specifically, Technological Uncertainty & Contract Expenditures
The Appellant, Formadrain Inc, is a private corporation founded in 1994 that develops technologies for the rehabilitation of underground pipes and industrial process pipes without digging. In this case, the Appellant sought to appeal the federal Income Tax Act determination made with regards to their SR&ED expenditures (and accordingly refundable investment tax credits) pertaining to the Appellant’s 2012 and 2013 taxation years. The Appellant testified that the factory testing and the two “in situ” trials made it possible to create technological advancement. While some tests documented were “intermediate tests”, used more for collecting data than for verifying specific hypotheses, they were still an integral part of the Appellant’s research.
The respondent called the RTA assigned to the appellant’s file, Eduardo Turcott, as a witness. Mr. Turcott indicated that the SR&ED expenses were disallowed because he considered that the information gathered did not make it possible for him to determine whether the Appellant’s activities were SR&ED within the meaning of section 248 of the Act. Mr. Turcott also stated that the source of technological uncertainty of the 2012 projects lay entirely in the chemical composition of the material, which was a task delegated to a rubber manufacturer and therefore the Appellant was not eligible to claim those expenses as their own. The judge disagreed with that conclusion as paragraph (d) of the definition of research and development activities in subsection 248(1) of the Act includes development activities undertaken in Canada on behalf of the taxpayer. The judge also referenced the Contract Expenditures for SR&ED Performed on Behalf of a Claimant Policy dated December 2014 as it also states that work performed under a contract on behalf of the performer is just as eligible as if the work was performed by the performer itself.
The judge evaluated the eligibility of the Appellants projects using the five questions outlined in Northwest Hydraulic Consultants Limited v. The Queen (1998), and the Appellant’s Laboratory Notebook, which contained the complete record of the research with photos. The judge determined that the evidence provided proved that the Appellant formulated hypotheses and used a systematic method during its 2012 and 2013 taxation years.
The Judge stated that part of the expenses incurred were directly related to the research and development activities of the Appellant during its “in situ” trials, however, the judge also determined that the expenses incurred to repair sewers by using the traditional method were not directly related to the research activities. As there was no breakdown of costs offered regarding these events, the judge decided to allow half of the amount claimed. Therefore, half of the
For more details and analysis, please view our complete analysis of Formadrain Inc. v. The Queen (2017)
Dave’s Diesel Inc. v. The Queen (2022)
Topic: Technical Eligibility – Contemporaneous documentation & Scientific Method
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 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 Appellant’s 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 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.
For more details and analysis, please view our complete analysis of Dave’s Diesel Inc. v. The Queen (2022).
Airzone One Ltd. v. The Queen (2022)
Topic: Technical Eligibility – specifically, Expert Witnesses
The Appellant, Airzone One Ltd. (Airzone), provides comprehensive air quality monitoring services to government agencies and departments, international organizations, and for‐profit businesses. In this case, the Appellant sought to appeal the reassessments of their 2014 and 2015 taxation years including the SR&ED expenditures and the investment tax credits that were claimed for each tax year respectively across a total of six projects. 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 5 questions of eligibility as they were posed within the case of C W Agencies Inc v. The Queen (2001), the “why” and “how” factors explained in the current SR&ED eligibility guidelines, as well as the definition of SR&ED within the ITA to determine whether the Appellant’s activities constituted as SR&ED. The judge analyzed each project individually with these references.
The judge noted that the Minister utilized several factual assumptions during the initial denial of Airzone’s SR&ED claim. By the end of this hearing, those factual assumptions were acknowledged as incorrect. The judge emphasized that while the Respondents witness, Mr. Melnyk, a research and technology advisor for the Canada Revenue Agency (the “CRA”) who carried out the technical audit of the six projects on behalf of the CRA, had a scientific background; it was quite limited compared to the Appellant’s witness. The judge specifically remarked that Mr. Fellin, the Appellant’s witness, was “an extremely knowledgeable, credible and reliable witness.”
After examining each project to qualify the work on the projects as experimental development, and that the work was undertaken to tackle technological uncertainties for the purpose of gaining “technological knowledge” not available within its organization or through publicly available sources, the judge determined that the Minister erred in their initial assessment, and the Appellant was able to provide sufficient information and evidence to show that all projects, except project 1 and project 3 from the 2015 taxation year, were SR&ED eligible. The judge allowed the appeal and referred it back to the Minister for reconsideration and reassessment.
For more details and analysis, please view our complete analysis of Airzone One Ltd. v. The Queen (2022)
Summary of SR&ED Updates
SR&ED program updates from July-September 2022 were quiet, however, at SR&ED Education and Resources continued our educational mandate, writing seven more informative blog posts, analyzing four more legal rulings, and keeping our readers up to date regarding topics that may affect the SR&ED program. Check back for more updates as we continue through 2022.