AboutSR&ED Updates and Changes

SR&ED Program Updates: July-September 2023

Janette Conway
SR&ED Program Updates: April-June 2022
SR&ED Program Updates: July-September 2023

What happened with SR&ED in the third quarter (July-September) of 2023? Here, we discuss the updates.

This post outlines Scientific Research and Experimental Development (SR&ED) program updates from July-September 2023, including administrative, policy, tax law, and court cases. SR&ED Education and Resources was busy in the third quarter of 2023. We kept our readers up to date, including summarizing four legal rulings on the subject of SR&ED, examining how system uncertainty may play a big role in your company’s SR&ED, discussing some basic SR&ED terminology, and discussing an often overlooking industry which may contain SR&ED eligible work, and more.

SR&ED Policy and Program Updates

There was no new SR&ED policy or program update in the third quarter of 2023. The SR&ED news and updates page is an important source of information for SR&ED taxpayers as the CRA lists any changes or updates to the SR&ED program by order of date.

SR&ED Education and Resources Articles

In the hopes of further illuminating the world of SR&ED during the third quarter of 2023, we published six posts discussing some potentially confusing topics in the SR&ED program:

Administrative, Policy, and Legislative

In the third quarter of 2023, we published two articles regarding SR&ED news and information updates from the CRA:

Judicial Proceedings

In the third quarter of 2023, we summarized four SR&ED court rulings for our readers.

Canafric Inc. v. The King (2023)

Topic: Technological Eligibility – specifically, Routine Engineering & Technological Uncertainty

The Appellant (Canafric Inc.) is a food manufacturing business specializing in developing frozen pies. During the 2013-2016 taxation years, the Appellant carried on various projects and activities aimed at developing new or advancing pre-existing products. The Appellants’ SR&ED claim was reassessed by the Minister of National Revenue (‘Minister’), and the expenditures related to projects 1304, 1306, 1401, 1402, 1501, 1502 and 1602 were denied. In this case, the Appellant appealed the Minister’s decisions, arguing the work done in these projects did constitute SR&ED within the meaning of subsection 248(1) of the Act.

The Judge noted that the appellant’s expert witness, Mr. Suvrut Pandya, was credible and reliable. Mr. Pandya was involved at every stage of the review process for all the Taxation Years, and he spoke to the specific technical challenges encountered in every project. The Judge was impressed with Mr. Pandya’s good recollection of the various meetings with CRA representatives during the review process as well as the specifics of the technical discussions that took place during those meetings. In contrast, the Judge also stated that the Respondent failed to address the Appellant’s evidence in a forthright manner, especially the documentation provided to the CRA and the detailed technical discussions which took place during the on-site meetings.

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 within each of the denied projects 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.

Based upon the evidence, which the Judge stated was “most compelling and met the burden put forth upon them by the pleadings”, the Appellant was able to successfully establish that the 2013, 2015, 2015 and 2016 SR&ED Claims met all five criteria established in Northwest Hydraulics:

  1. There was a technological risk or uncertainty, which could not be removed by routine engineering or standard procedures.
  2. Canafric formulated hypotheses specifically aimed at reducing or eliminating that technological uncertainty.
  3. The procedure adopted accord with the total discipline of the scientific method including the formulation testing and modification of hypotheses.
  4. The process resulted in a technological advancement.
  5. A detailed record of the hypotheses tested, and results were kept as the work progressed.

The appeal was allowed with costs.

For more details and analysis, please view our complete analysis of Canafric Inc. v. The King (2023).

Gordon v. Canada (2023)

Topic: Financial Eligibility – specifically, Carry-forward Amounts & Change of Control

In this case, the Appellant, Allan Jay Gordon, together with James A. Deacur and Associates Ltd. (JAD), sought to appeal the decision of Justice Barnes’ of the Federal Court (the Judge), rendered on June 25, 2019 in which the Appellants’ actions in damages against the Government of Canada were dismissed.

The actions arise from the CRA’s criminal investigation against the Appellant beginning in 1995 which was focused on the Appellants’ use of backdating documents to claim SR&ED expenses, purportedly incurred in previous years. In some instances, the creation of a shell corporation and backdated contracts for the SR&ED through the created company were utilized to increase the Appellants SR&ED refund. Sometimes, the wages of employees allegedly involved in SR&ED work were calculated after the fact according to JAD’s assessment of the fair market value for the labour. The CRA’s investigation resulted in the indictment and prosecution of James Allan Deacur and Allan Jay Gordon on five counts of fraud, attempted fraud, and possession of the proceeds of crime. In 2006 the Appellant and JAD began to seek damages against the court on the basis of multiple causes of action, including negligent investigation, breach of their rights under the Canadian Charter of Rights and Freedoms, misfeasance in public office, malicious prosecution, and intentional interference with contractual relations. Justice Barnes decision in 2019 was that the CRA’s investigation was not carried out in a manner that could be characterized as negligent and was not motivated by malice or any other improper purpose.

In this case, the Appellants challenged Justice Barnes’ decision on the basis that the Judge misunderstood the legal requirements for a valid SR&ED tax credit claim, and contended that the procedures set out in the Taxation Operations Manual (TOM) 11 for CRA investigations were not properly followed. The Appellants further asserted that the CRA’s preferred method of valuing labour costs was flawed and the CRA’s investigation into suspected inflated wages was negligent. The Appellants believed that the Judge misunderstood these facts and the evidence supporting them, leading him to dismiss their arguments without substantive engagement.

The Judge in this case reviewed the findings made by Justice Barnes’ in 2019 and stated that they demonstrated a thorough and careful assessment of the evidentiary record before him. With respect to the argument in connection with the TOM 11 for CRA investigations, the Judge agreed with Justice Barnes’ statement in 2019 that the TOM 11 “is a set of guidelines that have no binding legal effect and their breach is not evidence per se of a wrongful prosecution or negligence”. As the Appellant failed to demonstrate any palpable and overriding error on the part of Justice Barnes, the Judge determined that there was no reason to disturb the his findings and dismissed the appeal with costs payable from the Appellant.

For more details and analysis, please view our complete analysis of Gordon v. Canada (2023).

Anne-Marie Chagnon Inc. v. The King (2023)

Topic: Technological Eligibility – specifically, Routine Engineering & Technological Uncertainty

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.

For more details and analysis, please view our complete analysis of Anne-Marie Chagnon Inc. v. The King (2023).

Deans Knight Income Corporation v. Canada (2023)

Topic: Financial Eligibility – specifically, Carry-forward Amounts & Change of Control

Prior to this case, the Appellant, Deans Knight Income Corporation (“Deans Knight”), then operating under the name Forbes Medi‑Tech Inc. (“Forbes”), had approximately $90 million of unused non‑capital losses, scientific research and experimental development (SR&ED) expenditures, and investment tax credits. The Appellant entered into an investment agreement with a venture capital company, Matco, and a complex arrangement was devised to take advantage of the loss carryover deduction in Section 111(1)(a) without triggering the restriction in Section 111(5).

Many companies may have carry-over SR&ED ITCs; however, they should be careful entering into investment agreements for the purpose of leveraging these ITCs or other carry-over deductions.

First, Forbe’s assets and liabilities were moved into a new parent company, Newco. Second, pursuant to the investment agreement, Matco purchased a debenture convertible into some of the voting shares and all of the non‑voting shares that Newco held in Forbes. While Newco was not obliged to sell its shares to Matco, it was promised that it would receive at least a guaranteed amount if it sold the shares or if such an opportunity did not present itself. Third, Matco would find a new business venture for Forbes, which would be used to raise money through an initial public offering (“IPO”). The profits from this venture could be sheltered by the tax attributes Forbes originally could not utilize. Other than when acting pursuant to the investment agreement, Newco and Forbes could not engage in a variety of activities without the consent of Matco. Matco was able to find a mutual fund management company, Deans Knight Capital Management, that agreed to use Forbes for an IPO through which it would raise money to invest in high‑yield debt instruments. Forbes’ name was changed to Deans Knight. The IPO and subsequent investment business succeeded. Consequently, the Appellant deducted its non‑capital losses to reduce its tax liability for its 2009 to 2012 tax years.

Beginning in 2015, the Appellants 2009-2012 claims were reassessed and denied by the Minster under the rationale that the non‑capital loss deduction transactions were abusive and, therefore, the General Anti-Avoidance Rule (GAAR) applied. In 2019, the Appellant appealed the Minister’s 2015 decision to the tax court and was successful. The Judge reasoned that “The use of the Appellant’s Tax Attributes against income from the investment business could have been achieved even if the Investment Agreement had not been entered into.”

In this case, the court conducted an in-depth analysis of the Appellant’s transactions to determine whether they constituted abusive tax avoidance under the ITA. The court determined that they were abusive and restored the judgment of the Tax Court of Canada from 2015:

 “[6][…] Through a complex series of transactions, the appellant underwent a fundamental transformation that achieved the outcome that Parliament sought to prevent, while narrowly circumventing the text of s. 111(5). The result of the transactions thereby frustrated the provision’s rationale. Since the GAAR applies to deny the tax benefits, the Minister’s reassessments must be restored.”

For more details and analysis, please view our complete analysis of Deans Knight Income Corporation v. Canada (2023).

Summary of SR&ED Updates

SR&ED program updates from July-September 2023 were busy; we wrote eight more informative blog posts, summarized four more legal rulings, and kept our readers up to date regarding topics that may affect the SR&ED program. Check back for more updates as we wrap up 2023.

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