SR&ED Program Updates: January-March 2019
This post outlines the updates to the program from January to March 2019, including administrative, policy, tax law, and court cases. We have identified some key trends to watch in the SR&ED environment.
The first quarter of 2019 was relatively quiet in relation to SR&ED and the CRA. There were no major program or policy changes announced and all of the forms remained unchanged. The CRA did not announce any changes to the program in the first quarter until the budget was released in late March.
Over at SREDucation the January – March first quarter brought some interesting blog posts, mostly questioning whether or not change would be in the air with the new budget forecast dropping in March. In fact, the announcement was quite significant.
Administrative, Policy, and Legislative
No updates were announced on the “What’s New – SR&ED Program” website between January and March 2019.
Legislative Changes – Federal Budget 2019
There was one significant change to the SR&ED program in the 2019 Federal budget (released 2019-03-19): the use of taxable income as a factor in determining a CCPC’s annual expenditure limit was repealed, meaning smaller CCPCs with taxable capital of up to $10M are now eligible to apply for SR&ED credits. This came as somewhat as a surprise as previous budgets focused mainly on reducing SR&ED spending. The change was attributed to the desire to encourage businesses of all sizes and all sectors to conduct research in Canada.
To learn more, please visit: Investing in the Middle Class 1
The first quarter was busy in terms of judicial rulings. A full six appeals were heard before the courts, four were dismissed and only two allowed, one of these under proviso. Basic facts are listed along with links to summaries below.
Dock Edge + Inc. v. The Queen.
The Appellant is a privately-owned company which is involved in the manufacture and sale of various marine products for docks and boats both in Canada and internationally. The Appellant’s claim for the 2011 taxation year of $204,786 qualified SR&ED expenditures and SR&ED ITCs totalling $71,675 was denied; the Appellant appealed the ruling. Five projects were submitted in the Appellant’s claim. The judge ruled that the Appellant failed to produce sufficient evidence of technical risks or uncertainties for all five projects. Additionally, the judge ruled the Appellant failed to produce sufficient documentation of the scientific method for their projects; detailed records or ample oral testimony may have sufficed but the Appellant only provided three pages of handwritten notes for one project. Furthermore, the judge ruled the Appellant did not illustrate a technological advance for their projects. The appeal was dismissed.
For more details and analysis, you can view our complete analysis of Dock Edge + Inc. v. The Queen.
Madison Pacific Properties Inc. v. Canada.
The Appellants are part of a corporate group who acquired the unused non-capital losses, net capital losses, SR&ED expenses and/or investment tax credits of two publicly traded corporations. During their appeal to the CRA of their denied SR&ED expenses and investment tax credits, the Appellants “[…] made requests under the Access to Information Act, R.S.C. 1985, c. A-1 (the ATIP requests), seeking communications between the legislative policy divisions of the Canada Revenue Agency (the CRA) and the Department of Finance relating to loss utilization or loss trading under the ITA.” Many of the documents the Appellant received had information redacted which led the Appellant to bring forth a motion to the court seeking to compel the CRA to provide unredacted documents. The documents requested fell into two categories:
First, the redactions from various documents produced in response to the ATIP requests and, second, a general request for all correspondence between the legislative policy division, income tax rulings directorate and/or the GAAR Committee of the CRA and the legislative division of the Department of Finance for the period 2001 through 2012 “with respect to the legislative scheme dealing with so-called corporate loss trading, tech wrecks, transfer of corporate losses, whatever the colloquial terms might be”.
In the original case, the court ruled:
It refused disclosure of these additional documents because it concluded they were not relevant and offered as an additional reason the fact that the documents contained information of other taxpayers which is protected from disclosure by section 241 of the ITA. The Tax Court also refused the broad request for all correspondence between the legislative policy division, income tax rulings directorate and/or the GAAR Committee of the CRA and the legislative division of the Department of Finance for the period 2001 through 2012 with respect to the legislative scheme in the ITA dealing with transfer of corporate losses, finding such request to be “a fishing expedition of vague and far-reaching scope”, “overly broad” and an “onerous task to satisfy”
The judges, in this case, upheld the prior ruling and the appeal was dismissed.
For more details and analysis, you can view our summary of Madison Pacific Properties Inc. v. Canada.
Concept Danat Inc. v. The Queen
The Appellant, Concept Danat Inc., is a company who manufactures and distributes all-season clothing, sports clothing, and office clothing; their work includes decorating for advertising, embroidery, silk-screen printing, digital printing, and laser and transfer. For the tax year ending October 31, 2015, the Appellant claimed three projects were eligible for SR&ED income tax credits. Project 1 involved laser printing on clothing, Project 2 involved enhancing embroidery techniques and combining embroidery and laser printing on the same sweater, and Project 3 involved a sublimation technique on elasticized necklines and printing on 210 denier nylon. The Appellant claimed $48,671 as eligible SR&ED expenses and $32,056 SR&ED related expenditures deduction. The Appellant claimed an SR&ED ITC of $13,862. The CRA denied their claim. The judge ruled that in Project 1 that the Appellant used existing technology to address issues encountered and that the project was technical, not technological. In Project 2, the judge ruled that there was no technological uncertainty but a technical issue for which the existing knowledge base was sufficient to find a solution. In Project 3, the judge ruled that there was no technological uncertainty, as well as, that no advancement to existing technology was made; a new product was created but it did not mean a technological advance was made. Additionally, the Appellant provided estimates of time employees worked on these projects but was unable to provide details on the hours worked on the projects. The judge was not satisfied by the documentation provided and stated an accurate record of hours worked was required for an SR&ED claim. The appeal was dismissed.
For additional information relevant to this case, please review our full summary of Concept Danat Inc. v. The Queen (2019)
A & D Precision Limited v. The Queen
The Appellant is a manufacturer of machine components and does most of their business with GE. This case reviewed SR&ED projects over three fiscal years (2006-2008). Two different projects were examined over the course of three years. The first project consisted of finding new lathes (machines that shape metal workpieces by rotating the workpieces rapidly against changeable cutting tools) in order to meet the demands of their customer as the old lathes were unable to shape the metal pieces precisely as required. Initially, the Appellant bought three Tachi lathes from another company, which then broke after their warranty had expired. The Appellant attempted to fix the machines but later sold the machines as the issues were unable to be resolved. Next, the Appellant built their own lathe called the 80 ton Matteo. Once the 80 ton Matteo was complete 60 and 40 ton Matteos were also built. Finally, the Appellant attempted to build a double-wheel roll grinding machine. This project was unsuccessful and abandoned after the costs became too high. The Judge ruled that the purchase and sale of the three Tacchi lathes were not eligible SR&ED expenses, the 80 ton Matteo and double-wheel roll grinding machine were eligible SR&ED projects, and the 60 and 40 ton Matteos were not eligible SR&ED projects.
For additional insight read the full A & D Precision Limited v the Queen summary (2019).
Laforest Marketing Internationals Inc. v. The Queen
The Appellant applied for SR&ED investment tax credits for a project involving a water mist collector which was designed to catch water when spraying the leaves of indoor plants. The CRA denied the claim because it did not fit the definition of SR&ED. The Respondent also claimed that not all of the SR&ED expenditures submitted by the Appellant were qualified SR&ED expenditures. The judge stated “It is not enough for information to be unknown to the taxpayer; it must be unknown to the field in general. It is possible for a product or process to exist already and for a technological uncertainty to persist. However, it is instead the application of common methods that matters in analyzing SR&ED activity.” The Appellant testified that projects known about in the industry were used in this project; additionally, the Appellant testified known welding methods and plastic which already existed were used in the project. The judge ruled that there was no evidence that this was a new process and another company was already using it. Furthermore, the judge ruled that the project did not fit the criteria of an SR&ED project. The appeal was dismissed.
An extensive summary on this case can be read at Laforest Marketing Internationals Inc. v. The Queen.
CRL Engineering Ltd. v. The Queen
The Appellant, in this case, is an engineering firm who specializes in developing public transit-related technology. The project in dispute was titled “A Real‑Time Vehicle Arrival Prediction Model for Transitlive”. The goal of the project was to develop a web-based system using algorithms and GPS to provide real-time data on buses. The Respondent alleged that the project used routine engineering and no technological uncertainty existed. The judge ruled in favour of the Appellant and stated that the Appellant demonstrated there was technological risk or uncertainty and that the project met the criteria of SR&ED and engaged in SR&ED related activities during the tax years in question. While the judge ruled in favour of the Appellant, the appeal was limited to $25,000 per taxation year due to the Informal Procedure that was held.
Read the extensive summary of CRL Engineering Ltd. v. The Queen for additional information.
Summary of Court Rulings
Of the six rulings heard in this quarter, only one was fully allowed. The others were dismissed due to insufficient evidence and/or the fact that the work was deemed not SR&ED-related. It is imperative for applicants to understand eligibility prior to applying, so they can ensure their documentation is in order. The work being conducted must be for the purpose of achieving a technological advancement in order for it to be considered SR&ED. It is not enough to modify an existing piece of equipment and it doesn’t matter if the final project outcome results in a materially changed object, there has to be evidence that the organization has worked towards the “generation of information or the discovery of knowledge that advances the understanding of scientific relations or technology”. 2
If you are at all uncertain whether your project constitutes a technological advancement we have an excellent blog post that explains the concept of a technological advancement. Take the example of A & D Precision who were permitted to claim the SR&ED tax credit on one of their projects — the 80 ton Mateo. This was considered a technological advancement as it was a brand new machine design. Their 60 and 40-ton versions were not eligible, however. Why? Simply changing the size of the machine does not constitute a technological advancement, unless you can clearly articulate what scientific or technical knowledge is missing at the outset of the project.
Taking the example of Concept Danat, the company attempted to claim SR&ED tax credits because the end product they produced was physically transformed into something different. While it is true that they changed the product, they failed to demonstrate how this represented a technological advancement, therefore, making the claim ineligible.
The second major reason that claims were denied was the lack of documentation. Proof of work is required for SR&ED claims and the evidence must be contemporaneous. You must keep all information related to the project, whether it is work notes, employee hours or purchase receipts. This information is the backbone of your claim. Without irrefutable evidence, your claim can be denied, whether or not the project itself is eligible for SR&ED. Read what we wrote about getting (and keeping) your SR&ED facts straight.
As we wrote in our blog this budget definitely brought a minor change with a major impact.
Along with the budget post referenced above, we wrote two more interesting blog posts in the first quarter; the first speculating on potential budget changes “Is SR&ED Going to Change – again?”; and the second outlining SR&ED in relation to Federal Tax Expenditures.
Clearly the budget was weighing heavily on our minds in the early part of the year. Any changes to the SR&ED program are impactful as researchers are frequently concerned that additional complications to the application process could mean a complete repeal of the entire program. The past few budgets have in fact reduced support for the SR&ED program so this year’s about face in allowing smaller companies to potentially apply for the benefit could in fact cost the government more money. That, combined with the complex claims process and the frequency of claims appeals, could mean difficult times ahead for the SR&ED program. Time will tell.
Summary of SR&ED Updates
As noted, the big news was the change to the SR&ED program announced in the federal budget, but there were several noteworthy court cases. It will be interesting to see when the changes receive royal assent and when companies and whether the same themes will continue in the courts the rest of the year. Did we miss any Q1 trends in SR&ED for 2019?
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- “Investing in the Middle Class.” Government of Canada, https://www.budget.gc.ca/2019/home-accueil-en.html. Accessed 22 September 2019. ↩
- “Scientific or technological advancement”. SR&ED Glossary. Government of Canada, https://www.canada.ca/en/revenue-agency/services/scientific-research-experimental-development-tax-incentive-program/glossary.html#dvncmnt. Accessed 23 September 2019. ↩