The 5 Questions For SR&ED – Intent and Evolution

September 20, 2022 Danielle Cooper

Attention: Policies May Have Been Updated

*** Some of the policies referenced were updated 2021-08-13. We are working to update this article and others. ***

From 2015 to 2021 the five questions appeared in the Eligibility of Work for SR&ED Investment Tax Credits Policy. In late 2021, in an attempt to simplify the policies the CRA removed these questions from the policy; however, they are indirectly referenced and taxpayers should be aware of them prior to any submissions to the Tax Court of Canada. In 2022, a legal ruling by the Federal Court of Appeal continued to stress the importance and validity of the five questions.

The 5 Questions For SR&ED – Intent and Evolution

The Scientific Research and Experimental Development (SR&ED) program uses five questions to determine the eligibility of the work performed. While it is important to know the Canada Revenue Agency (CRA) policies, it is also helpful to review the Tax Court of Canada’s original intent with the five questions of SR&ED eligibility.

The first ruling to introduce the 5-part test was Judge Bowman in Northwest Hydraulic Consultants v. The Queen (1998). In Northwest Hydraulic Consultants v. The Queen (1998) the judge developed a 5-part test to determine SR&ED eligibility. Based on this five-part test, it was the opinion of the court that four of the five projects in 1994 qualified for SR&ED investment tax credits. This assessment was then expanded to all 17 projects submitted from 1983-1994.

In 2012, this five-part test was formally added to the Eligibility of Work for SR&ED Investment Tax Credits Policy and it was later refined in the 2015 revision to the same policy. The policy has since been archived and replaced by the Guidelines on the eligibility of work for scientific research and experimental development (SR&ED) tax incentives, and the 2012 version of the policy is no longer publicly accessible. Nevertheless, the five questions are still utilized as a regular practice in SR&ED-related legal rulings. The five questions Judge Bowman outlined have been referenced often by other judges: as of June 29, 2022, this ruling has been cited over 55 times in other court cases, the most significant recent case was National R&D Inc. v. The Queen (2022).

Tax Court of Canada - Questions from Northwest Hydraulics Ruling (1998)	Original Policy Questions (2012)	Policy Questions (2015)	Current Guidelines Reference (2021)
1. Is there a technical risk or uncertainty?	1. Was there a scientific or a technological uncertainty—an uncertainty that could not be removed by standard practice?	1. Was there a scientific or a technological uncertainty?	"The recognition that scientific or technological uncertainty exists marks the starting point for the SR&ED work."
2. Did the person claiming to be doing SR&ED formulate hypotheses specifically aimed at reducing or eliminating that technological uncertainty?	2. Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty?	2. Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty?	"Generating an idea consistent with known facts, which serves as a starting point for further investigation towards achieving your objective or resolving your problem."
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?	3. Was the adopted procedure consistent with the total discipline of the scientific method, including formulating, testing, and modifying the hypotheses?	3. Was the overall approach adopted consistent with a systematic investigation or search, including formulating and testing the hypotheses by means of experiment or analysis?	"Work must be a systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis."
4. Did the process result in a technological advance, that is to say, an advancement in the general understanding?	4. Did the process result in a scientific or a technological advancement?	4. Was the overall approach undertaken for the purpose of achieving a scientific or a technological advancement?	"Work must be conducted for the advancement of scientific knowledge or for the purpose of achieving technological advancement." "...conceptual knowledge, such as theories or prediction models, rather than just factual knowledge, such as data or measurements."
5. Was a detailed record of the hypotheses, test, and results kept as the work progressed?	5. Was a record of the hypotheses tested and the results kept as the work progressed?	5. Was a record of the hypotheses tested and the results kept as the work progressed?	A systematic investigation calls for: "Keeping evidence that is generated as the work progresses."

The five questions have evolved since Northwest Hydraulic Consultants v. The Queen (1998). This article outlines the five questions of SR&ED eligibility as they first appeared in 1998, the revisions that appeared in the CRA’s Eligibility of Work for SR&ED Investment Tax Credits Policy, in the 2012 version and the 2015 version, followed by the current indirect references to the questions as they appear in the current guidelines. We compare and contrast the differences between the text and the implications this may have for taxpayers seeking to access the SR&ED program. We also look at the implications of the National R&D Inc. v The Queen (2022) legal ruling and how the five questions remain the standard to determine SR&ED eligibility.

To view the original sources, please visit:

What can we discern from reviewing the evolution of the terms? Quite a lot. We will review each of the questions individually and provide our commentary.

Five Questions SR&ED Eligibility

Question #1

Original: Is there a technical risk or uncertainty?

2012: Was there a scientific or a technological uncertainty—an uncertainty that could not be removed by standard practice?

In 2012, this was modified and broadened to “scientific or technological uncertainty” when it was added to the policies.

In particular, the switch from the term technical to technological is significant. The CRA uses the term technical in the context of technical problems which are defined as:

Technical problem was defined in the SR&ED Glossary as:

“the existing scientific or technological knowledge base is sufficient to resolve the problem. Overcoming a technical problem will not lead to a technological advancement, although it may lead to the creation of a new or improved product or process.”¹

The term has been removed from the glossary as of 2021.

The CRA’s current definition of Scientific or Technological Uncertainty is:

“Scientific or technological uncertainty means whether a given result or objective can be achieved, or how to achieve it, is unknown or uncertain due to an insufficiency of scientific knowledge.”²

More information on technical versus technological can be found in our post Technical vs. Technological in SR&ED.

Further, in 2012 the CRA added “that could not be removed by standard practice” to the question. This stems from Northwest Hydraulic Consultants v. The Queen (1998), where the judge ruled that “routine engineering” did not qualify as SR&ED. Judge Bowman stated:

“What is “routine engineering”? It is this question, (as well as that relating to technological advancement) that appears to have divided the experts more than any other. Briefly it describes techniques, procedures and data that are generally accessible to competent professionals in the field.”³

The term “standard practice” was used as a synonym for routine engineering. This became a source of contention in many SR&ED applications, as the concept of “standard practice” was sufficiently broad such that it nullified the “uncertainty” of many projects. The CRA would argue that all work was “standard practice” if a known method was used, even if the subsequent analysis generated new results/information. The original intent of the judge was to ensure that the purpose was to generate new information/knowledge that could not be generated without experimentation or analysis.

Judge Bowman states:

“The respondent’s position, ably articulated by Mr. Yaskowich, was essentially that the appellant, admittedly a world leader in the field of hydraulic model testing, by its own excellence sets the standard for what represents routine engineering or standard practice.

With respect I think that this sets an unrealistically high standard – indeed a standard of perfection that would discourage scientific research in Canada.

It is quite true, as Mr. Yaskowich observes, that the work done by NHC does raise the client’s confidence in a solution that is proposed or devised, but I do not think that this fact in itself detracts from the nature of the activity, or makes it any the less SRED.”⁴

2015: Was there a scientific or a technological uncertainty?

Due to widespread complaints from taxpayers stating their projects were denied as they were “standard practice,” the text “– an uncertainty that could not be removed by standard practice” was removed from the policies in 2015.

2021: The CRA now expresses the importance of technological uncertainty within SR&ED in the current Guidelines on the eligibility of work for scientific research and experimental development (SR&ED) tax incentives as:

The recognition that scientific or technological uncertainty exists marks the starting point for the SR&ED work, while the advancement is the targeted outcome of the work. Therefore, an attempt to resolve scientific or technological uncertainty is an attempt to achieve scientific or technological advancement.⁵

The new CRA guidelines offer more room for interpretation, however, the key point remains that for work to be SR&ED eligible, there must first exist scientific or technological uncertainty. See our article Line 242: Uncertain about Uncertainty? No problem. to gain a more complete understanding of how the scientific or technological uncertainties need to be formatted and explained on the SR&ED tax forms.

National R&D Inc. v. The Queen (2022): Justice Rennie used Justice Bowman’s guidance from Northwest Hydraulic Consultants v. The Queen (1998) to determine if technological uncertanties existed in the case. This shows that five questions in their original form are still relevant to determining if a project is SR&ED eligible.

Question #2

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

Formulating a hypothesis is a vital part of an SR&ED project; failure to document what is being verified through experimentation (and the subsequent knowledge or information generated) can result in having the application disqualified.

The SR&ED Glossary defines a hypothesis as “A hypothesis is an idea, consistent with known facts, that serves as a starting point for further investigation to prove or disprove that idea.”⁶ Further, a well-developed hypothesis can help to answer Questions #3-5.

Judge Bowman outlined a five-step plan where Questions #3-5 are solved organically:

(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;

(e) the methodical and systematic testing of the hypotheses.⁷

2012: Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty?

In 2012, the question was shortened and given more clarity. The phrase “the person claiming to do SR&ED” was changed to “did the effort”, presumably many SR&ED projects are conducted by more than one person.

2015: It was not altered in 2015.

2021: The current guidelines now state that the overall approach utilized must be a systematic investigation:

It is important to distinguish between a systematic approach to carrying out work and the approach that is a systematic investigation or search called for in the definition of SR&ED. The latter approach includes:

Generating an idea consistent with known facts, which serves as a starting point for further investigation towards achieving your objective or resolving your problem. Your idea may be expressed as a possible solution to a problem, a proposed method or an approach. This can be referred to as a hypothesis […]⁸

The new guidelines do not state the strict requirement of a hypothesis; however, in order for the project the be SR&ED eligible it must fall under the definition of being a systematic investigation. The guidelines do state that for a systematic investigation to occur there must be a clear idea of a starting point. In other words, a hypothesis. For more information on how to formulate a hypothesis, or determine a clear starting point for SR&ED, please see our article What Is a Good Hypothesis for SR&ED Purposes?

National R&D Inc. v. The Queen (2022): Justice Rennie used Justice Bowman’s guidance from Northwest Hydraulic Consultants v. The Queen (1998) to determine if hypothesis were modified as a result of testing/experimentation. This shows that five questions in their original form are still relevant to determining if a project is SR&ED eligible.

Question #3

Original: 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?

The judge stated his intent with question #3:

“It is important to recognize that although the above methodology describes the essential aspects of SRED, intuitive creativity and even genius may play a crucial role in the process for the purposes of the definition of SRED. These elements must however operate within the total discipline of the scientific method.”

“What may appear routine and obvious after the event may not have been before the work was undertaken. What distinguishes routine activity from the methods required by the definition of SRED in section 2900 of the Regulations is not solely the adherence to systematic routines, but the adoption of the entire scientific method described above, with a view to removing a technological uncertainty through the formulation and testing of innovative and untested hypotheses.”⁹

2012: Was the adopted procedure consistent with the total discipline of the scientific method, including formulating, testing, and modifying the hypotheses?

In 2012, this question was dramatically simplified. Terms such as “accord with established and objective principles of scientific method” and “observation, measurement, and experiment” were all removed. The three words are crucial aspects of the scientific method and while it may have seemed redundant for the CRA to keep them in the question they provided guidance for the taxpayer in terms of the process the CRA expects them to follow. Instead, the focus was on the formulation, testing, and modification of hypotheses, not necessarily the overall process (“trained and systematic observation, measurement, and experiment”).

2015: Was the overall approach adopted consistent with a systematic investigation or search, including formulating and testing the hypotheses by means of experiment or analysis?

In 2015, the language was changed and softened, including the modification of “adopted procedure” to “overall approach adopted” and removal of the term “scientific method” in favour of “systematic investigation or search”. The reference to modifying the hypothesis has also been removed.

The original version of Question #3 was clearer, although more limited in scope. It may be preferable to have kept the original definition, to avoid the confusion faced today. By removing “scientific method” and “observation, measurement, and experiment” over the years, confusion sometimes arises over what method is most acceptable for experimentation and how to measure results. That said, the inclusion of the term “systematic investigation or search” better aligns with the definition for income tax purposes provided in subsection 248(1) of the Income Tax Act: “ʽscientific research and experimental developmentʼ means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis […]”¹⁰

2021: The current guidelines do reference the necessity of a systematic approach, however, it has been further simplified from the 2015 Eligibility policy by stating:

Work must be a systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis.¹¹

The reference to ‘formulating and testing the hypotheses’ has been removed from the initial statement within the text, however, the guidelines do go on to describe what components must be present for the approach utilized to be considered a systematic investigation, including:

Generating an idea consistent with known facts, which serves as a starting point for further investigation towards achieving your objective or resolving your problem. Your idea may be expressed as a possible solution to a problem, a proposed method or an approach. This can be referred to as a hypothesis.

Testing of the idea or hypothesis by means of experiment or analysis. The idea can evolve and change as a result of testing.

Developing logical conclusions based on the results or findings of the experiment or analysis.

Keeping evidence that is generated as the work progresses.¹¹

As mentioned above, for the work to be considered a systematic investigation as opposed to a systematic approach, there must be a clear starting point, a hypothesis. The CRA has preserved an explanation which aligns smoothly with the definition for income tax purposes provided in subsection 248(1) of the Income Tax Act: It is also defined within the SR&ED Glossary:

The systematic investigation or search called for in the definition of SR&ED is an approach that includes defining a problem, advancing a hypothesis towards resolving that problem, planning and testing the hypothesis by experiment or analysis, and developing logical conclusions based on the results.¹³

The key terms that have endured since Justice Bowman’s initial statement include ‘systematic’, ‘experiment’, and ‘hypothesis’. From these terms, we can decipher a clear idea of what type of process is required to determine it as SR&ED eligible. If the process carried out begins with a clear starting point (hypothesis) and has a scientific or technologically clear and logical pathway of experiments or tests laid out to determine the accuracy of said hypothesis, then it will be considered a systematic investigation as per the current eligibility guidelines. A common spot where we see potential SR&ED claimants get caught up involves performing experimentation through trial and error. A trial and error approach does not qualify as SR&ED eligible because it is not ‘systematic’. See our series of articles regarding the topic of trial and error for further details: Trial And Error: Separating SR&ED From Bling Approaches (Pt. 1 of 2) & Trial And Error: Separating SR&ED From Bling Approaches (Pt. 2 of 2).

National R&D Inc. v. The Queen (2022): Justice Rennie states that the ITA requires a systematic investigation:

SR&ED is defined in subsection 248(1) as follows:

scientific research and experimental development means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis¹⁴

He also states:

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.¹⁵

This shows that five questions in their original form are still relevant to determining if a project is SR&ED eligible.

Question #4

Original: Did the process result in a technological advance, that is to say, an advancement in the general understanding?

Judge Bowman understood that the scientific community is large and diverse. In Question #4 the judge implies that a “technological advance” is synonymous with “an advancement in the general understanding.”¹⁶ The judge also stated, “A technological advance in Canada does not cease to be one merely because there is a theoretical possibility that a researcher in, say, China, may have made the same advance but his or her work is not generally known.”¹⁷

Another vital part of the judge’s reasoning was identified as follows:

“The rejection after testing of a hypothesis is nonetheless an advance in that it eliminates one hitherto untested hypothesis. Much scientific research involves doing just that. The fact that the initial objective is not achieved invalidates neither the hypothesis formed nor the methods used. On the contrary it is possible that the very failure reinforces the measure of the technological uncertainty.”¹⁸

2012: Did the process result in a scientific or a technological advancement?

In 2012, the phrase “advancement in the general understanding” was removed and the question was reworded to imply that a “scientific or technological advancement” was required. The CRA went on to define advancement as follows:

“Scientific or technological advancement is the generation of information or the discovery of knowledge that advances the understanding of scientific relations or technology.”¹⁹

This implies that the claimant must be able to articulate the new information generated or knowledge discovered. Put another way, it limited the scope of multi-year projects where 8-12 months may be required to set up an experiment but running the experiment or analyzing the results does not occur in the same period. In these multi-year scenarios, the work would not qualify as the claimant would not be able to demonstrate new information being generated or knowledge discovered. This posed an issue for taxpayers with multi-year or large/complex SR&ED projects.

2015: Was the overall approach undertaken for the purpose of achieving a scientific or a technological advancement?

In 2015 the question was modified to explicitly allow for advancement not yet achieved. It was altered to ensure that the intent of the project (“for the purpose of”) was for a scientific or technological advance, regardless if that advance has already occurred.

The 2015 version of the question better aligns with the current Income Tax Act definition of SR&ED:

“ʽscientific research and experimental developmentʼ means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is

(a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view,

(b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or

(c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto,”²⁰

2021: The current guidelines also stress the necessity of advancement as the overall purpose of the SR&ED project, by stating:

Work must be conducted for the advancement of scientific knowledge or for the purpose of achieving technological advancement (contained in paragraphs (a) to (c) of the definition). The key to both is the generation or discovery of knowledge that advances the understanding of science or technology.²¹

The CRA has maintained that the intent of the project must be for a scientific or technological advancement, regardless of whether any advancement occurs within the tax year. The wording stills allows for both long and short-term projects to be considered for SR&ED purposes so long as they begin with the intent to advance the related knowledge base. The new guidelines go one step further on the topic of advancement by describing the type of knowledge that must be advanced:

The type of knowledge in this context is conceptual knowledge, such as theories or prediction models, rather than just factual knowledge, such as data or measurements.²²

This clarification can be linked back to Justice Bowman’s initial question because the general understanding (“conceptual knowledge”) is what is necessary to advance, as opposed to facts and statistics. While the work will in all likelihood result in factual knowledge, it does not constitute as scientific or technological advancement within the definition of SR&ED until it has been taken one step further and used to draw new conclusions, theories, and/or knowledge. We have discussed the knowledge base in greater detail in Determining if the Knowledge Base Has Been Advanced: The CRA Perspective.

National R&D Inc. v. The Queen (2022): Justice Rennie uses the five questions in their original form which shows that they are still relevant to determining if a project is SR&ED eligible.

Question #5

Original: Was a detailed record of the hypotheses, test, and results kept as the work progressed?

Judge Bowman stated, “Although the Income Tax Act and the Regulations do not say so explicitly, it seems self-evident that a detailed record of the hypotheses, tests, and results be kept, and that it be kept as the work progresses.”²³ It is very hard to prove that SR&ED work was conducted if there is no record.

2012/2015: Was a record of the hypotheses tested and the results kept as the work progressed?

In 2012, the word “detailed” was removed in 2012 and not added back in 2015, likely due to the vague definition of “detailed”. Further, the question was rephrased to imply that you do not have to keep the test information, only the hypotheses, and results.

In the Eligibility of Work for SR&ED Investment Tax Credits Policy it is explained:

“It is expected that the work be recorded, clearly showing why each major element is required and how each fits into the project as a whole. It is also expected that the indicators or measures that will be used to determine if the goals of the work are met will be identified and recorded at an early stage of the work.”²⁴

Despite these changes, the question of “How much documentation is enough documentation?” remains contentious, particularly in software claims.

The guide to Form T661, the T4088 elaborates on the importance of documentation:

Most often, supporting evidence is in the form of contemporaneous documents (for example, documents generated as the SR&ED was being carried out). In fact, contemporaneous documentation that is dated, signed, and specific to the work performed are the best supporting evidence that you can provide.²⁵

Lines 270-282 on Form T661 list evidence one may have to support their claim:²⁶

Project planning documents
Records of resources allocated to the project, time sheets
Design of experiments
Project records, laboratory notebooks
Design, system architecture and source code
Records of trial runs
Progress reports, minutes of project meetings
Test protocols, test date, analysis of test results, conclusions
Photographs and videos
Samples, prototypes, scrap or other artifacts
Contracts

This list is not an exhaustive list and lines 281 and 282 allow for additional types of documentation to be submitted with your claim.

2021: The Guidelines on the eligibility of work for scientific research and experimental development (SR&ED) tax incentives do not directly state the necessity of documentation for a process to be considered as SR&ED, however, it does state that a systematic investigation includes:

Keeping evidence that is generated as the work progresses.²⁷

Although documentation is not explicitly stated as a requirement for SR&ED eligibility, if an SR&ED claim is chosen for review, the absence of documentation is equal to the absence of SR&ED work and that claim will be denied. Please see Why do I need contemporaneous documentation for SR&ED? for an in-depth explanation of the importance of keeping documentation and records of your SR&ED work and what documentation is the most effective.

National R&D Inc. v. The Queen (2022): Justice Rennie uses the five questions in their original form which shows that they are still relevant to determining if a project is SR&ED eligible.

Conclusion

As you can see, the five questions of SR&ED eligibility have changed over time. As the five questions of SR&ED eligibility have been altered throughout the years the original intent was sometimes hidden. Occasionally the questions become clearer, other times less so. In the 2015 iteration, there appeared to be more of an effort to align with the text in the Income Tax Act. In the 2021 Guidelines, the intent has been to simplify the wording but the five questions can still be seen throughout the document.

It is important to show alignment with the Income Tax Act first and the policies second. Understanding the nuances of the five questions of SR&ED eligibility and how they relate to the definition of the Income Tax Act can be helpful when preparing your claim and in the case of a dispute. As Northwest Hydraulic Consultants v. The Queen (1998) is still being cited as legal precedence by judges today, ensuring that projects align with the original legal text is important for a claim to be accepted.