REASONS FOR JUDGMENT
Lamarre A.C.J.
INTRODUCTION
[1]
Hypercube Inc. (the appellant) is
appealing from an assessment regarding the taxation year ending April 30, 2012,
by which the Minister of National Revenue (Minister) disallowed an
amount of $28,800 claimed as scientific research and experimental development (SR&ED)
expenditures.
[2]
The Minister submits that the expenditures do
not fall within the definition of SR&ED given in subsection 248(1) of
the Income Tax Act (ITA) and that the appellant is therefore not
entitled to investment tax credits under subsections 127(5) and 127(9) and
section 127.1 of the ITA. All the SR&ED expenditures that were claimed
and disallowed were accepted by the Minister as business expenses.
[3]
The appeal was filed under the informal
procedure.
FACTS
[4]
The appellant operates a business that has been
providing information technology services since 2009. Over the years, the
appellant has built up an expertise in programming Web sites. It is a business
with five employees.
[5]
Karl Villeneuve is the appellant’s founder,
president and sole shareholder. He was the only witness to appear for the
appellant. Mr. Villeneuve has a bachelor’s degree in business
administration, finance and marketing from Bishop’s University and a Master of
Business Administration (MBA) degree from the Université de Montréal. He took
several courses in computer science and earned a certificate from Seneca College
for technical computer training.
[6]
For 2012, the appellant claimed an SR&ED credit
for a computer program it was developing.
[7]
According to the documentation provided, the
project consisted of developing a program to read and analyze source code from
Web sites to detect weaknesses (Reply to the Notice of Appeal, paragraph 8(g);
Tab 1 of Exhibit I‑1, page 3, form T661).
[8]
At the hearing, Mr. Villeneuve stated that
the program was supposed to be able to inspect and check Web sites and was more
than a just a tool for detecting defects (transcript, page 22).
[9]
Two other people worked on developing the
program with Mr. Villeneuve: Jean‑François Noël and Jean‑Simon Lyonnais.
These two other people have a computer science background. Jean‑François Noël
has a degree in computer science from Bishop’s University, and Jean‑Simon Lyonnais
is a computer graphics designer and programmer who received his training at the
Centre de formation professionnelle Jacques-Rousseau. Neither of them appeared
in court to give their scientific point of view regarding the project.
[10]
The SR&ED expenditures claimed by the
appellant are the wages paid to the employees who took part in developing the
program. However, the logs showing the hours worked record only Mr. Villeneuve’s
work (Tab 8 and Exhibit I‑1).
[11]
Mr. Villeneuve stated that he began
thinking about this project in 2010 and discussed it with the appellant’s other
employees around the beginning of 2012. The project was the product of a reconsideration
of the various programming tools available.
[12]
Currently, when a programmer analyzes a Web
site’s code to find weaknesses and optimize performance, the programmer
analyzes the code manually, page by page. The appellant wanted to use the
program to automate this analysis. Mr Villeneuve explained that the
appellant’s goal was to develop a new technique to allow programmers to work
more efficiently. The program was supposed to analyze the Web sites’ code
quickly and help the programmers do their checks.
[13]
The initial hypothesis on which the project was
based, as Mr. Villeneuve mentioned in his testimony, was that if a new way
of performing Internet diagnostics was adopted, significant effects in terms of
technological advancement could be observed (transcript, page 15).
[14]
With this hypothesis established, the
appellant’s employees conducted research to determine whether there was an
existing technology that could be used to carry out the project, or whether it
was possible to achieve this by improving on existing technologies.
[15]
Mr. Villeneuve claimed that no existing
solution or technology could be used to test the hypothesis. This is why, he
said, the appellant developed the program.
[16]
Mr. Villeneuve explained that the program was
based on a “crawler”. According to his explanations, a crawler is a computer
program that reads a Web site’s source code. It is created by writing a
computer program. The appellant therefore wrote a crawler as the first step in
developing its program. On cross-examination, Mr. Villeneuve noted that
crawlers are a commonly used tool in computer science (transcript, page 70).
[17]
As I understand it, the appellant’s crawler had
to inject itself into the Web site’s source code to be able to collect the
required information, analyze it, extract the necessary results and, finally,
complete a full diagnostic of the Web site. The program had to be able to
produce a diagnostic report in PDF format.
[18]
Mr. Villeneuve noted that no existing
technology allowed this to be done. Current technology, he explained, could not
collect the information, validate it and retrieve it in the way they wanted it
to. Mr. Villeneuve stated in his testimony that the program would improve
the underlying technology. He described the underlying technology as being
various programming languages (transcript, page 67).
[19]
The witness said that the technological
advancement was the creation of a new way of generating source code reports for
Web sites. The technology that the appellant claims to have developed is able
to seek out information in a Web site’s code and retrieve it for the purposes
of running a diagnostic.
[20]
Mr. Villeneuve explained that the project was
carried out methodically, using a process of [translation] “trial
and error”. The appellant’s employees analyzed whether they could retrieve an
initial piece of information in a Web site’s code, validated their attempt and
then made another attempt to obtain a second piece of information, and so on.
The work plan consists of a tree diagram of the program that was attached to
the Notice of Appeal and filed as Exhibit I‑1, at Tab 5,
page 53.
[21]
Regarding the technological uncertainties facing
the appellant, Mr. Villeneuve stated that they were connected with the
underlying technology. The uncertainties related to whether the underlying technology
could be improved so that a crawler could be programmed as required to carry
out the project.
[22]
Mr. Villeneuve then spoke in more detail
about what he saw as the problems they experienced in developing the program
and explained the various measures taken to resolve them.
[23]
An initial problem was that the program did not
work for certain domain names that were being used by the Web sites being
analyzed. Changes were made to the program so that it would work with all
existing domain names.
[24]
A similar problem arose with the different Web
browsers that were being used to launch the program. In this case, the program
did not work when it was used with certain Web browsers. The program was
changed to make it compatible with most existing Web browsers.
[25]
Another problem cropped up when the program was
used more than 150 times a day. Mr. Villeneuve said that the problem
was caused by a coding error in the program.
[26]
Another difficulty detailed by Mr. Villeneuve
arose when the program analyzed a Web site that was automatically redirected to
another URL. The solution was to develop new code for the program.
[27]
As supporting evidence, Mr. Villeneuve
referred to the tree diagram of the crawler created by the appellant and to an
Excel document showing the hours that the employees spent developing the
program. These exhibits were attached to the Notice of Appeal and filed as
Exhibit I‑1, at Tabs 5 and 8. He noted that these documents
showed all the hypotheses that were tested throughout the project. As was
mentioned above, only Mr. Villeneuve’s hours appear in the documentation provided.
[28]
Mr. Villeneuve stated that the program’s
development did not generate any profit. He noted that the appellant had no
short-term commercial goals and that this was an experimental project to
improve existing technology.
[29]
The respondent called Roger Andria as an
expert witness. Mr. Andria is a research and technology advisor with the
Canada Revenue Agency (CRA). He has a bachelor’s degree in computer engineering
from Université Laval.
[30]
Mr. Villeneuve objected to the
qualification of Mr. Andria as an expert witness. I found that although he
perhaps did not have the required expertise to give expert testimony in the specific
field relevant to this case, he could certainly testify as a CRA officer and
give his reasons for determining that the project was not eligible for
SR&ED credits under the applicable criteria.
[31]
In Mr. Andria’s view, the appellant
developed a new product based on existing technology. He submitted that the
appellant had not shown that the planned project could not be carried out using
current technology.
[32]
Mr. Andria asserted that the program was
developed from existing computer languages. In his view, the problems
experienced in developing the program were normal programming problems. All the
problems were resolved by using existing programming techniques. Code
correction is not considered to be a technological advancement. Rather, it is
common practice in computer programming.
[33]
Regarding the technological uncertainty
criterion, he concluded that it was a matter of resolving problems with
specific functions of the program on a case-by-case basis. He went on to state
that, in its hypotheses, the appellant did not define the technological
uncertainties that were overcome and failed to explain how this represented a
technological advancement in the field of computer science.
Issue
[34]
The only issue before this Court is whether the
work done by the appellant in developing the computer program constitutes SR&ED
within the meaning of subsection 248(1) of the ITA.
Appellant’s position
[35]
The appellant submits that its activities
constitute SR&ED. In its Notice of Appeal, the appellant alleges that its
project consists of a series of related activities collectively required to
achieve a technological advancement. It argues that the CRA’s auditor divided
the project into subprojects and assessed them as standard engineering
practices. At the hearing, Mr. Villeneuve suggested that all the work done
in developing the program constituted SR&ED because it improved the existing
technology.
Respondent’s position
[36]
The Minister, on the other hand, submits that
the appellant’s expenditures are not covered by the definition of SR&ED
given in subsection 248(1) of the ITA. The Minister alleges that the project
does not involve any technological advancement and instead involves resolving discrete
problems within the constraints of the technologies used.
ANALYSIS
[37]
Subsection 248(1) of the ITA defines the
phrase “scientific research and experimental development” 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 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,
and, in applying
this definition in respect of a taxpayer, includes
(d) work undertaken by or on behalf of the taxpayer
with respect to engineering, design, operations research, mathematical
analysis, computer programming, data collection, testing or psychological
research, where the work is commensurate with the needs, and directly in
support, of work described in paragraph (a), (b), or (c)
that is undertaken in Canada by or on behalf of the taxpayer,
but does not
include work with respect to
(e) market research or sales promotion,
(f) quality control or routine testing of materials,
devices, products or processes,
(g) research in the social sciences or the humanities,
(h) prospecting, exploring or drilling for, or
producing, minerals, petroleum or natural gas,
(i) the commercial production of a new or improved
material, device or product or the commercial use of a new or improved process,
(j) style changes, or
(k) routine data collection.
[38]
The case law has established five criteria for
determining whether a particular activity is SR&ED. These criteria were
laid down by Judge Bowman in Northwest Hydraulic Consultants Ltd. v.
Canada, [1998] T.C.J. No. 340 (QL), [1998] 3 C.T.C. 2520 (T.C.C.)
at paragraphs 14, 15 and 16. These criteria were cited with approval by
the Federal Court of Appeal in RIS‑Christie Ltd. v. Canada, [1998]
F.C.J. No. 1590 (QL), 99 DTC 5087, at paragraph 10. The Federal Court
of Appeal summarized these criteria in C.W. Agencies Inc. v. The Queen, 2001 FCA
393, [2002] 1 C.T.C. 212, at paragraph 17, as follows:
1. Was there
a technological risk or uncertainty which could not be removed by routine
engineering or standard procedures?
2. Did
the person claiming to be doing SRED formulate hypotheses specifically aimed at
reducing or eliminating that technological uncertainty?
3. Did
the procedure adopted accord with the total discipline of the scientific method
including the formulation, testing and modification of hypotheses?
4. Did
the process result in a technological advancement?
5. Was a
detailed record of the hypotheses tested, and results kept as the work
progressed?
[39]
In Northwest Hydraulic, supra, Judge Bowman
made the following observations on the question of whether there is a
technological risk or uncertainty (at paragraph 16):
Implicit in the
term "technical risk or uncertainty" in this context is the
requirement that it be a type of uncertainty that cannot be removed by routine
engineering or standard procedures. I am not talking about the fact that
whenever a problem is identified there may be some doubt concerning the way in
which it will be solved. If the resolution of the problem is reasonably
predictable using standard procedure or routine engineering there is no
technological uncertainty as used in this context.
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.
[40]
As was noted in Zeuter Development
Corporation v. The Queen, 2006 TCC 597, at paragraph 22, “[s]oftware development
can certainly be eligible as SR & ED on the basis that its goal is to
advance computer science or information technology”.
[41]
The onus is on the appellant to show, on a
balance of probabilities, that the expenditures it made relate to SR&ED
within the meaning of subsection 248(1) of the ITA.
[42]
In the present case, I am not satisfied that the
appellant’s work goes beyond routine engineering or standard procedures, as is
required to find that the work constitutes SR&ED.
[43]
The technological advancements and technical
obstacles of this project are set out in the T661 report prepared by the
appellant (Tab 1, Exhibit I‑1). At the hearing, Mr. Villeneuve
explained what he believed to be the technological uncertainties that were
overcome to develop the program and achieve a technological advancement.
[44]
However, the appellant has not satisfied me that
the technological uncertainties that it overcame could not have been removed by
routine engineering. On the contrary, the evidence showed that the appellant
used standard software development techniques to deal with the various
difficulties it experienced.
[45]
In my opinion, the appellant’s activities were
generally accessible to competent professionals in the field. Mr. Villeneuve
himself mentioned that a crawler is a commonly used tool in computing. Even if
the crawler was developed to accomplish new actions, the evidence showed that
the appellant used commercially available programming tools and existing
computer languages.
[46]
In my view, the testimonial evidence shows that
all the difficulties described by the appellant were resolved in the end by
using recognized programming techniques to modify the program’s code. The appellant
confined itself to using available computer languages. In my opinion, the
program’s development did not go beyond the limits of current technological
standards. It seems to me that the solutions that the appellant used are standard
techniques and not the product of a technological advancement. As Mr. Andria
mentioned in his testimony, the programming problems that arose during the
program’s development were normal ones.
[47]
Although the appellant’s program could constitute
an entirely new product, it was created using well-known techniques. Novelty or
innovation in a product is not sufficient to illustrate technological
advancement (Zeuter Development Corporation, supra, at
paragraphs 23 and 24).
[48]
Moreover, the appellant produced very little
evidence documenting its project. The only documents introduced in evidence are
the program’s tree diagram and a log of hours worked. This tree diagram was not
specifically explained in Court, and the time log does not appear to reflect
reality. I do not think that this evidence is sufficient to support an SR&ED
claim as prescribed by the ITA. On this point, I think it is helpful to note
the words of Justice Little in Zeuter Development Corporation v. The
Queen, supra, at paragraph 28:
[28] In
passing, an overall observation of the case is that no adequate supporting
documentation has been provided by the Appellant. While not absolutely
necessary, it is beyond doubt that a taxpayer who creates a well-supported
claim will facilitate the process in determining whether something qualifies as
SR & ED. As stated in RIS-Christie, the only reliable method of
demonstrating that scientific research was undertaken in a systematic fashion
is to produce documentary evidence. The Appellant has not presented sufficient
facts to support his claim as a systematic investigation or search that is
carried out in the field of science or technology as specifically required in
the definition of SR & ED.
[49]
The appellant has not succeeded in showing on a
balance of probabilities that the development of its program constituted SR&ED
within the meaning of subsection 248(1) of the ITA. The taxpayer’s appeal
is dismissed.
Signed at Ottawa, Canada, this 17th day of March 2015.
“Lucie Lamarre”
Translation
certified true
on this 20th day
of May 2015.
Michael Palles,
Translator-Language Advisor
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