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Reference: 2004TCC341
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Date: 20040527
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File: 2000-3532(IT)G
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BETWEEN:
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TACTO NEURO SENSORY DEVICES INC./APPAREILS
NEUROSENSORIELS TACTO INC.,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
Bédard J.
[1] During
the taxation year ending on July 31, 1998, the appellant incurred expenditures
of $37,379 in order to change and improve a tactometer, a device that enables
precise studying of the hand-arm vibration syndrome and repetitive movements.
In its income tax return for the 1998 taxation year, the appellant declared
that it had spent $37,379 as scientific research and experimental development
expenditures and had claimed an income tax credit refund of $15,046.
[2] Via
a notice of assessment dated May 6, 1999, stating that no income tax was
payable, the Minister of National Revenue (the “Minister”) denied the amount of
$37,379 as scientific research and experimental development expenditures,
and did not refund the amount of $15,046 claimed by the appellant for the 1998
taxation year.
[3] Therefore,
it needs to be determined whether the work undertaken by the appellant during
the 1998 taxation year constituted scientific
research and experimental development within the meaning of section 37 of the Income Tax Act (the “Act”)
as well as subsection 248(1) of the Act.
Preliminary comments
[4] It
is appropriate to highlight that the respondent filed, as Exhibit I-2, an
expert report prepared by André Okoniewski, a research and technology advisor
for the Canada Customs and Revenue Agency (the “CCRA”). This report analyzed
the work carried out by the appellant during the 1998 taxation year and
concluded that the work did not constitute scientific research and experimental
development. Also, the appellant did not challenge Mr. Okoniewski’s capacity as
an expert. Lastly, the appellant did not file any expert reports and did not
have any of the people who had carried out the work at issue testify.
Analyse
[5] Pursuant
to the Act, “scientific research and experimental development” is defined in
subsection 248(1) of the Act as follows:
(1) "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 248 (1) "scientific research and
experimental development" (a), 248 (1) "scientific research
and experimental development" (b), or 248 (1) "scientific
research and experimental development" (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.
[6] In
Northwest Hydraulic Consultants Ltd. v. Canada, [1998] T.C.J.
No. 340, 98 D.T.C. 1839, Bowman J., as he then was, set out in paragraph
16 the criteria that establish whether the work undertaken constitutes
scientific research and experimental development. According to him, the
approach to be taken is the following:
1. Is there a technical risk or uncertainty?
a) 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.
b) 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.
2. Did
the person claiming to be doing SRED formulate hypotheses specifically aimed at
reducing or eliminating that technological uncertainty? This involves a five stage
process:
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.
It is important to recognize that although
a technological uncertainty must be identified at the outset an integral part
of SRED is the identification of new technological uncertainties as the
research progresses and the use of the scientific method, including intuition,
creativity and sometimes genius in uncovering, recognizing and resolving the
new uncertainties.
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?
a) 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.
b) 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.
4. Did
the process result in a technological advance, that is to say an advancement in
the general understanding?
a) By general I mean something that is known to, or, at
all events, available to persons knowledgeable in the field. I am not referring
to a piece of knowledge that may be known to someone somewhere. The scientific
community is large, and publishes in many languages. 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.
b) The rejection after testing of an 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.
5. 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.
[7] In
C.W. Agencies Inc. v. Canada, [2001] F.C.J. No. 1886, 2002 D.T.C.
6740, the Federal Court of Appeal confirmed the comments made by Bowman J. by
maintaining, in paragraph 17:
Both sides in front of us relied on the test outlined
in Northwest Hydraulic Consultants Limited v. Her Majesty the
Queen, [1998] D.T.C. 1839. In that case, Judge Bowman of the Tax Court
outlined five criteria which are useful in determining whether a particular
activity constitutes SRED. Those criteria have been approved by this Court in RIS-Christie
v. Her Majesty the Queen, [1999] D.T.C. 5087 at page 5089. The criteria
are 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?
Facts
[8] In
a letter dated September 26, 1997, (Exhibit I-1, Tab 14) from the appellant to
Dr. Martin Cherniack, M.D., of the University of Connecticut,
Dr. Robert A. Bertrand confirmed that the appellant had been able to
sell a model 200 tactometer to the University of Connecticut.
[9] In
a letter dated September 16, 2000 (Exhibit I-1, Tab 15), Dr. Cherniack
confirmed to the appellant that he had had the device for three years and he
used it as a clinical and research tool. However, he pointed out that the
device had been “buggy;” it had some defects and still needed some
research and development work for it to be reliable.
[10] The claim for scientific research and experimental development
expenditures submitted by the appellant (Exhibit I-1, Tab 5) for the 1998
taxation year showed three types of expenditures.
a) expenditures of a current nature
for SR&ED undertaken in Canada for the appellant’s employees: $23,131
It should be noted that these expenditures arose from work undertaken by
Mr. Xingwen Hao. To support its claim, the appellant did not file
Mr. Hao’s timesheets; instead, it filed a statement of the work done for
the appellant by Infomedic BR Inc., which used Mr. Hao’s services to do the
work. Essentially, the timesheets showed that the work involved mainly
debugging the tactometer and making some changes to the software.
b) cost of materials consumed in the
prosecution of SR&ED: $13,388
The evidence showed that this amount represented expenditures related to
the acquisition of equipment used to build a second prototype.
c) cost of SR&ED undertaken by
independent contractors for the appellant: $860
The evidence revealed that the $860 had been paid to Mr. Jean‑Pierre Chassé,
an independent contractor, who basically made changes to the electronic circuit
to eliminate electronic noise at low frequencies.
Conclusion
[11] The appellant had the burden of showing, based on the balance of
probabilities, that the expenditures it had incurred corresponded to scientific
research and experimental development, and to do so, it had to show that there
was a technological risk or uncertainty that could not
be removed by routine engineering or standard procedures. If the resolution of the problem is reasonably predictable using
standard procedure or routine engineering, there is no technological
uncertainty. Thus all of the work done to resolve a problem using techniques,
procedures, and data that are generally accessible to competent professionals
in the field cannot, in my opinion, be scientific research and experimental development since there is no
technological risk or uncertainty.
[12] Mr. Okoniewski testified that the work conducted by Mr. Hao and
Mr. Chassé was essentially related to the problem he
called background noise monitoring and the reprogramming of
the software for the Windows 95 system. It would be appropriate to point
out that, in his testimony, Mr. Okoniewski basically resumed the analysis
he had provided of these two problems in Tab 2 of his expert report (Exhibit
I-2, Tab 2), which is worth citing:
Re: background noise
monitoring
[TRANSLATION]
In my opinion, electronic
instruments measuring low frequency signals should always assess vibrations
from the environment. I think that, when working with this type of equipment,
it is current practice in this industry to gauge background noise. This
analysis can be done automatically and continually or semi‑automatically
for each location and measurement.
As the taxpayer stated in the
section of its documents concerning R&D on July 31, 1997, it did not intend
to develop the new electronic card to analyze continuous noise during the
medical examination. The taxpayer opted for the second approach of adapting the
known technology.
This adaptation required that new
functions be added to the software. According to information circulars 97-1 and
86-4R3, adaptations and additions of new functions do not constitute work that
advances already developed technology.
Re: reprogramming the
software in Windows 95
In general, I would like to make
the same comments as above. Reprogramming, by adding new functions, is not an
eligible activity according to the Regulations.
All of the changes were made to
meet ISO standards or improve the software’s performance (e.g, graphical
display).
These activities improve the
product as such, but they do not advance the technology of the field, which was
already developed in previous years.
[13] The expert report, Mr. Okoniewski’s testimony, and the evidence
submitted show that the work done by Mr. Hao and Mr. Chassé does not constitute
scientific research and experimental development because there was no
technological risk or uncertainty in this case. Indeed, the appellant showed
that the purpose of the work carried out by Mr. Hao and Mr. Chassé was to
improve the tactometer’s performance, but it failed to show that there was a
technological risk in this case that could not be removed
by routine engineering or standard procedures. In fact, I conclude that the
techniques and procedures used by Mr. Hao and Mr. Chassé to resolve the tactometer problem were routine techniques and standard procedures generally accessible to
competent professionals in the field.
[14] Regarding the expenditure of $13,388, the evidence showed beyond a
doubt that it represented the purchase of equipment to build a second prototype
of the tactometer. In my opinion, this type of expenditure could not constitute
expenditures incurred in the prosecution of scientific research and
experimental development.
[15] Therefore, the appeal is dismissed without costs.
Signed at Ottawa, Canada, this 27th
day of May 2004.
Bédard
J.
Certified
true translation
Colette Beaulne
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