Citation: 2011 TCC 391
Date: 20110819
Docket: 2007-4786(IT)G
BETWEEN:
SONEIL INTERNATIONAL LIMITED,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent,
Docket: 2007-4787(IT)G
AND BETWEEN:
SONEIL USHA INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
D'Arcy J.
[1]
Each of the Appellants
has appealed a notice of assessment with respect to its 2002 taxation year. The two appeals
were heard together on common evidence. The issue before the Court is whether
certain expenditures made by each of the Appellants during their 2002 taxation
years constituted expenditures on scientific research and experimental
development (“SR&ED”).
[2]
During the hearing I
heard from three witnesses. Mr. Sachindra Jain testified for the Appellants.
Mr. Jain is president and vice-president, product development and R&D, for
Soneil International Limited (“International”) and vice-president, product
development and R&D, for Soneil Usha Inc. (“Soneil”). Mr. Jain was the
founder of both companies.
[3]
The Respondent called
two witnesses, Mr. Yashvant Parmar and Mr. Christopher Stoute. Mr. Parmar
is a research and technology advisor for the Canada Revenue Agency (the “CRA”).
Mr. Stoute appeared as an expert witness. He is a consultant, who previously
worked for the CRA.
Summary of the Relevant Facts
[4]
Mr. Jain testified that
he started the Appellant’s business in the basement of his home in 1994. Mr.
Jain testified that “[h]e brought to market the application of switch-mode
technology in battery chargers, which made the chargers very small, lightweight
and compatible for onboard application.”
The technology was different from the conventional chargers that were available
in the market place in 1994.
[5]
He noted that the
battery chargers are used in many applications, such as golf carts, material
handling devices and scrubbing-cleaning devices. However, the primary
application for the chargers is the charging of battery-operated wheelchairs.
[6]
The Appellants have
been very successful. Their products are developed in Canada and manufactured
in China and Malaysia. The Appellants sell approximately 95% of their products outside of Canada.
[7]
Mr. Jain is clearly
qualified to carry out scientific research and experimental development
relating to the business of the Appellants. He holds four university degrees
(Bachelor of Science in physics, Bachelor of Technology in mechanical
engineering, Master of Science in controlled system engineering and an MBA) and
has received numerous academic awards. In addition, he qualified as a registered
industrial accountant (now referred to as a certified management accountant [CMA])
and a professional engineer. Mr. Jain has extensive work experience in multiple
fields, including mechanical and electrical engineering and electronics.
[8]
Mr. Jain testified that
he was the key technology person for the research carried out by the Appellants.
He filed with the Court a list of equipment used at the Appellants’ testing
facility (Exhibit A-3). However, he provided few details with respect to the
actual testing facility.
[9]
It is the Appellants’
position that they conducted SR&ED in their 2002 taxation years with
respect to the following four projects:
1.
Power optimization for
dual application in front- and rear-wheel-driven scooters and wheelchairs (the
“Power Optimization Project”). International carried out this project, which
involved designing a system to allow power to be switched from the front wheels
to the back wheels of a wheelchair (or vice versa).
2.
Development of an
inhibitor control system (the “Inhibitor Project”). International carried out
this project, which involved designing a device (the inhibitor) to ensure that
power to the wheels of a wheelchair is cut when the wheelchair is being
charged.
3.
Creation of a virtual
battery system (the “Virtual Battery Project”). Soneil carried out this
project, which involved designing a method to deliver 36 volts from two 12-volt
batteries.
4.
Development of a multi-voltage
output charger that is capable of sensing battery voltage (the “Multi-voltage
Project”). Soneil carried out this project, which involved developing a
multi-voltage output charger that could sense the battery voltage of the
specific wheelchair and then charge at the appropriate voltage.
Law
[10]
The only issue before
the Court is whether the work performed by the Appellants constituted SR&ED
as that term is defined in subsection 248(1) of the Income Tax Act (the
“Act”).
[11]
The relevant wording,
for the purposes of this appeal, is contained in paragraph (c) of the
definition, which reads 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
(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.
[12]
Schedule A to my
reasons for judgment contains the complete subsection 248(1) definition of
scientific research and experimental development.
[13]
Five criteria have been
used by the courts to assist in determining whether a
particular activity constitutes SR&ED. The
criteria were first outlined in the decision of Judge Bowman (as he then was)
in Northwest Hydraulic Consultants Limited v. The Queen. The Federal
Court of Appeal, in C.W. Agencies Inc. v. The Queen, summarized these
criteria 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?
[14]
The onus is on the
appellant to show, on the balance of probabilities, that the expenditures it
incurred were for scientific research and experimental development as that term
is defined in subsection 248(1).
Application of Law to Facts
[15]
For each of the
projects Mr. Jain described various stages of development under the following
headings:
-
Observation of the subject
matter of the problem
-
Formulation of a clear
objective
-
The identification and
articulation of the technological uncertainty encountered
-
The formulation of a
hypothesis designed to reduce or eliminate the uncertainty
-
The methodical and
systematic testing of the hypothesis
-
The technological
advancement
-
The technological
content.
[16]
It is clear from Mr.
Jain’s testimony that he (and his assistant) spent a significant amount of time
working on upgrades to the Appellants’ products, but I do not have sufficient
evidence before me to conclude, on a balance of probabilities, that the work
performed by the Appellants constituted SR&ED.
[17]
In discussing whether a
technical risk or uncertainty existed, Judge Bowman noted the following in the Northwest
Hydraulic decision (at paragraph 16):
Implicit in
the term “technological 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.
[18]
Mr. Jain described what
he believed was the technological uncertainty encountered for each project as
follows:
Power Optimization Project: Whether a safe and effective switchover
system could be developed that would be suitable for disabled people operating
power wheelchairs and scooters in both indoor and outdoor environments.
Additional uncertainty related to power optimization and the ability to
retrofit the system on existing power wheelchairs.
Inhibitor Project: Whether a safe and effective inhibitor
could be developed that would be suitable for use by disabled people operating
power wheelchairs and scooters in both indoor and outdoor environments. The
key uncertainty was mechanical and electrical problems relating to the ability
to retrofit on existing power wheelchairs.
Virtual Battery Project: Whether a safe and effective virtual
battery could be developed that would be suitable for use by disabled people
operating power wheelchairs. The key uncertainty was certain mechanical
problems with respect to power optimization and the ability to retrofit on
existing power wheelchairs.
Multi-voltage Project: Whether a safe and effective different
voltage charger could be developed that would be suitable for use by disabled
people operating a power wheelchair. The uncertainty arose when trying to
retrofit the charger on different types of wheelchair power systems.
[19]
This testimony was the
only evidence provided by the Appellants of the alleged technological
uncertainty. After reviewing Mr. Jain’s testimony it is simply not clear to me
whether he is referring to uncertainties that could only be resolved by
scientific research and experimental development or if he is referring to
design issues that could have been resolved by using techniques, procedures,
and data that were generally available to competent professionals in the field.
[20]
Mr. Jain stated, in
cross-examination, that he did not produce any new components when conducting his
work on the four projects. He also acknowledged that each of the projects
involved areas where products performing similar functions already existed. He
testified that that there existed a wide body of knowledge with respect to the
use of different controllers for front-and rear-wheel power, with respect to
the signal to motor speed controllers for the inhibit function, with respect to
power supply for a power transfer, and with respect to battery charging systems.
He stated that, while the Appellants used existing parts and components, the
research was with respect to the application of the parts and components.
[21]
The Appellants did not
provide sufficient evidence to show that their work with respect to the application
of the existing parts and components required more than routine engineering or
standard procedures.
[22]
In addition, Mr. Jain’s
credibility on this point was damaged on cross‑examination. He had
difficulty explaining certain emails between him and a third‑party
manufacturer that appear to show that a third party redesigned the units for
the virtual battery.
Mr. Jain testified that the redesign by the third party referred to in the
emails was routine engineering. I have a difficult time accepting, based upon
the evidence before me, that the redesign of existing components and parts is
routine engineering when conducted by a third party and SR&ED when the
redesign is conducted by the Appellants.
[23]
In addition to not
providing sufficient evidence to show that a technological risk or uncertainty
existed, the Appellants did not provide sufficient evidence with respect to the
testing performed. As Judge Bowman noted in Northwest Hydraulic (at
paragraph 16), “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.”
[24]
After an appellant has
identified the technological risk or uncertainty, it is important for it to
provide evidence to the Court that it conducted methodical and systematic
testing of any hypothesis designed to reduce or eliminate the uncertainty.
[25]
As noted by my
colleague Justice Little in Zeuter Developments, at paragraph 28:
… 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.
[26]
Based upon the
testimony of Mr. Jain, it appears that the Appellants did not maintain a
detailed record of the testing of any hypothesis formed for the projects or of
the results of the testing, as the work progressed.
[27]
Mr. Jain testified that
he performed the work on each project with the help of an assistant. He
acknowledged that they did not keep detailed records of their work. He noted
that his assistant would run a series of tests, with many of the tests
producing similar results. He stated that once the Appellants encountered
change they conducted detailed tests. Mr. Jain did not provide evidence of the
Appellants encountering change or of what any change meant with respect to a
specific hypothesis, nor did he indicate whether a change in the hypothesis was
required.
[28]
This can be seen by
reviewing the evidence the Appellants provided to the Court (and the Canada
Revenue Agency [the “CRA”]) with respect to the testing conducted during each
of the four projects.
[29]
The only evidence
provided with respect to the Power Optimization Project was a single page
entitled “Project 02SILA – Power optimization – Specifications”. Mr. Jain
referred to this single page as a systematic testing plan. However, it merely
contains 11 items in point form and there is no indication that it is a plan.
[30]
International did not
file with the Court any analysis of specific tests conducted with respect to
the Power Optimization Project or the results of such tests. Mr. Jain testified
that the Appellant did not maintain records of the analysis of each test.
[31]
International also
filed what Mr. Jain referred to as a systematic testing plan with respect to
the Inhibitor Project.
It is similar to the systematic testing plan for the Power Optimization
Project. The testing plan for the Inhibitor Project contains 9 items in point
form, 6 of which also appear in the testing plan for the Power Optimization
Project.
[32]
Mr. Jain referred to
Exhibit A-9 and page 7 of Exhibit A-4 as containing evidence of the methodical
and systematic testing carried out with respect to the Inhibitor Project. I do
not agree with this description of the documents. Four of these pages are
handwritten notes, with no sentences or detailed comments. Two of the
handwritten pages contain simple diagrams. The pages do not contain any details
with respect to the nature or results of the tests. It is not clear who
prepared the notes or when they were prepared. The second page of Exhibit A-9 is
a diagram, which Mr. Jain referred to as the design for the inhibitor. He was
not sure if employees of International or third parties prepared the diagram.
[33]
On cross-examination,
Mr. Jain confirmed that International did not file with the Court any analysis
of specific tests conducted with respect to the Inhibitor Project or the
results of such tests.
[34]
Soneil provided a
number of pages that, Mr. Jain testified, evidenced the testing Soneil carried
out with respect to the Virtual Battery Project. Mr. Jain referred to Exhibits
A-8, pages 2, to 21, A-11 and A-12. Mr. Jain testified that A‑12 evidenced
testing over a number of days.
[35]
However, on
cross-examination, counsel for the Respondent asked Mr. Jain whether a Hong
Kong company called Le Fronte produced pages 2 to 7 of Exhibit A‑8.
These pages contained detailed design diagrams. Mr. Jain testified that he was
not sure if Le Fronte produced the drawings. This damaged Mr. Jain’s
credibility. He had at first testified that the documents evidenced the testing
conducted by Soneil and then, on cross-examination, he could not tell the Court
whether the documents actually evidenced Soneil’s testing or were design
documents prepared by a Hong Kong company.
[36]
With respect to the
last project, the Multi-voltage Project, Soneil provided the Court with a
single page systematic testing plan.
Similar to the other testing plans, this was in point form and merely noted
seven items that were required in a prototype.
[37]
Soneil also filed with
the Court a single page document entitled Test Report No 1. Mr. Jain
testified that this document evidenced the result of a test conducted with
respect to the multi-voltage device.
Mr. Jain was not sure who prepared the report, but thought his assistant had prepared
it.
[38]
After reviewing all of
the evidence on the record, I have concluded that the Appellants did not
provide sufficient evidence to support a finding that they adopted procedures
that accorded with established and objective principles of scientific measure. In
particular, the Appellants did not provide the Court with sufficient evidence
to support a finding that their work was characterized by trained and
systematic observation, measurement and experiment and the testing and
modification of hypotheses.
[39]
Mr. Jain, a certified management
accountant, clearly understands the importance of maintaining adequate records
[40]
For the foregoing
reasons the appeals are dismissed.
[41]
Having found that the
Appellants have not shown the Court, on a balance of probabilities, that the
expenditures they incurred constituted expenditures for scientific research and
experimental development, it is not necessary for me to consider the evidence
provided by the Respondent, particularly the evidence of her expert witness.
However, my finding with respect to the evidence of the expert witness, Mr. Stoute,
is important for purposes of costs.
[42]
The Appellants’ agent
objected to the Court’s accepting Mr. Stoute as an expert witness on the basis
that he did not possess the requisite degree of independence or impartiality. Mr.
Stoute does not presently work for, or advise, the CRA. However, in prior
years, he provided consulting services to the CRA. In 2004, he prepared for the
CRA a review report recommending that the CRA deny the Appellants’ SR&ED
claim. After receiving assurances from Mr. Stoute that he based the expert
report filed with the Court on an objective review of the evidence filed by the
Appellants with the Court, I accepted him as an expert witness.
[43]
However, while
listening to his testimony and after briefly reviewing his expert report, it
became clear to me that his expert report was more in the nature of advocacy
then an expert report. During his testimony, he consistently referred to his
meetings with the Appellants’ personnel in 2004. Further, Mr. Stoute based a
substantial part of his expert report on his meetings with Mr. Jain in 2004. It
appears to me that the primary purpose of Mr. Stoute’s expert report was to
justify his 2004 conclusion that the Appellants’ four projects did not qualify
as SR&ED. As a result, I would have given no weight to the expert report. Therefore,
while the Respondent is awarded costs, she will not be awarded any costs with
respect to her expert witness.
Signed at Antigonish,
Nova Scotia, this 19th day of August 2011.
“S. D’Arcy”
Schedule A
Income Tax Act, Section 248(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 (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;
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