Citation: 2012 TCC 376
Date: 20121025
Docket: 2010-3660(IT)I
BETWEEN:
1726437 ONTARIO INC. o/a
AIRMAX TECHNOLOGIES,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Hogan J.
[1]
The appellant, 1726437
Ontario Inc. o/a Airmax Technologies, is an installer of heating, ventilation
and air conditioning systems in residential homes. In 2007 and 2008, the
appellant worked on a project (the “Project”) named “High Static High Velocity
Fan Coil System Development” (“HVAC System”). The Project led to the
development of an HVAC system for multi-storey residential townhouses. The
appellant claimed scientific research and experimental development (“SR&ED”)
credits with respect to the expenses for the Project.
[2]
The Minister of
National Revenue (the “Minister”) disallowed most of the expenses claimed by
the appellant on the grounds that the activities constituted routine
engineering. The Minister moved the deduction of the eligible expenses incurred
and claimed by the appellant for its 2007 taxation year to the appellant’s 2008
taxation year because those expenses were not paid within 180 days of the end
of the appellant’s 2007 taxation year. Finally, because the appellant opted for
the informal procedure, the respondent argues that, in any event, its investment
tax credits (“ITCs”) cannot exceed an additional $12,000 for 2008.
I. Factual
Summary
[3]
For the 2007 and 2008
taxation years the appellant claimed the following amounts in respect of
SR&ED:
|
TAXATION YEAR
|
2007
|
2008
|
|
Allowable SR&ED Expenditures
|
|
SR&ED portion of salary or wages of employees directly engaged
in SR&ED
Cost of materials transformed in the prosecution of SR&ED
SR&ED contracts performed on the appellant’s behalf
|
-
$ 15,150
$179,149
|
$ 25,089
$ 18,764
$213,543
|
|
Total
allowable SR&ED expenditures
|
$194,299
|
$257,396
|
|
Qualified
SR&ED Expenditures
|
|
Unpaid
amounts from previous years that were paid in the year under subsection
127(26) of the Act
Prescribed
proxy amount
less Government and non-government assistance, and contract payments
less
Unpaid amounts deemed not to be incurred in the
year under subsection 127(26) of the Act
|
-
-
$ 4,091
$153,393
|
$153,393
$ 16,308
$ 42,710
-
|
|
Total
qualified SR&ED expenditures
|
$ 38,815
|
$384,387
|
|
Investments
Tax Credits “ITCs” from SR&ED
Expenditures
|
|
Total
ITCs
|
$ 12,885
|
$134,535
|
[4]
The evidence shows that
during the years at issue the appellant undertook to develop a new and
innovative HVAC system that was compact, quiet and efficient, and designed for
multi-storey townhouse installations.
[5]
The evidence also shows
that, prior to the appellant’s development activities, there was technological uncertainty
with respect not only to noise, but also to space and efficiency with those
types of systems.
[6]
According to the
appellant’s witness Jack Van Beurden, the appellant had to reduce noise from the
vents present throughout a house, achieve constant pressure and a set number of
operating BTUs. To make the system work at the level necessary to ensure
commercial success, modifications had to be made to the constituent parts of
the system: the diffuser, the flexible ductwork, the boiler and the electronically
commutated fan motor (ECM). The evidence shows that the development work was undertaken
by the appellant to ensure that the constituent parts of the HVAC system could
function together as a complete system that met the design requirements of a heating
system for multi-storey townhouses.
[7]
One of the major drawbacks
of an HVAC system is noise due to the fact that the system operates at a high
air pressure level which is necessary to move air vertically between the
multiple levels of a townhouse. The appellant determined that the air diffusers
in use in the market place contributed to the high noise levels, and undertook
development work in the 2007 taxation year which ultimately led to the design
of a quieter air diffuser. The Minister accepted that this work was eligible
SR&ED.
[8]
To reduce noise levels
further, the appellant undertook testing of the flexible duct used as the conduit
to move the hot air generated at the heating source. The appellant put holes in
the core of the flexible duct for that purpose, experimented with the size, number
and position of the holes, and adopted those variables which reduced noise
levels the most.
[9]
In 2008, the appellant
incurred expenses to bring a European‑sourced boiler into conformity with
North American standards. The appellant also undertook testing of ECMs to
ensure that they could be programmed at the speeds necessary to meet the design
requirements set for the appellant’s HVAC system while still meeting the
manufacturer’s safety specifications, which were required to be adhered to in
order to ensure coverage under the manufacturer’s warranty. The ECMs used in
the test were purchased from a Korean manufacturer, Essen Tech. The appellant worked
with a consultant to develop new program settings for the control board. The
evidence shows that the appellant had the right to use the intellectual
property generated from the testing, along with Essen Tech.
[10]
The Minister determined
that only the work conducted by the appellant between June 16, 2006 and January
2, 2007 on the development of a new diffuser in order to reduce sound levels
constituted eligible SR&ED. According to the Minister, all of the remaining
development work involved routine engineering. Accordingly, the Minister
reduced the appellant’s SR&ED claim by the amounts of $153,617 and $257,396
for the 2007 and 2008 taxation years. The Minister allowed $40,682 as eligible
SR&ED expenditures incurred by the appellant in connection with the
development work on the diffuser and some work on the flexible ducts. These expenses
were paid more than 180 days after the end of the appellant’s 2007 taxation year
and the Minister accordingly treated them as eligible SR&ED expenses for
the appellant’s 2008 taxation year.
[11]
At the hearing, the
appellant conceded that its total SR&ED claim of $421,203 should be reduced
by an amount of $33,650. This amount pertained to the cost of a plastic mould
which was recognized by the appellant not to be a qualified SR&ED
expenditure. This leaves an amount of $387,553 in dispute in this appeal.
II. Issues
[12]
The issues in this
appeal are:
(1)
Other than those
recognized as such by the Minister, did the appellant’s activities in the 2007
and 2008 taxation years constitute SR&ED as defined for the purposes of the
Income Tax Act (“ITA”)?
(2)
If so, what are the
appellant’s additional SR&ED expenditures for the 2007 and the 2008
taxation years, and what, if any, are the consequential adjustments to the
appellant’s refundable investment tax credits for those years?
(3)
Do the Tax Court of
Canada Act (the “TCCA”) and the Tax Court of Canada Rules (Informal
Procedure) limit the relief that can be granted to the appellant?
III. Analysis
[13]
SR&ED is defined in
subsection 248(1) of the ITA as follows:
“scientific
research and experimental development”
“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 in 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;
[Emphasis added.]
The definition is based on a “catch and release”
concept. The definition first includes a broad category of development
activities under paragraphs (a) to (c), then items otherwise
included are excluded under paragraphs (e) to (k).
[14]
Justice Bowman, as he
then was, considered the definition of SR&ED in Northwest Hydraulic
Consultants Limited v. The Queen. He
enunciated five criteria to be used for the purpose of determining whether a
taxpayer’s activities constituted SR&ED:
(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 SR&ED formulate hypotheses specifically aimed at reducing or
eliminating that technological uncertainty?
(3)
Did the procedures
adopted accord with the established and objective principles 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, tests and results kept as the work progressed?
[15]
I will use the above
criteria to evaluate the appellant’s SR&ED claim.
1. Was there a
technological risk or uncertainty which could not be removed by routine
engineering or standard procedures?
[16]
At the time it began
its development work, the appellant had determined that existing HVAC systems
used for townhouse installations did not operate efficiently. The systems that
were on the market at the time did not distribute heating evenly throughout the
living space of multi-storey townhouses and they operated at high noise levels.
The appellant set out to correct these problems with the development of a new
HVAC system. The appellant’s goal was to:
(a)
Reduce noise from vents
occurring throughout a house;
(b)
Achieve constant static
pressure; and
(c)
Adapt a foreign boiler
and motor to North American standards in order to use them in a system for
which they were not designed and in which they had not been previously tested.
All of the constituent parts of the
appellant’s system needed to function in unison to achieve the appellant’s
design objectives. For example, the appellant undertook testing on the flexible
ductwork together with the diffuser for the purpose of ensuring that the system
operated within the specified noise parameters.
[17]
In Information Circular
86-4R3, the Canada Revenue Agency (“CRA”) acknowledges that “[w]ork on
combining standard technologies, devices and/or processes is eligible if
non-trivial combinations of established (well-known) technologies and
principles for their integration carry a major element of technological
uncertainty . . . called a “system uncertainty”.
Paragraph (d) of the ITA definition of SR&ED captures such work when
it is “commensurate with the needs, and directly in support, of work described
in paragraph . . . (c)” of the definition.
2. Did the person claiming to be doing
SR&ED formulate hypotheses specifically aimed at reducing or eliminating
that technological uncertainty?
[18]
The evidence shows that
the appellant set the following technological objectives for the overall
system:
(1)
Achieving a sound level
reduction from 60 dB to 40 dB;
(2)
Achieving constant
static pressure;
(3)
Adapting a foreign
boiler to meet North American standards;
(4)
Achieving the required
BTUs, and
(5)
Adapting an
electronically commutated motor (ECM) for use in the system.
[19]
These technical objectives
formed part of the basis of the testing conducted by the appellant.
3. Did the procedures
adopted accord with the established and objective principles of the scientific
method, including the formulation, testing and modification of hypotheses?
[20]
The evidence
demonstrates that the appellant identified the problems with, and deficiencies of,
existing HVAC systems. In response, the appellant developed a testing site to conduct
testing with respect to its diffusers, the integration of the boiler into its
system, the programming of the ECM, and the relevant safety and operational
standards. Experiments were run, the results were collected and modifications
were made.
4. Did the process
result in a technological advancement?
[21]
The evidence shows that
the appellant developed a product that was unlike any other product on the
market intended for similar applications. It performed better than competitors’
products. The system was unique in the market insofar as it utilized higher
than usual pressure in response to the problem of the narrower duct work used in
narrow multi-storey townhouses. It used an unconventional heat source that also
provided domestic hot water, unlike more commonly used indirect‑fired
furnaces.
5. Was a detailed
record of the hypotheses, tests and results kept as the work progressed?
[22]
Considering the evidence
as a whole, I am of the opinion that the appellant has demonstrated that it
maintained a level of record-keeping that illustrates that it identified a
problem, developed hypothetical solutions, tested them, and modified its
approach in response to the results.
[23]
In summary, in weighing
the evidence as a whole, I conclude that the appellant has established that the
$387,553 balance of its SR&ED claim constituted qualified SR&ED
expenditures.
A. Refundable
ITCs
[24]
The evidence shows that
none of the eligible expenses incurred by the appellant in 2007 were paid
within 180 days of the end of that taxation year. Under subsection 127(26) of
the ITA, those expenses are therefore deemed to have been incurred in the
appellant’s 2008 taxation year for the purpose of determining its refundable
ITCs for that year.
B. What are the
consequences of the appellant’s election to have its appeal heard under the
informal procedure?
[25]
The appellant elected
to have its appeal heard under the informal procedure. Paragraph 17(1) of the
Tax Court of Canada Rules (Informal Procedure) provides as follows:
17.
Election to Limit Appeal to Informal Procedure -- (1) Where
(a) the
aggregate of all amounts in issue exceeds $12,000, or
(b) the
amount of the loss in issue exceeds $24,000,
and
the appellant wants the informal procedure under the Act to apply to the
appeal, the appellant shall elect to limit the appeal to $12,000 or $24,000, as
the case may be.
[26]
The respondent contends
that the appellant’s refundable ITCs cannot be increased by more than $12,000
for its 2008 taxation year because of section 18.1 of the TCCA, which reads as
follows:
18.1 Limit
-- Every judgment that allows an appeal referred to in subsection
18(1) shall be deemed to include a statement that the aggregate of all amounts
in issue not be reduced by more than $12,000 or that the amount of the loss in
issue not be increased by more than $24,000, as the case may be.
[27]
Section 2.1 of the TCCA
defines “the aggregate of all amounts” as the total of all amounts assessed or
determined by the Minister of National Revenue under the Income Tax Act,
but not including any amount of interest or any amount of loss determined by
the Minister.
[28]
The interaction of the
above provisions was considered by the Federal Court of Appeal (“FCA”) in Innovations
et Intégrations Brassicoles Inc. v. The Queen In that
case, the appellant had elected to have its appeal concerning refundable
SR&ED‑related ITCs exceeding $12,000 heard under the informal
procedure. The appellant won its appeal before the Tax Court but the judgment
limited the appellant’s tax refund to $12,000. The FCA acknowledged that the
taxpayer would have been entitled to a refund of $19,000 had the taxpayer’s
appeal been pursued under the general procedure. However, because the taxpayer
elected to have its appeal heard under the informal procedure, the FCA found
that the Tax Court judge was correct in limiting the taxpayer’s refund to
$12,000.
[29]
I am bound to follow that
decision. Therefore, the amount of the appellant’s additional refundable ITCs
for the 2008 taxation year is limited to $12,000 notwithstanding the fact that
its qualified SR&ED expenditures for that year totalled $387,553.
Signed at Ottawa, Canada, this 25th day of October 2012.
“Robert J. Hogan”
Email this Content