Date: 20010615
Docket: 2000-3621-IT-I
BETWEEN:
NASHEN & NASHEN CONSULTANTS INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Reasons for Judgment
McArthur, J.
[1]
The issue in this appeal for the Appellant's taxation year
ending September 30, 1998 is whether certain activities
constitute scientific research and experimental development
(SRED) for the purposes of sections 37 and 37.1 of the Income
Tax Act. SRED is defined in subsection 248(1) of the
Act 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,[1]
...
[2]
The Appellant was represented by its accountant, Ather Kandella,
and by one of its officers, Barry Nashen. Expert evidence was
given by Claude M. Papion on behalf of the Appellant and Charles
Fakiris on behalf of the Respondent. The Minister disallowed the
SRED expense of $88,188 and consequently an investment tax credit
(ITC) of $30,866, claimed by the Appellant. The Appellant elected
the informal procedure for this appeal knowing the amount in
issue is deemed not to be greater than $12,000.[2] The hearing of the appeal
commenced on May 15, 2001 but was adjourned to May 22, 2001 to
permit the Appellant to have Mr. Papion testify on its
behalf.
[3]
Mr. Kandella informed the Court that the Appellant's
assessment was overstated by $59,085. While counsel for the
Respondent agreed, she advised that this error was not an issue
before the Court and was not prepared to deal with it in this
appeal. I accepted that position and proceeded with the issue of
whether the Appellant's research activities were eligible for
ITC for the year end September 30, 1998. While I make no ruling
on the $59,085 overstated assessment, I am confident the Minister
will do what is necessary to correct the error.
[4]
The Appellant has been in business for over 16 years. Its payroll
presently is over $600,000. Broadly speaking, its business
includes developing, customizing and modifying accounting,
distribution, manufacturing and related software for the
distribution and manufacturing industries. These systems run on
"midrange" computer servers (currently the IBM AS/400
with 10 to 500 attached workstations).[3]
[5]
Mr. Nashen testified that over the past 15 years, the Appellant
relied heavily on its research and development efforts and the
SRED tax credit program to maintain its competitive edge and
conquer new markets. The Appellant's various SRED claims have
been reviewed in past years and accepted as filed in each
instance prior to 1998.
[6]
The project we are concerned with has to do with the electronic
mailing of complex documents that include design elements. In the
Appellant's Exhibit A-3 it is described as follows:
B.
Technological Limitations of Current Technology
At this time, there is no capability for the AS/400 system to
e-mail directly (with no other intervention) a document (i.e. a
spool file ready for printing) which has more than just text.
When the spool file has only text, the AS/400 command,
snddst, will after some straightforward configuration, be
able to easily e-mail the file to any address on the
Internet.
However, many applications today create spool files which have
advanced function printing (AFP) capabilities. These functions
include the embedding into documents of design elements, such as
graphics, forms (called overlays) logos (page segments), bar
codes, different font character sets, etc.
There is no facility, either offered by IBM, or by third
parties, to e-mail directly from the AS/400 these complex
documents. In our discussions with IBM, and with third parties
that offer related fee-based products, a tool of this type would
be very marketable!
Charles Fakiris, the expert called by the Respondent presented
two reports, the first dated October 5, 1999. He stated that the
Appellant did not provide the additional information he required
and somewhat in frustration, concluded that the Appellant's
project did not qualify. Mr. Nashen explained that Mr. Fakiris
did not speak to any of the officers of the corporation but to an
uninformed employee. Mr. Nashen provided him with a project
description dated November 5, 1999 and Mr. Fakiris, in turn,
wrote an addendum to his report dated November 10, 1999
wherein he again concluded that the project was not eligible for
SRED and ITC.
[7]
Mr. Papion reviewed the four projects for which the Appellant was
claiming ITC. He concluded that two of these qualified and two
did not. I will only deal with the two projects which he found
qualified. At page 2 of his report dated June 16, 2000 (Exhibit
A-2), he made the following general comments about the
Appellant's technological work:
Over the past years, Nashen+Nashen Consultants Inc. aimed at
designing, with a modular concept, each application software to
fulfil a specialized role in the support of the client's
mission. It addresses the requirements of distribution logistics,
manufacturing business intelligence and document management.
After decades of computerized automation of specialized
processes such as manufacturing and distribution, paperwork still
constructs the flow of information and working environment in
most companies. In fact, it is estimated that 80% of company
documents remain paper-based forms.
The Company identified a need for a different approach to
those static, inefficient and outdated paper forms. Errors are
common in paper forms and can often be difficult to identify.
Printing, storage and shipping of pre-printed forms drive up
costs substantially of adapting the print program of the
application software each time the form is revised.
With introduction of Electronic Forms, there is an opportunity
to eliminate these obstacles by exploiting intelligent, dynamic,
context sensitive forms on screen to capture structured
information. Then the Electronic Form can act as a window into a
complete workflow system that allows for the routing of
information quickly and economically to its recipient.
During 1997, the Company's team undertook to create a
workflow based system, with folders as controlling objects.
During 1998, the research team focused on the creation of a
Graphical Development Tool that was to be capable of producing
exact electronic replicas of paper forms, store them in a server
(a AS-400 machine) and a Form Filler Tool to provide accurate and
flexible form filling.[4]
[8]
Both experts have been consulted by the Minister with regard to
the admissibility of SRED over the years. I believe Mr. Papion
assisted the Minister from 1985 to 1998 with respect to more than
1,000 applications. He now does similar consultant work for
taxpayers. Mr. Fakiris has been a consultant with Revenue Canada
with respect to SRED since 1995. In arriving at his
conclusions, Mr. Papion was guided by three criteria
described in Information Circular 86-4R3[5] together with
Information Circular 97-1 on Administrative Guidelines for
software development. The criteria are: (i) scientific or
technological advancement; (ii) scientific or technological
uncertainty; and (iii) scientific or technological
content.
[9]
The projects were highly technical and I relied heavily on the
evidence of the experts. Both are qualified in the subject
matter. Mr. Papion who was retained by the Appellant, spent nine
hours with Mr. Nashen before he felt he could analyze the
projects. Mr. Fakiris spent one hour with Mr. Nashen who was the
guiding mind with respect to the projects. Mr. Papion grouped the
relevant projects 2 and 3 together because "they are
intimately linked". They are e-mail alternatives and
integration of AFP documents.
[10] The
Appellant's goal is to create the technology to make exact
electronic replicas of paper forms. Most corporate documents are
paper-based forms. The Appellant sought to duplicate these forms
electronically. The Appellant found a need for a different
approach to those static, out-dated paper forms. It envisages the
context sensitive forms on screen to capture structured
information and send the information quickly and
economically.
[11] The
Appellant's 1998 research team focused on the creation of a
Graphical Development Tool capable of producing electronic
replicas of paper forms, store them in a server (an AS-400
machine) a form filler tool to provide accurate and flexible form
filing. Both parties referred to Information Circular 86-4R3 and
the three criteria referred to earlier but no case law.
[12] In
Northwest Hydraulic Consultants Ltd. v. The Queen,[6] Bowman J. set out a
number of criteria that are useful in determining if a particular
activity constituted SRED. In their abbreviated form, they
are:
(a)
Is there a technological risk or uncertainty?
(b)
Did the person claiming to be doing SRED formulate hypotheses
specifically aimed at reducing or eliminating that technological
uncertainty?
(c)
Did the procedures adopted accord with established and objective
principles or scientific methods, characterized by trained and
systematic observation, measurement and experiment, and the
formulation, testing and modification of hypotheses?
(d)
Did the process result in a technological advance, that is to say
an advancement in the general understanding?
(e)
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.
I will apply these criteria to the present facts:
(a)
Was there a technological risk or uncertainty? I accept that
there was no existing technology creating electronic replicas of
paper forms. The resolution of the problem was not reasonably
predictable using routine engineering.
(b)
With respect to second item of the Northwest criteria, I
am not sure what hypotheses were formulated to eliminate the
uncertainty. Mr. Papion stated the following:
The Company has systematically explored a number of avenues
leading to a three-prong software engineering project:
-
Form Design Graphical Development Tool-Kit
-
Form Filler Front-End capability
-
Central Advanced Function Printing Mechanism.
a)
Form Design Graphical Development Tool-kit:
The project is aimed at building and advanced technology
capable of creating exact electronic replicas of paper forms.
It encompasses a number of design tools to duplicate the
various features of any paper form such as:
-
Lines
-
Boxes
-
Arcs and circles
-
Texts and text formats
-
Tables
-
Check boxes
-
Buttons
-
Data fields.
(c) I
assume that the methods of testing were in accordance with
established methods of scientific method. Mr. Papion stated the
following:
The Company has acquired the Advanced Function Printing (AFP)
Utilities for the AS-400 computer that is compatible with the
OS-400. Thus a created PC form may be up-loaded to the
AS-400 server. The AFP Utilities include several resources
such as form definitions, overlays, page segments, fonts and page
definitions.
However, the AFP function is not a Form Design Graphical
Development tool. It is not compatible with popular graphic
formats such as PC Paintbrush bitmap (PCX), Tag Image File Format
(TTIFF), Graphics Interchange Format (GIF), JPEG compressed
bitmap (JPEG) and Portable Document File (PDF) (Adobe Acrobat
- displayable with a Web browser).
For the desired E-Mail capability, after experimenting with
all PC-based e-mail utilities, it was found that there was a need
for a Form Design Tool that could convert the AFT form into a PDF
format, which was retained as the most promising standard.
b)
Form filler
The Company explored with an automated process that enables
the user to fill a given form, on a PC, transmit it to the AS-400
server that combines the form and its contents.
c)
Central Advanced Function Printing Mechanism
The Company's team could create electronic documents
containing both the form and the text on the AS-400. From then,
the document could easily be faxed (using FAX/400) or printed to
an AFP capable printer.
(d)
Was there a technological advance? It appears that there was no
apparent technological advance. Mr. Papion stated:
Therefore, the still unresolved problem remained the
development of a Form Design Graphical Development toolkit,
capable of taking the AFP combined form/text document and
automatically translate it to the PDF/ADOBE Publishing Document
Format for automatic e-mail transmission.
(e)
There was no evidence of a detailed record of the hypotheses,
tests and results kept. Mr. Papion stated as follows:
By the end of the 1998 fiscal year, following tests with JPEG,
GIF and PDF standards the 1999 planned research program called
for the development of a Framework that combined:
-
Form Design Toolkit
-
Form Filler Frontend
-
And Central Advanced Function Printing
[13] To be
successful, the Appellant has to establish on a balance of
probabilities, the work done was SRED. It is a subtle exercise. I
would venture to say that we would get as many different opinions
as the number of experts who offered opinions. Disagreeing
experts are not uncommon in a comparative analysis of such
complex projects.
[14] Mr.
Papion is highly qualified and he spent a good deal more time
analyzing the evidence than Mr. Fakiris. I accept his conclusion
taken from his report as follows:
On the basis of our project review we conclude that:
Project #1 - Common Driver for API's, and Project #4
- Knowledge-based business, do not display strong enough
evidence of a technological advancement to support the SRED
claim.
On the other hand:
Project #2 - E-mail alternatives, and Project #3 -
Integration of AFP documents, display a strong evidence of an
experimental development process that converges towards the
achievement of a technological advancement in the field of
Software Engineering, along the lines of section 6.10(f) of
Information Circular 86-4R3.
Projects #2 and #3 are therefore assessed as eligible to tax
credits, in accordance with section 2.9 of I.C. 86-4R3.
[15] The
Appellant was claiming $88,188 as qualified SRED and
consequently, an ITC of $30,866. The Appellant elected the
informal procedure which limits its claim to $12,000. The
Appellant's own expert eliminated two of the Appellant's
projects. In lack of any evidence to the contrary, I accept that
this amounts to 50% of the amount claimed. In conclusion, the
appeal is allowed on the basis that the qualified SRED
expenditures are reduced to $44,094 and the informal procedure
limitations remain in effect. The Appellant is entitled to its
costs, if any.
Signed at Ottawa, Canada, this 15th day of June, 2001.
"C.H. McArthur"
J.T.C.C.
COURT FILE
NO.:
2000-3621(IT)I
STYLE OF
CAUSE:
Nashen & Nashen Consultants Inc. and
Her Majesty the Queen
PLACE OF
HEARING:
Montréal, Québec
DATE OF
HEARING:
May 15 and 22, 2001
REASONS FOR JUDGMENT BY: The
Honourable Judge C.H. McArthur
DATE OF
JUDGMENT:
June 15, 2001
APPEARANCES:
Agents for the
Appellant:
Ather Kandella and Barry Nashen
Counsel for the
Respondent:
Pascale O'Bomsawin
COUNSEL OF RECORD:
For the
Appellant:
Name:
N/A
Firm:
For the
Respondent:
Morris Rosenberg
Deputy Attorney General of Canada
Ottawa, Canada
2000-3621(IT)I
BETWEEN:
NASHEN & NASHEN CONSULTANTS INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeal heard on May 15 and 22, 2001, at
Montréal, Québec, by
the Honourable Judge C.H. McArthur
Appearances
Agents for the
Appellant:
Ather Kandella and Barry Nashen
Counsel for the Respondent: Pascale
O'Bomsawin
JUDGMENT
The
appeal from the assessment of tax for the Appellant's year
end September 30, 1998 made under the Income Tax Act,
notice of which is dated December 16, 1999 is allowed, with
costs, if any, and the assessment is referred to the Minister of
National Revenue for reconsideration and reassessment on the
basis that the Appellant is entitled to claim an investment tax
credit in the amount of $12,000 as a result of its scientific
research and experimental development expenditures.
Signed at Ottawa, Canada, this 15th day of June, 2001.
J.T.C.C.
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