REASONS
FOR JUDGMENT
C. Miller J.
[1]
Emotion Picture Studios Inc. (“Emotion”) appeals by way of the Informal Procedure
the Minister of National Revenue’s (the “Minister”)
assessment of its 2012 taxation year, in which the Minister denied Investment Tax
Credits of $51,196 based on $146,279 of what Emotion claimed were Scientific
Research and Experimental Development expenditures (“SRED”).
The Minister maintains that the work conducted by Emotion does not constitute
SRED as defined in section 248 of the Income Tax Act (the “Act”), which reads:
“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;
[2]
In the leading case of Northwest Hydraulic
Consultants Ltd. v The Queen,
Chief Justice Bowman provided guidance as to how to interpret this definition:
Although I do not
presume to have the technological expertise of the persons who assisted in the
preparation of the circular, or the witnesses who appeared before me, including
the highly qualified experts who appeared on behalf of the appellant and the
respondent, I should like to set out briefly my own understanding of the
approach to be taken:
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.
[3]
The Minister argues that there was no
uncertainty nor technological advancement in the work performed by Emotion,
thus the expenditures do not qualify as SRED.
[4]
So what did Emotion do in 2012 to claim $146,274
worth of qualifying SRED? I note at the outset that Emotion, by proceeding in
the Informal Procedure, has limited the claim to $25,000, not the full
$51,196. Also, there was no dispute that the expenses were actually incurred.
[5]
Emotion produced two witnesses at trial, the
chief executive officer, Mr. Scott Wilson and a data scientist, Mr.
Moodley. Mr. Wilson emphasized at the outset that in the world of big data, the
internet world, there is considerable uncertainty. In the area that Emotion is
interested in, optimizing the efficiencies of search engines, the very fact
that only one trillion of thirty trillion pages of information is ever accessed
glaringly points out the uncertainty with respect to search engines generally.
In the Appeal Emotion summarized the technological uncertainties as follows:
The technological
uncertainty proposed in this work, is to identify and evaluate the contributing
variables greater than 200 used in Google algorithms to structure the data
better for indexing the pages in accordance with the key word that has been
searched.
[6]
Emotion’s objective was to create algorithms
that would organize or structure data to significantly increase the likelihood
of data being retrieved while at the same time decreasing required links to
make that happen. This was not limited to simply the words on a page, but also
off-page influences such as the location of the searcher for example, as well
as the interrelationship between thousands of variables that affect a search.
As Mr. Wilson explained, some variables work together synergistically while
others do not. Again, in the Notice of Appeal the objectives were described
as follows:
i.
To create a data structure to keep page rank on
the first page for potential key words; data is the information which is
relevant to potential customers.
ii.
To increase page ranking by 50% in one month
versus right now it takes six months.
iii.
To reduce labour cost and time required for
increasing the page ranks on internet and accurate indexing of the pages.
iv.
To implement a method for indexing and
optimizing the data to rank high in key word search through various search
engines.
[7]
Emotion acquired a Google Search Appliance so it
could test how Google classifies data and breaks it down into data collections.
The Appellant did not limit its work just to Google but covered other search
engines as well. It created tests using similar language in different formats
(in one experiment 25 websites were created) to figure out how data could be
more efficiently organized for optimal retrieval. Mr. Wilson objected to the
Respondent’s portrayal of these activities as reverse engineering of the Google
search engine, as he believed it was much broader research and certainly not
limited to Google. Emotion described in its Appeal that the technological advancement
was to propose the most effective structure of data for indexing pages which
can be used by search engine companies to optimize their algorithms to more
effectively use the 200 factors in the algorithm; in effect, extending the
knowledge about search engine algorithms for indexing pages. Mr. Moodley
testified that industry protocols have been developed through a consortium of
experts on these issues since 2012, but that Emotion was developing ways of
structuring data before these protocols were developed. The Canada Revenue
Agency put forward its views on the uncertainty and technological advances in a
proposal letter suggesting:
Uncertainty
described in determining the effects of a web page’s keyword density on its
ranking, or the effects of footer links, are general uncertainties with the
outcome of a process. For example, it is uncertain what the results of having a
web page Facebook-like over a million times will have on its ranking on
Google. However, this type of uncertainty is not technological because
there is no uncertainty with the fact that technologies associated with the
process work. Associated technologies for the given example include: background
HTTP requests, asynchronous web technologies, etc.
Technological
uncertainty or obstacle within the context of the scientific method is
uncertainty that an experienced professional would have regarding whether or
not a goal can be achieved using her/his current knowledge of technology. One
has to know the underlying technologies used by search engines in order to
perform work that addresses these uncertainties. In this case, it is known that
major search engine operators constantly change their ranking algorithms and
the claimant has acknowledged that they do not know the methods used by major
search engines in ranking websites. The fact that the intellectual property in
search engines algorithms is not shared is not a technological
uncertainty/obstacle.
…
The attempt to
identify the undisclosed intellectual property of search algorithms used for
ranking websites and the tests claimant ran for this purpose is not a
technological advancement. The trial and error process in this project is the
standard approach to reverse engineering the search algorithms and the results
often cannot be consistently repeated and verified as major search engine
operators are constantly changing their ranking algorithms.
[8]
Emotion maintains there were uncertainties
addressed by their research, with clear objectives in mind. They identified
hypothesis for ranking variables and reached conclusions on optimal methods to
structure data. The Respondent argues it was not Emotion, but the major search
engine companies such as Google or Yahoo for example, that created the
technology, and all Emotion did was rely on that existing technology to conduct
its own market research. It was just sorting the data. The Respondent also
suggested the nature of the work falls more appropriately into the exceptions
in section 248 of the Act of either market research or routine data
collection.
[9]
I have particular concern with respect to two
areas of the usual SRED analysis: first, the issue of uncertainties, and
second, the identification of a technological advancement. While Mr. Wilson
claims in sweeping terms there are unlimited uncertainties when dealing with
the internet generally, I do not find this as an adequate response to clearly
establishing the particular uncertainties addressed by Emotion’s research. I
glean from Mr. Wilson’s testimony that the particular uncertainty was how
on-page and off-page variables interrelate to determine ranking and how to
structure data to improve ranking. Certainly, I would consider this in the
nature of applied research, but is this type of uncertainty one that, citing Northwest
Hydraulics, “cannot be removed by routine
engineering or standard procedures”. With the
greatest respect to Mr. Wilson whose enthusiasm for and considerable
knowledge in the research carried on by Emotion was evident, I have not been
convinced that the work was other than routine engineering or standard
procedures. The experiments of submitting several different versions of
websites to determine the significance of variables relies on existing
technology in a routine manner. As explained in Northwest Hydraulics, “routine” describes techniques, procedures and data
generally available to competent professionals in the field. And that is how
I interpret what Emotion did.
[10]
The second area of concern is the question of
identifying the technological advancement. Here, the advancement would be the
determination of algorithms that relate variables for purposes of ranking
sites. I entertain no doubt this is complicated given the hundreds or thousands
of variables, but I fail to see how it is a scientific advancement to figure
this out. It strikes me more of solving an equation someone has already solved,
rather than coming up with a new proof. Or using the well-worn mousetrap
analogy, it is not creating a better mousetrap, just figuring out why mice get
caught in existing traps (location, nature of enticement etc.). I simply
do not see the technological advancement. I see thorough, extensive but routine
research leading to a practical application for example, for those who rely on
the internet to market their product. I see neither the evolution of computer
hardware or software that I could label as a technological advancement that
would justify qualifying Emotion’s expenditures as SRED.
[11]
The Appeal is dismissed.
Signed at Ottawa, Canada,
this 11th day of December 2015.
“Campbell J. Miller”
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