Promac Informatique Inc. v. R., [1998] 1 CTC 2754

Lamarre Proulx T.C.J.:

This is an appeal for the 1993 taxation year and it concerns the deduction for scientific research and experimental development activities, “SR & ED”, mentioned in s. 37 of the Income Tax Act (“the Act”). The Minister of National Revenue (“the Minister”) did not approve the SR & ED expenses claimed and the appellant was thus not entitled to the investment tax credit pursuant to s. 127(5) of the Act..

The issues are, first, to determine whether there were SR & ED activities for the 1993 fiscal year, and second, if so, whether there were expenses of a current nature actually incurred in the amount of $110,261 within the meaning of s. 37(1)(a) of the Act.

Gilles Pellerin, the appellant’s president, represented it, having previously received the Court’s leave to do so by an order dated August 16, 1996. Gilles Pellerin testified for the appellant. According to the witness, he obtained a bachelor’s degree in administrative sciences from Laval University in 1982 and is self-taught in computer sciences. He said the appellant was incorporated in 1991 to operate a business involving computer equipment and provide consultation services. Mr. Pellerin and a Mr. René Fournier were the two equal shareholders. Mr. Pellerin said at that time he was the vice-president and Mr. Fournier the president. Mr. Fournier did not testify because relations between the two associates had deteriorated. The appellant’s fiscal year is May 1 to April 30.

Sherif Negm and Jacques Cayer, regional scientific advisers, testified for the appellant. Counsel for the respondent filed Exhibit I-1, containing 21 tabs.

Mr. Pellerin filed Exhibit A-1, consisting of three letters from Revenue Canada: the first was dated June 23, 1993 and gave Mr. Pellerin additional time to file his 1993 claim so that the 1992 and 1993 claims could be dealt with together. Although the 1993 claim had not been filed, Sherif Negm on July 7, 1993, accompanied by a tax auditor, went to the appellant’s place of business to check on the SR & ED activities for the 1992 claim. Mr. Pellerin could not give them any demonstration because he did not have access to the information kept in his computer. It seems that it was a problem due to a security system installed on his computer. Mr. Negm therefore returned in September 1993. According to his testimony, he explained to the appellant’s representative that he had come to assess the effort for the 1992 fiscal year. In any case, the application for 1993 had not yet been filed. It was not filed until February 1994. Mr. Pellerin then demonstrated an interactive game lasting one minute in which he saw a lumberjack with a hatchet. With a key it was possible to touch the hatchet and the lumberjack’s face moved.

Mr. Negm agreed that this was a project which could meet the Department’s requirements in its evaluation of SR & ED activities in connection with technological uncertainties, technological breakthroughs and technological content. In this interview he did not check the documentation. On October 8, 1993 the appellant received a letter confirming that the claim for SR & ED for the fiscal year ending April 30, 1992 had been approved.

The third letter in Exhibit A-l was dated October 13, 1994 and informed the appellant that the claim for SR & ED for the fiscal year ending April 1993 had not been approved.

According to Exhibit I-1, tab 1, the application to deduct expenses for SR & ED was received on February 17, 1994. According to the testimony of Jacques Cayer, the application did not include a description of the project. He asked for this on April 11, 1994. He received a plan from the appellant on May 4, 1994 which gave him partial information. He made another request to which there was no reply. In any case, on August 28, 1994 he went to the appellant’s premises with two tax auditors. According to him, the game he was shown lasted ten seconds. It again involved a lumberjack with a hatchet. To ensure that it was not a copy, he asked to be given the source code. The appellant’s representative was unable to provide him with it. The scientific adviser saw no documentation describing the project. Mr. Cayer’s report was contained in tab 20 of Exhibit I-1. These are certain passages from the report:

[TRANSLATION]

II. Project(s): 1 project, documented in 18 pages.

Research and development of an interface for computerized production of interactive games on CD-ROM in 2D and 3D (games generator), and research and development of a prototype CD drive with a vocal interactive command.

III. Evaluation:

We asked the taxpayer (Mr. Pellerin) to show us the progress in his project during the year of the claim. The activities carried out during the year were purchase and installation of computer equipment, and purchases of software: games and application generators, installation of such software and tests and evaluation of the software purchased.

We asked him if he had designed and made a prototype and to give us a demonstration of the software he had developed. The taxpayer was unable to show us anything, except an animated game which lasted about eight seconds and resembled the one shown the previous year to the scientific adviser (Shérif Negm) who visited the taxpayer in September 1993. When I returned to the office, I checked with Shérif Negm and it would appear this was exactly the same game software that was used for the demonstration in the previous year. The taxpayer continued to search throughout the files of the Macintosh microcomputer but was unable to make any other software operate. I asked him to show me the files containing instructions and the code which should be used to program these games, but he was unable to show us anything. He told us that because of financial problems he was unable to hire the specialists needed to develop the prototype.

In short, the only activities carried out by the taxpayer during the year of the claim appear to be the purchase of software and its evaluation. These activities do not represent technological advance or technological uncertainty, but rather finding out what is available on the computer games market, learning these games and evaluating them..

There seemed to be no documentation, whether on follow-up of the project, its content or the results of the research. On the microcomputer which the taxpayer used for the demonstration there was a vast number of files which might contain something, but the taxpayer was unable to open them so we could check their content.

Based on analysis of the file and a visit to the taxpayer, the project claimed meets none of the three Revenue Canada tests regarding technological advancement, technological uncertainty and technological content.

IV. Conclusion:

I consider that the aforementioned project is not eligible for the SR & ED tax credit for the 1993 fiscal year.

The appellant made no application for a review of this decision.

On the second point at issue, namely the amount of the expenses actually incurred, these were professional fees which had not been paid because the appellant lacked liquidity, but had been converted into capital stock at the end of the fiscal year. As will be seen below, since the first question was not answered in the affirmative, there is no need to examine the question of the actual amount of expenses of a current nature.

Section 2900(1) of the Income Tax Regulations reads as follows:

For the purposes of this Part and sections 37 and 37.1 of the Act, “scientific research and experimental development” means systematic investigation or search carried out in a field of science or technology by means of experiment or analysis, that is to say,

(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,

(c) experimental development, namely, work undertaken for the purposes of achieving technological advancement for the purposes of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, or

(d) work with respect to engineering, design, operations research, mathematical analysis, computer programming, data collection, testing and psychological research where that work is commensurate with the needs, and directly in support, of the work described in paragraphs (a), (b) or

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.

The argument of the appellant’s representative was that this refusal by the Minister to approve his application for SR & ED expenses caused him serious financial hardship and prevented him from continuing with his project.

Counsel for the respondent referred to this Court’s decision in Sass Manufacturing Ltd. v. Minister of National Revenue (1988), 88 D.T.C. 1363 (T.C.C.), and in particular to the following passage at 1371: [1]

The evidence falls far short of establishing the existence of any systematic investigation or search carried out in a field of technology by means of experiment or analysis. In my view Regulation 2900 requires an appellant to adduce cogent evidence of such investigation or search. Systematic investigation connotes the existence of controlled experiments and of highly accurate measurements and involves the testing of one’s theories against empirical evidence. Scientific research must mean the enterprise of explaining and predicting and the gaining knowledge of whatever the subject matter of the hypothesis is. This surely would include repeatable experiments in which the steps, the various changes made and the results are carefully noted. There is no evidence of such an approach in the case at bar, either in the context of applied research or development. The appeal on this issue cannot succeed.

No documents providing any proof whatever of SR & ED activities were filed by the appellant. He spoke of an important collection of documents and purchase of equipment. That does not suffice. The demonstration required by s. 2900 of the Income Tax Regulations must be given, that there was a systematic investigation or search carried out in the field of science or technology by means of experiment or analysis. That demonstration was not provided.

The appeal is dismissed.

Counsel for the respondent asked that the appeal be dismissed with costs. The appellant’s representative mentioned the lack of financial resources. It is true that the respondent won the case. However, but for the amount in question the appellant could have proceeded by the informal procedure. I also take into account the fact that the respondent’s defence did not require calling an expert witness. For these reasons, but with some hesitation, I will not award costs in the instant case.

Appeal dismissed.