REASONS FOR JUDGMENT
Spiro J.
[1] In trying to build high-efficiency, direct-contact, water heaters for the fracking industry that were mountable on a truck or trailer (the “project”
), did the Appellant engage in “experimental development”
in its 2014 and 2015 taxation years within the meaning of the phrase “scientific research and experimental development”
(“SR&ED”
) in subsection 248(1) of the Income Tax Act (the “Act”
)?
2014 Taxation Year – Appeal No. 2019-894(IT)G
[2] The Appellant claimed SR&ED expenditures of $1,454,874 for its 2014 taxation year on the basis that its work on the project in that year constituted experimental development. Most of the work performed during the Appellant’s 2014 taxation year was on a pair of ten million BTU units (unit number 1 and unit number 2), the first of which failed catastrophically during testing.
[3] On assessment, the Minister of National Revenue (the “Minister”
) disallowed the claimed 2014 SR&ED expenditures.
2019 Taxation Year – Appeal No. 2021-1471(IT)G
[4] The Appellant claimed SR&ED expenditures of $507,989 for its 2015 taxation year on the basis that its work on the project in that year constituted experimental development. Most of the work performed during the Appellant’s 2015 taxation year was on a single 35 million BTU unit (unit number 3).
[5] On assessment, the Minister disallowed the claimed 2015 SR&ED expenditures. The Appellant did not object to their disallowance but, instead, carried forward the disallowed 2015 SR&ED expenditures into its 2019 taxation year. In reassessing the Appellant’s 2019 taxation year, the Minister disallowed the carry-forward.
The Legal Test for SR&ED
[6] The term “scientific research and experimental development”
is defined in subsection 248(1) of the Act:
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;
[7] In Northwest Hydraulic Consultants Ltd. v The Queen, Judge Bowman provided guidance on interpreting and applying the definition of “SR&ED”
in subsection 248(1) of the Act. The five criteria set out in Northwest Hydraulic have been endorsed and applied by the Federal Court of Appeal on several occasions, most recently in National R&D Inc. v Canada, where Justice Rennie confirmed that those criteria “reflect the court’s understanding of what Parliament intended by subsection 248(1).”
[8] Northwest Hydraulic teaches that if work is to qualify as SR&ED under subsection 248(1) of the Act, the following questions should be answered in the affirmative:
1. Was there a technological risk or uncertainty that could not be removed by routine engineering or standard procedures? The phrase “routine engineering”
describes techniques, procedures and data that are generally accessible to competent professionals in the field.
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 established and objective principles of scientific method, characterized by trained and systematic observation, measurement and experiment, and the formulation, testing and modification of hypotheses?
4. Did the process result in a technological advance?
5. Was a detailed record of the hypotheses, tests, and results kept as the work progressed?
The Appellant’s Case
[9] In its pleadings, the Appellant alleged that during its 2014 and 2015 taxation years it:
… developed technology (the “Technology”) described as a high-efficiency direct-fired heater primarily utilized for heating water in the hydraulic fracturing process in oil and gas extraction wells.
The Technology is more particularly described as a mobile direct-fired heating unit which, once in operation, is expected to heat water for use in oil and gas extraction more efficiently than existing processes. The mobile nature of the Technology is expected to allow this more efficient process to be employed in remote oil and gas fields, thereby saving the costs of constructing less efficient heating technologies on site.
The Appellant believes the Technology is the first to combine a direct-fired heating system with mobile capability.
The Appellant’s experimental work related to the Technology during the Appellant’s [taxation] years ended May 31, 2014 and May 31, 2015 is summarized in the following paragraphs:
(1) Direct-fired heaters differ significantly from indirect-fired heaters. Direct-fired heaters heat water by applying an open flame directly to the water, with both the water and the open flame contained in a chamber. Indirect-fired heaters use a flame external to the chamber containing the water so that the flame heats the chamber which in turn heats the water, similar to a conventional boiler. Within the oil and gas industry, direct-fired heaters are more energy efficient than indirect-fired heaters. However, direct-fired heaters are inherently more unstable than indirect-fired heaters. For this reason, indirect-fired heaters are more commonly used in the industry. Stationary direct-fired heaters have been used in indoor locations, though they consume significant capital resources in building and maintenance. There has been no successful mobile direct-fired heater developed. The Appellant sought the development of such a direct-fired heater which, if operational, would promote energy-efficiency by surpassing indirect-fired heaters and reducing costs in the industry by eliminating the need to build multiple stationary direct-fired heaters.
(2) Against this contextual background, the Appellant developed engineering guidelines to design the Technology.
(3) The Appellant faced technological uncertainty in developing such engineering guidelines because of the unprecedented nature of the Technology. The Appellant had no existing prototypes or guidelines to rely upon. In particular, the Appellant did not know how the engineering guidelines should address:
- Large variations in the exterior temperatures surrounding the Technology caused by the extreme climates of remote working areas;
- Large variations in the temperature of the water inside the Technology caused by the extreme climates of remote working areas; and
- The functionality of the small heating chamber in the Technology, likely required to be 60% less volume as compared to existing technology.
(4) The Appellant formulated the hypothesis that a new set of engineering guidelines combined with software-based controls could result in a working direct-fired heating system with mobile capability.
(5) The Appellant built a prototype of the Technology with a transportable chamber and components. This prototype was destroyed in testing.
(6) The Appellant built another prototype with reinforced heaters and
enhancements to the software-based control system.
(7) Throughout, the Appellant tested its engineering designs on the prototype, recorded data during testing, evaluated the results, and made adjustments. After each adjustment, the Appellant conducted additional tests.
(8) This experimental process resulted in advancements in the design, structural requirements, and software required for the Technology.
(9) As at March 8, 2019 the Technology is still in the testing and development phase.
The Crown’s Case
[10] The Crown pleaded that in determining the Appellant’s tax liability for the relevant taxation years, the Minister made certain assumptions of fact, including that:
…
b) the appellant provides energy-related services to the oil and gas industry, builds swamp mats, and provides mixing and heating systems to the oil and gas industry;
….
e) the appellant's objectives were to:
i) develop a high-efficiency water heater for a hydraulic fracturing process used in oil and gas extraction; and
ii) develop the heater as a mobile heater installed on a trailer which could be transported to extraction sites;
…
g) to accomplish its objectives, the appellant needed to determine the proper mechanical design for a mobile outdoor burner capable of firing under varying weather conditions and create an automated firing and water circulation control program;
h) the appellant studied high-efficiency water heaters available on the market and determined that a direct contact heater would be an efficient heater;
i) direct contact heaters for other applications were available, however, they did not meet the appellant's needs because they were not mobile direct contact heaters and had limited capacity;
j) in the appellant's design, water entered into the heater at the top and was sprayed over a layer of packing bed by water spray nozzles. The burner section was located under the packing bed where a burner on the wall of the heater blew a flame into the heater. Water droplets passed through the flame and hot water was collected in the chamber at the bottom of the heater. Combustion gases flew up through the packing, pre-warmed the entering water, and left the heater at the top of the heater;
k) the heater was powered by propane gas;
1) the appellant evaluated various off-the-shelf measurement instruments to determine their suitability for the applicant's product;
m) the appellant completed the construction of a heater with the capacity of 10 million BTU and tested it;
Burner
n) one of the challenges the appellant encountered was the unavailability of a commercial burner capable of producing a flame suitable for a direct contact heater. Accordingly, the appellant attempted to modify a commercially available burner in order to produce a larger flame;
o) the appellant enlarged the air inlet holes on the mixing cone of a commercially available burner to increase volumetric air flow going through the mixing cone;
p) to increase the flame size, the appellant increased the flow rate of propane gas to the burner by increasing the gas pressure;
q) the appellant custom-tuned the proportion of gas to air with respect to flow rated by changing propane gas pressure and air flow rate;
r) the appellant used a larger air blower to increase the flow rate of air to combust excess propane gas in the heater's exhaust;
s) the appellant calculated the burner's efficiency by analysing the heater's exhaust and measuring unburned propane gas;
t) based on existing knowledge in chemical engineering, when there is an adequate proportion of fuel to air, flame size will increase and will result in the consumption of the entire fuel supply;
u) based on established scientific and technological knowledge, making larger holes reduces the resistance to air flow and simultaneously increases air supply;
Water spray nozzles
v) the appellant needed to modify water spray nozzles in order to achieve a wider spray angle;
w) the appellant hired a contractor to modify water spray nozzles based on specifications provided to the contractor;
x) the contractor's experience was sufficient to provide the requested modifications to the water spray nozzles;
Heater box
y) the burner produced pulses which had a tendency to magnify in a mobile heater and pull the welded joints in the heater apart, especially at the corners. To solve this problem, the appellant redesigned the body of the heater box by increasing the thickness of the material to provide a secondary layer of protection and attaching a bent steel plate at the corners of the heater to form a double wall;
z) based on existing knowledge in mechanical engineering an increase in wall thickness and the addition of an extra plate in the corners of the heater box will increase the resistance of the wall and corners to vibration and mechanical stress;
Overheating inside trailer
aa) the heater designed by the appellant was located inside a trailer;
bb) the appellant used an air blower with a reverse fan to cool down the inside space of the trailer to prevent the heater burner from shutting off as a result of its safety control system;
cc) a blower with a reverse fan replaced warm air in the trailer space with cold air from the outside and cooled down the burner;
Additional design work
dd) the appellant undertook additional design work on the mobile heater as follows:
i) Adding a pump to increase the pressure of propane gas exiting the propane vaporization tank;
ii) providing cathodic protection to the heater to prevent corrosion; and
iii) applying protective spray on the outside surfaces of the heater and tubing;
Automation software
ee) the appellant hired a contractor with specialization in computer programming to supply software;
ff) the computer programming contractor's knowledge base and expertise were sufficient to develop the software;
Crown Motions to Amend the Replies
[11] At the commencement of the hearing, Crown counsel made a motion under section 54 of the Tax Court of Canada Rules (General Procedure) to amend each Reply to add, at the end of the assumptions paragraph, additional assumptions made by the Minister in assessing:
(gg) with respect to the appellant’s SR&ED claim in respect of a mobile direct-contact water heater:
i) there existed no scientific or technological uncertainty;
ii) the appellant did not formulate hypotheses specifically aimed at reducing or eliminating that uncertainty;
iii) the appellant’s overall approach was not consistent with a systematic investigation or search, including formulating and testing the hypotheses by means of experiment or analysis; and
iv) the appellant’s overall approach was not undertaken for the purpose of achieving a scientific or technological advancement.
[12] I was satisfied that these assumptions were made by the Minister in assessing. I was also satisfied that the proposed amendments would assist in determining the real questions in controversy between the parties, would not result in an injustice not compensable in costs, and would serve the interests of justice. The Appellant did not object to the Crown’s motions. For all those reasons, I granted the motions with costs fixed in the amount of $500 for each.
Summary of the Evidence
[13] Mr. Andrew Bodner testified on behalf of the Appellant. He described himself as an entrepreneur and business owner having a diploma in petroleum engineering technology. Immediately before incorporating the Appellant in 2013, Mr. Bodner was an importer and exporter of granite cabinets. Before then, he was employed in various roles by several oil field service companies in Alberta. In cross-examination, he admitted that he was not a professional engineer.
[14] Mr. Bodner has a 25% interest in the Appellant, along with three other 25% shareholders including his father-in-law, who is in the grain business, and Mr. Joe Bazley who is a cattle farmer.
[15] Today, the Appellant’s business includes providing various services for the oil and gas industry including drilling and excavating for pipelines and power lines and installing temporary roadways to help drilling rigs and service rigs travel to remote areas. The Appellant also removes drilling waste products and provides portable fire suppression services.
[16] But immediately following its incorporation in 2013, the Appellant’s exclusive focus was trying to build high-efficiency, direct-contact, water heaters for the fracking industry that were mountable on a truck or trailer. Heated water is necessary for fracking in the winter to keep the water from freezing. It is also necessary in the summer as some of the chemicals must remain above a certain temperature in order to be effective.
[17] According to Mr. Bodner, high-efficiency, direct-contact, water heaters were used by the fracking industry in 2013, but none of them were mountable on a truck or trailer. The Appellant wanted to build mobile units ranging from ten million BTUs to 35 or 36 million BTUs. To that end, it purchased various components, such as burners and burner bodies, from third-party suppliers and then tested and modified them to suit its needs.
[18] Notes taken as part of those tests were produced as Tab 100 (Exhibit A-12). Mr. Bodner described the contents of Tab 100 as “experimental findings and data”
and testified that certain physical tests were conducted at Mr. Bazley’s cattle farm. For example, Appellant’s counsel asked Mr. Bodner about tests performed at the cattle farm on April 8, 2014:
Q: … If you look at page 502, for instance.
A: Yeah, 502 is just some sketch notes that I made on testing our mixing cones for the burner.
Q: Yeah, so quickly, are those your notes? Those are my handwriting – that’s my handwriting.
Q: Yeah, and basically the date. What date is that? April 8th, 2014 test?
A: Yeah, April 8th, 2014 test.
Q: It talks about Alberta Central Permit Office, Quebec Permit Office. So where was this taking place?
A: This was all taking place at Joe Bazley's farm in his shop right there. He had a tank, a 400-barrel tank, which is common in the oil field, that we had filled with water to hook our unit into and do physical tests with.
Q: That's right.
JUSTICE: What did he fill with water?
A: A 400-barrel tank.
JUSTICE: What did he use that for?
A: He used it for watering his cattle, but it was tied straight into his wall.
JUSTICE: Oh, okay. It was a cattle farm?
A: It was for his cattle originally. He just had that tank there. He bought it in an oil field auction years ago, and it was an old tank. He cleaned it out and used it for feeding – watering his cattle.
[19] In the words of Mr. Bodner, the Appellant “found out the hard way”
that a larger flame creates a larger harmonic disturbance (i.e., vibrations). This is how he described the catastrophic failure of unit number 1:
But with the bigger flame, you also get a huge harmonic disturbance that we found out the hard way. It destroyed unit number 1 with the vibrations. So instead of just making a bigger flame, we had to fine-tune and kind of create our own burner to, I guess, manipulate the shape of the flame to reduce the harmonics in the chamber to achieve the output we were desiring.
…
The cracks were created by the harmonic - the sound pressure waves inside the vessel itself. It would flex and rumble as you increased the flow rates and the, I guess, turned the volume of the burner up. It would create new sound pressure waves inside your chamber and vibrate the burner body apart. So it was just the vibrations that blew out the welds.
…
… it was too loud to hear individual welds popping and cracking. You've got your generator running. You can hear the burner and the sound waves from the burner rumbling. And as the rumbles increase, you know, you increase the harmonics and it just starts leaking, right? The whole thing shakes apart.
JUSTICE: And you weren't injured?
A: No, it was catastrophic to the equipment, but not to human life or safety.
[20] At the time of the hearing in November 2024, the Appellant continued to operate its remaining ten million BTU unit (unit number 2) and the larger unit number 3. Oil companies hire the Appellant to work, as a third party, alongside their fracking crews. According to Mr. Bodner, no mobile units have been built by anyone else. Unit number 2 and unit number 3 are the only units of their kind operating in Alberta’s oil patch alongside 30 to 40 conventional (non-mobile) water heating units.
Appellant’s Argument
[21] In oral argument, counsel relied heavily on this Court’s decision in Canafric Inc. v The King. In that case, the appellant made a variety of frozen pies. The projects at issue developed new frozen pies or improved existing frozen pies. Chief Justice Rossiter allowed the appeal after concluding that the appellant:
[115] … successfully established that the 2013, 2015, 2015 and 2016 SR&ED Claims met all five criteria established in Northwest Hydraulics:
i. There was a technological risk or uncertainty, which could not be removed by routine engineering or standard procedures.
ii. Canafric formulated hypotheses specifically aimed at reducing or eliminating that technological uncertainty.
iii. The procedure adopted accord with the total discipline of the scientific method including the formulation testing and modification of hypotheses.
iv. The process resulted in a technological advancement.
v. A detailed record of the hypotheses tested, and results were kept as the work progressed.
[116] I am more than satisfied the Appellant discharged its burden. The appeal is allowed.
[22] Appellant’s counsel, Mr. Johnson, also argued that:
What the Appellant believes was missing from CRA’s assumptions of fact was the magnitude of the task faced by the Appellant based on existing technology at the time and the Appellant’s accomplishments during the taxation years in question in designing and building a mobile direct fired heater.
[23] Counsel emphasized the amount of work that went into the project. For example, “a lot of work went into finding the correct burner/gas flow configuration.”
Counsel also submitted that the Minister failed to recognize, among other things, “the technological achievements contained in the Appellant’s prototype heater.”
[24] Counsel argued that the Court should consider the “why”
and the “how”
of the work performed. With respect to the latter, he contended that:
… the Appellant’s work on the mobile direct fired heater was done by starting with a current state of the art stationary heater of the desired output and modifying it to meet all of the following parameters:
1. fit on a trailer that was roadworthy (no more than 8 feet wide or 8 feet high);
2. withstand vibrations from being transported (unlike a stationary heater);
3. operate in a variety of temperatures from plus 40° to minus 40° C (unlike a stationary heater);
4. provide a range of water temperatures (unlike a stationary heater); and
5. provide the same heat output as the stationary unit.
[25] Counsel submitted that lack of documentation is not necessarily fatal to an SR&ED claim. In this regard, he relied on the reasons of the Federal Court of Appeal in RIS-Christie Ltd. v Canada:
[14] In addition to developing new products or processes, scientific research connotes the existence of controlled experiments involving the testing of models or prototypes. Thus, evidence of scientific research must be adduced by the taxpayer in order to demonstrate that such research (including testing) was undertaken and that it is eligible for favourable tax treatment: see, for example, Progressive Solutions Inc. v. R., 96 DTC 1232 (T.C.C.). Not only must taxpayers establish that tests were performed, they must also demonstrate that they were conducted in a systematic fashion. In my view, the requirement that research efforts be "systematic" is a higher threshold than simply requiring that research, including testing, be conducted. Although both documentary and viva voce evidence are admissible, the only sure-fire way of establishing that scientific research was undertaken in a systematic fashion is to adduce documentary evidence which reveals the logical progression between each test and preceding or subsequent tests.
[15] Thus, it is reasonable to expect a taxpayer to adduce documentary evidence of systematic research, including testing. If, however, a taxpayer has a plausible explanation for the failure to adduce such evidence, it is still open to the court to hold that, on a balance of probabilities, systematic research was undertaken. For example, where research notes are accidentally destroyed, it should be permissible for the trial judge to infer that systematic research was conducted, having regard to the totality of the evidence. During oral argument, counsel for the Minister accepted this proposition, if only because that scenario was inapplicable in the present case. However, in my view, it should also be permissible to infer that a taxpayer had conducted systematic research where it is established that such research led to a technological advancement. I say this because the whole foundation of the scientific research provisions of the Act and Regulations should not rest solely on the repeatability criterion. Otherwise, repeatability would negate the validity of all other evidence pertaining to scientific research.
Analysis
[26] The question before the Court is whether the Appellant has demonstrated, on a balance of probabilities, that its work on the project satisfies the Northwest Hydraulic criteria and, therefore, qualifies as SR&ED under the Act. In arriving at the answer to that question, I have considered the assumptions and the evidence under each criterion in turn.
[27] Our starting point is the Minister’s assumption of fact that:
(gg) with respect to the appellant’s SR&ED claim in respect of a mobile direct-contact water heater:
i) there existed no scientific or technological uncertainty;
[28] In light of this assumption of fact, the onus was on the Appellant to prove that the project presented at least one scientific or technological uncertainty. It failed to do so. The onus was also on the Appellant to demolish each of the following ancillary assumptions of fact:
Burner
…
t) based on existing knowledge in chemical engineering, when there is an adequate proportion of fuel to air, flame size will increase and will result in the consumption of the entire fuel supply;
u) based on established scientific and technological knowledge, making larger holes reduces the resistance to air flow and simultaneously increases air supply;
Water spray nozzles
…
x) the contractor's experience was sufficient to provide the requested modifications to the water spray nozzles;
Heater box
…
z) based on existing knowledge in mechanical engineering an increase in wall thickness and the addition of an extra plate in the corners of the heater box will increase the resistance of the wall and corners to vibration and mechanical stress;
…
Automation software
…
ff) the computer programming contractor's knowledge base and expertise were sufficient to develop the software;
[29] The Appellant alleged that it faced technological uncertainty because it:
… did not know how its engineering guidelines should address:
- Large variations in the exterior temperatures surrounding the Technology caused by the extreme climates of remote working areas;
- Large variations in the temperature of the water inside the Technology caused by the extreme climates of remote working areas; and
- The functionality of the small heating chamber in the Technology, likely required to be 60% less volume as compared to existing technology.
[Emphasis added]
[30] The problem with the Appellant asserting that it “did not know”
is that technological uncertainty is not determined on a subjective basis (what the Appellant knew), but on an objective basis (what a competent professional in the field would have known). As Justice Russell pointed out in Mold Leaders Inc. v The King:
[57] In Logic Data Products Inc. v. The Queen, 2021 TCC 36, Justice Monaghan then of this Court observed (para. 69):
Technological uncertainty does not arise simply because the Appellant does not have the requisite knowledge. The question is whether the uncertainty identified by the Appellant is an uncertainty to those knowledgeable and experienced in the relevant field.
[58] As well, in Dave’s Diesel v The Queen, 2022 TCC 62, my colleague Justice Spiro specified that the concept of technological uncertainty is not subjective. He wrote (para. 28) that: “[i]f it were subjective, a grade school student trying to build a simple electric motor would meet the test.”
[59] Here there was not evidence as to the overall industry state of knowledge in the context of any of the eight projects.
[31] In these appeals, the Appellant chose not to lead expert evidence demonstrating (a) technological risks or uncertainties and (b) that any such technological risks or uncertainties could not be removed by routine engineering or standard procedures. The Court, therefore, is obliged to rely on the assumption of fact that there existed no scientific or technological uncertainty.
2. Did the person claiming to be doing SR&ED formulate hypotheses specifically aimed at reducing or eliminating that technological uncertainty?
[32] Assuming there was at least one technological uncertainty to be resolved, our starting point is the assumption of fact made by the Minister that:
(gg) with respect to the appellant’s SR&ED claim in respect of a mobile direct-contact water heater:
ii) the appellant did not formulate hypotheses specifically aimed at reducing or eliminating that uncertainty;
[33] The only hypothesis alleged by the Appellant was a single, overarching hypothesis at paragraph (iv)(4) of the Appellant’s Amended Notice of Appeal in 2019-894(IT)G and the Appellant’s Notice of Appeal in 2021-1471(IT)G:
(4) The Appellant formulated the hypothesis that a new set of engineering guidelines combined with software-based controls could result in a working direct-fired heating system with mobile capability.
[34] But that is no hypothesis at all. It is simply a restatement of the objective of the entire project. In Joel Theatrical Rigging Contractors (1980) Ltd. v The Queen, Justice Sommerfeldt held that “a hypothesis is a statement to be tested by an experiment or a trial.”
The Appellant’s alleged hypothesis is incapable of being tested by an experiment or a trial. What experiment or trial could prove that “a new set of engineering guidelines combined with software-based controls could result in a working direct-fired heating system with mobile capability”
? To use the words of Judge Bonner, the Appellant’s alleged hypothesis is simply “too vague”
.
[35] Furthermore, in Northwest Hydraulic, Judge Bowman described a five-stage process to determine whether the person claiming to have done SR&ED formulated hypotheses specifically aimed at reducing or eliminating the technological uncertainty. According to Judge Bowman, such a person would have engaged in:
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 a hypothesis or hypotheses designed to reduce or eliminate the uncertainty; and
e. the methodical and systematic testing of the hypotheses.
[36] Judge Bowman used the plural “hypotheses”
throughout Northwest Hydraulic, particularly in the second, third, and fifth criteria. The Northwest Hydraulic criteria do not contemplate a single, overarching hypothesis, as the Appellant assumes, but a particular hypothesis that precedes each test and that is subject to modification in light of the results of that test. I saw no evidence of that here.
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?
[37] Our starting point is the assumption of fact made by the Minister that:
(gg) with respect to the appellant’s SR&ED claim in respect of a mobile direct-contact water heater:
iii) the appellant’s overall approach was not consistent with a systematic investigation or search, including formulating and testing the hypotheses by means of experiment or analysis;
[38] Mr. Bodner’s oral evidence and the contents of Tab 100 (Exhibit A-12) – to which we shall return later – demonstrate that the tests performed by the Appellant were conducted by trial and error. In other words, there was no systematic investigation. As Chief Justice Rossiter noted in Canafric (citations omitted):
[101] This Court has consistently held that trial and error does not come within the scientific method if used alone. Trial and error aim to solve a functional problem using different options. Unlike the systematic investigation required under subsection 248(1) ITA, trial and error does not attempt to understand why a particular option did not work and simply moves on to the next option.
4. Did the process result in a “technological advance”?
[39] Has the Appellant demonstrated, on a balance of probabilities, that building high-efficiency, direct-contact, water heaters for the fracking industry that were mountable on a truck or trailer was a “technological advance”
? The answer is no. In the absence of expert evidence from a professional engineer, I have no way of knowing whether that work constituted a “technological advance”
.
5. Was a detailed record of the hypotheses, tests, and results kept as the work progressed?
[40] The Appellant has not demonstrated that, with respect to any test, or series of tests, performed during its 2014 or 2015 taxation years, it recorded:
(a) the formulation of a hypothesis;
(b) the testing of that hypothesis; and
(c) the modification of that hypothesis in light of the results of the test.
[41] As we shall see below, Mr. Bodner testified – quite candidly so – that “we were trying to just achieve an end goal of what would work. Half of our failures were just, okay, well, that didn't work, let's try this.”
That is the essence of trial and error.
[42] Mr. Bodner made that statement during a voir dire on the admissibility of the contents of Tab 100. During that voir dire, I gave Mr. Bodner an opportunity to explain the contents of Tab 100. The scattered and disorganized nature of Mr. Bodner’s oral evidence is consistent with the scattered and disorganized nature of Tab 100:
A: It's an example of the tests that we were doing.
JUSTICE: How many tests?
A: Countless.
JUSTICE: Countless tests...
A: I would do...
JUSTICE: ...are under Tab 100?
A: This is one example of numerous tests that we did for...
JUSTICE: One example. Where are all the tests located?
A: We didn't document a lot of them because a lot of them were failures. We weren’t looking...
JUSTICE: No, but don't you document the failures so that you can learn from them and then do it right the next time? Keep trying?
A: When a pump fails because of some sort of - we just - okay, that pump failed, we're going to do this now. We didn't document it per se. We were never looking to go out and, you know, I didn't know anything about an SR&ED program.
…
A: Yeah. So, I mean, we were trying to just achieve an end goal of what would work. Half of ours were just, okay, well, that didn't work, let's try this. Nothing that I had written down. And I mean, I do have pages, notes at home, books and books and books of what we had done and stuff that were part of our submission to SR&ED.
JUSTICE: Okay. I don't really care what was part of the submission to CRA. I'm just asking about Tab 100, which your counsel wants to have marked as an exhibit. I'm just not quite sure what it is.
A: It's just an example of some of the notes that we took for (INDISCERNIBLE).
JUSTICE: Well, I don't know that it's an example of anything. It’s – like, when does it start and when does it end, and it's a test or a number of tests? I don't know. I don't have a clue. Let's start with page - we'll go page by page. Page 483, what's that?
A: These are tests that we performed on our unit to test our theories of modifying a (INDISCERNIBLE).
JUSTICE: Okay. Which unit?
A: This is unit number 1 and 2.
JUSTICE: And what were the theories?
A: We needed a higher output of the burner to produce a higher output for our water. So when we would turn the burner up to its maximum capacity, we wouldn't get our desired results that they would get in their stationary units.
JUSTICE: Where do I see that?
A: You don't see it. This is just notes of those tests.
MR. JOHNSON: Well, I guess – (INDISCERNIBLE) page 485. Looking at page 485.
JUSTICE: But what was the test? Was it item 3 in page 485, results of tests? But what were the tests?
A: These tests were for our heat output. So we were testing, you know, at water flow rates, what temperature differentials we were getting, how much heat was getting into the water, how much heat we were losing, what our flue gas analysis emissions were.
JUSTICE: And this is all with a view to doing what?
A: Increasing heat output of a portable unit.
JUSTICE: What are the variables?
A: Pardon me?
JUSTICE: What are the variables?
A: Of?
JUSTICE: Increasing the output?
A: I guess burner size, burner function, harmonics within the unit.
JUSTICE: Where do I see all of that?
A: Those are all results of our tests.
JUSTICE: So page 485.
A: This is just one of the tests that we did.
JUSTICE: Okay. And what was the result of that test?
A: The result of that test, I believe this one was – let me see it for a second.
MR. JOHNSON: Yeah and look at page 513 for instance.
A: This test was to test the size of the flame, how we could minimize the size and shape of the flame to eliminate the harmonics of the unit.
JUSTICE: Where does it say that?
A: It doesn't say that. In the conclusion there - conclusion test.
JUSTICE: Page?
A: At the bottom of page 485. Conclusion on test 46.
[Emphasis added]
[43] And as we saw earlier, Mr. Bodner testified that the Appellant “found out the hard way”
that a larger flame creates a larger harmonic disturbance (i.e., vibrations). Finding out something the hard way was a result of trial and error.
[44] The Appellant alleged that it:
… tested its engineering designs on the prototype, recorded data during testing, evaluated the results, and made adjustments. After each adjustment, the Appellant conducted additional tests.
[45] The Appellant has failed to prove this allegation on a balance of probabilities. For example, where are the records of the tests leading to the destruction of unit number 1? How high were the relevant pressures immediately before its failure? How high were the relevant temperatures at that time? What was the frequency of the vibrations that were shaking the unit apart? What was the source of those vibrations?
[46] Such records are nowhere to be found. Why not? Because, by his own admission, Mr. Bodner chose not to keep records of experiments that failed. As Justice Russell has noted: “technological advancement includes new knowledge that results even from a failed attempt to achieve a technological advance.”
[47] The Appellant’s trial and error method is a far cry from the way that testing was conducted on a cooling system for a massive tractor engine in Buhler Versatile Inc. v The King (citation omitted):
[39] The appellant tested the cooling system using the dynamometer (called dyno testing) as well as doing field testing. Mr. Minaker stated that the dyno testing took place in a test cell which was a large enclosed room. The tractor would run at full throttle for 6 to 8 hours at a time and approximately 30 variables such as temperatures, pressures, and flows would be measured to determine how the cooling system was working.
[48] In Buhler Versatile, Justice Wong concluded that the work qualified as experimental development after finding the following facts:
[64] The appellant was focused and methodical in the way it uncovered, recognized, and resolved the issues involving cooling and the torsional coupler, as two examples of the larger challenges. It did not always know whether a specific theory would successfully resolve a particular issue but it always knew why it was testing that theory.
[65] For example, the appellant moved away from rubber couplers to spring-based ones because the rubber was breaking; however, the appellant did not know that the spring couplings would work. The appellant then eventually moved away from a 2-piece welded design to a one-piece design. As another example, the appellant knew that the larger cooling system must be accommodated without knowing how to do so. It systematically formulated and tested theories, resulting in a combination of changes to component orientation, spacing, the design of the charge air cooler, and two increases in the size of the tractor itself, among other things.
[49] In these appeals, the Appellant’s evidence fell far short of the mark.
Conclusion
[50] The Appellant has failed to show, on a balance of probabilities, that its work on the project during its 2014 or 2015 taxation years qualified as “experimental development”
within the meaning of SR&ED in subsection 248(1) of the Act. Accordingly, the appeals must be dismissed.
Signed this 28th day of April 2025.
“David E. Spiro”
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