Eligibility of work for SR&ED investment tax credits

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Eligibility of Work for SR&ED Investment Tax Credits Policy

Date: April 24, 2015

Changes to the Eligibility of Work for SR&ED Investment Tax Credits Policy

Reasons for revision

This revision provides clarification of concepts in policy, based on feedback received from stakeholders.

Revision overview

Clarification is provided through three approaches to the revision of the text:

  1. Wording has been revised and editorial changes have been made.
  2. Some terminology has been removed or changed.
  3. Examples have been added to illustrate concepts.

The text of this document has been revised to reflect these changes, see Appendix A.1 Explanation of changes.

This document clarifies what work constitutes scientific research and experimental development (SR&ED). It is directed at personnel who identify SR&ED work. Identifying SR&ED requires technical personnel who performed, are familiar with, or are responsible for the work.

Table of contents

1.0 What is SR&ED?

Scientific research and experimental development (SR&ED) is defined for income tax purposes in subsection 248(1) of the Income Tax Act as follows:

"ʽscientific research and experimental developmentʼ 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;"

What is generally understood to be "research and development", or "R&D", is not necessarily "SR&ED". SR&ED is carried out in a certain way and for specific reasons. The definition of SR&ED describes how (section 1.1 below) and why (section 1.2 below) SR&ED work is carried out.

Note
"Eligible" and "ineligible" (including the forms "eligibility" and "ineligibility") are widely used in the SR&ED program, although the Act does not define these terms. For this document, "eligible" or "ineligible", without any other qualifier, means work that meets or does not meet the definition of SR&ED in subsection 248(1) of the Act. In addition, "uncertainty" and "advancement" without any other qualifiers refer to scientific or technological uncertainty and scientific or technological advancement respectively.

1.1 How SR&ED is carried out

The definition of SR&ED describes how SR&ED is performed—a "systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis."

Most work, especially research and development, is carried out systematically. It follows known design methods, techniques, procedures, protocols, standards, and other practices. Also, in many situations, problems are solved by following established procedures and standards. In other words, a systematic approach is used to carry out work.

It is important to distinguish between a systematic approach to carrying out work and the approach that is a systematic investigation or search called for in the definition of SR&ED . The latter approach includes defining a problem, advancing a hypothesis towards resolving that problem, planning and testing the hypothesis by experiment or analysis, and developing logical conclusions based on the results.

The systematic investigation or search is common to all work, including scientific, engineering or other development, that involves SR&ED. And, it is recognized that in an industrial context, a "possible solution to the problem" may be considered a hypothesis, and "building and testing of a prototype" may be considered part of the experiment or analysis.

How the work is carried out is only one aspect of whether it is SR&ED. Before it can be determined that work is SR&ED, consideration must also be given to why the work was carried out.

1.2 Why SR&ED is carried out

The definition of SR&ED also describes why SR&ED is undertaken—for the advancement of scientific knowledge, or for the purpose of achieving technological advancement aimed at creating new, or improving existing, materials, devices, products, or processes including incremental improvements.

The systematic investigation or search carried out in a field of science or technology by means of experiment or analysis must be seeking scientific or technological advancement for it to be SR&ED.

Work for the advancement of scientific knowledge or for the purpose of technological advancement implies an attempt to resolve what is called scientific uncertainty or technological uncertainty. Basically, the advancement is the targeted outcome of the SR&ED work while the uncertainty is the impetus for the SR&ED work. Therefore, an attempt to achieve advancement is an attempt to resolve uncertainty.

Depending on the purpose of the work, SR&ED can involve:

1.2.1 Basic research

Basic research is work undertaken for the advancement of scientific knowledge without a specific practical application in view. It is usually carried out in a laboratory setting. Claims involving basic research sometimes include third-party payments to, for example, universities, research institutes, and consortia. The results of basic research are usually published in scientific journals.

One example of basic research is research in the field of elementary particles. This work had its origin as a hypothesis in theoretical physics or scientific models of the structure of matter. Originally there was no physical evidence that the hypothetical particles existed, let alone that there could be a practical value to them. At some point, experiments were devised and performed that demonstrated that these particles existed, and measured their properties (mass and charge). The electron was one of these discoveries.

1.2.2 Applied research

Applied research is also work undertaken for the advancement of scientific knowledge, but with a specific practical application in view. Like basic research, the results could be published in scientific journals.

The discovery of the principle of the transistor, that is, the ability to control the conductivity of a semiconductor, can be considered an example of applied research. A private company did this particular work. Its research objective was to gain knowledge of the properties of semiconductors, particularly how electrons (one type of elementary particles that was discovered as a result of the basic research noted above) behaved in them. The company clearly hoped to develop a practical application (a semiconductor amplifier) based on the scientific knowledge gained although at this point no device or product had been made.

1.2.3 Experimental development

Experimental development is 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.

One example of experimental development is the work that came about from the discovery of the principle of the transistor. It resulted in the development of devices that used this principle to create solid-state amplifiers and other devices. The development of technology to make devices and eventually products using this discovery was done through experimental development. The applied research was rapidly followed by the development of working prototypes and eventually by practical techniques to make a new product—the transistor. Developing a transistor after discovering the principle of the transistor did not advance scientific knowledge. It did, however, advance technology (the practical application of scientific knowledge and principles).

2.0 Methodology to determine if work meets the definition of SR&ED

The following 2-step methodology can be used to determine if and to what extent work meets the definition of SR&ED:

Step 1: Determine if there is SR&ED

In this step, the details of the work are examined to the point where the five questions (described in Section 2.1 below) can be answered.

Step 2: Determine the extent of eligible work

In this step, the details of the work are examined to determine what work is SR&ED.

2.1 Step 1: Determine if there is SR&ED

Determining if there is SR&ED means showing that there is a:

"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,"

The method to establish this involves answering the following five questions:

  1. Was there a scientific or a technological uncertainty?
  2. Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty?
  3. Was the overall approach adopted consistent with a systematic investigation or search, including formulating and testing the hypotheses by means of experiment or analysis?
  4. Was the overall approach undertaken for the purpose of achieving a scientific or a technological advancement?
  5. Was a record of the hypotheses tested and the results kept as the work progressed?

These questions follow the progression of SR&ED work from identifying the uncertainty, through carrying out the work for its resolution, to the resulting advancement. They are also interrelated, with question 1 and question 4 looking at why the work was done and questions 2, 3, and 5 looking at how the work was done. Because of the relationships between the questions, the five questions should be considered jointly across the entire body of work being evaluated.

There is SR&ED if the answer to each of the questions is yes.

With respect to the five preceding questions, consideration must be given to the scientific or technological knowledge base and the business environment of the individual company. Business environment characteristics include business size, competition, area of industry, and access to technical resources. It is expected that any company making a claim for SR&ED will have or will access the expertise necessary to carry out that work.

Sections 2.1.1 – 2.1.5 provide additional details in relation to the five questions in order to determine if there is SR&ED.

2.1.1 Was there a scientific or a technological uncertainty?

Scientific or technological uncertainty means whether a given result or objective can be achieved or how to achieve it, is not known or determined on the basis of generally available scientific or technological knowledge or experience. Specifically, it is uncertain if the goals can be achieved at all or what alternatives (for example, paths, routes, approaches, equipment configurations, system architectures, or circuit techniques) will enable the goals to be met based on the existing scientific or technological knowledge base. There is scientific uncertainty in basic research or applied research. There is technological uncertainty in experimental development. Recognition of the uncertainty is an integral step in the systematic investigation or search and implies recognition of the need for advancement.

Technological uncertainties may arise from shortcomings or limitations of the current state of technology that prevent a new or improved capability from being developed. In other words, the current state of technology may be insufficient to resolve a problem.

Example 1: Technological uncertainty

Introduction

Technological uncertainty may arise from limitations of the current technology that prevent you from developing a new or improved capability. Technological uncertainty exists when you don’t know whether you can achieve a certain result or objective or how to achieve it based on generally available scientific or technological knowledge or experience.

We cannot determine eligibility without understanding the work performed and evaluating it using the five questions. In this example, there are indicators that suggest there is uncertainty but they do not point to any specific uncertainty.

Example

You use the current technology to extract oil from oilseeds, which involves batch processing. In batch processing, the seeds are crushed, conditioned, and flaked at high temperature (80–100°C). The residue after removing the oil is made up mostly of protein-rich flour and seed coats with some trapped oil. This residue (also called meal) is then ground and the trapped oil is extracted with solvent. The solvent is recovered from both the meal and the extracted oil by toasting and distillation. You generally sell the meal as an animal feed product. However, it would be better if you could sell the meal as nutrition rich flour.

The meal product you get with this process is a mixture of protein-rich flour, which you want, and seed coats, which you don’t want. Seed coats have no nutritional value, and they make the flour visually unappealing as a potential ingredient in food for humans to consume. Also, the high temperature used in the conditioning and flaking harms the nutritional value of the oil and the flour. With the current technology, your ability to separate the protein-rich flour from the seed coats without affecting the nutritional value of the oil and flour is limited. You want to develop a low-temperature oil extraction process that would let you separate the protein-rich flour from the seed coats for a particular type of oilseed, so you can produce a protein-rich product suitable for humans to consume.

In particular, you want to be able to separate the seed coats from the protein-rich flour at a low temperature. This is difficult because the seed coats and the flour have similar physical properties and because the two are bonded together.

Although there are many different methods to separate solid particles with different physical properties, there is no effective low-temperature method to separate solid particles with very similar physical properties when the particles themselves are bonded together.

After literature review and discussing it with academic and industrial experts, you found out that one technology that had reportedly been tried to separate seed coats from flour on a small scale was ultrasonic maceration (without extraction) in a batch process. But, you could not find any information on using ultrasonic maceration with solvent extraction for your particular oilseed. On top of that, you believed that you needed to develop a continuous process for a large-scale operation (as opposed to a small-scale batch process) that involved ultrasonic maceration and simultaneous solvent extraction. There was no information that showed whether large-scale ultrasonic maceration and solvent extraction had been used for any type of oilseed. There was technological uncertainty associated with developing a large-scale continuous method using ultrasonic maceration and simultaneous solvent extraction to process a particular type of oilseed at low temperatures to produce a protein-rich product suitable for humans to consume. You did not know whether you could achieve that or how to achieve it based on generally available technological knowledge or experience.

Conclusion

Technological uncertainty arose because of the limitations of current technology. You could not use the current technology to develop a large-scale, continuous process to separate the seed coats from the protein-rich flour at a low temperature. There was technological uncertainty because you did not know whether you could achieve a specific result or objective or how to achieve it based on generally available scientific or technological knowledge or experience.

It is important to recognize that this question relates to more than simply identifying that how to achieve the objectives is unknown. One must be able to identify specifically what is lacking in the scientific or technological knowledge base that is creating this uncertainty. This is necessary to formulate an appropriate hypothesis for further investigation.

In relation to a problem identified in creating new or improving existing materials, devices, products, or processes, there might have been some doubt concerning the way of solving it. This doubt could have arisen from a technical problem or from a technological uncertainty. It is therefore important to understand the distinction between the two. In the case of a technical problem, the existing scientific or technological knowledge base is sufficient to resolve the problem. Overcoming a technical problem will not lead to a technological advancement, although it may lead to the creation of a new or improved product or process. On the other hand, in the case of a technological uncertainty, the solution or the method of finding the solution to the problem is not known based on the existing scientific or technological knowledge base, and requires experimental development to resolve the problem.

Example 2: Technical problem versus technological uncertainty

Introduction

There is a difference between a technical problem and a technological uncertainty.

We cannot determine eligibility without understanding the work performed and evaluating it using the five questions. In this example, there are indicators that suggest there may be uncertainty but they do not point to any specific uncertainty.

Example

Scenario 1 – Technical problem

You are a chemical company and you are developing a new process for a chemical product. Part of the process involves a series of pumps. The pumps started to corrode after six months, even though they had an expected lifespan of 10 years. Surprised to see corrosion so soon, you contacted the pump supplier. After looking at the pumps, the pump supplier found that there was a corrosive liquid in them. The pumps were not designed to come into regular contact with a corrosive liquid. So you looked at your whole process, including the parts involving the pumps. You found that there were low levels of a corrosive liquid in the streams entering the pumps from time to time. After many weeks, you were able to trace the source of the corrosive liquid back to a sporadic leak in a filter system upstream of the pumps. You also found that the leak was likely caused by the filter system operating at a higher temperature than it was designed for. You replaced the filter system with a new high-temperature filtration unit. This appears to have resolved the problem of the corrosive liquid getting into the pumps.

In this scenario, the problem with the pumps in the new process was technical and not technological. You resolved the technical problem—corroding pumps—by identifying the true source of the problem and fixing it with an existing solution.

Scenario 2 – Technological uncertainty

This time you are the pump supplier. A series of pumps supplied by you started to corrode after six months of operation rather than after the expected lifespan of 10 years. You were asked to investigate the problem. You found that the pumps were corroding because of a leak in the seal on their shaft, which allowed a corrosive liquid into the units. In this case, the pumps were designed to operate in a corrosive environment. You replaced the seals in the pumps, but the pumps again showed signs of corrosion after six months. Again the cause was a leak in the seal on their shaft.

You investigated further and found that the temperature of the shafts of the pumps, after they had been working for a long time, was above the maximum recommended operating temperature of the seal material. After prolonged operation, the seal failed, letting corrosive liquid leak into the units.

Once you discovered the cause of the problem, you started working on understanding the relationship between the sealing material and the seal profiles in a high-temperature, corrosive environment. You wanted to figure out the most suitable seal profile and seal material to achieve a 10-year lifespan. The manufacturers had data on the behaviour and physical properties of the seal materials at much lower temperature ranges, but there was no information or data on their corrosion resistance and physical properties at higher temperatures and in that specific type of environment. Nor was there any information on the profile that would be suitable for the high-temperature, corrosive environment the pumps were going to be used in.

In this scenario, you likely faced technological uncertainty which prevented you from choosing a combination of seal profile and sealing material that would offer long-term performance in a high-temperature, corrosive environment. That technological uncertainty could be related to the properties of the materials in the corrosive conditions as well as to the effect of seal profile on performance.

Conclusion

There is a difference between a technological uncertainty and a technical problem that can be resolved by applying practices, techniques, or methodologies that are known or that are openly available.

It is important to be able to differentiate experimental development to resolve a technological uncertainty from the use of known tools and techniques to solve a technical problem. To this end, it is helpful to describe the work leading up to the identification of the uncertainty. This will help establish (a) why the uncertainty faced could not be resolved on the basis of generally available scientific or technological knowledge or experience and (b) the scientific or technological knowledge base of the company.

Sometimes there is little doubt that a product or process can be developed when cost targets are no barrier. In commercial reality, however, a reasonable cost target is always an objective. Although such cost targets on their own do not create scientific or technological uncertainty, trying to meet them might. For example, cost targets may require that technologically uncertain paths be attempted, although more costly and proven alternatives exist. A technological uncertainty may thus arise that is imposed by economic considerations. Hence the existence of a costly technologically certain alternative does not negate the possibility that SR&ED work was performed to develop a product or a process.

Example 3: Cost targets leading to technological uncertainty

Introduction

Even though a cost target in itself does not necessarily create a technological uncertainty, a technological uncertainty might exist when the paths to meeting the cost target are technologically uncertain.

No specific technological uncertainty is identified in this example because what is specifically lacking in the scientific or technological knowledge base, which is preventing the cost target from being met, is not explained.

We cannot determine the eligibility without understanding the work performed and evaluating it using the five questions. In this example, there are indicators that suggest there may be uncertainty but they do not point to any specific uncertainty.

Example

You want to develop an air recirculation system for energy-efficient homes that will permanently remove carbon monoxide. A key component of this system is a module in which carbon monoxide is converted to relatively harmless carbon dioxide at room temperature.

There is a process that uses a tin oxide and platinum catalyst to convert carbon monoxide to carbon dioxide at room temperature. You could develop a product that includes a module based on this process. However, the high cost of using this process will make the selling price of the product out of reach for your customers. There are other methods to convert carbon monoxide, but they are not effective at room temperature. It is important that the module operate at room temperature.

To achieve your project objective (a room-temperature carbon monoxide remover), you have to develop a new inexpensive process. There might be technological uncertainty associated with how to convert carbon monoxide to carbon dioxide at room temperature without using the costly tin oxide and platinum process.

Conclusion

Your motivation for doing the work is the cost target. The cost target—a business or commercial objective—by itself does not create a technological uncertainty. However, a technological uncertainty might arise from the need to meet the cost target, even though a more costly process is known to work.

Doubt about the business or commercial success of the material, device, product, or process being developed is not a scientific or technological uncertainty.

Furthermore, complexity does not necessarily mean the existence of technological uncertainty. The size and complexity of a project by itself does not justify that the work performed in that project falls within the definition of SR&ED . Likewise, the fact that a large and complex system was developed cannot support the inference that an uncertainty existed. However, a form of technological uncertainty called system uncertainty can arise from or during the integration of technologies, the components of which are generally well known. This is due to unpredictable interactions between the individual components or sub-systems. It may be difficult or impossible to predict how the integrated system will perform due to unforeseeable adverse interactions. The uncertainty here is not in the individual modules or components, but in the modules or components acting as an integrated system. The attempt to resolve these uncertainties by a systematic investigation or search can lead to technological advancement.

By its nature, system uncertainty requires that the technological specifications of the integrated system are such that the underlying technologies of the sub-systems are unable to achieve those specifications. Therefore, (some or all of) the underlying technologies of the sub-systems would have to be changed. It is important to be able to distinguish between the work that is done to advance the underlying technology of a sub-system that results in technological advancement and the work that does not require the underlying technology to be advanced.

There is a difference between experimental development work and development work.

Development work is based on the application of the existing scientific or technological knowledge base, such as directly adapting a known engineering or technological practice to a new situation, where there is reasonable certainty of meeting the technological objectives. Under these circumstances, there is no technological uncertainty.

Example 4: Development based on existing scientific or technological knowledge

Introduction

Development work is based on an existing scientific or technological knowledge base. Specifically, you might be directly adapting a known engineering or technological practice to a new situation when you are reasonably certain that the known technology or practice will achieve the desired objective.

We cannot determine eligibility without understanding the work performed and evaluating it using the five questions. In this example, there are indicators that suggest there may be uncertainty but they do not point to any specific uncertainty.

Example

You are a greenhouse grower. After successfully verifying that a newly developed plant variety can be grown in a small scale, you believe there is a good chance you can use the new plant variety to produce commercial crops. You are trying to find the optimum conditions to maximize production.

You plant a controllable zone (between 2 and 10 acres) in a greenhouse and monitor the growth of your crop. Depending on its performance, you make adjustments to guide the crop to optimal production. These adjustments involve using optimization techniques for variables such as light, temperature, carbon dioxide, and humidity. You also develop and implement management protocols to optimize the control of nutrient levels, de-leafing, thinning, and other operational practices. These adjustments and management protocols are often called the "development of cultural management strategies" or "crop husbandry strategies."

Based on the results from your controllable zone, you start commercial production.

Conclusion

These strategies are well-known and practised in this industry. You are fairly sure that the techniques, data, and procedures you used in this case would work to optimize production. So, although you might not be certain of the specific parameters, figuring them out using these strategies is drawing on the existing scientific or technological knowledge base of the industry. In this case, there is no scientific or technological uncertainty in determining the optimum conditions to maximize production of a new plant variety. This is development based on the existing scientific or technological knowledge base.

In terms of SR&ED work, some elements of work may involve the application of techniques, data, and procedures that are generally known and available (for example, running an analytical test, which follows standard protocols). When those elements of work are used to support SR&ED work, they may be eligible.

Trouble-shooting is routinely correcting equipment, software, or processes by identifying technical problems. The goals may be to resolve software problems, optimize a process both technically and economically, adjust equipment performance, evaluate it during breakdowns, improve working conditions, minimize production losses, or control the generation and/or disposal of waste. Trouble-shooting sometimes brings out the need for SR&ED, but more often it involves detecting faults in equipment or processes and results in changes to standard equipment and/or processes without seeking to resolve uncertainties in the underlying science or technology. This type of detection and modification, on its own, is not SR&ED, even though it is carried out systematically, because it does not seek to resolve scientific or technological uncertainty. On the other hand, trouble-shooting may be needed when SR&ED is carried out, in which case it could be part of the eligible work for the associated SR&ED project.

2.1.2 Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty?

Formulating a hypothesis designed to resolve the scientific or technological uncertainty is an essential step and requires observing and understanding the subject matter of the problem. Here, "hypothesis" means an idea, consistent with known facts, that serves as a starting point for further investigation to prove or disprove that idea. The meaning of the term hypothesis is applied in the most general sense and is sufficiently broad to apply to an industrial context as well.

2.1.3 Was the overall approach adopted consistent with a systematic investigation or search, including formulating and testing the hypotheses by means of experiment or analysis?

In SR&ED, it is expected that a planned approach is formulated; that is:

This means that the objectives of the SR&ED work, as well as the indicators and measures to be used to determine if those objectives have been met, must be clearly stated at an early stage in the work’s evolution. In addition, the method of experimentation or analysis by which the scientific or technological uncertainties are to be addressed must be clearly set out. Finally, the results of the SR&ED efforts that follow have to be properly identified. Often, this is an iterative process as new uncertainties are recognized and new or modified hypotheses are developed and tested based on the results of the prior iteration.

Experimentation and analysis are approaches used to investigate hypotheses. Experimentation involves structured and organized tests and studies to obtain information in order to address the hypotheses. Experimenting involves not only testing and analyzing but also exploring the relationships between tests, explaining the results as they relate to the hypothesis, drawing conclusions, proposing a new hypothesis, or conducting additional tests. Such experimentation can include work on the evolution of prototypes or models.

Analysis is the detailed examination of information to differentiate the various parts of a whole, determine their attributes, or explain their relationships. It is performed against the background of available knowledge and experience and it involves using tools such as models, graphs, statistics, tables, diagrams, mathematical formulas, and computer programs to express this knowledge or experience. Analysis is an integral part of a systematic investigation or search and it can be used to generate or test a hypothesis.

It is expected that the work will be performed or directed by qualified individuals who are knowledgeable in the field and have relevant experience in science, technology, or engineering. Note that qualification is not necessarily limited to formal training, but includes skills and knowledge gained through experience.

The need for a systematic investigation or search does not preclude ideas that result from intuitive processes. These ideas can lead to hypotheses for testing that are part of experimental development.

Sometimes problems are solved by trial and error. Trial and error involves executing a series of tests in no particular order and not part of a systematic plan. The objective in such a case is to resolve a functional problem rather than to address a problem in the underlying technology that may have caused this functional problem. The lesson learned in each attempt of trial and error is simply that "an option did not work." There is no further analysis of the reason why it did not work to make the lesson applicable in a broader sense. The test conditions that are judged to be the most effective in resolving the immediate problem are chosen for the next attempt, and the process simply moves from attempt to attempt without trying to understand or address the problem associated with the underlying technology. Solving problems by trial and error is not experiment or analysis within the framework of a systematic investigation or search.

2.1.4 Was the overall approach undertaken for the purpose of achieving a scientific or a technological advancement?

Scientific or technological advancement is the generation of information or the discovery of knowledge that advances the understanding of scientific relations or technology. One implication of advancement is that the new knowledge could be useful to other situations or circumstances beyond the current project in which the advance was made.

By showing why a possible solution will not succeed or will not meet the desired objectives, advancement in science or technology is still possible. In some instances, the project's objectives might not have been achieved but, in the process, SR&ED was carried out to understand the reasons for the failure. Hence, scientific or technological advancement can be achieved even if the project’s objectives are not met.

The rejection of a hypothesis is advancement because it eliminates a possible solution.

In experimental development, the work is carried out for the purpose of achieving technological advancement that, in turn, is for the purpose of creating new, or improving existing, materials, devices, products, or processes. This means that when a new or improved material, device, product, or process is created as a result of SR&ED, it must embody a technological advancement. Hence, the technological advancement that is being sought is not the same as the benefits of the new or improved material, device, product, or process. Technological advancement moves the scientific or technological knowledge base of a company to a higher level through an increase in the understanding of technology. In other words, it is a discovery or gain in understanding of technological principles, techniques, and concepts beyond the existing scientific or technological knowledge base.

The creation of new, or improvement of existing, materials, devices, products, or processes can be achieved without technological advancement. Also, novelty, innovation, uniqueness, feature enhancement, or increased functionality alone does not represent or establish technological advancement. Instead, it is how these attributes or features arise (that is, whether or not they arise through technological advancement) that is important.

Example 5: Creating new materials, devices, products or processes without technological advancement

Introduction

The creation of new materials, devices, products, or processes, or the improvement of existing ones, can be achieved without technological advancement.

Work can be done systematically to produce a new product. However, without technological uncertainty and an attempt to achieve technological advancement, the work is not SR&ED.

We cannot determine eligibility without understanding the work performed and evaluating it using the five questions.

Example

The basic design of the potato peeler has not changed for more than 100 years. You wanted to develop a novel peeler by adding a phosphorescent substance to the plastic handle so it would be easier to find the peeler in a dark kitchen drawer.

You obtained several samples of phosphorescent powders from various suppliers. You carried out a number of production runs, testing each powder at varying levels in the molding process. Adding the phosphorescent substance did not require any change to the molding process or the type of plastic, nor did it affect the other physical properties of the handle or how the peeler worked. As a result of the work you performed, you determined, for each powder, the amount needed to produce the proper glow in the handle. You then chose a supplier based on an analysis of the amount of powder needed and the unit cost of the powder.

You came up with a new and novel product, and the work you performed to choose the appropriate powder, based on performance and cost, was carried out very systematically. However, there was no technological advancement required to develop this glow-in-the-dark peeler.

There was no technological uncertainty. You could claim you were unsure about how to achieve your objectives because you did not know which powder to use and what level you needed to use it at to make the peeler. However, there are no lacking scientific or technological knowledge or principles that prevented you from making that determination. You knew how to add the phosphorescent substance and adding it did not affect the properties of the handle or the performance of the peeler.

Conclusion

New or improved materials, devices, products, and processes can be developed without a technological advancement.

The success, failure, marketability, or commercial significance of work is not relevant to its eligibility.

Process optimization and cost reduction are examples of process development efforts with the objectives of improved efficiencies, better output quality, or financial or strategic advantages. These developments are represented, for example, by the functions of industrial engineering, time and motion analysis, methods engineering, value analysis and engineering, and tool and machine design. These developments result in trends towards optimal conditions–improving the material, device, product, or process. Most often they are conducted based on the existing scientific or technological knowledge base. As identified in Section 2.1.1 there is a difference between experimental development work to advance the scientific or technological knowledge base and development work based on the application of the existing scientific or technological knowledge base.

2.1.5 Was a record of the hypotheses tested and the results kept as the work progressed?

A record of the hypotheses, tests and results should be kept as the work progresses.

It is expected that the work be recorded, clearly showing why each major element is required and how each fits into the project as a whole. It is also expected that the indicators or measures that will be used to determine if the goals of the work are met will be identified and recorded at an early stage of the work.

As part of the systematic investigation or search, the progression of work is built on analyzing results from step to step. To build on the results of testing in a systematic way requires the organized recording of the work undertaken during experimentation or analysis. This is a basis for being able to capture, communicate, and, if necessary, repeat the work leading to the advancement of scientific knowledge or the technological advancement.

It is important to note that this question pertains only to records that are naturally produced during the performance of SR&ED and simply expresses that a systematic investigation generally cannot be carried out without recording the work as it progresses. It is not suggestive of the types of information to support an SR&ED claim. Please refer to Appendix 2 of the latest version of the T4088 Guide to Form T661 Scientific Research and Experimental Development (SR&ED) Expenditure Claim for information on documentation and other evidence to support an SR&ED claim.

2.2 Step 2: Determine the extent of eligible work

The method used to assess whether there is SR&ED is described in section 2.1. This method, however, does not identify the extent of the SR&ED work.

The definition of SR&ED in the Act helps determine the extent of the SR&ED work by including support work and excluding some other types of work.

Specifically, the definition of SR&ED states:

"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;"

The following sections provide additional details on how to determine the extent of SR&ED work based on the definition of SR&ED in the Act.

2.2.1 Support work

The work identified in paragraph (d) of the definition of SR&ED is usually referred to as support work. Work with respect to the eight categories listed in paragraph (d) does not constitute SR&ED on its own. However, if it is commensurate with the needs and directly in support of basic research, applied research, or experimental development work undertaken in Canada, it falls within the meaning of SR&ED.

Support work must be the following:

Example 6: Commensurate with the needs and directly in support

Introduction

Only the amount, size, extent, or duration of work that is necessary for and directly in support of the basic research, applied research, or experimental development work undertaken in Canada is eligible.

The work below includes a production run to produce a product for testing. The context of the production run is not dealt with in this example.

We cannot determine eligibility without understanding the work performed and evaluating it using the five questions.

Example

You produce field hockey sticks in large numbers for the world market. The main element of the production stage is a machine that accepts pre-cut lengths of timber and produces the cut forms for further processing, which includes rasping, curing, and finishing.

You started a project involving experimental development. You wanted to integrate an advanced scanning and laser cutting technology to cut and rasp hockey sticks into one machine instead of having two separate machines. This integration step involved collecting data including size and other tolerances and testing for mechanical strengths and other performance requirements. Based on statistical analysis and your in-house knowledge of the existing machinery, you determined that an experimental sample size of 500 sticks from the cutting and rasping machine would generate enough data to test and validate your hypotheses with 95% confidence. It would also be enough to conclude that the development is complete and successful.

You produced 2,000 sticks.

Conclusion

The testing and data collection associated with cutting and rasping the first 500 sticks is commensurate with the needs and directly in support of your SR&ED work. (Note that this is all this example deals with. It does not deal with treating expenditures, including materials, for SR&ED investment tax credits.)

2.2.2 Excluded work

The work identified in paragraphs (e) to (k) of the definition of SR&ED is typically referred to as excluded work and, collectively, these paragraphs are referred to as the exclusions. This work is not SR&ED. These exclusions identify work that, although might be seen as enabling an SR&ED project to be carried out in some manner, represents work that cannot be claimed for SR&ED tax credits.

It is important to realize that consideration is given to the exclusions only after it has been determined that there is SR&ED. The exclusions generally do not apply to the overall SR&ED. Rather, only after it has been determined that there is SR&ED; the exclusions help to delineate work that is included in the meaning of SR&ED, and work that is not. For example, a project is not excluded because it involves prospecting for minerals. However, if SR&ED is identified, the work with respect to prospecting for minerals is not included in the SR&ED.

It can be difficult to differentiate between the SR&ED work that is carried out in conjunction with non-SR&ED work. Where paragraphs (d) and (e) through (k) are particularly helpful is in defining the boundary (or to differentiate) between SR&ED work and that other work.

The key feature that distinguishes between support work and excluded work is purpose. Why was the work done—was it done to support basic research, applied research or experimental development, or was it done for some other reason?

3.0 SR&ED project

Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim, requires SR&ED work to be claimed as SR&ED projects. As a result, claimants should be aware of the meaning of "project" in the context of SR&ED.

3.1 Characteristics of an SR&ED project

Every project claimed must fall within the definition of SR&ED in subsection 248(1) of the Act. An SR&ED project is defined as a project comprising a set of interrelated activities that:

Whether the work claimed meets the definition of SR&ED in subsection 248(1) of the Act is determined solely by examining the nature and characteristics of the work itself. In other words, it is not the overall commercial objective but rather what is actually occurring at a technical level that is relevant. The key point is whether the work has the characteristics to meet the definition of SR&ED, and not the overall goals in a commercial sense. The SR&ED project's success or failure in terms of meeting its overall commercial goals is not a factor in determining its eligibility for investment tax credits.

It must first be determined whether there is SR&ED within the project (section 2.1). If there is SR&ED, the next step is to assess the extent of the work (section 2.2) and the associated expenditures against the objectives of the SR&ED project.

The SR&ED project definition is not intended to support dividing a correctly identified SR&ED project into smaller, and possibly ineligible, activities. At a detailed level and by itself, the work may appear routine. Projects should be identified at a level where all the effort captured by the project falls within the definition of SR&ED . This requires that appropriate internal procedures and accounting methods are in place and sufficient to link the work and associated expenditures to the project.

3.2 Company project versus SR&ED project

A distinction must be drawn between a company project and an SR&ED project. "Company project" is a generic term referring to undertakings by a company to have an impact on its business; for example, building new facilities or expanding facilities, developing new products and product lines, changing business practices, upgrading processes and facilities, and engineering projects. A company project is a project with a commercial purpose, whereas the purpose of an SR&ED project is for the advancement of scientific knowledge or for achieving technological advancement. Paragraph (c) of the definition of SR&ED recognizes, and in fact requires, that the experimental development be done for the purpose of achieving technological advancement in the context of creating new or improved materials, devices, products or processes.

An SR&ED project usually occurs as a subset of a company project. Therefore, not all of the work performed within a company project will necessarily fall within the scope of the SR&ED project. Also, it is possible that the same company project contains one or more SR&ED projects, some of which may involve experimental development and some of which may involve basic research or applied research.

3.3 Duration of an SR&ED project

The start of the SR&ED project is identified as the point at which the scientific or technological uncertainties are identified, resulting in the definition of scientific or technological objectives, as opposed to business or commercial objectives. Work that is conducted as part of standard business practice and is not needed to define the scientific or technological objectives is not part of the SR&ED project.

It is recognized that once a scientific or technological uncertainty is identified, work may be required before the hypothesis is tested (that is, before experimentation begins). Such work may fall within the meaning of SR&ED . For example, a technical feasibility study could be eligible only if followed-up with experimentation or analysis to test a hypothesis. This type of study must be distinguished from all other types of studies (marketing, commercial, and financial), which are not eligible as SR&ED.

The duration of an SR&ED project is not a factor in determining whether the work performed meets the definition of SR&ED . Some projects are short—carried out fully within the tax year—while other projects extend over several tax years. As an SR&ED project can span a number of years, a snapshot of the work in a given year may not reflect the overall effort to achieve the advancement of scientific knowledge or technological advancement. Once an SR&ED project has started, work in any year that is commensurate with the needs of and directly in support of the attempt to achieve a scientific or technological advancement is considered part of the SR&ED project.

The SR&ED project is complete when either the advancement has been achieved and the associated uncertainty resolved or when it is determined that the uncertainty cannot be resolved. Commercialization or certification might not necessarily mean that the SR&ED project is complete. Neither financial indicators (such as first sale) nor issuing warranties alone are enough to mark the end of an SR&ED project.

However, work generally associated with trouble-shooting, debugging, and fine-tuning when there is no need to resolve technological uncertainties, is not SR&ED work. Furthermore, work carried out when the product or process is installed or implemented at the customer’s facility or testing in an end-user’s environment (beta site testing) to ensure that all technical specifications agreed upon with the customer have been met is also not SR&ED work. Whether or not SR&ED work continues into these stages of a project depends on the continued presence of a technological uncertainty (or a new uncertainty arising) and the systematic investigation or search undertaken to resolve it.

4.0 SR&ED in a production or manufacturing environment

SR&ED in a production or manufacturing environment is referred to as "shop floor SR&ED." It occurs in a variety of industry sectors and is mostly experimental development in nature. However, basic research and applied research can also occur in a shop floor environment.

SR&ED, especially experimental development, in a shop floor environment is generally not carried out in isolation. Rather, it is performed with other non-SR&ED work. For example, SR&ED can be carried out:

  • at the same location where other work is being performed;
  • by staff performing their regular duties; or
  • while building or operating commercial equipment or facilities.

Shop floor SR&ED usually occurs when SR&ED is carried out in conjunction or simultaneously with excluded commercial work. Paragraph (i) of the definition of SR&ED specifically excludes work with respect to the commercial production of a new or improved material, device, or product or the commercial use of a new or improved process. Therefore, it is important to be able to distinguish between the SR&ED work and other non-SR&ED work so that the project costs can be allocated accordingly.

There are two situations that are commonly encountered that may involve both SR&ED and non-SR&ED work—(1) SR&ED while developing an asset and (2) SR&ED during production runs. The following two documents explain how to isolate SR&ED work and the associated expenditures in these two situations:

  1. SR&ED while Developing an Asset Policy – An asset is a thing or item that has some value to the company. When an asset (a material, device, product, or process facility) results from, or is developed for, SR&ED work; consideration must be given to what aspects of the development of the asset to include as SR&ED work.
  2. SR&ED During Production Runs Policy – When SR&ED is conducted while operating a commercial process facility; consideration must be given to how much of the facility’s operation should be included as SR&ED work.

Appendix A

A.1 Explanation of changes

The following are the explanation of changes to the Eligibility of Work for SR&ED Investment Tax Credits Policy:

  1. The term "scientific method" has been removed. Although the term has been removed, the fundamental concepts remain in policy and are embodied in the term "systematic investigation or search."
  2. The use of the five questions to establish if there is SR&ED is now referred to as a "method." Originally referred to as an "approach", this has been changed to distinguish it from the "approach" referred to within the five questions.
  3. Question 1 of the five questions has been shortened by removing "- an uncertainty that could not be removed by standard practice." This phrase was redundant to the question.
  4. Question 3 of the five questions has been modified to remove the term "scientific method." Reference to modifying the hypothesis has also been removed to simplify the question.
  5. Question 4 of the five questions has been modified to explicitly allow for advancement not yet achieved.
  6. The term "technology base or level" has been changed to "scientific or technological knowledge base." The change is to clarify that the concept applies equally to basic research, applied research, and experimental development.
  7. The reference to the three criteria, in Section 2.1 has been removed. That text was intended to aid the transition from the three criteria to the five questions when the Eligibility of Work for SR&ED Investment Tax Credits Policy was released in 2012. All previous policy documents have now been archived.
  8. Six new examples have been added. These examples illustrate concepts found in policy and are meant to aid the understanding of these concepts.
  9. The term "standard practice" has been removed to remove any confusion.
  10. Section 2.1.5 has been rewritten to better express the difference between the records referred to in Question 5 of the five questions and evidence to support a claim.
  11. Editorial changes to bring further clarity.

A.2 Previous versions

Previous versions are provided for reference purposes:

Eligibility of Work for SR&ED Investment Tax Credits Policy (December 19, 2012)

Date modified:
2015-04-24

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