Scientific Research & Experimental Development

The taxpayer (“Mac & Mac”) was approached by a potential client to use its expertise in hydrodemolition to develop a technique to remove the worn inner linings or, failing that, both the inner and outer linings, of large metal pipes that had been used in transporting bitumen, so that the necessity of replacing the pipes would be eliminated. Mac & Mac used numerous different approaches to applying high-pressure water to this end, and changed only one variable with each test.

In denying the taxpayer’s SR&ED claims, Graham J stated (at paras 7, 8, 9 and 10):

Mac & Mac’s claims … do not meet the last test [in Northwest Hydraulic.] That test requires Mac & Mac to have kept detailed records of hypotheses, tests and results as the work progressed.

Mac & Mac kept a set of handwritten notes. … There is simply no way that someone, even someone very experienced in the industry, could hope to replicate or confirm Mac & Mac’s results from these notes.

A spreadsheet … provided more detail than the notes. However, it was prepared after the fact for the purpose of supporting the SR&ED claim and still did not contain the level of detail I would have expected. …

As noted … in Highweb & Page Group Inc. v. The Queen:

. . .While evidence of the outcome is important, … [s]ince a negative answer to the hypothesis is a more frequent outcome and frequently as helpful in advancing technological knowledge, detailed step-by-step logging, analysis, and measurement is a mandatory requirement, not an optional addendum. …

The taxpayer was a natural health product company. Its alleged SR&ED consisted of reviewing the literature and consulting other researchers in order to devise three new naturopathic formulations. It described its final testing as submitting its formulations to Health Canada for approval which, once obtained, caused it to deem its formulations to be effective.

In dismissing the appeal, Boyle J stated (at paras 49-50):

[A] newly hypothesized formulation cannot on its own be considered either knowledge or the advancement of knowledge for these purposes.

It is the absolute absence of testing of the natural health products by Life Choice after their formulations were hypothesized by Dr. Dahl that is fatal to this appeal. …

Boyle J further stated (at para 53):

My decision in this case is in no way intended to suggest that literature reviews and consultations with other researchers cannot be qualifying activities giving rise to qualifying expenses as legitimate constituent parts of SR&ED activities. …

Project 705 (the “Plant Sterols Beverage Project”) of the taxpayer, which carried on an energy drink business, sought to develop a beverage containing a mixture of 800 milligrams of plant sterols in a two-ounce format. This was more challenging than what Cargill had succeeded in doing, which was to disperse 400 milligrams in an eight-ounce serving. Project 806 (the “Partial Hot Fill System Project”) sought to develop a pasteurization system that focused on pasteurizing only the active ingredients by pumping these ingredients in a side kettle and then pumping back the mixture into a larger tank. The taxpayer’s related expenditures did not qualify as SR&ED.

D’Auray found that the taxpayer did not satisfy four of the five criteria in Northwest Hydraulic: it had has not established technological uncertainty since it was using methods and techniques that were available in the industry (para 44); there was no formulation of specific hypotheses related to technological risk or uncertainty (para 49); it was not clear that there was testing in accordance with the principles of the scientific method as it was not clear that the taxpayer used the results of its experimentation to modify its hypotheses with respect to the feasibility of its dispersion targets (para 54); and using known methods and products to attempt to disperse sterols in a smaller format did not constitute a technological advancement (para 57).

Project 806 also did not meet the requirements and, in addition, it was not clear that the Partial Hot Fill System was developed in the taxation years in question (para 67).

The taxpayer was a corporation that improved customer’s equipment by increasing their lifespan, improving their security mechanisms or by standardizing them in order to produce economies of scale. In 2012, it entered into four separate contracts with four customers to provide them with specific solutions within the scope of this services business, and treated $182,483 of the expenditures which in incurred in the course of performing this customer-specific work as SR & ED expenditures.

Respecting the first project undertaken for an alcohol products company, Jorré J stated (at paras 50, 58, and 62-63, TaxInterpretations translation):

… [T]he purpose of the project was to make the palletizers and depalletizers [of beverage bottles] conform to current security standards and to eliminate the risk of the lifting platform falling when an operator or mechanic was underneath. …

… [T]here is nothing in the evidence that suggests that palletizers and depalletizers meeting the required safety standards do not already exist or that there is an improvement over what already existed . …

… Difficulties by themselves are not sufficient for their resolution to become experimental development.

Looking for technological advances in a process, I would expect that the novelty or improvement sought could be clearly and accurately described in relation to current processes. That is not the case here.

Jorré J similarly found that the second project, which entailed designing, making and installing a “flow rectifier plate” to straighten-out rectangular aluminum bars coming out of an extruder as part of the customer’s production process, did not meet the criteria for experimental development, stating (at para. 86):

There is no clear and detailed proof for each stage of the work that would lead to the conclusion that specific individual work, certain groups of work or all of the work was engaged in to resolve technological uncertainties that could not be resolved with current methods and existing knowledge.

Jorré J further found that the third project, to upgrade a municipal water treatment plant, did not require unusual methods (para 95), and the fourth project, to optimize the performance and safety of a milling machine, did not deal with technical uncertainties (para 106). Jorré J dismissed the appeal.

The taxpayer (“JTR”) undertook a project in 2008 (the “Fire Curtain Project”) and in 2009 (the “Manual Override Project”) to solve two problems that it had encountered in its business of designing, manufacturing and installing theatrical rigging. The Fire Curtain Project successfully developed a technique for producing a controlled descent of a fire curtain without using counterweights (which consumed space.) The Manual Override Project successfully developed a technique for dealing with an issue in opening and closing curtains after there had been a power outage that eliminated the memory of a limit switch and, therefore, its ability to help control the movement of the curtain. Both projects were performed by employees with no science degrees or qualification as professional engineers, and involved trying out different combinations and configurations of standard equipment and devices to identify what could produce the desired result.

Sommerfeldt J found that this work was routine engineering and otherwise failed many of the tests enunciated in Northwest Hydraulic, so that it did not qualify as scientific research and experimental development. In the course of so finding, he stated (at para. 40) that “there are several cases which, while not saying so explicitly, suggest that trial and error may well fall outside the scientific method” and that the activities in the first project and the reconfiguring steps in the second project “seemed more in keeping with trial and error than with the scientific method” (at para. 42 re the Manual Override Project, similarly at para. 41 re the Fire Curtain Project).

He concluded (at para. 53):

JTR has failed to adduce sufficient evidence to establish that those activities did not constitute routine engineering, that there was technological uncertainty in respect of the Fire Curtain Project and the Manual Override Project, that the scientific method was followed, and that technological advancements were achieved in respect of each project.

The taxpayer was engaged in determining how on-page and off-page variables for websites interrelate to determine their Google (or other internet search engine) ranking and how to structure data to improve such ranking. In finding that this activity did not qualify as SR&ED, C Miller J stated (at para. 9) that “the experiments of submitting several different versions of websites to determine the significance of variables relies on existing technology in a routine manner,” and (at para. 10):

Here, the advancement would be the determination of algorithms that relate variables for purposes of ranking sites. … I fail to see how it is a scientific advancement to figure this out. It strikes me more of solving an equation someone has already solved, rather than coming up with a new proof.

The taxpayer had to adapt its existing system for implementing a nation-wide health information system in Belize given the severe telecommunications and internet connectivity issues there. In finding that this project satisfied the test of technological uncertainty, Campbell J stated (at para. 31):

The Appellant had no reasonable expectation of success with the Belize project unless new knowledge could be obtained. …[T]he Appellant developed a new approach by creating a multi-write database replication system.

Before finding (at para. 42) that the taxpayer "had identified the problems with the project, developed its objectives, formulated hypotheses and testing scenarios and modified or re‑developed its approach in response to the results it was obtaining," she noted (at para.39) that:

While it will always be preferable that an appellant maintain contemporaneous documents to support its systematic investigative procedures and methods…the Act contains no legislative requirement to file those documents in order to qualify… .

Accordingly, the related expenditures gave rise to investment tax credits.

Lamarre ACJ found that the taxpayer's development of code analysis software for websites was not experimental development. All problems encountered on the project were "resolved in the end by using recognized programming techniques to modify the program's code" (para. 46), and the team's alleged "trial and error" approach was really just ordinary debugging - for example, the program was initially only compatible with certain web browsers, it had a defect in the code that prevented it from working if used more than 150 times in one day, and it had initially not been designed to handle URL redirects correctly. As per Zeuter, mere novelty or innovation in software does not automatically elevate it to SR&ED (para. 47).

After developing and commercially launching a miniature portable printer, the taxpayer pulled the product in 2009 after identifying problems with curling paper and battery life. The taxpayer performed further work in 2009 and 2010 to remedy these defects (with partial success). The Minister characterized the work as routine engineering.

D'Auray J allowed the taxpayer's appeal. Paragraph (c) of the definition of "scientific research and experimental development" ends with "including incremental improvements thereto," and the French wording ("même légère, de ceux qui existent") makes it clear that experimental development includes "a slight improvement to materials, devices, products, or processes" (para. 100).

The further work included investigating the causes of the defects (which both turned out to be related to the anti-paper-curling mechanism), investigating and implementing a power-consumption curve in the printer's driver to avoid power-costly motor-stalling, finding new materials and surfacing methods in the anti-curling mechanism to make it more resistant to wear, and figuring out how to test paper at different moisture levels. D'Auray J disagreed with the Minister's "analytical approach" of applying the SR&ED tests to each of these activities individually - although, in any event, each individual activity passed those tests (para. 103). Although the taxpayer did not file any documents establishing its systematic investigation, this was established on the testimony of its chief researcher (paras. 92-3) (whose testimony that the required scientific report had been included with a form T661 filing was also accepted).

The taxpayer, a veterinary consulting firm, undertook four research projects to test new diets, supplements, and vaccines on cattle, and paid feedlot operators to perform these protocols. The 7000 cattle used in testing by the operators were, apart from the test protocols, raised for commercial production on behalf of their owners. The Minister disallowed scientific research and experimental development credits respecting over $1.6 million paid by the taxpayer to one of the farms ("Jim Farms"), for costs incurred by Jim Farms for the feeding the cattle, on the basis inter alia that Jim Farms was not engaged in SRED.

Before finding that the amounts paid to Jim Farms were "in respect of" the prosecution of research undertaken on the taxpayer's behalf within s. 37(8)(a)(ii)(B)(II), and that the work undertaken by Jim Farms was with respect to testing and data collection as per para. (d), Woods J found that Jim Farms' work was not SRED because it was performed "with respect to" the commercial use of a new process (i.e. the feeding protocols), as the cattle were at the same time exploited in his regular cattle business, and therefore was caught by the exclusion in para. (i) of the SR&ED definition, an exclusion which extended to work by third parties (para. 80).

The taxpayer, which installed heating, air conditioning and ventilation systems in residential homes, claimed SR&ED credits relating to its "High Static High Velocity Fan Coil System Development" project. The Minister denied the credits on the basis that the project entailed routine engineering.

Hogan J. granted the taxpayer's appeal, subject the $12,000 limit under the informal procedure. The goal of the project was to reduce noise from vents occurring throughout a house, achieve constant static pressure, and adapt a foreign boiler and motor to North American standards in order to use them in a system for which they were not designed and in which they had not previously been tested. These goals entailed substantial technological risk and uncertainty. Based on that finding, and considering the project under the other four factors listed in Northwest Hydraulic, Hogan J. found that the project qualified as SR&ED.

Woods J. found that it was not reasonable for the taxpayer, a professional corporation belonging to Dr. Arlin, to claim credits on the basis that one fifth of Dr. Arlin's salary was in respect of scientific research. Dr. Arlin was a dental surgeon, who used specialized software to accumulate data over approximately fifteen years on the approximately 12,000 dental implants he administered in that time. His evidence was too vague to support a conclusion that he actually spent much time on these activities, and the convenient nature of the software suite also suggested that the time investment would have been minor.

Woods J. also stated (at para. 20):

It is the position of the respondent that there was insufficient evidence of systematic investigation because hypotheses were not determined prior to the data collection. This position is very narrow and I am reluctant to agree with it.

D'Arcy J. denied the taxpayer's claimed SR&ED credits arising from the development of various electrical systems for use in wheelchairs - a power optimizer to switch power between the front and back wheels of a wheelchair or scooter, an inhibitor to ensure that a wheelchair remain stationary while being charged, a virtual battery system to derive 36 volts of potential from two 12-volt batteries, and a multi-voltage output charger. The purported technological uncertainty was not compelling, as the issues raised were design problems rather than scientific problems. (For example, the purported uncertainty in the virtual battery project was "whether a safe and effective virtual battery could be developed that would be suitable for use by disabled people operating wheelchairs.") The work could be completed using existing electronic and mechanical components, and products performing similar functions already existed.

The taxpayer in carrying out work largely under the supervision of a researcher who was not its employee or representative, and in testing the effectiveness of products that had already been commercially developed, did not qualify for deduction as SR&ED.

Little J found that a project of developing an interactive software tool to assist high school students with physics and mathematics did not qualify as SR&ED because there was no technological or scientific uncertainty involved. He stated (at para. 24):

Novelty or innovation in a product is not sufficient to illustrate technological advancement; rather, it is how these features arise that is important, that is whether or not they arise through the process of SR & ED.

Work carried out by the taxpayers to improve the performance of a tactometer represented "routine techniques and standard procedures generally accessible to competent professionals in the field" (p. 461), and did not qualify as SR&ED.

Various efforts made by the taxpayer to improve the accuracy of a freight weighing device did not qualify given that there was "some merit" in the Crown expert's contention that the manner in which the taxpayer proceeded was akin to the use of routine or standard engineering practices, it was difficult to understand what hypothesis, if any, was made and what steps were being proposed to eliminate the technological uncertainty if one existed, and virtually no records were kept of any hypotheses tested and of results as the work progressed.

Bonner T.C.J. accepted (at p. 2382) the evidence of the Crown's expert that the cost incurred by a lottery ticket marketer in developing an information system employing object-oriented architecture did not represent SR&ED because "the project used commercially available products and services, and current information systems development methodologies and practices throughout". Bonner T.C.J. also noted (at p. 2381) that "mere size and complexity do not support a conclusion that the work was anything more than routine information systems development".

McArthur TCJ found (at p. 2360):

"What the Appellant did was take existing technology computer hardware and PacRat software, and record personal messages that cannot be understood or tested by anyone else but [its principal]. This does not constitute SR&ED."

Two projects for the development of a system for recycling sludge or dealing more economically with the disposition of waste chemicals did not evidence a type of uncertainty that could not be removed by standard engineering practice and routine development and, accordingly, did not qualify.

Before finding that the taxpayer had been engaged in qualifying SR&ED, Archambault TCJ. noted (at p. 1821) that the Act and Regulations "do not require that... written reports be produced in order for a taxpayer to qualify for the deduction of such expenditures: it is possible to adduce evidence by way of oral testimony".

The taxpayer, which was engaged in researching and developing advanced data management and memory management software systems for large mainframe computers, and which had adopted the proxy method for calculating SR&ED expenditures, was able to include in s. 37(8)(a)(ii)(B)(I) the cost of a dedicated telephone line that was used to pass instructions and data from the taxpayer's employees in Ottawa (none of whom left Canada) to the staff of an independent company in Birmingham, Alabama whose mainframe computer the taxpayer was leasing for testing purposes. Lamarre TCJ. stated (at p. 1883):

"Testing would not normally be considered as an eligible SR&ED activity. It becomes an eligible activity only when it is required as part of a systematic experimental investigation, which is the case here."

The taxpayer was an engineering consultant firm that specialized in the development, management and protection of water resources. Of the five hydraulic model studies reviewed by Bowman TCJ., four were found to have a sufficient degree of technological uncertainty for the work to qualify as SR&ED. Bowman TCJ enunciated five factors to be considered in SR&ED determinations (at para. 16):

1. Was there a technological risk or uncertainty which could not be removed by routine engineering or standard procedures?
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 the established and objective principles of the scientific method, including the formulation, testing and modification of hypotheses?
4. Did the process result in a technological advancement?
5. Was a detailed record kept of the hypotheses, tests and results kept as the work progressed?

The taxpayer was found not to be engaged in SR&ED given that the only tests conducted by it in the year in question was testing of devices already on the market that had been designed from technologies developed in the United States.

Archambault TCJ. accepted the evidence of the taxpayer's expert witness that the development by the taxpayer of a program improved an existing computer process (enabling the taxpayer to produce more efficient high-quality software products) and was the result of systematic investigation (notwithstanding very little documentary evidence of such investigation). Furthermore, the development of a second software program was undertaken directly in support of designing the first program. Accordingly, both activities constituted SR&ED.

A supposed research project which folded after the initial phases of work and therefore consisted only of routine data collection and research in the educational area did not qualify as scientific research described in Regulation 2900.

In finding that "thinking, contemplating and meditating" by a researcher did not constitute scientific research and experimental development, Rip J. stated (p. 172):

"... Scientific research contemplates activities which might be based on hypothesis in respect of which the objective is the gaining of knowledge. To obtain that objective, theories must be tested against empirical data ... There is no evidence produced by the appellant to indicate d'Alerta carried on any of his work in nerve and muscle therapy research according to any plan or organized method."

Christie A.C.J. accepted the evidence of the Crown's scientific expert that the proposed research program of the taxpayer was not carried out in any systematic, scientific manner and that the principals involved had no work experience in the central areas of the project. Accordingly, their work did not qualify as scientific research and experimental development.

The taxpayer's appeal failed with respect to the deduction of expenses it incurred in manufacturing a machine in accordance with the engineering design and detailed drawings of a customer not only because the taxpayer had no right to the results of its research and investigation but also because the evidence fell "far short of establishing the existence of any systematic investigation or search carried out in a field of technology by means of experiment or analysis" (p. 1371).