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SR&ED: A more balanced approach to determine eligibility?

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SR&ED: A more balanced approach to determine eligibility?
Insights
October 29, 2015

There’s some good news for SR&ED claimants. Recent “tax-payer” favourable Tax Court of Canada (TCC) rulings, followed by wording clarifications in CRA eligibility requirements in April 2015 and modifications to Form T661 questions (November 2015), mark a welcome departure from the otherwise very strict eligibility line adopted by the CRA in years prior.

Recent rulings favor taxpayer

 

  • In the past year, three tax court rulings overturned CRA eligibility denials on shop floor research and development (R&D) projects, and on software development:
  • In October 2014, in the case of Les Abeilles service de conditionnement inc. v. The Queen[1], the Tax Court of Canada decision notably insisted on the importance of considering the project as a whole when being evaluated, in the context of four projects involving R&D in the field of mechanical and electrical systems to increase efficiency on the line while maintaining quality.
  • Similarly in March 2015, in the case of 6379249 Canada Inc. v. The Queen[2], the need to evaluate the project at the appropriate level was again highlighted, in the context of incremental improvement on an already launched miniature portable printer.
  • Most recently in October 2015, in the case of ACSIS Electronic Health Record Inc. v The Queen[3], Honourable Justice Diane Campbell details her analysis of the law and allowed 100% of the company’s SR&ED claims. These decisions significantly departed from the common CRA practice of evaluating the eligibility of each test phase individually and within a given year. Bye-bye standard practice! Among other April 2015 updates to their application Policy on the Eligibility of Work[4], the CRA has removed the dreaded “standard practice” benchmark from the wording of the first question of their eligibility approach[5].
  • Based on audit experience, several CRA auditors interpreted the “standard practice” benchmark as any method known to others in that specific field of research. Auditors used the term to "de-construct" SR&ED projects into “tasks” until they could be seen as "routine engineering". Such an argument was very difficult to counter and was therefore referred to as “cheap denial” by frustrated claimants. This CRA decision, in turn, may lead to a more balanced determination of project eligibility in future audits.
  • “Technological advancement”: closer to the intent of the law! The CRA also recently announced an update to form T661 (November 2015), which, on top of suppressing the above-mentioned “standard practice” in section 242 of the form, also added wording to reintroduce the possibility of expected scientific or technological advancement not achieved at the end of the year (section 246 of T661). In line with the previously mentioned TCC ruling, this decision comes as a much needed correction to current wording, which assumes that an advancement must actually be achieved every year to qualify as such. An evolution but still not a revolution!
  • These changes, though definitely paving the way to a more “industry-balanced” eligibility determination, do not fundamentally change the CRA’s current “compliance rather incentive” interpretation of the SR&ED program. In keeping with this approach, the above-mentioned TCC also re-confirmed the demanding requirements in terms of contemporaneous documentation and the overall validity of the “five questions” method to eligibility determination.
  • In the meantime, another ruling (Hypercube Inc. v. The Queen[6]) on June 15 validated CRA eligibility denial on the basis of “standard practice” debugging in a software project. Ironically enough, change after change, the program remains more or less the same.

[1] Les Abeilles service de conditionnement Inc. c. La reine, 2014 CCI 313 (T.C.C.)

[2] 6379249 Canada Inc. v. The Queen, 2015 TCC 77

[3] ACIS EHR( Electronic Health Record) Inc. v The Queen, 2015 TCC 263

[4] Eligibility of Work for SR&ED Investment Tax Credits Policy

[5] Question 1: “Was there a scientific or a technological uncertainty—an uncertainty that could not be removed by standard practice?” was limited to “Was there a scientific or a technological uncertainty?” [6] Hypercube Inc. v. The Queen, 2015 TCC 65

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