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SR&ED credit: contemporaneous documentation is not essential

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Tax Bulletin

On October 23, 2014, the Honorable Justice Gaston Jorré of the Tax Court of Canada ("TCC") rendered a judgement favorable to businesses carrying on scientific research and experimental development ("SR&ED") in Les Abeilles service de conditionnement inc. v. The Queen[1]. The TCC ruled in favour of the Appellant (the "Corporation") and rejected the arguments of the Canada Revenue Agency ("CRA"), which had argued that the four projects to optimize and improve the Corporation's assembly lines did not qualify for the SR&ED program because they consisted of routine activities which did not involve scientific uncertainty.

The Court also indicated in very clear terms that contemporaneous documentation required by the CRA is not a condition sine qua non to the SR&ED tax credit being allowed.

1. The facts

The Corporation sub-assembled mechanical parts for a business that assembled dryers in the Montreal region. To remain competitive, the Corporation invested large amounts annually to improve efficiency and productivity on its assembly lines. Those costs were traditionally claimed as SR&ED expenditures.

Some of the expenditures the Corporation claimed related to four SR&ED projects to optimize and improve its production line. The projects were generally aimed at reducing the time to assemble various parts that were produced while maintaining quality, and to make the assembly lines more versatile. Most of the expenditures claimed were for salaries incurred during production line testing.

In 2011, the CRA reassessed the Corporation for 2009 and denied the eligibility of the four projects for the SR&ED tax credit for the year.

2. The parties' claims

The CRA argued that the Corporation's activities did not qualify for the SR&ED program since they constituted routine procedures. The Corporation argued, on the other hand, that the projects met all the criteria for eligibility for the SR&ED program since they were part of a systematic investigation, they involved scientific uncertainty and they were undertaken for the purpose of achieving technological advancement.

3. Decision

Justice Jorré based his analysis on the jurisprudential tests developed in Northwest Hydraulic Consultants Limited v. The Queen[2]:

  • Was there a technological risk or uncertainty which could not be removed by routine engineering or standard procedures?
  • Did the person claiming to be doing SRED formulate hypotheses specifically aimed at reducing or eliminating that technological uncertainty?
  • Did the procedure adopted accord with the total discipline of the scientific method including the formulation, testing and modification of hypotheses?
  • Did the process result in a technological advancement?
  • Was a detailed record of the hypotheses tested, and results kept as the work progressed?

Weighing these five criteria overall after analyzing the available evidence, the Court came to the conclusion that the projects, considered globally[3], were all eligible for the SR&ED program:

 [Translation] "It is clear that the appellant did not know how it would achieve its goals and that there was technological uncertainty. It was work undertaken for the purpose of achieving technological advancement which did not involve routine procedures."[4]

The Corporation's appeal was therefore allowed. Other than the decision in favour of the Corporation on a factual level, this judgement is relevant for all taxpayers carrying out SR&ED because of Justice Jorré's strong comments on the impartiality of expert witnesses as well as the obligation to produce contemporaneous documentation.

4. Important points

a) The CRA's expertise

The parties each submitted an expert's report on the disputed activities. The CRA called Steven Kooi as an expert witness, a CRA employee who acted as scientific during the audit of the Corporation. Although Mr. Kooi's qualifications as an expert were not questioned by the parties, the judge nonetheless decided to give his testimony very little weight[5]. According to the judge, the fact that Mr. Kooi was employed by the CRA was not enough in and of itself to reject Mr. Kooi as an expert[6]. However, the Court said that it questioned Mr. Kooi's impartiality given the disproportionate emphasis he placed on the CRA guidelines compared to his own expertise:

[Translation] "During his testimony and in his report, there was confusion between his role as a scientific adviser during the audit and his role as an expert witness.

As a scientific adviser at the audit stage, it is quite normal for Mr. Kooi to be guided by the Canada Revenue Agency's guidelines regarding scientific research and experimental development, including certain standards relating to the proof of facts the taxpayer must establish to satisfy the Agency.

However, his role as an expert witness is different since it involves his personal expertise on issues such as whether there is technological uncertainty. An expert may agree with a recognized authority in an area but it must nonetheless be his own opinion.

During his testimony and in his report, there were times when Mr. Kooi often seemed to be guided more by the Canada Revenue Agency's guidelines and policies than by his personal expertise."[7]

This decision should therefore encourage the CRA's experts to base their opinion on their own expertise rather than referring to the guidelines and policies of their employer, the CRA, in determining what activities qualify for the SR&ED credit.

b) Contemporaneous documentation

Justice Jorré clearly indicated that, despite the CRA's claims[8], contemporaneous documentation relating to SR&ED projects is not an essential condition to benefit from the program:

[Translation] "Whether or not contemporaneous documents exist and whether or not the documents contain certain information are relevant to the Court's determination of a question of fact. However, the existence of contemporaneous documentation, or contemporaneous documents with specific content, is not a condition for the scientific research or experimental development to be recognized."[9] (Emphasis added).

The judge explained his thinking by referring to the words of Justice Archambault in 116736 Canada Inc.[10]:

[Translation] "In 116736 Canada inc. v. Canada, [1998] ACI No. 478 (QL), Justice Archambault explained that contemporary reports of any testing are potentially very important evidence but they are not mandatory. He says the following:

[…] In my view, contemporary reports showing detailed records of each experiment attempted by a researcher could constitute evidence of a systematic investigation. Any taxpayer attempting to convince the Minister that he is entitled to deduct R & D expenditures without such evidence puts himself in a very precarious position. A taxpayer would be in a similar position when appearing before this Court to contest the Minister's refusal to allow the deduction of his R & D expenditures.

However, the Act and the Regulations do not require that such 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. Whether the Minister or a judge could conclude that the activities purported to have been carried out by the taxpayer were actually carried out then becomes a question of credibility."[11] (Emphasis added by the judge).

The judge's legal reasoning that the CRA cannot ask more from a taxpayer than what the law requires has recently been applied in other decisions. For example, in a decision involving claims for input tax credits (GST), Justice Tardif of the TCC also pointed out that the CRA must abide by the law in assessing the available proof:

"With respect, regarding this interpretation, I question this position given that this condition is not in the Regulations; moreover, in tax matters, taxpayers cannot be required to do more than the obligations the Act imposes on them."[12]

This decision confirms that, although contemporaneous documentation is recommended, it is not essential to qualify for the SR&ED credit.

[1]      2014 TCC 313.

[2]       [1998] D.T.C. 1839. Tests reiterated in CW Agencies Inc. v. Canada, 2001 FCA 393.

[3]       In this regard, the judge said in paragraph 153 of the decision that [Translation] "each project must be considered globally over the year, not each test individually".

[4]       Les Abeilles service de conditionnement inc. v. The Queen, 2014 TCC 313, par. 174.

[5]       Id., par. 114.

[6]       Id., 2014 TCC 313, footnote 36.

[7]       Id., par. 87-91.

[8]       See in particular the Guide to Form T661 - Scientific Research and Experimental Development (SR&ED) Expenditures Claim (31 October 2013), in which the CRA states: "The business environment in which SR&ED is carried out will influence the nature and sources of evidence that are available to support the SR&ED claim. If your SR&ED claim is selected for review, you will be asked during the review to support your claim by providing supporting documentation that were generated as the SR&ED was being carried out. Work for which you have no relevant supporting evidence will likely be disallowed."

[9]       Les Abeilles service de conditionnement inc. v. The Queen, 2014 TCC 313, par. 94.

[10]     116736 Canada inc. v. Canada, [1998] ACI No. 478 (QL).

[11]     Les Abeilles service de conditionnement inc. v. The Queen, 2014 TCC 313, footnote 41.

[12]     Salaison Lévesque Inc. v. The Queen, 2014 TCC 36, par. 57 (aff'd Canada v. Salaison Lévesque Inc., 2014 FCA 296).

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