Scientific research not sufficiently documented
The Income Tax Act provides generous incentives for businesses to undertake scientific research and experimental development (SR&ED). For a Canadian controlled private corporation that is not large, these incentives include a 35% refundable tax credit, effectively subsidizing over 1/3 of the cost of the SR&ED, even for a business that pays no corporate income tax. Many provinces offer additional incentives.
The definition of SR&ED in the Income Tax Act is “systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis”, with further specification that the work must be “basic research”, “applied research” or “experimental development”, providing definitions for those terms, and then listing various inclusions and exclusions.
In addition, the Tax Court of Canada and Federal Court of Appeal have developed a set of questions for determining whether SR&ED was conducted:
- Was there technological risk or uncertainty which could not be removed by routine engineering or standard procedures?
- Did the person formulate hypotheses specifically aimed at reducing or eliminating that uncertainty?
- Did the procedure adopted accord with the total discipline of the scientific method including formulation, testing and modification of hypotheses?
- Did the process result in technological advancement? (There cannot be technological advancement unless there is technological uncertainty.)
- Was a detailed record kept of the hypotheses tested and results, as work progressed?
There have been many reported cases from the Tax Court in recent years, as businesses have claimed these generous incentives. Every claim is carefully audited by the CRA. As well as regular auditors (accountants examining the financial side of the claim), the CRA uses “Scientific Auditors” with a science background, to determine whether the conditions above have been satisfied.
In a recent case, Mac & Mac Hydro demolition (2017 TCC 256), a company was trying to develop techniques for removing lining from pipes transporting bitumen. Its work looked like SR&ED: it was trying to solve a difficult technical problem. However, the CRA denied its claim and it appealed to the Tax Court of Canada, which agreed with CRA since the company’s testing notes were vague.
Businesses engaged in SR&ED should be aware of this requirement if they hope to obtain the tax relief.