SR&ED Advisory & Alert: CRA Policy Consolidation: from the desk of Russ Roberts, Senior Vice President Tax, Finance and Advocacy, CATAAlliance
February 1, 2013

View Video Update: CATA CEO interviews, Russ Roberts, on the SR&ED program.

Background: CRA's Boundaries on SR&ED Claims Clarified


On December 19, 2012, the Canada Revenue Agency (CRA) issued the results of its
policy consolidation and clarification efforts as a series of 23 “new, consolidated SR&ED
policy documents."

Please see http://www.cra-arc.gc.ca/txcrdt/sred-rsde/clmng/srdplcyrvwprjctpdt-eng.html
and http://www.cra-arc.gc.ca/txcrdt/sred-rsde/whtsnw/menu-eng.html.

The documents set out where the CRA has been coming from over the last several
years in its audits. The documents attempt to simplify and codify the methodology and
issues to be addressed in identifying an eligible SR&ED project and the SR&ED work,
i.e., in claiming SR&ED.

The starting points for anyone wanting to work through the CRA's thinking are its
positions on:

what is an advancement in technology. Some key ideas in the new documents
include: "...the generation of information or the discovery of knowledge that
advances the technology...." “Technology is the practical application of scientific
knowledge and principles." "It is the knowledge of how scientifically determined
facts and principles are embodied in the material, device, product, or process.”

and

what work can be associated with an SR&ED project once a project is started.
This is found in "Eligibility of Work for SR&ED Investment Tax Credits Policy"
at http://www.cra-arc.gc.ca/txcrdt/sred-rsde/clmng/lgbltywrkfrsrdnvstmnttxcrdts-
eng.html
.

This document is a must read for anyone considering a claim for SR&ED. It establishes
the key questions that the CRA expects a claimant to be capable of addressing and the
process/methodology the CRA associates with how SR&ED projects take place and are
documented. Two of the key essentials to be able to demonstrate are that:

• the "total discipline of the scientific method” is followed (or at least CRA's concept of
it); and

• a true (my word) technological uncertainly exists that is addressed by the SR&ED
project – not simply some technical uncertainty that was addressed by applying
standard practices.

Comment

Over the last several years, many SR&ED claimants have experienced CRA SR&ED
reviews that have been conducted using these new concepts.

The result of the new, consolidated policies when used in audits has been support
for a much narrower scope of SR&ED, both in terms of what are SR&ED projects
and what work can be associated with them. The orientation of the program and the
documentation requirements are now much more consistent with research projects,
particularly those dedicated to the development of core technologies, than with the
breadth of projects that have been historically supported by CRA policies.

We are hearing that the documentation now expected by the CRA is requiring
companies to look closely at whether claiming is worth it.

We believe that these new, consolidated policies will be particularly challenging to many
claiming in the software sector and in the manufacturing sector.

In principle, if these new, consolidated policies are applied with reasonableness and
finesse by the CRA, the program can be made to work. Albeit, it will be a forced
fit in many instances. Use of these policies would seem to require a stronger CRA
management presence than has historically been achievable – witness the CRA's past
track record. The Government and the CRA are promising extensive training of their
field staff and reasonableness.

A quick review of a redacted version of the CRA's 2012 training material that was used
across the country with CRA staff does seem to counsel reasonableness in the reviews.
The course material, entitled "SR&ED TGD training course 2012", was developed
by the Technical Guidance Division (TGD) of the SR&ED Directorate. We found the
training material very helpful in understanding what the CRA is trying to do and suggest
that anyone involved in the preparation of claims may wish to seek the material through
Access to Information. Better yet, the CRA should post the material.

As well, the Division posts what appear to be monthly summaries of their policy work
and advice to the field on the CRA's "Infozone" for the information of CRA staff. This
should be obtainable through Access to Information as "Technical Guidance (TGD)
Issues and Initiatives."

We have found all of this material to be well developed and informative as to the CRA’s
policy thinking.

The focus of the CRA on the Scientific Method is particularly out of step with how a
lot of engineering needs to be conducted and how studies in the natural sciences
are conducted, and is concerning. The inappropriateness of this methodology in
many situations has been discussed extensively by academics, senior scientists and
engineers.

Why the Change?

One can only wonder why the CRA and this Government have tied themselves to
the Scientific Method and the other restrictive positions outlined in these new policy
documents.

We have been told several times by senior CRA officials that there were significant
compliance issues with the SR&ED Program; albeit, there has been no substantiation.
The CRA's new policies provide a number of tools for saying no and limiting the breadth
of studies and associated work that can be claimed, and for controlling the cost of the
program by the Government. To say more is just speculation.

As well, the focus on the Scientific Method could come in part from a mis-use of the
jurisprudence that has evolved around * Northwest Hydraulic Consultants Limited.
Arguably, this case is supportive of the CRA's focus on the Scientific Method. However,
having participated in this case, what seems to have been missed is that the Scientific
Method was appropriate for the studies at issue. The use of the Scientific Method will
not be appropriate in many other situations.

Given the calibre of those who highlight the need for using other systematic
methodologies in many areas of the sciences and engineering, one wonders if there is
any reason to believe that the CRA's positions are particularly supportable.

Certainly, there are other challenges that could be made to the positions taken in these
new documents. It is well established in jurisprudence that the courts are very reluctant
to look upon CRA published policies and positions as substantive references. And,
the new CRA policy documents are not likely to receive the kind of positive support
in jurisprudence that Information Circular IC 86-4 has received. Specifically, the
courts tend to look much more closely to policy advice that reflects senior community
consensus on an issue, as in IC 86-4, than to that normally found in ** CRA positions. 
Additionally, the courts tend to counsel looking at the credits broadly in the context of
making them work effectively as incentives.

Caution

The new, consolidated policy documents came into effect immediately on their release,
on December 19, 2012. It is unclear whether they apply to only claims filed on or after
this date or to all claims in process. However, certainly, these positions have been experienced
in recent reviews.

Most companies say they are better off not getting entangled in non-productive
challenges, and instead getting on with their businesses. These new policies outline
with some clarity CRA's limits. They give companies a reference point to reflect on
when evaluating whether to claim or not.

The CRA’s methodology and their questions demand that a company
contemporaneously document SR&ED; and that the company’s personnel be able
to explain why SR&ED exists, with facts that demonstrate that a technological
advancement was required and what was worked on.

We suggest that companies may wish to have their R&D groups evaluate where they
are at, now that the CRA's expectations are clearer. The CRA’s policy on SR&ED work
is relatively short and clearly written. Maybe this is a good time to do cross-checks
amongst those in your company who will be entangled if a review should take place. If
the CRA has recently completed an onsite review of your SR&ED claims, the results
and comments of the CRA reviewers my help you in your assessment.

Where an appeal and/or litigation may be anticipated, you may wish to ensure that you
have retained copies of the historical, consensus based documents for consideration,
as the CRA plans to remove the consensus based documents from its web site.

Footnotes:

* Northwest Hydraulic Consultants Limited v. The Queen 98 DTC 1839, Tax Court of Canada, May 1, 1998.

**  It is to be noted that Judge Bowman in Northwest Hydraulic commented that in general he was “reluctant to rely too heavily on interpretation bulletin and information circulars in determining contested issues under the Income Tax Act.” However, he made an exception for IC 86-4R3, because it represented a public and private based consensus:

It was the result of extensive consultations between government and
the scientific community both in industry and in universities. It represents
a broad consensus of persons in the public and private sector who are
likely to be affected by or to have an interest in the interpretation of the
SRED provisions of the Income Tax Act. The process demonstrates
the sensitivity of the government to the concerns of the scientific and business
communities in this area. Numerous submissions were received from organizations....
(paragraph 13)

In light of the extensive consultation and the impressive credentials
of the persons who participated in the process, the document that
emerged, IC 86-4R3 is a generally useful and reliable guide. (paragraph 15)

About Dr. Russ Roberts:


Dr. Roberts has 27 years of experience with Canada’s SR&ED Tax Incentive Program, from the perspective of both the public and private sectors. As the Senior Science Advisor of Revenue Canada during the program’s inception, he led the development of the interpretive policies on the eligibility of R&D for the tax credits, including Information Circular IC86-4 and the associated application papers. He was a contributor to the development of the refined definition of SR&ED found in subsection 248(1) of the current legislation and the guidance subsequently developed by the CRA on its application. He led the development of the Software Guidance for  the software community.

++ Action Requested

Please join the CATA SR&ED, Tax & Finance Group for a moderated peer discussion (870 members) on key issues affecting access to SR&ED and related issues. Go to this URL to add your name to the Group: http://www.linkedin.com/groups/SR-ED-Tax-Finance-Group-3246301/about