Dave’s Diesel Inc. v. The Queen in Tax Court Canada of Canada June 2022

Docket: 2018-1618(IT)G

BETWEEN:

DAVE’S DIESEL INC.,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Appeal heard on May 10, 2022, at Hamilton, Ontario

Before: The Honourable Justice David E. Spiro

Appearances:

Counsel for the Appellant: Mark S. Grossman

Counsel for the Respondent: Christopher Ware

JUDGMENT

The appeals from assessments made under the Income Tax Act for the

Appellant’s 2013 and 2014 taxation years are dismissed with costs in accordance with the Tariff.

Signed at Ottawa, Canada, this 10 th day of June 2022.

“David E. Spiro”

Spiro J.

Citation: 2022 TCC 62

Date: 20220610

Docket: 2018-1618(IT)G

BETWEEN:

DAVE’S DIESEL INC.,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

REASONS FOR JUDGMENT

Spiro J.

In trying to find a way to remanufacture used fuel injectors for diesel

engines (the “project”), did the Appellant engage in “experimental development” during its 2013 and 2014 taxation years within the meaning of the phrase “scientific research and experimental development” (“SR&ED”) in subsection 248(1) of the Income Tax Act (the “Act”)? The Appellant says that it did. The Respondent argues it did not. For the reasons that follow, I agree with the Respondent.

In computing tax for its 2013 and 2014 taxation years, the Appellant

deducted investment tax credits of $26,865 and $31,134, respectively, on the basis thatdevelopment”. its work on 1 Onthe assessment, project duringthethoseMinisteryearsofconstitutedNational Revenue “experimental (the “Minister”) disallowed the deduction of those credits. These are the appeals of those assessments.

I. The Legal Test for SR&ED

The term “scientific research and experimental development” is defined in subsection 248(1) of the Act:

248(1) …

scientific research and experimental development means systematic investigation

or search that is carried out in a field of science or technology by means of

experiment or analysis and that is

(a) basic research, namely, work undertaken for the advancement of

scientific knowledge without a specific practical application in view,

(b) applied research, namely, work undertaken for the advancement of

scientific knowledge with a specific practical application in view, or

(c) experimental development, namely, work undertaken for the purpose

of achieving technological advancement for the purpose of creating new,

or improving existing, materials, devices, products or processes, including

incremental improvements thereto,

and, in applying this definition in respect of a taxpayer, includes

(d) work undertaken by or on behalf of the taxpayer with respect to

engineering, design, operations research, mathematical analysis, computer

programming, data collection, testing or psychological research, where the

work is commensurate with the needs, and directly in support, of work

described in paragraph (a), (b), or (c) that is undertaken in Canada by or

on behalf of the taxpayer,

but does not include work with respect to

(e) market research or sales promotion,

(f) quality control or routine testing of materials, devices, products or

processes,

(g) research in the social sciences or the humanities,

(h) prospecting, exploring or drilling for, or producing, minerals,

petroleum or natural gas,

(i) the commercial production of a new or improved material, device or

product or the commercial use of a new or improved process,

(j) style changes, or

(k) routine data collection;

In Northwest Hydraulic Consultants Ltd. v The Queen, [1998] 3 CTC 2520

[Northwest Hydraulic], Justice Bowman, as he then was, provided guidance on how to interpret and apply the definition of “SR&ED” in subsection 248(1) of the Act. The five criteria set out by Justice Bowman in Northwest Hydraulic have been endorsed by the Federal Court of Appeal on several occasions, most recently in National R&D Inc. v Canada, 2022 FCA 72, where Justice Rennie confirmed that thosesubsectioncriteria 248(1).” “reflect 2 the court’s understanding of what Parliament intended by

Northwest Hydraulic teaches that if work is to qualify as “SR&ED” under

subsection 248(1) of the Act, the following questions should be answered in the affirmative:

1. Was there a technological risk or uncertainty that could not be

removed by routine engineering or standard procedures? The phrase

“routine engineering” describes techniques, procedures and data that

are generally accessible to competent professionals in the field.

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 established and objective

principles of scientific method, characterized by trained and

systematic observation, measurement and experiment, and the

formulation, testing and modification of hypotheses?

4. Did the process result in a technological advance?

5. Was a detailed record of the hypotheses, tests, and results kept as the

work progressed?

II. The Nature of the Project

The Appellant called Mr. Rushi Dave as its only witness. Mr. Dave was

General Manager of the Appellant in 2013 and 2014. He was one of four

individuals who worked on the project.

Mr. Dave did not study mechanical engineering and has no degree,

certificate or designation in the field. However, he did study business and

marketing and worked for a large advertising, marketing, and public relations firm before joining the Appellant 15 years ago.

Mr. Dave’s father established the Appellant’s business in Brampton, Ontario a decade before starting the project. Although Mr. Dave described the Appellant as a fuel injection shop for the diesel engine industry, it was not a mechanic shop as no mechanics worked there.

Before starting the project, the Appellant remanufactured components of

used mechanical fuel injection systems for dealers under warranty programs offered by the manufacturers of the injectors. The Appellant went about remanufacturing components of used mechanical fuel injectors in the following way:

The process was to receive the component from an engine shop, like the dealership,

then we would disassemble it, do an assessment of its failures, and then reassemble

it with brand new components, and put it on a test stand to recalibrate [it] to [the]

provided manufacturer specifications. 3

By 2007 or 2008, electronic fuel injection systems began to replace

mechanical fuel injection systems in diesel engines. The Appellant found itself in difficulty as manufacturers would no longer pay the Appellant to remanufacture components of their used fuel injection systems. Presumably, they wanted their customers to purchase new units as replacements. In any event, the Appellant needed a new source of income.

The Appellant, therefore, set out to find a way to remanufacture injectors on its own. Those injectors were found in diesel-powered trucks, generators, marine equipment, and construction and farm equipment. The Appellant studied three types of injectors as part of the project:

(a) Delphi 4 Pin (an electronic fuel injector used in certain Volvo diesel engines);

(b) C7 (an electronic fuel injector used in certain Caterpillar diesel

engines); and

(c) ISX (a mechanical fuel injector used in certain Cummins diesel

engines).

Four individuals worked on the project in 2013 and 2014: Mr. Dave, his

father, and two unskilled labourers employed by the Appellant. Mr. Dave testified thattechnicians, the Appellantand we “wouldwouldhireget themunskilledto dolabourers, this worktrainwiththem, myselfandandbuildmy father.” them into 4 It was never made clear exactly what training was given to these unskilled labourers. What is clear, however, is that none of the individuals involved in the project in 2013 or 2014 were engineers or mechanics.

At trial, Mr. Dave produced a fully-assembled fuel injector as well as a

disassembled fuel injector of each type (Exhibits AP-1 to AP-6). He described certain technical differences between each of the three types. None of those differences is material as the process employed by the Appellant was the same for each type. The Appellant appears to have followed a four-step process. The following steps were taken by the Appellant in respect of each type of injector:

Step 1: Taking apart the injector to understand how it worked

The Appellant did not understand how the injectors worked, so it needed to take them apart first. This required the use of tools allowing it to take the injectors apart without breaking them. The Appellant had to fabricate some of its own tools to accomplish this task. After a particular type of injector was taken apart, the Appellant inspected it with a view to understanding exactly how it worked.

Step 2: Simulating the operation of the injector and determining which parts of the injector were likely to fail

The Appellant would place the injector in one of its machines to simulate its operation with a view to ascertaining which of its parts were likely to fail.

Step 3: Purchasing or modifying parts designed to prevent those failures

The Appellant would purchase or modify parts that it thought were likely to fail with a view to meeting, or improving on, the manufacturer’s original specifications.

Step 4: Incorporating those parts into used injectors to be remanufactured by the Appellant

The final step would be the assembly of a remanufactured used fuel injector that met or exceeded the specifications of a new one. The Appellant hoped to remanufacture all three types of injectors with used injectors as “cores”. It hoped to sell the remanufactured injectors at a price below that charged by manufacturers for new ones.

The Appellant did not remanufacture any of the three types of injectors

during its 2013 or 2014 taxation years.

The Meaning of “Remanufacturing”

Before reviewing the Appellant’s documents, it is important to understand exactly what the Appellant meant by “remanufacturing”. Mr. Dave described “remanufacturing” in this context as:

… the process of taking a used component, disassembling it, identifying its failure

points, rectifying those failure points, and sometimes improving those failure points

so it can be a better injector, and putting it back together and being able to sell it to

the end user or resellers or engine rebuilders. 5

III. The Documentary Evidence

Mr. Dave produced a handwritten diary for each of 2013 and 2014 (Exhibits A-3 and A-4). This is how he described the diaries (which he called “notebooks”):

So essentially I keep a notebook for the purposes of SR&ED. And what I do is at

the end of every day, if we’ve done any SR&ED work, that I just go and write it

down quickly; what was done and what we did, and who did it. 6

Most of the diary entries are rather concise. The following are some of the more descriptive ones (square brackets indicate the type of injector tested):

January 4, 2013

Broke [Delphi 4 Pin] injector trying to understand how it comes apart.

January 23, 2013

Purchased and tested 12 [C7] cores and found all to be operating differently and

having leaks from different sections of injector.

February 25, 2013

Received prototype [C7 adapter] from machine shop and installed. The thinner

O-ring would not stand up to the pressure and kept breaking.

March 6, 2013

Continued [ISX] trials and documenting results. Not ideal and still not operating as

expected. No atomization.

March 15, 2013

Used a thin steel punch and applied pressure from the top of the [Delphi 4 Pin]

injector and popped out the terminal insulating sleeve and seal.

MarchRan trials 21, using 2013 [C7] cores based on Ray’s findings. 7

May 14, 2013

Diesel in oil leaks at top of [ISX] injector; trial test to better understand faults.

July 17, 2013

Continued to run trials [ISX]; Still trying to determine how it comes apart.

September 12, 2013

Run [Delphi 4 Pin] trials with different shim thicknesses.

September 25, 2013

Spring pressure trials [Delphi 4 Pin].

October 12, 2013

Test 4 [C7] injectors with rebuilt control valves and all leaked badly. There were

no leaks before.

October 18, 2013

Created a spring cage pressure test to define a different shim for every [Delphi 4

Pin] injector.

October 23, 2013

Tested again and [Delphi 4 Pin] valve and spool still leaked.

November 15, 2013

Test [C7] injectors; Everything inside seems to always be worn and full of filings.

November 26, 2013

Test [C7] injector with oversized piston and still had internal leaks.

January 13, 2014

Test [C7] valve and still leaking.

April 14, 2014

Test [ISX] injectors with prototype springs.

April 15, 2014

All [ISX] springs failed test and no solution to date.

July 21, 2014

Tried different materials and tested [ISX].

July 22, 2014

Test proved successful after a number of trials [ISX]; Not repeatable.

November 4, 2014

All [ISX] tests failed.

November 24, 2014

Test results proving to work [Delphi 4 Pin].

December 3, 4, 5, 6, 2014

Test and record results [C7]. 8

December 19, 2014

Analyze [C7] results; No consistency.

December 20, 2014

No consistency in [C7] results.

December 23, 2014

Unable to build valve or rebuild [C7] injector at this time.

The Appellant also produced a partial record of a single test performed on a C7 injector in 2013 (Exhibit A-2 reproduced at Appendix “A”) and a partial record of a single test performed on the same type of injector in 2014 (Exhibit A-1 reproduced at Appendix “B”).

As Mr. Dave presented his oral evidence, he showed the Court a series of colour photographs illustrating the machines and tools used in the project. Counsel for the Respondent objected to their admission on the basis that none of the usual notice requirements in subsection 89(1) of the Tax Court of Canada Rules

(General Procedure) (the “Rules”) had been followed. 9 As Mr. Dave offered each photograph to illustrate his evidence, I identified it for the record and reserved my ruling on its admissibility.

I have now decided that each of those photographs should be admitted into evidence as they satisfy the usual conditions for the admissibility of photographs, namely:

(a) accuracy in representing the facts;

(b) fairness and absence of any intention to mislead; and

(c) verification on oath by a person capable of doing so. 10

IV. Applying the Legal Test to the Facts

Having reviewed all of the evidence in respect of the project, the question is whether the Appellant has demonstrated, on a balance of probabilities, that the work performed satisfies the Northwest Hydraulic criteria.

1. Was there a technological risk or uncertainty that could not be removed by

routine engineering or standard procedures? The phrase “routine

engineering” describes techniques, procedures and data that are generally

accessible to competent professionals in the field.

The Appellant says that the relevant “technological uncertainty” was

whetherdifferentittypescouldofsuccessfullyinjectors. 11 develop a process to remanufacture the three

The fact that a small group of non-engineers and non-mechanics, including two unskilled labourers, did not know whether they could remanufacture three types of used fuel injectors tells us nothing about whether it was “technologically uncertain” that those fuel used injectors could have been remanufactured by a competent professional in the field.

The Appellant rests its case on the subjective knowledge of the four

non-engineers and non-mechanics who worked on the project. To them, every aspect of the project was a “technological uncertainty”. The “technological uncertainty” standard, however, is not subjective. If it were subjective, a grade school student trying to build a simple electric motor would meet the test. When she was a member of this Court, Justice Monaghan noted that “technological uncertainty”:

… does not arise simply because the Appellant does not have the requisite

knowledge. The question is whether the uncertainty identified by the Appellant is

an uncertainty to those knowledgeable and experienced in the relevant field. 12

The onus was on the Appellant to demonstrate that it was “technologically uncertain” competent professionalthat the usedinfueltheinjectorsfield -acouldmechanicalhave beenengineer, remanufacturedfor example. by 13 a

But even if I had found the requisite “technological uncertainty”, I would still have no basis on which to decide whether the steps taken by the Appellant were anything other than “routine engineering” for a competent professional in the field. There was no evidence that taking a fuel injector apart without breaking it was anything other than “routine engineering” for such a professional. Similarly, there was no evidence that understanding how the fuel injectors worked was anything but “standard procedure” for a competent professional in the field.

2. Did the person claiming to be doing SR&ED formulate hypotheses

specifically aimed at reducing or eliminating that technological uncertainty?

Mr. Dave testified that the Appellant’s hypothesis was:

… whether we could develop a remanufacturing procedure and be able to

remanufacture these injectors, and that’s the hypothesis. 14

As noted above, the Appellant also claims that the “technological

uncertainty” was whether it could successfully develop a process to remanufacture the fuel injectors. Only in Alice’s Adventures in Wonderland could it be argued thatuncertainty” one’s hypothesisis one’s hypothesis. is the “technological 15 uncertainty” and that the “technological

The Appellant faces two other challenges. First, as noted above, the

Appellant has not adduced any evidence demonstrating that it was “technologically uncertain” that the fuel injectors could have been remanufactured by a competent professional in the field. Second, the Appellant’s single, overarching “hypothesis” is not the type of hypothesis contemplated by the second criterion in Northwest Hydraulic.

In Northwest Hydraulic, Justice Bowman describes a five-stage process to determine whether the person claiming to have done SR&ED formulated hypotheses specifically aimed at reducing or eliminating the technological uncertainty. According to Justice Bowman, such a person would have engaged in:

a. the observation of the subject matter of the problem;

b. the formulation of a clear objective;

c. the identification and articulation of the technological uncertainty;

d. the formulation of an hypothesis or hypotheses designed to reduce or

eliminate the uncertainty; and

e. the methodical and systematic testing of the hypotheses.

Justice Bowman uses the plural “hypotheses” throughout Northwest

Hydraulic, particularly in the second, third, and fifth criteria. The Northwest Hydraulic criteria do not contemplate a single, overarching hypothesis, as the Appellant contends, but a discrete hypothesis that precedes each test and that is subject to modification in light of the results of that particular test.

An example will illustrate the point. Here is the diary entry for February 25, 2013:

February 25, 2013

Received prototype [C7 adapter] from machine shop and installed. The thinner

O-ring would not stand up to the pressure and kept breaking.

The hypothesis to be tested might have been: “An O-ring 5 mm. thick should withstand pressure of 50 lb/ft. as effectively as an O-ring 7.5 mm. thick”. That hypothesis would have been the subject of the test. The results of the test would

have been recorded and analyzed and modifications made to the hypothesis in light of the test results.

by an experimentAs Justice Sommerfeldtor a trial.” 16 has noted, a hypothesis is “a statement to be tested

In respect of any particular test performed in 2013 or 2014, the Appellant has failed to show:

(a) the formulation of a hypothesis (e.g., in respect of the O-ring on

February 25, 2013, or the shim thickness on September 12, 2013, or

the spring pressure on September 25, 2013, etc.);

(b) the testing of that hypothesis; and

(c) the modification of the hypothesis in light of the results of that test.

3. Did the procedures adopted accord with established and objective

principles of scientific method, characterized by trained and systematic

observation, measurement and experiment, and the formulation, testing and

modification of hypotheses?

As noted above, there is no evidence that in respect of any particular test the Appellant formulated a particular hypothesis, tested that hypothesis, and modified that hypothesis in light of the results of that test.

There is no evidence that any of the four individuals involved in the project used “established and objective principles of scientific method” in their testing. Even a cursory review of the diary entries at paragraph 21 above suggests that the projectwith thehadscientificmore inmethod. common 17 with “tinkering” or “simple trial and error” than it did

4. Did the process result in a technological advance?

The process might have resulted in an “environmental advance” as used fuel injectors would be remanufactured rather than dumped in landfills. It might have resulted in a “financial advance” for the Appellant as it could fill the hole in income left by the withdrawal of the warranty programs. But, after hearing all the evidence, I still have no idea whether the project resulted in a “technological advance”.

5. Was a detailed record of the hypotheses, tests, and results kept as the work

progressed?

The Appellant has not satisfied its onus to demonstrate that it recorded, in respect of any particular test performed in 2013 and 2014:

(a) the formulation of a hypothesis;

(b) the testing of that hypothesis; and

(c) the modification of that hypothesis in light of the results of the test.

Take the shim thickness test of September 12, 2013 or the spring pressure test of September 25, 2013 as examples. What shim thicknesses were tested? What were the results of each test? Which shim thicknesses passed the test? What was the standard selected for passing the test? For the spring pressure test, what pressures were applied and for how long? What were the results of each test at each pressure and for each duration? At what pressure, and at what point, did each spring fail? There is no record of the answers to these questions.

The problem is not only the Appellant’s lack of documentation. The problem is that the Appellant’s lack of documentation makes it almost impossible for it to meet its onus in respect of the second and third criteria in Northwest Hydraulic. A partial record of a single test performed on a C7 injector in 2013 (Exhibit A-2 reproduced at Appendix “A”) and a partial record of a single test performed on the same type of injector in 2014 (Exhibit A-1 reproduced at Appendix “B”) are insufficient to discharge that onus.

V. Conclusion

The Appellant has failed to meet its onus to show, on a balance of

probabilities, that its work on the project in 2013 or 2014 qualifies as “experimental development” within the meaning of “SR&ED” in subsection 248(1) of the Act. Accordingly, the appeals must be dismissed.

At the conclusion of the hearing, I asked each party for their position on costs. The Appellant requested an opportunity to make submissions on costs. The Respondent requested costs in accordance with the Tariff. The appeals for the Appellant’s 2013 and 2014 taxation years will, therefore, be dismissed with costs in accordance with the Tariff.

Signed at Ottawa, Canada, this 10 th day of June 2022.

“David E. Spiro”

Spiro J.

APPENDIX “A”

APPENDIX “B”

CITATION: 2022 TCC 62

COURT FILE NO.: 2018-1618(IT)G

STYLE OF CAUSE: DAVE’S DIESEL INC. AND HER

MAJESTY THE QUEEN

PLACE OF HEARING: Hamilton, Ontario

DATE OF HEARING: May 10, 2022

REASONS FOR JUDGMENT BY: The Honourable Justice David E. Spiro

DATE OF JUDGMENT: June 10, 2022

APPEARANCES:

Counsel for the Appellant: Mark S. Grossman

Counsel for the Respondent: Christopher Ware

COUNSEL OF RECORD:

For the Appellant:

Name: Mark S. Grossman

Firm: Shuh Cline &Grossman

Kitchener, Ontario

For the Respondent: François Daigle

Deputy Attorney General of Canada

Ottawa, Canada

1 The investment tax credits were claimed under a combination of subsection 127(5), subsection

127(9), and subparagraph 37(1)(a)(i) of the Act. The disallowed “SR&ED” expenditures were

$56,065234567 NationalTranscript, Transcript, Transcript, Transcript, Ray wasforR&Donethepagepagepagepageof 2013 Inc. the 21, 39, 73, 64, vtaxationunskilledlineslineslineslinesCanada 9-14. 20-23. 15-21. 12-16. year, labourers 2022 andFCA $69,604 who 72, workedatforparathe 12. on 2014 thetaxationproject. year. Exhibit A-2 (reproduced at

Appendix “A”) relates to this diary entry and constitutes a partial record of one of the tests

performed 8 Exhibit A-1 on March (reproduced 21, 2013. at Appendix “B”) relates to this diary entry and constitutes a partial record 9 Subsectionof one 78(1) of theofteststhe performedRules provides: on December 3, 2014.

78 (1) In sections 78 to 91, document includes a sound recording, videotape, film,

photograph, chart, graph, map, plan, survey, book of account and information

recorded or stored by means of any device.

[Emphasis added]

Subsection 89(1) of the Rules provides:

89 (1) Unless the Court otherwise directs, except with the consent in writing of the

other party or where discovery of documents has been waived by the other party,

no document shall be used in evidence by a party unless

(a) reference to it appears in the pleadings, or in a list or an affidavit

filed and served by a party to the proceeding,

(b) it has been produced by one of the parties, or some person being

examined on behalf of one of the parties, at the examination for

discovery, or

(c) it has been produced by a witness who is not, in the opinion of

the Court, under the control of the party.

10 See R. v Creemer, [1968] 1 CCC 14, [1967] NSJ No 3 (NSCA) as cited in Lederman, Bryant & Fuerst, Sopinka, Lederman &Bryant: The Law of Evidence in Canada, 5th ed. (Toronto:

LexisNexis, 2018) at §2.22. I would, therefore, direct that Exhibits I-1 to I-12 now be marked as

Exhibits 11 See theP-1 cross-examinationto P-12 for the record. of Mr. Dave at page 154, lines 17-21 of the transcript where he

testified that the “technological uncertainty” was “whether we could successfully develop a

process to remanufacture the injector[s].”

1213 LogixIn referringData ProductsspecificallyInc. tovaThemechanicalQueen, 2021 engineer, TCCI 36 doatnotparaintend 69. to exclude the possibility that

the perspective of a knowledgeable and experienced diesel engine mechanic could have been

helpful. The point here is that the Appellant called neither a mechanical engineer nor a duly

qualified 1415 LewisTranscript, Carroll, dieselpageengineThe 159, Annotatedmechanicline 25 toAlice: inpagerespectAlice’s 160, oflineAdventuresthis 3. critical inquestion. Wonderland &Through the Looking- Glass, 150th Anniversary ed. by Gardiner &Burstein (New York: W.W. Norton &Company,

2015). In this context, the following passage is à propos (at pp. 84-85):

“Then you should say what you mean,” the March Hare went on.

“I do,” Alice hastily replied; “at least -at least I mean what I say -that’s the same

thing, you know.”

“Not the same thing a bit!” said the Hatter. “Why, you might just as well say that

‘I see what I eat’ is the same thing as ‘I eat what I see’!”

16 Joel Theatrical Rigging Contractors (1980) Ltd. v The Queen, 2017 TCC 6 at para 26 citing Advanced 17 By “simpleAgriculturaltrial and error” TestingI meanInc. vtestingThe Queenwithout, 2009 theTCCprior 190 formulationat paras. 30-31. of a hypothesis.