Appealing an SR&ED Claim

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Appealing an SR&ED claim

he Canadian tax system’s provisions for research and development aren’t quite as old as

CAmagazine, but they do date back more than 60 years, to 1948. While the provisions always tar-

program. For example, the Canadian Manufacturers and Exporters reported in a submission to the expert review panel that “problems in the administration of the [SR&ED] system include uncertainty with respect to eligibility, tighter definitions that exclude many previously eligible development activities, lack of technical expertise, long processing times, and lack of client [taxpayer] support.”

geted scientific research, they were broadened in 1985 to include “experimental development” — giving us the acroSR&ED rules and current trends nym SR&ED. In 1994, the government further strengthened the definition of experimental development, thereby CRA has published a variety of guidelines, administrative reaffirming its support for industrial R&D undertaken in policies and interpretation bulletins to help taxpayers better understand the SR&ED rules. However, these are pursuit of new products or processes.

not law themselves, but merely statements of adminisGiven the government’s apparent commitment to fostrative policy. The actual legislation is to be found in the tering R&D in Canada, it is discouraging to see how much Income Tax Act (Canada). There, the definition of SR&ED CRA has varied its views on SR&ED eligibility over the has not changed in any material way since the mid-1990s.

years, with no material changes in the legislation to back them up. Peter Weissman, one of the co-authors of this article, wrote about The definition of SR&ED in the Income Tax Act has this problem in the 1990s (see “Credit where it’s due,” September 1997, p. 30) not changed in any material way since the 1990s and it’s happening again today.

What is driving this trend? Has The challenge right now is to keep up with CRA’s moving CRA changed its policies on SR&ED eligibility? If so, are administrative definition of what is eligible.

these changes supported under the legislation? If not, what Ultimately, Canada’s tax courts decide on the correct is the best way to get redress?

interpretation of the act. But although there have been some important decisions, none can justify the extent to The political environment The federal government has to balance competing (even which CRA has narrowed its definition of SR&ED eligibilconflicting) goals when it comes to economic development ity. While the act and jurisprudence can probably support policy for science and technology. One is to offer an intersome of CRA’s recent policy tightening, we are seeing an nationally competitive R&D tax credit incentive. Another increasing number of aggressive SR&ED assessments that is to control actual tax credit disbursements to contain are not supportable by either. Unfortunately, most taxpaycosts. Yet another is to guard against what appears to be ers (and many accountants) are not sufficiently familiar an explosion of abusive claims.

with the nuanced differences between law and adminOver the past four years, cost containment and abuse istrative policy to appreciate which audit positions are correct. Here are some audit strategies that, in our view, control seem to have won out. Now there are growing indiare not supported.

cations that both taxpayers and the government believe Project deconstruction: The taxpayer makes a claim for a the SR&ED program is malfunctioning. In September project involving a set of interrelated activities that are 2009, the taxpayer’s ombudsman, Paul Dubé, was asked to investigate whether CRA was correctly administering collectively necessary for the technological advancement.

the program. His report has yet to be released, but he has The CRA auditor arbitrarily breaks the project into smaller been quoted as saying there have been “a lot of industry subprojects, then assesses some of these as “standard engicomplaints.” Then in October 2010, the federal government neering” and, therefore, not eligible. The claim is either reduced or disallowed altogether.

set up a six-member SR&ED expert review panel headed Misinterpretation of experimental development: Most SR&ED by Open Text chair Tom Jenkins to review the economclaims are made for work that is experimental developic benefits of all forms of government funding for R&D, including SR&ED. And in the past few months, several ment as defined in paragraph 248(1)(c) of the act. The term associations have voiced their dissatisfaction with the “experimental development” was first enacted in 1985 spe14 CA magazine

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cifically to broaden the legislation to cover industrial R&D aimed at product development. However, CRA auditors are now too frequently importing the more restrictive wording from paragraphs 248(1)(a) or (b) and saying the taxpayer has failed to demonstrate “an advancement in a field of science or technology,” thus imposing pre-1985 rules.

Technological obstacle versus technological uncertainty: An SR&ED claim is disallowed on grounds that there was no “technological uncertainty” or “technological obstacle” that would justify making a systematic investigation.

The act doesn’t actually contain the words “technological uncertainty” or “technological obstacle.” Rather, the term “technological uncertainty” evolved from a 1997 court case, Northwest Hydraulic Consultants Ltd. There, Justice Bowman described uncertainty as something not known to a qualified specialist in a given field. The term “technological obstacle” appeared in 2008 with CRA form T661-08, but has yet to be sanctioned by any jurisprudence. In various publications since then, CRA has taken to defining “obstacle” as shortcomings in the existing state of the art. It now seems to be using the entire world as a benchmark and as such is setting the eligibility bar much higher than it was set in 1997.

Traditional versus proxy overhead methods: A taxpayer makes a claim using the traditional method for overhead costs, which involves a more detailed accounting of actual overheads, but also allows for a broader scope of eligible activity than the proxy method, where the overhead is deemed to be 65% of the claimed T4 wages.

The CRA auditor denies the expenditures for these broader-scope activities, allows an overhead of about 65% of the T4 wages, and effectively negates the taxpayer’s use of the traditional method.

Once the notice of appeal is filed, a trial can be secured within 24 months. However, most actions are resolved at a settlement meeting or conference.

While the TCC route looks promising, it still requires expert knowledge of the rules of procedure and the legislation. Also, the taxpayer must be prepared to present evidence as to why the claimed activity meets the legislated definition. This is critical in the TCC process because the onus of proof is on the taxpayer. The facts the CRA used to make the assessment are presumed correct. Despite these caveats, we still think the TCC is the best option for resolving SR&ED disputes. Of course, it would be preferable not to have any disputes at all. We look forward to seeing the CRA realign its operating doctrines with the original objective of the SR&ED program — encouraging research and innovation in the private sector.

For an expanded version of this article, please visit www.camagazine.com/SR&ED2011. David R. Hearn is managing director of Scitax Advisory Partners LP and has been working in the SR&ED advisory field since 1993. A. Christina Tari, LLB, LLM, is a founder of Richler and Tari, Tax Lawyers, and has a practice restricted to tax dispute resolution. Peter M. Weissman, CA, TEP, is a partner in Cadesky and Associates LLP, a Toronto firm focusing on income tax planning, and was formerly the leader of the SR&ED practice in a national accounting firm

Redress options Given the administrative policies CRA has recently adopted, we think the Tax Court of Canada (TCC) is currently the best venue for SR&ED matters where the main issue is scientific eligibility. Of course, a notice of objection remains useful for expenditurerelated issues in an eligible claim. However, we find it is now taking 24 to 36 months for an appeals officer even to be assigned to an SR&ED objection.

Before the TCC process can begin, a notice of objection must have been served on CRA within 90 days of the date shown on the notice of assessment. In rare circumstances it might be possible to extend this deadline by up to a year. An appeal can be launched in the TCC on the 91st day after the notice of objection has been served, so long as CRA has not notified the taxpayer that it has made a decision on the objection within 90 days following the date it was served. In our view, the present objection backlog is so large, the objection will probably not even be acknowledged within 90 days.

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