Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
Summary of Tax Court Case of Northwest Hydraulic Consultants for CTF Conference purposes
How does decision of the case compare with our position regarding the meaning of SR&ED and the requirements respecting the criteria for determining SR&ED.
Position:
Summary of Issues, Court Findings, Law, Facts, Taxpayer's and Departments positions provided.
Reasons:
To set out the basis for the decision which, in our opinion, was made on a finding of fact
CANADIAN TAX FOUNDATION ROUNDTABLE
QUESTIONS AND RESPONSES
RE: Northwest Hydraulic Consultants Ltd.(NHC) v. Her Majesty The Queen
Appeal to the Tax Court of Canada (the “Court”)
Issue:
How does Judge Bowman’s (the “Judge”) approach in the above case square with that of Revenue Canada’s in the field with respect to his decision that work on certain engineering projects constituted scientific research and experimental development (SR&ED).
What is the status of Information Circular 86-4 (the Circular) as a result of that case.
Court findings
A total of 17 projects were in question before the Court and based on four out of five of those projects selected as representative of all 17 projects, the Court found that the work carried out thereon by NHC constituted SR&ED.
The Court recognized the three basic criteria of (i) scientific or technological advancement,(ii) scientific or technological uncertainty and (iii) scientific and technical content described in the Circular and required in respect of a project in order for it to be considered SR&ED. The Judge commented in some detail on the criteria that must be met, with various references to the Circular, in respect of each of the five projects. The Judge distinguished between situations that would not result in SR&ED because of the application of routine engineering or standard practice and concluded that four of the projects met the basic criteria while one did not.
Law
NHC relied particularly on paragraph 2900(1)(c) of the Income Tax Regulations (the “Regulations”), in support of its case, (although paragraph 2900(1)(d) might also be related thereto, subject to paragraphs 2900(1)(e) to (k)). Paragraphs 2900(1)(c), (d), (f) and (k) of the Regulations at the particular time read:
“2900.(1) For the purposes of this Part and sections 37 and 37.1 of the Act, SR&ED means systematic investigation or search carried out in a field of science or technology by means of experiment or analysis, that is to say,
(c) experimental development, namely, work undertaken for the purposes of achieving technological advancement for the purposes of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, or,
(d) work with respect to engineering, design, operations research, mathematical analysis, computer programming, data collection, testing and psychological research where that work is commensurate with the needs, and directly in support, of work described in paragraph (a), (b) or (c),
but does not include work with respect to
(f) quality control or routing testing of materials, devices, products or processes,
(k) routine data collection”.
In its interpretation of SR&ED for the purposes of subsection 2900(1) of the Regulations, the Department has set out in the Circular the basic elements and criteria that must be met in order to achieve SR&ED. The Circular also include commentaries on certain activities, such as routine engineering and standard practice that would not meet the criteria for SR&ED.
A taxpayer may be able to deduct an expenditure that qualifies as SR&ED under section 37 of the Act and may also be entitled to the investment tax credit (“ITC”) on such expenditure under subsections 127(5) and (9). Separate requirements are to be met for an expenditure to qualify for the deduction under section 37 and for the ITC under subsections 127((5) and (9).
Facts
NHC was generally known as an engineering consultant firm, specializing in the development, management and protection of water resources. Its fields of experience included hydraulic modeling, numerical modeling river engineering, hydrology, etc.
NHC’s clients, most of whom were outside Canada, were trying to solve hydraulic problems which included the design of structures like dams or weirs which they were unable to do with mathematical modeling. NHC was contracted to solve the problem in respect of 17 projects. In its work, NHC constructed physical models which the Court found generally to be of a precise scale that replicated the river or dam or other construction to which the design related.
NHC appealed assessments made by the Department for the 1994 and prior years for expenditures alleged to be on SR&ED and deducted by NHC in respect of the 17 projects and upon which NHC claimed the investment tax credit.
The alleged expenditures incurred by NHC covered the years from 1983 to 1994 in respect of the 17 projects. However, due to the common elements of some of the projects, an agreement was reached between NHC and the Department with the help of professional experts for the parties, to argue before the Court only the issues in respect of five projects that generally represented the 17 projects as those issues pertained to the 1994 taxation year and have the Court’s decision apply to all the projects.
The Court’s decision proceeded in three phases, namely, review of the applicable legislation and the Circular, review of the projects in light of the legislation and the Circular and review of expert evidence.
The Court held that the expenditures in respect of four of the five projects presented to it were SR&ED expenditures.
Taxpayer’s position
The taxpayer argued that the work carried out, including the construction of the physical models and the construction to which the design related, were not based on routine engineering or standard practice and met the criteria for technological advancement, technological uncertainty and risk and technical content, as provided in the Department’s Circular. Accordingly, the related expenditures should be SR&ED expenditure to which the tax incentives should apply.
Department’s position
The Department argued that NHC, by its own excellence as a world leader in the field of hydraulic model testing, appeared to give its clients confidence of a solution and set the standards for what represents routine engineering or standard practice and that the lack of confidence by NHC’s client that a particular design would work did not amount to technological uncertainty. Accordingly, the work carried out by NHC did not meet the basic criteria for SR&ED and the expenditure in respect thereof did not qualify for the tax incentives.
The Department has decided not to appeal the Court’s decision which was made on the particular facts of the case and in respect of which the tests for SR&ED were correctly set out by the Judge. For the purposes of determining such facts, the judge examined the facts of each of the five projects vis-a-vis the meaning of SR&ED and a review of the SR&ED criteria in the Circular, and:
(i) compared technological uncertainty with routine engineering by stating that technological uncertainty only existed where the uncertainty cannot be removed using routine engineering or standard procedures;
(ii) indicated that a systematic process must be undertaken with the identification of the uncertainty occurring, at the minimum, at the beginning of the process;
(iii) commented that technological advancement in SR&ED may involve the achievement of gradual progress and not necessarily spectacular breakthroughs citing the failure of a hypothesis as reinforcing the measure of technological uncertainty; and
(iv) regarded as self evident that a detailed record of the hypothesis, results and tests must be met.
It is the Department’s view that the Judge’s review of the Circular provided a comprehensive and comprehensible guide for the future review of SR&ED claims. His reference to the Circular as “useful and reliable” provided a judicial recognition of the Circular as a consensus of the scientific community which could be used as a basis for all future court cases. In general, it is our opinion that the Judge’s review of the criteria set out in the Circular for the determination of SR&ED provided some useful comment.
In sum, the finding of fact by the Court was based on the evidence presented, with no apparent overriding error which may have affected the Judge’s assessment of that evidence.
Per FFonta
98/09/22
982236
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