SR&ED Audits - Project Deconstruction
The first installment of our CrossDynamix blog discusses the topic of "project deconstruction" during a SR&ED audit. The CRA's Research and Technology Advisor ("RTA") often asserts that the project is claimed at too high a level and that it is necessary to drill down to lower-level and more detailed activities; assessing individual activities (or individual sentences) as though they needed to embody an entire SR&ED claim on their own. The suggested response to the RTA in these scenarios is that it is important that the SR&ED be viewed at the correct level and that there are plenty of established guidelines about the issue of breaking things down too finely.
The CRA's own guidance documents, such as IC97-1, and Recognizing Experimental Development, among others, caution RTAs against the practice of seeking too finely grained an examination of the component activities within a SR&ED project.
Interesting Facts:
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The CRA Guidance document, Recognizing Experimental Development (which like IC86-4R3 was developed after extensive industry consultation), under Discussion of Key Concepts, heading What Does Achieving Technological Advancement Mean?, and para 5: The development work must be viewed at the highest possible level to properly recognize the technological advancements attempted which define the full scope of eligibility. The definition of experimental development in 248(1)(c&d) uses the collective noun "work" to capture all the effort. This does not mean that all development work is experimental development work; support work of the kind listed in 248(1) d must be "directly in support" of and "commensurate with the needs" of the experimental development being undertaken. Work defined by paragraphs 248(1)(e) through 248(1)(k) is excluded. It is important to reiterate that it is not what the work is called but that all work that contributes to the effort to achieve a technological advance is included as experimental development. |
| Page 5 of IC97-1, paragraph 4 reads as follows: "The SR&ED project definition is not intended to support the subdividing of SR&ED projects that have been correctly identified into smaller and possibly ineligible activities. The concept of the "set of interrelated activities that collectively are necessary..." embodied in the SR&ED project definition ensures that a project is being performed for the purpose of technological advancement is evaluated as a unit, provided that all activities identified for the project are commensurate with the needs, and directly in support, of the attempt to achieve the technological advancement, as required by subsection 248(1) of the Act." |
| The instructions in Guide to T661 for filling in boxes 242, 244, 246 do not reference a 5-stage process (which was an observation or inference of Justice Bowman in the Northwest Hydraulics written judgement). |
| It is unclear as to why and on what basis it would be demanded of any Taxpayer to have followed a format that is prescribed nowhere in the official policies or guidance. |
| Moreover, given that the NW Hydraulics judgement itself was issued in 1998, more than 16 years ago, the CRA has had ample opportunity to have lobbied for statutory changes requiring the use of such methods in SR&ED claims, and has presumably chosen not to do so. Taxpayers are therefore astonished at the frequency with which the CRA demands something by way of a format that the law and the regulations do not require, nor even officially acknowledge. |
| 116736 Canada Inc. v The Queen, Appendix 2: "However the lack of detailed documentary information should not discourage you from making an SR&ED claim or be considered as an indication that SR&ED did not take place, particularly in the case of a first-time claimant. In such a case, the CRA may be consulted to help claimants identify other types of supporting evidence needed to support the SR&ED work and the related expenditures." |
| TCC, in the decision of Service de Conditionnement inc. c. La Reine, 2014 CCI 313 (CanLII), reiterated that projects must be considered at the upper level and not at the lower level activity, specifically the CRA must not deconstruct projects to determine eligibility. |
In cases where the RTA has (intentionally) proceeded to drill down to lower-level activities to what they call "underlying technologies" (HTML, Java etc.) in order to assess individual activities (and even individual sentences in a project description) as though they should embody an entire SR&ED project in and of themselves, the SR&ED projects will not have been reviewed (or assessed) at the correct level, that at which they were presented. If the work claimed as SR&ED under each project was directly in support and commensurate with the work required meeting the SR&ED definition then projects should be assessed in their entirety, rather than broken down into their constituent parts. If a project is broken down into isolated disconnected pieces, it is not possible to identify the SR&ED.
CrossDynamix is the industry leader in filing and defending SR&ED claims as well as appealing the CRA's SR&ED assessments.