Activities not qualified as 'scientific research and experimental development' under Income Tax Act
The Federal Court of Appeal has affirmed a decision denying a claim for tax credits filed by a consulting firm after finding that the activities undertaken during the development of a technology project did not qualify as scientific research and experimental development (SR&ED) under the Income Tax Act.
In National R&D Inc. v. Canada, 2022 FCA 72, the appellant, National Research & Development Inc., is a Canadian private corporation that provides consulting services in engineering, information technology, SR&ED tax credits, and Ontario interactive digital media tax credits.
The appellant filed a claim for tax credits with the Canada Revenue Agency (CRA) for its expenses in developing a project called “Project Tracking System” during the 2011 taxation year. The project is a computer program that aims to develop a web-based, cross-platform, and cross-browser framework to track claimable SR&ED projects for the appellant’s clients.
In denying the claim, the CRA found that the activities undertaken by the appellant in developing the project did not constitute SR&ED within the meaning of the s. 248(1) of the ITA. The Tax Court of Canada affirmed the CRA decision and held the appellant had not shown that the project qualified as SR&ED for failure to meet the criteria set out in Northwest Hydraulic Consultants Ltd. v. The Queen.
In its appeal, the appellant argued that the third Northwest Hydraulic criterion – “whether the procedure adopted accord with the total discipline of the scientific method” − was not a requirement for SR&ED eligibility under s. 248(1).
The Federal Court of Appeal dismissed the appeal and upheld the tax court decision.
According to the court, the argument put forward by the appellant had already been settled in Kam-Press Metal Products Ltd. v. Canada. In that case, the court declared that the Northwest Hydraulic criteria were the appropriate interpretation of the definition of SR&ED in s. 248(1).
Moreover, the court disagreed with the appellant’s argument that the Northwest Hydraulic criteria were inconsistent with the revised CRA guidance on SR&ED eligibility. While the new CRA guidance no longer uses the precise language of “scientific method,” the court noted that the “how requirement” section still speaks to the requirement of an underlying rigour or discipline in the experimental process.
“In any event, while the CRA guidance is useful context in understanding the purpose and intent of a particular provision, it is not binding on the court,” Justice Donald Rennie said. “The court is guided by the rules of statutory interpretation in Canada Trustco Mortgage Co. v. Canada and by precedent, and thus, the judge made no error in relying on the Northwest Hydraulic criteria.”
The court also determined that the appellant’s argument mischaracterized the relationship between the courts and legislation.
“The criteria relied on by the judge are not ultra vires section 248(1), rather they reflect the court’s understanding of what Parliament intended by section 248(1),” Justice Rennie wrote. “Parliament and the legislatures rely on the courts to give definition, amplitude, and precision to statutory language as required by the circumstances of the case.”
The appellant alleged that without the benefit of the expert report, the judge did not understand the evidence and was not in the position to assess whether it conformed to the requirements of s. 248 (1). The court disagreed.
“The judge’s reasons demonstrate a careful regard to the evidence,” Justice Rennie wrote. “The judge found on the evidence that the appellant did not conduct its work in a methodical manner and did not keep adequate records.”
“To the extent that the appellant kept records, the judge found them ‘vague,’ ‘unclear,’ and not reflecting a logical progression between the premise of an experiment and the result,” Justice Rennie added.