Interpretative Issues Regarding SR&ED Tax Credits: An Overview of Recent SR&ED Tax Cases and Related Implications for Claimants

• Author: David Sabina
• Pages: 245-276

245

Chapter 11

Interpretative Issues Regarding

SR&ED Tax Credits: An Overview

of Recent SR&ED Tax Cases and

Related Implications for Claimants

david sabina*

A. INTRODUCTION

In this chapter, I will examine Tax Court of Canada cases to illustrate some

of the most common interpretation problems concerning Scientif‌ic Re-

search and Experimental Development (SR&ED) tax i ncentives. My goal

is to illustrate the degree of inf‌luence that taxpayers and the courts have

had on the development of the SR&ED tax credit system. Given that we

are dealing with a cross-disciplinary team (i.e., scientists, accountants, and

lawyers), I will focus on the following themes:

an overview of the program itself; •

tax cases dealing with t he “technological eligibility” of projects (i.e., •

scientif‌ic issues); and

tax cases dealing with “f‌inancial eligibility” of t he costs in question •

(i.e., accounting issues).

1) What is the SR&ED Program?

The SR&ED program is an incentive program designed to encourage re-

search and development in Canada, administered by the C anada Revenue

Agency (CRA).

Each year, the CRA receives claims from over eleven thousand compan-

ies participating in the program and provides over $1.8 billion in tax cred-

* I would like to tha nk Laura Pizzale for edit ing assistance.

246 david sabina

its annually, delivered by more tha n f‌ive hundred CRA employees across

Canada. Approximately 70 percent of the claims are from small and med-

ium-sized businesses. Most provincial and ter ritorial governments provide

research and development incentives, either separately or as part of the

federal program.1 Qualifying companies get money back in the form of a

refund, a reduction of taxes payable, or both. If a company is developing

or improving any products, processes, or materials, this work may qualify

for substantial refunds and/or tax credits under the federal government’s

SR&ED program.

2) “Knowledge” Companies and Current Economic Growth

In 1996, the federal government released a report that examined the sources

of growth for t he Canadian economy.2 The results of t hat report, which

were shocking to many, are as follows:

From 1984 to 1994, there was

a net loss of 800,000 full-time jobs in Canada;•

a loss of 1.6 million permanent positions for individuals with second-•

ary school or equivalent education; and

1 CR A website, online: www.cra-a rc.gc.ca (April 2006).

2 Industry Canad a, Science an d Technology for the Ne w Century: A Federal Strat egy (March

1996), online: www.ic.gc .ca/pics/te/e-strat96.pdf.

Net change in employment

Employment changes 1984–94

Type of industry

Interpre tative Issues Regard ing SR&ED Tax Credits 2 47

a gain of 800,000 new jobs for those with post-secondary education, •

particularly within the technica l and scientif‌ic f‌ields.3

This phenomenon has been experienced by virtually all industrialized na-

tions. With respect to promoting SR&ED activities, Canada has one of the

most favourable tax credit systems in the world. The need to reta in and de-

velop a competitive worldwide technical base has been viewed by the Can-

adian government as a necessity for economic growth and prosperity.

3) Program Objectives

Currently, the federal government has three stated objectives for its science

policy:

a) sustainable job creation and economic growth;

b) improved quality of life; and

c) advancement of knowledge.4

With respect to the third criteria, the expanded explanation of the objective

is as follows: “ To create in Canada world centres of excellence in scientif‌ic

discovery; to build a broad base of scientif‌ic inquiry; to foster Canadian par-

ticipation in a ll major f‌ields of science a nd technology; and to ensure that

new knowledge c an be acquired and disseminated widely, from Canadian

sources and from around the world.”5

One way to summarize t he current Canadian SR&ED tax credit system

is to describe it as a “hedged transaction.” By this I mean that the types of

expenses that qualify for credit are mainly Canadian employees, taxable on

their wages, and taxable subcontractors, who must pay Canadian employees

and related income taxes. These types of payments will general ly create

more tax revenue for the CRA than they will pay out in related Investment

Tax Credits (ITCs).

While other types of qua lif‌ied SR&ED expenses, namely foreign ma-

terials and capital equipment, consumed in Canadian SR&ED may create

prof‌its attributable outside Canada, t hey are typically a smaller component

of most claims. The policy objective behind funding these purchases is dir-

ected to t he stated science policy objective of “[ensur ing] that new k now-

ledge can be acquired and disseminated widely, from Canadian sources and

from around the world.”6 Furthermore, certain provinces, such as Quebec,

3 Ibid. at 3.

4 Ibid. at 6.

5 Ibid.

6 Ibid.