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A – LEARNING OBJECTIVES

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0 Scientific Research & Experimental Development Tax Credits

1 A – LEARNING OBJECTIVES
To provide an overview of the SR&ED program To provide an understanding of the key elements of the SR&ED program through the use of examples

2 A – SR&ED – A key part of Canada’s Economic Action Plan
Canada supports world class research and innovation to stimulate productivity, create jobs and grow the economy Business Expenditure on R&D (BERD) is a key measure of innovation Global competition for R&D investment is increasing The federal government invests over $7 billion per year in direct and indirect support for R&D

3 A – SR&ED Program The SR&ED program encourages Canadian businesses of all sizes, and in all sectors to conduct R&D in Canada by providing tax based incentives Canada’s SR&ED program is the largest federal program providing over $3.5 billion in tax assistance in 2010 to nearly 24,000 taxpayers Most provinces have complementary SR&ED tax credit incentives that provide further assistance. These programs generally follow the same guidelines as the federal program The SR&ED tax credit generates net positive economic benefits through spill-over effects

4 A – Benefits of Claiming SR&ED
Deductions for SR&ED expenditures Investment tax credits for qualified expenditures Refundable ITCs for Canadian-controlled private corporations with taxable income and taxable capital in Canada below annual limits

5 A – Who can claim? SR&ED benefits are available to taxpayers that:
Carry on business in Canada Perform eligible SR&ED in Canada that is related to that business Make qualifying SR&ED expenditures and File a claim on prescribed forms before the 18 month filing deadline SR&ED is defined for income tax purposes[1], as follows: “scientific research and experimental development means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is (a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view, (b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or (c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, and, in applying this definition to a taxpayer, [1] in subsection 248(1) of the Act 5

6 A – Recent Trends in the Program
CRA is seeking improved compliance through increased reviews, stringent requirements for supporting evidence and penalties for non-compliant claimants and preparers CRA published policies have been revised Utilization of the SR&ED Program has increased dramatically 2012 budget introduced cut-backs through rate reductions and elimination of capital expenditures SR&ED is defined for income tax purposes[1], as follows: “scientific research and experimental development means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is (a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view, (b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or (c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, and, in applying this definition to a taxpayer, [1] in subsection 248(1) of the Act 6

7 A – SR&ED Legislative Changes - 2012
Reduce the SR&ED investment tax credit rate from 20% to 15% for taxation years ending after 2013 No change to the enhanced 35% credit for eligible Canadian controlled private corporations Exclude capital expenditures from SR&ED deductions and investment tax credits for property acquired after 2013 Exclude lease payments incurred after 2013 Exclude shared-use equipment for capital expenditure incurred after 2013 Reduce the prescribed proxy amount from 65% to 60% for 2013 and 55% for years after 2013 Reduce contract expenditures and third party payments to 80% effective January 1, 2013 SR&ED is defined for income tax purposes[1], as follows: “scientific research and experimental development means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is (a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view, (b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or (c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, and, in applying this definition to a taxpayer, [1] in subsection 248(1) of the Act 7

8 A – Exercise# 1 How does the SR&ED program increase Canadian competiveness on the world scale? Provides direct financial incentives to businesses that perform SR&ED Creates jobs and economic benefits for the country (spill-over effect) Business Expenditures on Research and Development (BERD) drives innovation which increases productivity which in turn increases GDP

9 A – Exercise# 2 Who can claim SR&ED benefits?
Taxpayers that carry on business in Canada Corporation Individuals Trusts Partnerships (general partners only) Must file claims on prescribed forms within filing deadlines

10 A – Exercise# 3 Identify 2 major changes in the SR&ED program that come into effect in 2013 and 2014. Reduce the SR&ED investment tax credit rate from 20% to 15% for taxation years ending after 2013 No change to the enhanced 35% credit for eligible Canadian controlled private corporations Exclude capital expenditures from SR&ED deductions and investment tax credits for property acquired after 2013 - Exclude lease payments incurred after 2013 - Exclude shared-use equipment for capital expenditure incurred after 2013 Reduce the prescribed proxy amount from 65% to - 60% for 2013 and - 55% for years after 2013

11 B – LEARNING OBJECTIVES
How to identify eligible SR&ED To introduce the definition of SR&ED in the Income Tax Act (ITA) To consider the interpretation of SR&ED in CRA policies To apply these rules and guidance to the T661 Part 2 SR&ED is defined for income tax purposes[1], as follows: “scientific research and experimental development means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is (a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view, (b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or (c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, and, in applying this definition to a taxpayer, [1] in subsection 248(1) of the Act 1 11

12 International definition of an R&D project
“For a … project to be classified as R&D, its completion must be dependent on a scientific &/or technological advance, the aim of the project must be the systematic resolution of a scientific and/or technological uncertainty.” Source: Frascati Manual 2002, paragraph 135 Maximum Efficient Use of Knowledge Corporation © 2013

13 International Def’n of Qualified Projects (Scientific Method)
Phase 0: Eligible fields of S&T (OECD) Phase 1: Objectives > “Standard Practice” Phase 2: Variables of Technological Uncertainty Phase 3: “Systematic” Experimentation Putting it all together – the Project template 13

14 B – Evaluating SR&ED Eligibility
The following questions can be used to help determine whether a project should be eligible SR&ED: 1. Has the main technological issue(s) for which a technological advancement is required been identified? 2. Is the work in a field of science or technology not excluded by the ITA 3. Has any potentially eligible work been carried out in the taxation year i.e. experimentation, analyses, trials? 4. In which category or categories would you consider the work to be attempting to achieve the advancement i.e. basic research, applied research, experimental development? 5. How is the work organized and tracked? How can it be claimed to satisfy the eligibility criteria and distinguish it as eligible under the ITA? SR&ED is defined for income tax purposes[1], as follows: “scientific research and experimental development means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is (a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view, (b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or (c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, and, in applying this definition to a taxpayer, [1] in subsection 248(1) of the Act 2 14

15 B – SR&ED Legislation on Eligibility
The Income Tax Act defines SR&ED in subsection 248(1) as: “systematic investigation or search”, that is carried out in a field of science or technology, by means of experiment or analysis and that is: a) Basic Research, b) Applied Research, or c) Experimental Development*, and Includes d) support work *technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes SR&ED is defined for income tax purposes[1], as follows: “scientific research and experimental development means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is (a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view, (b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or (c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, and, in applying this definition to a taxpayer, [1] in subsection 248(1) of the Act 3 15

16 B – Supporting SR&ED Activities
Para 248(1)(d) support activities: Engineering Design Operations research Mathematical analysis Computer programming Data collection Testing and psychological research The support activities claimed must be commensurate with project needs to overcome obstacles and remove technological uncertainties Analysis of inclusions With respect to amounts included in ITA paragraph 248(1) definition of “SR&ED,” (a-d) Generally speaking, the legislation above provides that all work aimed at incremental technical improvements is eligible for credit to the extent that it was “commensurate with the needs” involved with the resolution of some predetermined technical uncertainty. 4 16

17 B – Linked Activities Support activities described in paragraph (d) that are linked to an eligible project can be claimed by: The taxpayer or A related party provided that the work would have been eligible to the taxpayer, had they undertaken the work Use the same project description for support work undertaken by the non-arm’s length company and tick the box for joint R&D – T661 Part 2 Other support activities not described in paragraph (d) can only be claimed by the taxpayer and only if the traditional method is elected 5

18 B – Excluded Work There are certain activities that do not qualify as SR&ED. As set out in subparagraph 248(1), SR&ED does not include work with respect to: Market research or sales promotion Quality control or routine testing of materials, devices, products or processes Research in the social sciences or the humanities Prospecting, exploring or drilling for, or producing, minerals, petroleum or natural gas The commercial production of a new or improved material, device or product or the commercial use of a new or improved process Style changes or Routine data collection Exclusions: (e, h & i) market research, sales promotion and the commercial production are excluded activities to the extent that they extend beyond the resolution of the significant technical uncertainties. Where work which may normally be considered market research involves issues such as the quantification of future project objectives, this work may be eligible SR&ED. (f & k) quality control, routine testing and routine data collection - generally speaking, routine activities are those which can not be considered, “commensurate with the needs, and directly in support of,” the resolution of one or more technical uncertainties. (g) research in the social sciences or the humanities, includes work in any non technical field such as accounting, finance, business studies, economics and psychology to name a few. Some may note that psychological research is mentioned as a potentially supporting activity in paragraph (d) of the legislation. The CRA’s formal position is that this research will be limited to pharmaceutical medical industries where it is tied to other technical or scientific drug studies. (j) style changes include any work aimed at aesthetic improvements rather than objective and verifiable advancements of technical knowledge. 6 18

19 “Defining the SR&ED project” Tax Court vs. CRA Guidance
CRA SR&ED Guidance – the consolidated document Role of the TCC vs. expert witness Tax Court outlines the SR&ED process Defining the “Scientific method” SR&ED project eligibility – TCC vs. CRA requirements Project template (simple view) Step 1a): Ensure proper definition of existing knowledge at the outset Step 1 b): Quantification of objectives vs. standard practice Step 2: Correlate experiments to hypotheses Step 3a): Ensuring work was done “systematically” Step 3b): Clarifying the “technological conclusions / advancements” The CRA recently consolidated its SR&ED rules and procedures into s single document This included a comparison of the - CRA’s 3 eligibility criteria to - The Tax court of Canada’s 5 eligibility questions & - Its recommendations on the “steps required” in the process of recording projects We then examine these directives in the form of a “project documentation template” and examine specific pronouncements by the tax court as to relevant documentation for each of these steps Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge

20 CRA SR&ED Guidance – the consolidated document
December 19, 2012 the CRA released a consolidated document to replace all prior Interpretation Bulletins (IT’s) Information Circulars (IC’s) & Application Policy Papers (APP’s) related to SR&ED credits. While the CRA claims that it does not represent any new policies they do provide clarification on certain issues & remove ambiguities among former documents. Perhaps the most significant “new” analysis is an attempt to correlate; The CRA’s 3 component eligibility criteria to The 5 criteria used by the Tax Court of Canada / Scientific Method On Dec 19, 2012 the CRA consolidated its SR&ED directives into a single document. The CRA claims it does not represent any new policy but does remove ambiguities and provide additional clarification in certain areas. One of the notable clarifications is the comparison of the CRA’s 3 step eligibility criteria to the 5 steps used by the Tax court of Canada. Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge

21 Notable quote “There is nothing wrong with change, if it is in the right direction” - Sir Winston Churchill Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge

22 B – Five Questions for SR&ED Projects
Was there a scientific or a technological uncertainty—an uncertainty that could not be removed by standard practice? Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty? Was the adopted procedure consistent with the total discipline of the scientific method, including formulating, testing, and modifying the hypotheses? Did the process result in a scientific or a technological advancement? Was a record of the hypotheses tested and the results kept as the work progressed? The answer to all five questions must be yes 7

23 Maximum Efficient Use of Knowledge Corporation © 2013
Finally we provide a detailed comparison of The Tax Courts 5 “main questions” to The CRA’s 3 eligibility criteria And illustrate how each of these requirements is addressed and documented in the proposed RDBASE project template. Some of the major additions we feel could be relevant include: A further focus on defining A) The state of standard practice at the outset of the work B) the variables of experimentation & C) The use of the Scientific method We will illustrate that the courts have addressed each of these issues within their pronouncements but on many of these issues the CRA is still silent. Maximum Efficient Use of Knowledge Corporation © 2013

24 B – 1. Was there a scientific or a technological uncertainty—an uncertainty that could not be removed by standard practice? Identify specific technical obstacles encountered in a project to achieve an advance in a product, process or material Identify limitations and constraints of current technology (standard practice) The attempts to overcome these uncertainties should lead to an advance in knowledge. (whether successful or not) 8

25 Step 1a): Definition of existing knowledge at the outset
Northwest Hydraulics CRA position (all work SP) “work described … refers to standard devices and processes, which are routinely used in similar design situations all over the world.” Tax Court Position “It was the innovative combination and alignment of [these] factors that makes this project unique.” We will now examine specific pronouncements by the tax court judges with respect to each of these 5 steps: In the case of NW Hydraulics the CRA argued the work was routine engineering since the claimant had used all of the devices before. The judge disagreed with the CRA position since the claimant proved that the innovative combination and alignment of these devices carried elements of technology uncertainty which went beyond “standard practice” usage . Maximum Efficient Use of Knowledge Corporation © 2013

26 Author’s commentary: The Northwest Case illustrates how CRA officials may deny claims on the basis the project appears to be “routine engineering” without providing support for their position but identification of “variables” for experimentation provide adequate evidence for the TCC US / IRS directives – perhaps CRA can adopt? Patent safe harbour Rebuttal presumption IRS must demonstrate within common knowledge if denied This case outlines the importance of benchmarking the steps taken to review the existing (or standard practice) methods which would be typical for such a project and clarify why they are not applicable to the current environment. Once this step is performed, identifying the variables of uncertainty would provide evidence that that the hypotheses go beyond these standard practice models. Notably in the US SR&ED tax credit system IRS auditors are required to provide evidence of such methods if they intend to deny claims on the basis of standard practice. In the author’s opinion this level of accountability would be a excellent measure for the CRA to adopt as well. Maximum Efficient Use of Knowledge Corporation © 2013

27 Step 1 b): Quantification of objectives vs. standard practice
Sass Manufacturing “Systematic investigation connotes the existence of controlled experiments and of highly accurate measurements and involves the testing of one's theories against empirical evidence. Northwest Hydraulics "Most scientific research involves gradual, indeed infinitesimal, progress.” The cases of Sass Manufacturing and Northwest Hydraulics stress the importance of “extremely accurate measurements” & the expectation of infinitesimally gradual results As such the quantification of objectives becomes the starting point for such work. Maximum Efficient Use of Knowledge Corporation © 2013

28 Initial hypothesis formulation that may provide a solution to problem
B – 2. Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty? Initial hypothesis formulation that may provide a solution to problem Modification of hypotheses through testing and interpretation of results 9

29 Step 2: Correlate experiments to technological uncertainties (hypotheses)
CW Agencies “The word hypothesis in this context is normally considered to mean a provisional concept which is not inconsistent with known facts and serves as a starting point for further investigation by which it may be proved or disproved objectively.” Maritime Ontario Freight Lines “A hypothesis is a tentative assumption or explanation to an unknown problem and, as a rule, this requirement is met by the existence of a logical plan devised to observe and resolve the hypothetical problem.” The pivotal point of the project eligibility concerns the existing of technological uncertainties and related hypotheses to resolve them. The tax courts define “hypotheses” in several tax cases including CW Agencies & Maritime Ontario Freight Lines. These definitions clarify that hypotheses are: Tentative assumptions Based on existing facts For further investigation Maximum Efficient Use of Knowledge Corporation © 2013

30 Identifying “key variables” within “hypotheses”
Northwest Hydraulics “I do not think that conventional engineering would be adequate to deal with the variables and the uncertainties that were inherent in the major disruption and diversion of the flow of the river resulting from the construction” Technological uncertainty is something that exists in the mind of the specialist such as the appellant, who identifies and articulates it and applies its methods to remove that uncertainty.” As illustrated in the case of NW Hydraulics the judge will ultimately examine whether the “variables under experimentation” could have been resolved using the “standard practice’ methodologies. Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge

31 Additional definitions of “scientific hypotheses”
From Wikipedia, the free encyclopedia For a hypothesis to be a scientific hypothesis, the scientific method requires that one can test it. Scientists generally base scientific hypotheses on previous observations that cannot satisfactorily be explained with the available scientific theories. Normally hypotheses have the form of a mathematical model. A working hypothesis is a provisionally accepted hypothesis proposed for further research. Since the tax courts generally look to “generally accepted definitions” to interpret the meaning of words within the legislation we believe the following definitions are relevant to the definition of a “scientific hypothesis.” That “scientific hypotheses” require that one can test them They are based on observations which cannot be explained with existing theories They normally follow mathematical models & Represent a proposed basis for further testing Maximum Efficient Use of Knowledge Corporation © 2013

32 Author’s commentary: Evidence hypotheses via “test matrix.”
This would require the researcher to: Identify the key variables which he/she believes explain the performance Benchmark variables vs. existing models to predict their interaction Rank the variables in order of significance Test the variables to further understand shortfall of the existing models One of the earliest publications on the “science of design” was “Design of Experiments” first published by Sir R.A Fisher in 1935. This books provides guidance on the use of matrices to test the “variables” within theories in what is referred to as DOE model. We have found that strong SR&ED projects are those that can - Identify & rank the variables of uncertainty. Conversely where the research team is unable to identify the “variables” of experimentation it becomes more difficult to prove: The work was done systematically (via controlled experiments) & That it went beyond existing standard practice models. Maximum Efficient Use of Knowledge Corporation © 2013

33 Method of experimentation clearly set out at the onset of the project
B – 3. Was the adopted procedure consistent with the total discipline of the scientific method, including formulating, testing, and modifying the hypotheses? Method of experimentation clearly set out at the onset of the project Demonstrate systematic investigation Work performed by qualified personnel 10

34 Advances understanding of scientific relations or technologies
B – 4. Did the process result in a scientific or a technological advancement? Advances understanding of scientific relations or technologies Search for new knowledge or technical capability Departure from standard practice Resolution of a technical or scientific obstacle 11

35 Step 3b): Clarifying “technological conclusions / advancements”
Rainbow Pipeline “The rejection after testing of an hypothesis is nonetheless an advance in that it eliminates one hitherto untested hypothesis. Much scientific research involves doing just that. The fact that the initial objective is not achieved invalidates neither the hypothesis formed nor the methods used. On the contrary it is possible that the very failure reinforces the measure of the technological uncertainty.” The judge in the Rainbow Pipeline case also commented on evidence of “technological advancement” as required by the income Tax Act. The RDBASE SR&ED Consortium© 2013

36 Documented testing through experimentation or analysis
B – 5. Was a record of the hypotheses tested and the results kept as the work progressed? Documented testing through experimentation or analysis Evidence of results and conclusions 12

37 Step 3a): Ensuring work was done “systematically”
Sass Manufacturing Scientific research must mean the enterprise of explaining and predicting and the gaining knowledge of whatever the subject matter of the hypothesis is. This surely would include repeatable experiments in which the steps, the various changes made and the results are carefully noted.” Step 3 a) To ensure the work was done systematically the judge in Sass manufacturing indicated that the claimant needs to both; Correlate the research to the stated hypotheses & To Keep adequate records of this work. The RDBASE SR&ED Consortium © 2013

38 Step 3a): Ensuring work was done “systematically”
Rainbow Pipeline “What may appear routine and obvious after the event may not have been before the work was undertaken. What distinguishes routine activity from the methods required by the definition of SR&ED …. is not solely the adherence to systematic routines, but the adoption of the entire scientific method, with a view to removing a technological uncertainty through the formulation and testing of innovative and untested hypotheses.” In Rainbow Pipeline the judge also clarified that being “methodical or systematic” was a requirement but not in itself proof of SR&ED . To be systematic investigation as contemplated under the Income Tax Act the judge noted that it must also “follow the entire scientific methods including formulation & testing of untested hypotheses. The RDBASE SR&ED Consortium© 2013

39 B – Defining an SR&ED Project
An SR&ED project comprises a set of interrelated activities that collectively are necessary in attempting to achieve the specific scientific or technological advancement defined for the project by overcoming scientific or technological uncertainty The activities are pursued through a systematic investigation or search in a field of science or technology by means of experiment or analysis performed by qualified individuals 13

40 B – Form T661 Part 2 Prescribed form includes description of each eligible project: Structured format with word limits Preparer / employee information for each project No attachments – all information is contained in RSI bar codes Current version of T661 must be used 14

41 B – Experimental Development Project Descriptions (Section B - T661)
Word limits for project description sections: Line 240 – Advancements – 350 words Line 242 – Obstacles/Uncertainties – 350 words Line 244 – Work Performed – 700 words 15

42

43 Indicate the technological objective
B – Line 240 – What technological advancement(s) were you trying to achieve? Key content: Indicate the technological objective Describe the existing state of knowledge in the applicable field of technology Describe the new or improved capability Indicate how this new or improved capability advanced the existing state of knowledge in the applicable field of technology Explain what knowledge you gained as a result of the work you did, regardless of success or failure 16 43

44 Phase 1: Define “Standard Practice” (The Square )
B Phase 1: Define “Standard Practice” (The Square ) What is known? “Commonly available sources of knowledge or experience are those that can reasonably be assumed to be readily available to those with basic training or experience in the field of concern. These resources enable them to be sufficiently qualified to participate in SR&ED. They also include knowledge that is available in the business context of the firm….An enterprise may not have practical access to information proprietary to a competitor, or known in specialist or academic circles.” [1] “Essentially, the presence of a technological uncertainty puts the project into the realm of experimental development when solutions cannot be based on standard practice alone. A claim for qualifying expenditures should clearly explain all departures from standard practice in the experimental development activity.”[2] “The search for a meaningful advance in the body of scientific or technological knowledge should be present as a guiding element in every eligible project. This requirement is satisfied whether or not the activity is successful. In other words, determining that a hypothesis is incorrect also represents a scientific or technological advance.”[3] [1] CRA IC 86-4R3 – glossary [2] CRA IC 86-4R3 paragraphs 4.3 & 4.4 CRA Guidelines[3] Excerpt from IC 86-4R3 paragraph 2.12 Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge Maximum Efficent Use of Knowledge Corporation ME + U = Knowledge 44

45 TEMPLATE - THREE COMPONENTS OF AN SR&ED PROJECT – STEP 1:
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46 Maximum Efficient Use of Knowledge Corporation © 2013
Notable quote “He who asks a question is a fool for 5 minutes. He who does not ask a question remains a fool forever.” - Chinese proverb Maximum Efficient Use of Knowledge Corporation © 2013

47 B – Line 242 – What technological obstacles/uncertainties did you have to overcome to achieve those advancements? Describe the shortcomings and/or limitations of the current state of technology that prevented you from developing the new or improved capability Describe the technological problems and unknown elements that had to be removed while you attempted to achieve the technological advancement(s) identified in line 240 17 47

48 Phase 2: Technical Uncertainty (Triangle)
B Phase 2: Technical Uncertainty (Triangle) What is unknown? “Specifically, scientific or technological uncertainty may occur in either of two ways: [scientific uncertainty] it may be uncertain whether the goals can be achieved at all ; or [system uncertainty] the taxpayer may be fairly confident that the goals can be achieved, but may be uncertain which of several alternatives (i.e. paths, routes, approaches, equipment configurations, system architectures, circuit techniques, etc.) will either work at all, or be feasible to meet the desired specifications or cost targets, or both of these…Work on combining standard technologies, devices, and/or processes is eligible if non-trivial combinations of established (well-known) technologies and principles for their integration carry a major element of technological uncertainty; this may be called a "system uncertainty.”[1] “If the technological specifications or objectives to resolve the "system uncertainty" are such that the basic design of the underlying technologies must be changed to achieve the integration, the current costs of the overall project may qualify.”[3] [1] CRA IC 86-4R3 paragraph [2] CRA IC 94-2 – SR&ED Machinery & equipment industry application paper [3] Excerpts from CRA IC 86-4R3 paragraph 4.8 – characteristics of SR&ED Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge Maximum Efficent Use of Knowledge Corporation ME + U = Knowledge 48

49 TEMPLATE - THREE COMPONENTS OF AN SR&ED PROJECT – STEP 2:
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50 Maximum Efficient Use of Knowledge Corporation © 2013
Notable quote “They always say time changes things, but you actually have to change them yourself.” - Andy Warhol Maximum Efficient Use of Knowledge Corporation © 2013

51 B – Line 244: What work did you perform in the tax year to overcome the technological obstacles/uncertainties? (Summarize the systematic investigation) Describe only the work that was actually carried out during the tax year and for which you are claiming expenditures in the tax year Describe, in a clear and concise manner, how you attempted to overcome the technological obstacles/ uncertainties that you identified in line 242 Describe, in chronological order, the work done to overcome shortcomings in the underlying technology Clearly demonstrate the systematic nature of the investigation or search and describe the experiments and/or analyses conducted to overcome the obstacles, including the results obtained, their interpretation, and the conclusions made 18 51

52 Phase 3: Systematic Investigation (Circles)
B Phase 3: Systematic Investigation (Circles) What was done? The CRA requires work to be supervised by personnel with appropriate technical backgrounds and clarifies that in describing activities performed. “It must demonstrate the presence of analysis or experiment in the methodology you used to carry out the work. It must also include the results you obtained and the conclusions you made. For example, the types of technical records that are appropriate to support your claim are: ·         an analysis of the problem, ·         internal design documents and drawings, ·         test data and results, & ·         progress reports.”[1] “The improvement of existing technologies or methodologies using well-established "routine engineering or routine development" would be ineligible if the outcome is predictable. However,…if the .. activity is carried out in support of an eligible experimental development project, then the activity is eligible.”[2] Form T4088 – Guide to form T661 [2] Excerpt from IC 86-4R3 paragraph 2.13 Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge 52

53 TEMPLATE - THREE COMPONENTS OF AN SR&ED PROJECT – STEP 3:
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54 Maximum Efficient Use of Knowledge Corporation © 2013
Notable quote “The more original a discovery, the more obvious it seems afterwards.” - Arthur Koestler Maximum Efficient Use of Knowledge Corporation © 2013

55 Realm of Experimental Development
B Realm of Experimental Development The complete picture “An SR&ED project consists of a set of interrelated activities that meet the three criteria of SR&ED defined in the current version of Information Circular 86‑4, Scientific Research and Experimental Development. This means that the set of activities must be necessary for: 1) the attempt to achieve specific scientific or technological advancement and 2) overcome scientific or technological uncertainty, and 3) must be pursued through a systematic investigation by means of experiment or analysis performed by qualified individuals.” The model above represents the three components of an eligible SR&ED project. “Essentially, the presence of a technological uncertainty puts the project into the realm of experimental development when solutions cannot be based on standard practice alone.” Excerpt from IC 86-4R3 paragraph 4.3 “Achieving a technological advance would require removing the element of technological uncertainty through a process of systematic investigation… For an experimental development activity to be eligible the technological advance achieved has only to be slight.” Excerpt from CRA, IC 86-4R3 paragraph 2.13 “In the context of experimental development, scientific or technological advancement is the knowledge acquired in carrying out the SR&ED project, which advances the understanding of the underlying scientific relations or technology. ..For an experimental development activity to be eligible … it must seek to advance the taxpayer's technological knowledge base. The technological advance achieved has only to be slight.” Excerpt from IC 86-4R3 paragraph 2.13 Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge Maximum Efficent Use of Knowledge Corporation ME + U = Knowledge 55

56 Maximum Efficient Use of Knowledge Corporation © 2013 ME + U = Knowledge

57 B – Basic or Applied Research Project Descriptions (Section C – T661)
Word limits for project description sections: Line 250 – Advancement in scientific knowledge – 350 words Line 252 – Work Performed – 700 words 19 57

58 TCC - Role of the “expert witness”
RIS Christie : role of the scientists in determining SR&ED eligibility “What constitutes scientific research for the purposes of the Act is either a question of law or a question of mixed law and fact to be determined by the Tax Court of Canada, not expert witnesses, as is too frequently assumed by counsel for both taxpayers and the Minister. An expert may assist the court in evaluating technical evidence and seek to persuade it that the research objective did or could not lead to a technological advancement. But, at the end of the day, the expert’s role is limited to providing the court with a set of prescription glasses through which technical information can be viewed before being analyzed and weighed by the trial judge.” Before we look at the specific components of an SR&ED project let’s examine the role the TCC in determining SR&ED eligibility: In the case of RIS Christie the judge stated : “What constitutes scientific research for the purposes of the Act is a question of law to be determined by the Tax Court of Canada, not expert witnesses. the expert’s role is limited to providing the court with a set of prescription glasses through which technical information can be viewed before being analyzed and weighed by the trial judge.” Maximum Efficient Use of Knowledge Corporation © 2013

59 B – Line 250 – What advancements in scientific knowledge were you trying to achieve?
Indicate the objective of the project and describe the scientific knowledge that you gained or were attempting to gain with the work you did Explain why the new knowledge gained as a result of your work is an advance relative to the scientific knowledge that was available at the onset of the project, regardless of success or failure Describe how the results of your experiments and / or analyses advanced the understanding of scientific principles, methodologies, or relations 20 59

60 B – Line 252 – What work did you perform in the tax year and how did that work contribute to the advancements described in line 250? (Summarize the systematic investigation) Describe only the work that was actually carried out during the tax year and for which you are claiming expenditures in the tax year Indicate the knowledge gap that existed at the onset of the project that prevented you from achieving your scientific goals Describe the principles underlying the new concepts that will address the inadequacies of the scientific knowledge that existed at the onset of the project Summarize the experiments and/or analyses conducted, including the results obtained, their interpretation, and the conclusions made 21 60

61 B – Evidence to Support the Claim
22 61

62 B – CRA Publications T4088 – Guide to Form T661
Technical eligibility – Eligibility of Work for SR&ED Investment Tax Credits Policy New guidance documents and policies were released on December 19, 2012 23 62

63 B - Exercise #1 What distinguishes “SR&ED” from “research and development”? R&D is a broad category of activities and related costs which often includes market research and analysis, product development, packaging, consumer testing through to product launch, some of which does not qualify as SR&ED and some which may meet the SR&ED criteria Scientific research is basic or applied research for the purpose of achieving new scientific knowledge. Experimental development is undertaken to expand technological capabilities to produce new or improved materials, products or processes. SR&ED is therefore the eligible project within the business project. 24

64 B - Exercise #2 What is a technological obstacle and why is it important in determining eligibility? A shortcoming or limitation in current technology that prevented you from achieving the technological advancement Technological problems that could not be removed through application of existing knowledge or capabilities A distinguishing feature of an SR&ED project is development of a hypothesis to overcome a known technological obstacle which is a barrier to achieving a technological advance. The systematic investigation to overcome the obstacle must be supported by contemporaneous documentation. 25

65 B – Exercise #3 Relate each of the five questions to one of the three criteria. Was there a scientific or technological uncertainty, an uncertainty that could not be removed by standard practice? Criteria of Technological Uncertainty Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty? Criteria of Technological Uncertainty Was the adopted procedure consistent with the total discipline of the scientific method, including formulating, testing, and modifying the hypotheses? Criteria of Technical Content Did the process result in a scientific or a technological advancement? Criteria of Technological Advancement Was a record of the hypotheses tested and the results kept as the work progressed? Criteria of Technical Content 26

66 B – Exercise #4 Turn to the Project Information on page B-20. This sample was published by the CRA. Review T661 Part 2 Section B Lines 240, 242, 244 and consider the eligibility of the project. Discuss in your group. Are the advancements and obstacles clearly defined? Does the work performed section demonstrate systematic investigation? 27

67 New project format & related example – Nov. 10, 2008 -
New word limits for project descriptions: Standard Practice / objectives – 500 words Advancement (uncertainty) – 500 words Activities – 1000 words Sample form with CRA Project example Data Warehouse development The RDBASE.NET R&D Consortium

68

69 Project: Data warehouse improvement
OBJECTIVE: CPU Utilization 95 % busy to 70 % Response Time 60 to 15 seconds Data Compression 5:1 current - 15:1 goal DEPARTURES FROM STANDARD PRACTICE no relevant methods to characterize non- uniform, dynamic data of this environment. The RDBASE.NET R&D Consortium

70 The RDBASE.NET R&D Consortium
Project #6 II) TECHNOLOGICAL ADVANCEMENTS / UNCERTAINTY: Methods to characterize non-uniform data Compressed data blocks vs entire tables to traverse database III) SYSTEMATIC INVESTIGATION 5 separate development activities The RDBASE.NET R&D Consortium

71 Maximum Efficent Use of Knowledge Corporation ME + U = Knowledge

72 Maximum Efficent Use of Knowledge Corporation ME + U = Knowledge

73

74 Maximum Efficent Use of Knowledge

75 Maximum Efficent Use of Knowledge

76 Maximum Efficent Use of Knowledge

77 Maximum Efficent Use of Knowledge

78 Maximum Efficent Use of Knowledge

79

80 The RDBASE.NET R&D Consortium
Technology issues .NET Environment Performance and Scalability: timing issues (deadlocks, races), resource management (memory footprint, garbage collection), exception handling, thread synchronization, responsiveness (startup time, UI load time, response time & refresh rate in web app’s) late binding & reflection (tradeoff - code flexibility vs. safety, runtime performance and scalability) The RDBASE.NET R&D Consortium

81 Concurrency – Multi-Core Processing The RDBASE.NET R&D Consortium
Hot topical areas Concurrency – Multi-Core Processing bugs like races and deadlocks scheduling mechanisms (required) thread affinity (complexity) scalability (effects exaggerated) The RDBASE.NET R&D Consortium

82 A – Software CRA (Canada) focus on “constraints”
· Inter-operability · Conformance to standards · Performance (step response, throughput) · Concurrency · Footprint · Scale-ability · Stability · 3rd party components · legacy requirements The RDBASE.NET R&D Consortium © 2012

83 A – Software IRS (USA) – classify types of work
High Probability of Qualifying Activities Emerging fields - AI, speech, image rendering, Hardware integration, New algorithms &/or Techniques, System level work - O/S's or compilers The RDBASE.NET R&D Consortium © 2012

84 A – Software IRS (USA) – classify types of work
Medium Probability of Qualifying Consortium software, Embedded applications (in cell phones, cars, etc), Functional enhancements to existing software, Utility programs (debugger, backup systems, etc.) The RDBASE.NET R&D Consortium © 2012

85 A – Software IRS (USA) – classify types of work
Low Probability of Qualifying Debugging/QA, GUI or style changes, New certification/validation, Reverse engineering, Vendor products (Cloud services, databases, etc.) The RDBASE.NET R&D Consortium © 2012

86 A – Software IRS (USA) – classify types of work (ineligible)
Activities after commercial production: a) Preproduction planning for a finished business component; b) Tooling up for production; c) Trial production runs; d) Trouble shooting involving detecting faults in production equipment or processes; e) Accumulating data relating to production processes; & f) Debugging flaws in a business component. The RDBASE.NET R&D Consortium © 2012

87 C – ELIGIBLE & QUALIFIED EXPENSES LEARNING OBJECTIVES
Introduction to SR&ED expenditures Treatment of the SR&ED expenditure pool Introduction to the traditional and proxy methods Explanation of the significant differences between the two methods 1

88 C - SR&ED Expenditures & Expenditure Pool
SR&ED expenditures include: Salaries & Wages Materials Subcontractors (80% of contract payments for expenditure after 2012) Lease payments (prior to 2014) Overheads Capital equipment (prior to 2014) Third Party Payments SR&ED expenditures are added to a notional pool which is available for deduction or carried forward The pool is the starting point for the calculation of Qualified Expenditures which earn ITCs 2

89 C - Foreign Expenditures
SR&ED carried on outside of Canada does not create benefits under the program No deduction for capital expenditures No expenditure pool No ITC Limited exception for salaries and wages of Canadian employees working outside Canada 3

90 C - Related To The Business
SR&ED must be related to the business of the taxpayer SR&ED is not a business unless all or substantially all (“ASA”) revenues are derived from SR&ED SR&ED performed by a taxpayer and related to the business of a related corporation is considered to be related to the business of the taxpayer The intention is to provide benefits to performers, not passive investors 4

91 C - SR&ED Expenditure Pool
Current Expenditures (taxation years after 1973) Capital Expenditures (taxation years after 1958) Repayments of assistance in the year and all previous years Recapture of ITCs in previous years Other additions such as pools of amalgamated entities LESS Assistance received, receivable or expected Super-allowance benefits amount ITCs claimed to reduce taxable income or refunded in previous years Amounts previously deducted from the pool Other deductions such as insolvency adjustments EQUALS Balance available for deduction in the year or carry forward indefinitely Negative balance = income 5

92 C – Section B - T661 Sample Calculation of Allowable Expenditures Pool

93 C – Calculation of the pool of deductible expenditures
7

94 C - Method of Claiming Elect each year to use either proxy or traditional method Election is irrevocable, cannot be amended Determines calculation of pool and calculation of Qualified Expenditures Proxy: “directly engaged” salaries and wages, materials, contract payments, lease costs (100% or 50%), no overheads Traditional: “directly attributable” costs including salaries and wages, materials, contract payments, lease costs and other directly attributable and incremental overheads The purpose of section 37 is to permit a taxpayer carrying on business to deduct certain expenditures made in respect of scientific research and experimental development (“SR&ED”). Such expenditures might otherwise not be deductible either because of the possibility that they could be held not to have been incurred for the purpose of gaining or producing income, as provided in paragraph 18(1)(a), or on the basis that they were capital expenditures the deductibility of which is prohibited by paragraph 18(1)(b). Subsection 37(1), which applies where the taxpayer carries on a business in Canada, provides a deduction in respect of both current and capital expenditures on SR&ED in Canada, while subsection 37(2) permits a more limited deduction in respect of any business for SR&ED expenditures of a current nature made outside Canada. Under subsection 37(1) the expenditures made may be deducted in a subsequent taxation year, provided that the taxpayer carries on a business in Canada in the year. 8

95 C - Eligible SR&ED Expenditures Under The Traditional Method
Current Expenditures Expenditures ASA attributable to the prosecution of SR&ED or to the provision of premises, facilities or equipment for the prosecution of SR&ED in Canada Expenditures directly attributable, as determined by regulation, to the prosecution of SR&ED or to the provision of premises, facilities or equipment for SR&ED in Canada No lease payments after 2013 Capital expenditures ASA for the provision of premises, facilities or equipment for SR&ED No capital expenditures after 2013 9

96 C - Eligible SR&ED Current Expenditures Under The Traditional Method
The portion of salaries and wages of employees who directly undertake, supervise or support SR&ED The cost of materials consumed or transformed in the prosecution of SR&ED Payments to contractors for SR&ED performed on behalf of the taxpayer Prior to 2014, the cost of leasing SR&ED equipment used ASA for SR&ED or Pro rata share of cost of leasing equipment used partly for SR&ED, and Overheads (directly related and incremental) 10

97 C - Eligible SR&ED Current Expenditures Under The Proxy Method
Salaries and wages of employees directly engaged in SR&ED Materials consumed or transformed in the prosecution of SR&ED Payments to contractors for SR&ED performed on behalf of the taxpayer Until 2014, cost of leasing SR&ED equipment (other than general purpose office equipment and furniture (GPOEF) used ASA for SR&ED) 50% of cost of leasing equipment (not GPOEF) used at least 50% for SR&ED (until 2014). No “overhead or other expenditures” in the claim 11

98 C - Adjustments - Expenditure Pool
The expenditure pool starts with current and capital expenditures and is then adjusted for several amounts Deductions: Government & non-government assistance including provincial ITCs Federal ITC claimed in the prior year Proceeds of the sale of capital assets previously claimed as SR&ED Additions: Recapture of ITC paid in the previous year Repayments of government assistance previously deducted from the pool 12

99 C - Unpaid Amounts Unpaid amounts = expenditures incurred in a year that have not been paid 180 days after year-end For the purposes of calculating SR&ED Expenditures: Unpaid salaries, wages and other remuneration must be reported in year incurred but are not deductible until paid Unpaid amounts other than salaries, wages and other remuneration are deductible in the year incurred (no restrictions) but will not earn ITCs until paid 13

100 C – Prepaid Expenditures
Prepaid amounts considered incurred in the year Third Party Payments to approved research institutes, universities and non-profit R&D corporation are added to the pool when incurred Except non-arm’s length payments which are not added until paid Prepaid amounts not considered incurred in the year In-house expenditures and contract SR&ED payments Third Party Payments to corporations resident in Canada (other than non-profit R&D corporations) Other Third Party Payments to non-arm’s length parties These amounts are not added to the pool until the services are rendered 14

101 C – Exercise #1 What are the main differences between the proxy method and the traditional method? Proxy: the proxy method provides a notional amount in lieu of overhead amounts such as indirect salaries and wages, supplies, facilities maintenance, administrative costs and other variable direct costs that are related to the SR&ED The proxy method includes: Directly engaged salaries and wages, 100% or 50% of lease costs, and actual 5 The proxy method does not include overhead amounts including indirect salaries and wages and other amounts that may be related to the SR&ED but are not included in the eligible expenditures for this method Contract payments and materials costs are the same under both methods 15

102 C – Exercise #1 What is the main difference between the proxy method and the traditional method? Traditional: the traditional method includes all incremental and directly attributable expenditures, including: directly engaged salaries and wages, plus other salaries and wages for staff that support the SR&ED, administrative, maintenance, shop floor, supervisory the SR&ED share of allocated overheads and other incremental expenditures Traditional method includes all directly attributable amounts including: Directly engaged salaries and wages, plus other salaries and wages for staff that support the SR&ED, administrative, maintenance, shop floor, supervisory The SR&ED share of allocated overheads and other incremental expenditures 16

103 C – Exercise #2 What amounts are deducted from the expenditure pool in the year and why? The main adjustments to the expenditure pool are: investment tax credits applied or refunded in the previous year and government and non-government assistance received, receivable or expected to be received These amounts are deducted from the expenditure pool in order to bring them into taxable income. Investment tax credits are taxable in the year after they are used. Government assistance, such as grants and subsidies and provincial investment tax credits, is taxed when it is reasonably expected that it will be received. In the case of provincial ITCs, that occurs in the year that the related expenditures are incurred. 17

104 C – Exercise #3 Turn to HCL case study in Appendix I.
List the current expenditures that will be added to the SR&ED expenditure pool for the year: See T661 – labour, materials, contract payments (Appendix II) T661 p.4 of 7 lines 18

105 C – Exercise #3 Turn to HCL case study in Appendix I.
List the capital expenditures that will be added to the SR&ED expenditure pool for the 2013 year: Appendix II T661 p.4 of 7 line 390 19

106 D – LEARNING OBJECTIVES
To introduce the investment tax credit rates and rules To introduce the Expenditure Limit To introduce the calculation of Qualified Expenditures See table on D-3 1

107 D – Investment Tax Credits
Basic federal (20% non-refundable) –15% after 2013 Corporations, General Partnerships, Individuals and Trusts Enhanced credits (35% refundable) available to eligible CCPC’s on SR&ED expenditures of up to $3,000,000 per year Carryback 3 years, carry forward 20 years See table on D-3 2

108 D – Investment Tax Credits
Business Type Credit Rates Refund Rates (portion of the ITC that is refundable) Current and Capital 5 Current Expenditures Capital Expenditures Unincorporated Businesses 20/15 6 40 CCPCs with prior-year taxable income: - of $500,000 or less: Expenditures up to expenditure limit1 Expenditures over expenditure limit4 - between $500,000 and $800,000: Expenditures up to expenditure limit2 35 20 100 CCPCs with prior-year taxable capital employed in Canada: - of $10 million or less: Expenditures up to expenditure limit3 -between $10 million and $50 million All Other Corporations 1. Expenditure limit is generally $3 million per annum for the "associated group of companies" (i.e. all companies under common control). 2. Expenditure limit for CCPCs is phased out for prior-year "group" taxable income between $500,000 and $800,000 (prior year limits for 2010 and later) 3. Expenditure limit for CCPCs is phased out for prior-year taxable "group" capital employed in Canada between $10 million and $50 million (prior year limits for 2008 and later) Ontario and Quebec include foreign or public companies and use ranges of $25 and $50 million for phasing out their enhanced credits to "Qualified Corporations". 4. Refunds are available only if taxable income is $500,000 or less. 5. Capital expenditures are eliminated after 2013. 6. 20% reducing to 15% on January 1, 2014. 3

109 D – Enhanced Rates for CCPC
35% ITC rate on all qualified expenditures up to the expenditure limit Fully refundable for current expenditures 40% refundable for capital expenditures 20% ITC rate on all qualified expenditures in excess of the expenditure limit reducing to 15% effective January 1, 2014 40% refundable for qualifying CCPCs and qualified partnerships 4

110 D – Canadian Controlled Private Corporation (CCPC)
Definition: Canadian private companies that are not controlled by ‘public corporations’ and/or ‘foreign parties’ Qualified CCPC Taxable income under $500,000 and Taxable capital employed in Canada (TCEC) under $10 million Based on prior taxation year Include all associated corporations in Canada 5

111 D – Expenditure Limit Maximum is $3,000,000 per year
Adjusted for short taxation years Allocated among associated corporations each year The expenditure limit is reduced as a company grows, i.e.: Prior year taxable income between $500,000 and $800,000 Prior year taxable capital in Canada between $10 million and $50 million 6

112 D – Expenditure Limit Eliminated if:
a) Taxable income exceeds $800,000 or b) Taxable capital is greater than $50 million Determined by formula that calculates impact of taxable income and taxable capital on the expenditure limit 7

113 D – Calculation of the Expenditure Limit
For tax years starting after Feb 25, 2008, formula for the expenditure limit is: ($x million - 10A) × ($40 million - B)/$40 million X = $ 8 million A= greater of $500,000 and prior year taxable income B = nil if taxable capital < $10 million, otherwise lesser of Taxable capital employed in Canada minus $10 million, and $40 million 8

114 D – SRED Income Phase Out Example
9

115 D – Expenditure Limit Phase Out on Taxable Income
Credit on $3M of current expenditures in 2013 (assumes taxable capital of associated group in prior year was below $10M in 2012) 2012 Tax Income (Preceding Year) 2013 Expenditure Limit Total Credit Earned on $3 million Maximum Refundable ITC Non-Refundable ITC (20% prior to 2014) $500,000 $3,000,000 $1,050,000 $0 600,000 2,000,000 900,000 700,000 200,000 1,000,000 750,000 350,000 400,000 800,000 10

116 D – SR&ED Capital Phase Out Example
11

117 D – Expenditure Limit Phase Out on Taxable Capital
Credit on $3M of current expenditures (Assumes taxable income in prior year was below $500,000. There are no refunds for companies with taxable income over $500,000) 2012 Taxable Capital ($ millions) (Preceding Year) 2013 Expenditure Limit Total Credit Earned on $3 million Maximum Refundable ITC Non-Refundable ITC (20% prior to 2014) $ 10.0 $ 3,000,000 $ 1,050,000 $ 1,050,000 $ 20.0 2,250,000 937,500 787,500 150,000 30.0 1,500,000 825,000 525,000 300,000 50.0 600,000 12

118 D – Example of the 2013 Expenditure Limit
2012 Taxable income $400K; A = $500K 2012 Taxable capital $9 million; B = nil ($8 million - 10A) times (($40 million - B) divided by $40 million) $8 million less (10 * $500K) = $3 million Times ($40 million less $nil)/$40 million = 1 Expenditure limit = $3 million 13

119 D – Example of the 2013 Expenditure Limit
2012 Taxable income $750K; A = $750K 2012 Taxable capital $20 million; B = $10 million ($8 million -10A) times (($40 million – B) divided by $40 million) $8 million less (10 * $750K) = $500K Times ($40 million less $10 million)/$40 million = .75 Expenditure limit = $375,000 14

120 D – Taxation of SR&ED Tax Credits
Federal ITCs Taxed in the year after they are refunded or used to reduce taxes payable Provincial ITCs Taxed in the year earned Effected through a deduction from the SR&ED expenditure pool 15

121 D – Recapture of Investment Tax Credits
ITC Recapture applies where: Property is claimed as Qualified Expenditure (materials transformed or capital assets) Property is later sold or converted to commercial use Recapture of ITC on property acquired Increases Part I tax (federal) or provincial taxes payable (where applicable) Reverses the deduction of ITC from SR&ED expenditure pool and iincreases eligible expenditures in the following year Recapture both federal and provincial ITC (some exceptions apply) 16

122 D – Qualified Expenditures
Qualified Expenditures that earn investment tax credits include: amounts re: shared use equipment (prior to 2014) SR&ED expenditures – current SR&ED expenditures – capital (prior to 2014) prescribed proxy amount for overheads; Do not include prescribed expenditures and used capital equipment payments to non-arm’s length persons for SR&ED performed on behalf of the taxpayers payments to non-taxable suppliers (other than for expenditures such as materials, capital assets) qualified expenditures that have been paid for by government assistance or non-government assistance or compensated by SR&ED contract payments 17

123 D – Prescribed Proxy Amount (PPA)
Proxy election is optional Proxy election is annual Election must be filed with first filing of the T661, before the 18 month deadline and cannot be amended later Notional amount for overheads For calculation of ITC only Not treated as an SR&ED expenditure Actual overheads are deducted as business expense 18

124 D – Prescribed Proxy Amount Salary Base
Salaries and wages of employees directly engaged in SR&ED Salary base: PPA = prescribed % of salary base: excludes taxable benefits excludes bonuses or remuneration based on profits excludes deemed payments special limits for specified employees PPA calculation is 65% and prior; 60% in 2013; 55% in 2014 and subsequent years 19

125 D – Overall Cap on Prescribed Proxy Amount
Regulation 2900(6) limits PPA to Amount of total business expenses Less specified adjustments Proxy Cap is the amount of non-SR&ED expenditures, less rent, interest, CCA and other prescribed expenditures 20

126 D – Payments to Non Taxable Suppliers
Payments to persons who are not Taxable Suppliers are excluded from the definition of Qualified Expenditures Payments made for an expenditure in respect of SR&ED directly undertaken by the taxpayer (e.g., Salaries and wages and materials purchases) are NOT excluded from the definition of Qualified Expenditures 21

127 D – Taxable Supplier Definition
Person resident in Canada Canadian partnership Non-resident person or partnership with permanent establishment in Canada Extends to amounts paid for benefit of person who is not a taxable supplier 22

128 D – Non-Arm’s Length Contracting
Payments to persons that are providing SR&ED services and that do not deal at arm’s length are excluded from the definition of Qualified Expenditures Payer adds NAL contract payments to pool but full amount is deducted from calculation of Qualified Expenditures 23

129 D – Purchasing Goods or Services from Non-Arm’s Length Parties
Payments for goods and services provided by non-arm’s length parties may be subject to adjustment: Goods - capital cost is lesser of: Actual expenditure incurred and Adjusted selling cost to supplier Services - expenditure is lesser of: Adjusted service cost to supplier Covered in detail in Module H 24

130 D – Adjusted Cost Adjusted Selling Cost Adjusted Service Cost
Actual cost to supplier less Mark-ups charged by NAL sub-suppliers Bonuses or profit sharing to NAL parties Government or non-government assistance Adjusted Service Cost Profit on services acquired by supplier from NAL sub-supplier Profit on goods acquired by supplier from NAL sub-supplier Bonus, or profit share to NAL party 25

131 D – Prescribed Expenditures Excluded
Current Expenditures Administration salaries (except portion attributable to SR&ED) Legal or accounting fees Interest or other financing costs Entertainment Advertising or selling expenses Conference or convention expenses Dues or membership fees Fines or penalties Maintenance and upkeep of premises facilities or equipment (except portion attributable to SR&ED) Capital Expenditures excluded from Qualified Expenditures Capital expenditures which do not meet the ASA (90%) test or the primary (more than 50%) shared-use test Used capital equipment Qualified property – manufacturing and processing equipment After 2013, no capital expenditures allowed 26

132 D – Other Excluded Expenditures
Rights to SR&ED Expenditures deductible as donations Expenditures reimbursed by Canadian government or municipality Expenditures recovered from a non-resident where the payment is deductible against Canadian taxable income 27

133 D – Reduction for Assistance and Arm’s Length Contract Payments
Qualified Expenditures reduced by Government Assistance Non-Government Assistance Canadian sourced payments for SR&ED performed on behalf of a customer Qualified Expenditures not reduced by Foreign sourced payments for SR&ED performed on behalf of a customer 28

134 D – Arm’s Length Contract Payments – Qualified Expenditures
Contract Payments Made Addition to SR&ED Expenditure Pool (100% of eligible portion) Addition to Qualified Expenditures (80% after 2012) Contract Payments Received Reduction to Qualified Expenditures Contract payments treated as business income for tax purposes No reduction of expenditure pool After 2012, any capital property included in the contract amount must be disclosed and excluded from the SR&ED expenditures of the payer 29

135 D – Payments from Non-Residents
Qualified Expenditures are NOT reduced by foreign sourced contract payments Amounts received from non-residents are - Excluded from the definition of Contract Payments - Do not reduce qualified expenditures, unless - Payer is a reporting entity in Canada and entitled to deduct the payment 30

136 D – Unpaid Amounts Amounts unpaid 180 days after year-end
Expenditure deemed not to have been incurred in the year Expenditure is deemed to be incurred when paid Investment tax credit earned when expenditure deemed incurred No proxy on unpaid salaries and wages Pg. D-3 to D-29 = T4088 Re qualified experiments 31

137 D – Exercise #1 What is the basis for calculation of the investment tax credit? Qualified expenditures start with eligible current and capital expenditures, plus the prescribed proxy amount and SUE equipment Deduct contract payments received Deduct government and non-government assistance received, receivable or expected to be received Add/deduct qualified expenditures from/to a related company 35% on the expenditures up to the expenditure limit – if taxable capital is >$10M but less than <$30M in 2009, the expenditures limit is $1.5M. (see pg D-8) 32

138 D – Exercise #2 What is the ITC rate for a qualified CCPC with $1.5 million of qualified expenditures in 2013 and taxable income of $500,000 in 2012? 35% on expenditures up to the expenditure limit. if taxable capital was less than $10 million in 2012, the expenditure limit is $3 million. If taxable capital was $30 million in 2012, the expenditure limit would be $1.5 million, equal to the qualified expenditures. What is the ITC rate in 2014, using the same fact pattern? No change for CCPC. Rate is still 35%. Rate on amounts over the expenditure limit is 15%. Qualified expenditures start with eligible current and capital expenditures, add the prescribed proxy amount and SUE equipment 35% on the expenditures up to the expenditure limit – if taxable capital is >$10M but less than <$30M in 2009, the expenditures limit is $1.5M. (see pg D-8) 33

139 D – Exercise #3 What is the base for calculation of the PPA?
- PPA stands for prescribed proxy amount. - The salary base for calculating the PPA is the total directly engaged salaries and wages for the year, excluding bonuses and taxable benefits. There is a cap on the PPA for specified shareholders (see Module F) as well as an overall cap on the PPA which will be covered in Module D. 34

140 D – Exercise #4 What is the actual calculation of the PPA in 2013? What is the calculation for 2014? The salary base times 60% in 2013 and 55% in 2014. The PPA is subject to a cap (see pg. D-17). The salary base is directly engaged salaries and wages, excluding bonuses and benefits, subject to a limit for specified shareholders which will be covered in Module F The salary base times 65% The PPA is subject to a cap (see pg. D-15) 35

141 D – Exercise #5 Turn to the HCL case study in Appendix I.
What rate of ITC will HCL earn in 2013? 35% refundable – qualified CCPC, no associated corporations Should HCL elect to file a proxy or traditional claim? No information on overheads – claim 60% of directly engaged labour Did HCL make any contract payments that are qualified expenditures? What % of contract payment is eligible in 2013? 2 arms length contract payments 80% eligible in 2013 (excludes any portion related to capital property) Was any ITC claimed in 2012 (the prior taxation year)? - Yes. This amount must be deducted from the expenditure pool in 2013. 36

142 E – LEARNING OBJECTIVES
To understand the scope of provincial tax incentives for SR&ED To introduce the main features of the programs in each jurisdiction 1

143 E – Provincial SR&ED Incentives
Province Rate Refundable Newfoundland & Labrador 15% Yes Nova Scotia New Brunswick Prince Edward Island n/a Quebec 17.5% % Ontario 10%1 4.5% No Manitoba 20% Partially Saskatchewan Conditionally Alberta 10% Yes2 British Columbia Yukon 15%3 North West Territories (NWT) Nunavut 2

144 Maximum Efficient Use of Knowledge Corporation © 2013

145 Maximum Efficient Use of Knowledge Corporation © 2013 ME + U = Knowledge

146 E – British Columbia 10% tax credit in respect of SR&ED activities carried out in BC Corporation must have a PE in BC Available to corporate partners other than specified members Not available to individuals, trusts or corporations that are exempt from tax Refundable for CCPC’s on qualified expenditures up to the federal expenditure limit Otherwise non-refundable Apply non-refundable credits to BC taxes payable in the year Carry-back unused credits to previous 3 years or carry-forward 10 years Recapture rules apply Ability to renounce to non-refundable tax credits Must file within 18 months after the year end 3

147 E – Alberta 10% refundable tax credit up to $400,000 per year
In respect of SR&ED activities in Alberta after December 31, 2008 Corporation must have a PE in Alberta Available to all corporations that carry on R&D in Alberta Not available to partnerships, individuals or trusts Must file within 15 months after the corporation’s filing due date of the corporate income tax return for the year Recapture rules apply 4

148 E – Saskatchewan Prior to March 19, 2009: 15% non-refundable tax credit Between March 19, 2009 and April 1, 2012: 15% fully refundable tax credit – no cap After March 31, 2012: 15% refundable tax credit only for CCPC’s on qualified expenditures up to the federal expenditure limit ($3 million) Otherwise 15% tax credit non-refundable Available only to corporations, including corporations that are beneficiaries of a trust and corporations that are members of a partnership, with a PE in Saskatchewan in respect of SR&ED activities carried out in Saskatchewan, except for tax-exempt corporations Non-refundable credits to be applied against Saskatchewan taxes Carry-back unused credits three years or carry-forward ten years Recapture rules do not apply Ability to renounce to non-refundable tax credits No filing deadline 5

149 E – Manitoba 20% ITC – phase-in of refundability:
Prior to 2010 – non-refundable tax credit, ability to renounce if no benefit 2010 – introduced refundable ITC for expenditures on contracts with eligible institutions in Manitoba 2011 – 25% of the ITC becomes refundable for in-house SR&ED expenditures in addition to the fully refundable ITC on contracts with eligible institutions in Manitoba 2012 – refundability for in-house SR&ED ITC’s increased from 25% to 50% Available to all corporations with a PE in Manitoba in respect of SR&ED activities carried out in Manitoba Available to corporations through partnerships or trusts, but not available to individuals Carry-back unused credits three years or carry-forward up to ten years Recapture rules do not apply Ability to renounce to non-refundable tax credits Must file within 18 months after the year end 6

150 E – Ontario Innovation Tax Credit
10% refundable tax credit; maximum annual refund is $300,000 Available to all corporations with a PE in Ontario including CCPC, public company, foreign controlled company for SR&ED performed in Ontario, except for tax-exempt corporations Must be eligible for federal SR&ED tax credit Expenditure limit of $3 million is reduced when, for an associated group of corporations, the: prior year taxable income is greater than $500,000 and less than $800,000 prior year taxable capital is greater than $25M and less than $50M Recapture rules do not apply No filing deadline 7

151 E – Ontario Research & Development Tax Credit
4.5% non-refundable tax credit Available to all corporations with a PE in Ontario for SR&ED performed in Ontario, except for tax-exempt corporations Must be eligible for federal SR&ED tax credit No cap and no filing deadline Incurred in Ontario in taxation years ending after December 31, 2008 OITC reduces expenditures eligible for ORDTC Carry-back unused credits three years or carry-forward up to twenty years Recapture rules apply Ability to renounce to the ORDTC Harmonization: Tax credit to reduce Ontario tax; or Tax debt to increase Ontario tax 8

152 E – Ontario Business - Research Institute Tax Credit
20% refundable tax credit on Qualified Expenditures under eligible contracts Eligible Research Institutes (ERIs) must be approved The annual qualified expenditure limit is $20 million for an associated group of corporations Available to all corporations or corporate members of a partnership with a PE in Ontario, except for tax-exempt corporations Must be eligible for federal SR&ED tax credit Can be combined with the OITC for 30% benefit No filing deadline Harmonization: Tax credit to reduce Ontario tax; or Tax debt to increase Ontario tax 9

153 E – Québec Tax credit for Salaries and Wages (R-D)
Employees of the taxpayer and contractors working in an establishment situated in Quebec; Taxpayer does not require a PE in Quebec Eligible expenditures for the Quebec R-D ITC are: Salaries of employees who performed R&D in Quebec Payments made to contractors to perform R&D in Quebec on behalf of the taxpayer – portion of the remuneration of a contractor represented by salaries in Quebec 50% of contract fees paid to an arm’s-length contractor The amount paid that may reasonably be attributed to wages paid by a non-arm’s-length contractor Amounts paid to subcontractors (2nd level of contractor) are not eligible Recapture rules do not apply Must file within 18 months after the year end 10

154 E – Québec 17.5% tax credit on eligible salaries for SR&ED performed in Quebec Higher tax credit on the first $3M of eligible salaries for the year for corporations with: Prior year assets less than $50M - ITC = 37.5% Prior year assets between $50M and $75M - ITC decreases pro-rata to 17.5% Associated corporations: Worldwide assets are consider in the formula to determine the ITC rate Sharing of the $3 million expenditure limit and the $50-$75 million asset test on a worldwide basis 11

155 E – Québec Examples based on corporation’s assets in $ millions
(Only for corporation not controlled by non-Canadian residents) Rates Less than $50.0 37.5% Equal to $50.0 Equal to $55.0 33.5% Equal to $60.0 29.5% Equal to $65.0 25.5% Equal to $70.0 21.5% Equal to $75.0 17.5% 12

156 E – Québec – Other Tax Credits
• University research contract • Private partnership pre-competitive research • Research consortium fees • Tax exemption for foreign experts and researchers • Development of E-business • Biotechnology development centres • Multimedia titles • Design activities 13

157 E – Atlantic Canada 15% refundable credit in Newfoundland and Labrador, Nova Scotia and New Brunswick Available to corporations with a PE in the Province for SR&ED carried out in the Province Also available to individuals (only in Newfoundland), trust and partnerships Must file within 18 months Recapture rules apply (only in Nova Scotia and New Brunswick) Note - no credit in Prince Edward Island 14

158 E – Yukon 15% refundable credit in Yukon Territory
20% refundable credits for payments to Yukon College Available to corporations with a PE in the Yukon for SR&ED carried out in the Yukon Also available to individuals, trust and partnerships Must file within 18 months No recapture Note – no SR&ED programs in NWT or Nunavut 15

159 E – Exercise #1 Which province has the highest ITC rate for SR&ED refunds? Quebec has the highest rate of refundable credits (37.5% with no annual cap), and the program is available to all companies that make contract payments for SR&ED carried on in Quebec, even if they do not have a permanent establishment in the province. Manitoba is next with a 20% ITC rate. For corporations that carry on in-house SR&ED, these credits are 50% refundable. 16

160 E – Exercise #2 Describe the method by which provincial investment tax credits are taxed? Provincial ITCs are taxed as government assistance in the province, other than in Quebec. All provincial ITCs reduce the federal expenditure pool as government assistance. Note that non-refundable provincial tax credits can be renounced in order to avoid a reduction of federal ITCs which can be refunded or applied to reduce taxes payable. 17

161 E – Exercise #3 Refer to HCL case study in Appendix I. In which provinces will HCL claim investment tax credits? HCL has employees in BC, Alberta and Ontario which are presumed to create a permanent establishment. They also pay a contractor in Quebec. Therefore HCL will claim ITCs in each of these 4 provinces. 18

162 F – LEARNING OBJECTIVES
To understand the treatment of salary and wages under both the proxy method and the traditional method To introduce the calculation of the prescribed proxy amount 1

163 F - Salaries & Wages Significant portion of most SR&ED claims
Includes SR&ED portion of: Basic salary/wages & vacation pay/accrual Bonus (unless specified employee) Taxable benefits paid Does not include: Related benefits (company share of CPP, EI, WCB) Non-taxable benefits (health plan) Staff termination payments/retiring allowances (some exceptions) Notional benefits such as stock options and deemed interest on loans 2

164 F - Directly Engaged - Proxy
Directly engaged salaries and wages includes: Preparing equipment and material for experimentation and analysis Experimentation and analysis Technical support work - engineering, design operations research, non-routine data collection and testing that is directly in support of SR&ED Supervisors/management performing SR&ED Supervision/management of the above (first line supervision) Technical documentation 3 164

165 F – Prescribed Proxy Amount
65% of salary base (60% in 2013 and 55% in 2014) Salary base: salaries and wages of employees directly engaged in SR&ED less taxable benefits under s.6 or s.7 less bonuses or remuneration based on profits less deemed payments under s.78(4) 4 165

166 F - Directly Attributable (Traditional)
Directly attributable salaries and wages include: Salary and wages of employees that directly undertake, supervise or support the prosecution of SR&ED Salary and wages relating to clerical support and administrative support to the extent costs are incremental to the prosecution of SR&ED 5

167 F - Retirement Allowances / Termination Payments
Retirement Allowances/Termination Payments - For SR&ED purposes, treatment varies based on whether using traditional or proxy method Traditional Method A retiring allowance may be allowed as “Overhead or other expenditure” that is either “ASA attributable” or “directly attributable” to the prosecution of SR&ED in Canada Proxy Method A retiring allowance is not an allowable SR&ED expenditure – covered by proxy amount [Application policy ] 6

168 F - Specified Employee Specified employee owns 10% or more of shares (includes related S/H) Eligible salaries and wages for expenditure pool Limited to 5 times YMPE In calculating the proxy amount, the salary of a Specified Employee is limited to the least of: SR&ED portion of salary and wages 2.5 times YMPE 75% of total salary and wages Cap applies to the sum of salaries and wages received from an associated group of companies 7

169 Maximum Efficient Use of Knowledge Corporation © 2013

170 Maximum Efficient Use of Knowledge Corporation © 2013 ME + U = Knowledge

171 F - Example re Specified Employee (2012)
8

172 F - Example re Specified Employee (2013)
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173 F – SR&ED Salaries and Wages Example – no vacation, no sick leave
Page F-13 Year 1 — Directly engaged salary calculation: 125 days SR&ED Salary expense 12 months (January 1 to December 31) x $10,000 = $120,000 Accrued vacation expense (considered reasonable) — $9,600 Total — $129,600 Year 1 — Directly engaged portion: 125 / 250 days x $129,600 = $64,800 10

174 F - SR&ED Salaries and Wages Example – 40 days vacation, no sick leave
Page F-14 Year 2 — Directly engaged salary calculation: 168 days SR&ED Salary expense 10 months (January, April, and May 1 to Dec 31) x $10,000 = $100,000 Vacation expense (considered reasonable) — $9,600 Total — $109,600 Year 2 — Directly engaged portion: 168 / 210 days x $109,600 = $87,680 11

175 F - SR&ED Salaries and Wages Example – no vacation, 125 days sick leave
Page F-14 Year 3 — Directly engaged salary calculation: 42 days SR&ED Salary expense 6 months (January 1 to June 30) x $10,000 = $60,000 Sick leave expense — $60,000 Accrued vacation expense (considered reasonable) — $4,800* Total — $124,800 Year 3 — Directly engaged portion: 42 / 125 days x $74,400** = $24,998 12

176 F - Documentation T4 information / payroll records, if fiscal years not ended on December 31st Time sheets & Time tracking reports showing time spent on eligible SR&ED activities Project records, laboratory / engineers notebooks Progress reports, minutes of project meetings Analysis of time on ineligible activities Document approach taken in completing SR&ED salary calculations 13

177 Recommend details for SR&ED timesheet templates
Maximum Efficient Use of Knowledge Corporation © 2013

178 F - Salaries and Wages Outside Canada
Some foreign activities may be claimed: Salaries and wages of employees working outside Canada Employees resident of Canada and not taxed outside Canada Foreign work is an integral part of Canadian SR&ED project Amount is capped at 10% of Canadian SR&ED salaries and wages 14

179 F - Salaries and Wages Outside Canada
Example: Eligible engineering work in Canada: $ 225,000 Eligible engineering work outside Canada: $ 9,000* Total SR&ED salaries and wages: $ 234,000 * The $9,000 for SR&ED outside Canada is an eligible SR&ED expenditure. The total spent on activities outside Canada is less than 10% of the SR&ED salaries and wages for SR&ED in Canada ($225,000 x 10%=$25,000 cap). 15

180 F - Unpaid Amounts Accrued SR&ED salary and wages must be paid within 180 days of year-end If unpaid, amounts deemed not to have been incurred until year when payment made Amounts deemed incurred will be added to expenditure pool Not included in salary base for purposes of calculating proxy amount 16

181 F - Planning for Integration
Salaries vs. Dividends? Reduce taxable income to earn more refundable tax credits? If the bonus reduces taxable income and creates expenditure limit then there is an advantage to bonusing down. Otherwise neutral between bonus and eligible dividends 17

182 F – Exercise #1 Turn to the HCL case study in Appendix I. Calculate the SR&ED directly engaged salaries and wages. 18

183 F – Exercise #2 Are there any specified employees of HCL?
Specified employees are defined as employees that are shareholders of 10% or more of the shares of the company, or persons related to such shareholders. John Komb is a specified shareholder as he holds 65% of the Common Voting Shares of the Company. No other employees are identified as shareholders or relatives of shareholders. 19

184 F – Exercise #3 What are the special considerations for calculating the SR&ED salaries and wages of specified shareholders? Limit on eligible expenditures – 5 times YMPE Limit on salary base for prescribed proxy amount – 2.5 times YMPE Exclude bonuses and benefits from expenditures and PPA 20

185 F – Exercise #4 Calculate the prescribed proxy amount for HCL. 21

186 G – LEARNING OBJECTIVES
• To introduce the rules regarding materials consumed and materials transformed • To understand the treatment of supplies as overhead • To revisit the recapture rules that apply when materials are sold or converted to commercial purposes 1

187 G – Cost of Materials for SR&ED
Materials consumed or transformed are eligible/qualified expenditures Treatment of materials is same under traditional and proxy Materials Policy defines “cost”, “materials”, “consumed” and “transformed” Materials must be part of “the thing” at some point in the SR&ED process Supplies are not “materials” – only eligible under traditional method as overhead 2

188 G - ITC Recapture If SR&ED product is sold or converted to commercial use, Recapture may apply Recapture = lesser of (FMV or purchase price of material) x ITC rate ITC rate is that which applied when Qualified Expenditure was claimed Recapture of ITC on property acquired - Increase Part I tax increase pool in following year 3

189 G – Recapture Calculation
Recapture based on the least of: cost of property and proceeds of disposition of property or property that incorporates the real property, and 25% of proceeds of disposition for 1st term shared-use equipment and 50% of proceeds of disposition for 2nd term shared-use equipment Recapture amount is calculated at the original ITC rate Deemed proceeds = FMV of property at the time of disposition to an arms-length party or a conversion of the property to commercial use 4

190 G – Calculation of Recapture – example
5

191 G – Calculation of Recapture – example
The recapture will be $80, the lesser of $80 and $900. 6

192 G – Non-Arm’s Length Transfer of Property
Recapture is deferred if capital property is transferred to a related party, and continues to be used ASA for SR&ED ITC recapture applies to transferee when property is later sold/converted Recapture is calculated at the original ITC rate earned by the transferor 7

193 G – Exercise #1 Turn to HCL case study in Appendix I. Calculate the materials cost for the claim. 8

194 G – Exercise #2 How do you determine whether materials are transformed or consumed? - Components that become part of the ‘body of the thing’ (i.e. the custom prototype) are materials transformed. - Materials “consumed” are scrapped or have no value at the end of the project. Components are transformed into the ‘body of the thing’ other than the amounts that are scrapped. These are materials consumed as they have no value at the end of the project. The company has offices and testing facilities. They could have supplies for the test lab and the shop floor. However these are not eligible expenditures as the company elected the proxy method. 9

195 G – Exercise #3 Is HCL claiming any items that are supplies rather than materials? Why is this important? The company has offices and testing facilities. They may have expenditures related to supplies for the test lab and the shop floor. Supplies are treated as overhead expenses are not SR&ED eligible expenditures under the proxy method. Components are transformed into the ‘body of the thing’ other than the amounts that are scrapped. These are materials consumed as they have no value at the end of the project. The company has offices and testing facilities. They could have supplies for the test lab and the shop floor. However these are not eligible expenditures as the company elected the proxy method. 10

196 H – LEARNING OBJECTIVES
To understand the treatment of contract payments made for SR&ED including the taxable supplier rules To understand the treatment of SR&ED contract revenue To understand the special rules for related parties and foreign customers To understand the treatment of government and non-government assistance To introduce the concept of third party payments 1

197 H – SR&ED Contract Payments
SR&ED contract payments are added to the SR&ED expenditure pool SR&ED contract payments to arm's-length parties are Qualified Expenditures for ITC purposes After 2012, only 80% of the contract payment earns ITCs After 2012 contract payments must exclude any portion that relates to capital property Questions to ask: Is there a payment to a contractor for SR&ED activities? Was the work performed in Canada? Was it subcontracted outside Canada? Does the taxpayer deal with the contractor at arm’s-length? Or non-arm's length? Does the contractor have a permanent establishment in Canada?   Do you know if the contractor is claiming the work? 2

198 H – SR&ED Contractor Revenue
SR&ED contract revenue does not reduce the SR&ED expenditure pool SR&ED contract payments from arm's-length parties do reduce Qualified Expenditures for ITC purposes SR&ED contract payments from non-arm's length parties are not qualified Expenditures for the payer and do not reduce Qualified Expenditures of the sub-contractor Questions to ask: Is there an amount received for SR&ED activities performed on behalf of another party? Was the work performed in Canada?  Does the taxpayer deal with the payer at arm’s-length? Or non-arm's length? Does the payer have a permanent establishment in Canada?   Do you know if the payer is claiming the work? 3

199 H - Rules for Arm’s-Length Contracts
Payer incurs SR&ED expenditures Payee (performer) receives SR&ED contract payment Payer claims qualified expenditure for payment made to SR&ED performed on its behalf Performer claims qualified expenditure less the contract payment received 4

200 H - Arm’s-length Contract Payments - Example
Rules: Payer makes expenditure in accordance with a SR&ED contract Payee receives contract payment Payer claims qualified expenditure for SR&ED Payee claims qualified expenditure minus contract payment received from payer 5

201 H – Non-Arm’s-Length Contracts
Payer does not incur SR&ED expenditures (Qualified expenditures definition excludes payments to non-arm’s-length parties for SR&ED performed on behalf of the taxpayer) Payment received by performer is not a SR&ED contract payment for ITC purposes (Contract payments definition excludes amounts paid to non-arm’s-length parties for SR&ED performed on behalf of the taxpayer) Performer claims qualified expenditures Performer can transfer qualified expenditures to payer (up to contract amount) 6

202 H - Non-Arm’s-Length Contracting
R&D Co. (sub) Parent Co. Non-arm’s length R&D payment $200 to R&D Co. Arm’s length R&D costs $150 Contract Payment - Parent Co. $nil - R&D Co. $nil Qualified Expenditure - Parent Co. $nil R&D Co. $150 7

203 H - Transfer of Qualified Expenditures
Allows performer to transfer ITC to NAL payer Provided that the amount paid is a contract payment for SR&ED Transfer is limited to least of three amounts: The amount specified in the election The transferor’s SR&ED qualified expenditure pool at the end of year The notional contract payment amount The SR&ED qualified expenditure pool at the end of the year equals: Qualified Expenditures incurred in the year, plus Amounts transferred to the taxpayer in the year, less Amounts transferred by the taxpayer in the year 8

204 H – Government Assistance
Reduces the pool of SR&ED expenditures and the Qualified Expenditures Incudes government grants, subsidies, forgivable loans, deductions from tax, investment allowance, or any other forms of assistance Does not include the federal SR&ED ITC Does include all provincial SR&ED ITCs May include other provincial ITCs in respect of expenditures claimed as SR&ED 9

205 H – Non-Government Assistance
Reduces the pool of SR&ED expenditures and the Qualified Expenditures Incudes inducements, reimbursements, contributions, allowances or assistance Generally does not include amounts otherwise included in income 10

206 H – Indicators of Government Assistance
Absence of repayment terms Absence of business motive that would identify an investment rather than assistance Absence of terms indicating a normal commercial investment 11

207 H – Forgivable Loans Where repayment conditional on profits and characterized as royalties CRA views as government assistance Reduce the pool when the assistance is expected to be received and Increase the pool when repayments are made 12

208 H – Timing of Assistance and Contract Payments
Assistance and contract payments reduce the pool of Qualified Expenditures at the earliest of the following dates The payment is received The payment is receivable The payment can reasonably be expected to be received 13

209 H – Assistance Reduces Project Expenditures
Assistance and contract payments reduce the Qualified Expenditures on a project by project basis Reduce project expenditures to nil, excess is taxable income Do not apply excess receipts against other projects 14

210 H – Repayment of Government Assistance
Where an amount for assistance or contract payments has reduce the Qualified Expenditures and is subsequently repaid or cancelled The SR&ED expenditure pool is increased by the amount repaid The Qualified Expenditures calculation is increased and ITC at original rate ITCs on repayments are NOT refundable The repayment is only recognized to the extent that the pool was previously reduced 15

211 H – Third Party Payments
(i) Third Party Payment to a corporation resident in Canada For SR&ED carried on in Canada Related to the business of the taxpayer Only where taxpayer is entitled to exploit results of SR&ED (ii) Third Party Payment to: (A) approved associations (B) approved university, college, research institute or other similar institution (C) non-profit SR&ED corporations or (D) approved association making payments to (A), (B) or (C) SR&ED carried on in Canada (iii) Third Party Payment to non-profit SR&ED corporations for basic or applied research 16

212 H – Exercise #1 Turn to the HCL case study in Appendix I.
Calculate the contract payments to be claimed by HCL as SR&ED expenditures and Qualified Expenditures. The payments to Fab Co. and Test Co. are SR&ED payments to arm’s length corporations. They are eligible SR&ED expenditures that can be added to the pool and included in the calculation of Qualified Expenditures. 17

213 H – Exercise #1 Calculate the contract payments to be claimed by HCL as Qualified Expenditures for SR&ED purposes in What will this amount be in 2013? 18

214 H – Exercise #1 c) Calculate the Third Party Payments to be claimed.
- The payments totalling $120,000 to the University of Alberta for applied research are Third Party payments. - The instalment paid in 2013 is subject to a 20% reduction for ITC purposes. Only $48,000 is included in the calculation of qualified expenditures. 19

215 H – Exercise #2 What information regarding contract payments is required on Form T661? Name and business number of the contractor must be recorded on lines 268 and 269. A description of the work performed, a copy of the contract and a statement of work must be available for review by the CRA. After 2013, the contract performer will have to disclose any capital property included in the contract amount as these amounts will no longer be eligible under the program. 20

216 I – LEARNING OBJECTIVES
To introduce the types of expenditures that may be claimed as overheads and other expenditures under the traditional method 1

217 I - Election to Claim Overheads VS Proxy Method
Type of Work Traditional Method Proxy Method Salaries or wages are low relative to overheads (i.e. in a manufacturing environment) X The company outsources many SR&ED activities to independent contractors. The company hires many SR&ED employees through placement agencies. (Treated as contractors per CRA policy) Salaries or wages are high relative to overheads (i.e. in a lab or software development facility Overhead costs are not easily linked to SR&ED activities as incremental and “directly attributable” I - 2

218 I - Overhead and Other Expenses
Directly Attributable Expenditures Definitions: Directly related to the prosecution of SR&ED Incremental as a result of SR&ED Some examples of labour costs that are “overhead” include: Salary and wages that are not directly engaged but are incremental to the prosecution of SR&ED The company’s share of CPP, QPP, EI and WCB Payments to sub-contractors that do not meet the requirements of 248(1)(d) support activities Travel and training, moving expenses Certain retiring allowances Administrative and support costs Part of the recent changes to the SR&ED program, the Department of Finance instituted the following increases to the thresholds governing refundable ITCs for taxation years that end after February 25, 2008: The expenditure limit increased from $2,000,000 to $3,000,000. The net effect of this change is to increase the maximum annual refund from $700,000 to $1,050,000 for qualifying CCPCs. ITA 127.1(1) – allows a refund ITA 127.1(2) – definitions regarding refundability Basic refund is 40% of the ITCs earned at 20% for qualifying corporations, individuals and trusts Special rules for CCPCs The upper limit for taxable income increased from $600,000 to $700,000. The upper limit for taxable capital increased from $15 million to $50 million. I - 3

219 I – Overhead and Other Expenses
Directly attributed and incremental portion of: Insurance, taxes, R&M GPOEF Utilities Property taxes Lease costs Office supplies Contract work that is not SR&ED but is directly attributable and incremental Part of the recent changes to the SR&ED program, the Department of Finance instituted the following increases to the thresholds governing refundable ITCs for taxation years that end after February 25, 2008: The expenditure limit increased from $2,000,000 to $3,000,000. The net effect of this change is to increase the maximum annual refund from $700,000 to $1,050,000 for qualifying CCPCs. ITA 127.1(1) – allows a refund ITA 127.1(2) – definitions regarding refundability Basic refund is 40% of the ITCs earned at 20% for qualifying corporations, individuals and trusts Special rules for CCPCs The upper limit for taxable income increased from $600,000 to $700,000. The upper limit for taxable capital increased from $15 million to $50 million. I - 4

220 I – Exercise #1 Identify 3 types of expenditures that can only be claimed under the traditional method. Supplies that do not qualify as materials R&D share of administration and overhead expenditures Contract payments for services other than research or experimental development 5

221 I – Exercise #2 Refer to the HCL case study in Appendix I. Describe a situation in which the company may prefer to elect to use the traditional method rather than the proxy method. The proxy method is preferred as long as salaries and wages are high relative to other SR&ED expenditures. If the company starts to incorporate the new technology into their product, they may have a period of experimental production prior to commercial production. If they use a dedicated line for testing and the operating costs are high relative to salaries and wages of the engineering team, they may elect to use the traditional method for that particular taxation year. Similarly, if they start to use contract labour rather than salaried employees, the traditional method become more beneficial. An analysis is required each year to determine the preferred method of claiming, particularly as the PPA % is decreasing from 65% to 55%. 6

222 J – LEARNING OBJECTIVES
To understand the requirements of the SR&ED rules regarding capital expenditures To review the application of the recapture rules To understand the rules regarding lease costs as eligible SR&ED expenditures Part of the recent changes to the SR&ED program, the Department of Finance instituted the following increases to the thresholds governing refundable ITCs for taxation years that end after February 25, 2008: The expenditure limit increased from $2,000,000 to $3,000,000. The net effect of this change is to increase the maximum annual refund from $700,000 to $1,050,000 for qualifying CCPCs. ITA 127.1(1) – allows a refund ITA 127.1(2) – definitions regarding refundability Basic refund is 40% of the ITCs earned at 20% for qualifying corporations, individuals and trusts Special rules for CCPCs The upper limit for taxable income increased from $600,000 to $700,000. The upper limit for taxable capital increased from $15 million to $50 million. 1

223 J – 2012 Update – Elimination of capital expenditures
Exclude capital expenditures from SR&ED deductions and investment tax credits Applies to property acquired and available for use after 2013 Also excludes any amount that an arm’s length contractor has paid in respect of a capital expenditure made to fulfill the contract To eliminate/reduce complexity and administrative effort to track capital items especially for recapture Planning opportunities: Accounting policies on capitalization Carving out pure SR&ED work separate from capital assets Part of the recent changes to the SR&ED program, the Department of Finance instituted the following increases to the thresholds governing refundable ITCs for taxation years that end after February 25, 2008: The expenditure limit increased from $2,000,000 to $3,000,000. The net effect of this change is to increase the maximum annual refund from $700,000 to $1,050,000 for qualifying CCPCs. ITA 127.1(1) – allows a refund ITA 127.1(2) – definitions regarding refundability Basic refund is 40% of the ITCs earned at 20% for qualifying corporations, individuals and trusts Special rules for CCPCs The upper limit for taxable income increased from $600,000 to $700,000. The upper limit for taxable capital increased from $15 million to $50 million. 2

224 J - SR&ED Capital Equipment – prior to 2014
ASA intention test Deduction for new and used equipment acquired and available for use prior to 2014 ITC for new equipment Recapture if sale or change in use J - 3 2

225 J – Exclusion for Capital Expenditures
Exclusions for: commercial equipment land and buildings rights in or arising out of SR&ED general purpose, office equipment and furniture (proxy method) equipment acquired for SR&ED carried on outside Canada J - 4

226 J - Shared-Use Equipment – prior to 2014
New equipment which is used primarily for the prosecution of SR&ED ITC is earned over 3 taxation years Definitions First term shared-use equipment Second term shared-use equipment Draft legislation eliminates SUE for equipment that is not acquired and available for use prior to 2014 J - 5

227 J - Shared-Use Equipment – Exclusions
Does Not Include "Prescribed depreciable property" Building Leasehold interest in a building Property, or part of a property intended to be used in SR&ED during the assembly, construction or commissioning of a facility, plant or line for commercial manufacturing, commercial processing or other commercial purposes, and intended for primary use not SR&ED, or value consumed primarily not in SR&ED “General Purpose Office Equipment and Furniture” (GPOEF) J - 6

228 J - Shared-Use Equipment – prior to 2014
Computing ITC on SUE 1/4 of cost added to Qualified Expenditures at the end of each term Must qualify in the first term to be eligible for second term The ITC rates are usual SR&ED rates (20% or 35%) Normal CCA rules apply J - 7

229 J - Sale of Capital Assets and Recapture
Recapture deductions previously claimed Lower of costs and proceeds included in income as T661 reduction of expenditure pool or Add back to taxable income Excess over cost may be income or capital gain Recapture ITC’s earned (lower of cost and FMV times the ITC rate) J - 8

230 J – Adjustments to purchases from non-arm’s length suppliers
Equipment purchased from non-arm’s length person or partnership prior to 2013 The amount of the eligible qualified SR&ED expenditure for ITC purposes is limited to the cost to the non-arm’s length person The amount claimed is the lesser of the capital cost or the adjusted selling cost to the supplier of the property J - 9

231 J – Leased Equipment – prior to 2014
All or substantially all (“ASA) – eligible under proxy and traditional Less than ASA – directly attributable portion eligible under traditional, 50% of lease cost eligible under proxy General purpose office equipment or furniture (“GPOEF”) not eligible under proxy method No lease costs for land or building under either method After 2013, no claims for lease of capital property J - 10

232 J - Lease Expenses Exclude lease expenses from SR&ED deductions and investment tax credits after 2013 Rationale: Simplify the program Planning opportunities: Instead of leasing an asset, the activities can be subcontracted out J - 11 2

233 J – Exercise #1 Turn to HCL case study in Appendix I. Calculate the capital expenditures for the claim. J – 12

234 J – Exercise #2 If the SR&ED capital equipment claimed in the year is sold after 5 years, what is the tax impact to the company? Lower of cost and proceeds deducted from expenditure pool. Proceeds less original cost is a capital gain. ITC recapture (lower of cost and proceeds X ITC original rate) increases Part I tax in the year. Recaptured ITC is added to the expenditure pool in the following year. J – 14

235 J – Exercise #3 What are the advantages to leasing SR&ED assets vs. purchasing capital equipment? Prior to 2014, lease costs can be claimed for used equipment. Prior to 2014, lease costs can be claimed for equipment that is not ASA SR&ED. No recapture is the property is sold or moved out of SR&ED. J – 15

236 J – Exercise #4 What are the disadvantages to leasing SR&ED assets vs. purchasing capital equipment in 2013? In 2014? Only the monthly lease payments are eligible – not the full capital cost. After 2013, no expenditures can be claimed for lease or purchase of a capital property. J – 16

237 S – Financial statements
Adjusting JE’s (S-2) Note disclosure of ITCs & expenses Research vs. Development expenses Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge

238 Maximum Efficient Use of Knowledge Corporation © 2013 ME + U = Knowledge

239 T - Tax summary & forms Federal schedules:
T661/Sch 32 – expenses (T-1’s) Sch 31 & 49 – Expenditure limits & ITCs (T-2’s) Sch 1 – taxable income (T-3) T1146 & 1174 – NAL expenses (T-4’s) Ontario schedules (T-5 to 7) Sch 566 (OITC)/Sch 508 (ORDTC)/OBRI Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge

240 Maximum Efficient Use of Knowledge Corporation © 2013 ME + U = Knowledge

241 Maximum Efficient Use of Knowledge Corporation © 2013 ME + U = Knowledge

242 K – LEARNING OBJECTIVES
To understand the requirements to file a complete claim before the deadline review Prescribed Information and Electronic filing To introduce forms and guides impacting claim requirements To introduce the claim review process To introduce CRA’s services to SR&ED claimants K - 1

243 K - Prescribed Information
Must file a claim with prescribed information by the filing due date Form T661, Schedule T2SCH31, or Form T2038(IND) Prescribed information means all the relevant information requested on the prescribed form as authorized by the Minister of National Revenue Use tax preparation software for electronic filing K - 2

244 K - SR&ED Filing Deadline
Must file prescribed information within 12 months from filing deadline for the tax return for the year in which the expenditures were incurred 18 months for corporations 17.5 months for individuals; 17 months for many partnerships) NO EXCEPTIONS - if you do not file a complete claim by the deadline you lose the right to claim Recommended to file 90 days earlier in order to allow time to correct deficiencies K - 3

245 K - Partnership Filing Deadline
New filing requirements for partnerships: Effective January 1, 2011 for partnerships with fiscal periods ending on or after January 1, 2011 Any partnership that has a corporation as a member must now file a partnership information return T5013 To claim SR&ED, the partnership must file a completed Form T661, with this return A corporation that is a member of a partnership no longer files Form T661 for the partnership with its T2 Corporation Income Tax Return Investment tax credits allocated to corporations by partnerships must now be supported by a completed Form T5013, Statement of Partnership Income K - 4

246 K - T661 Highlights Supports electronic filing
Project descriptions – top 20 projects are described in Part 2 of the T661 Prescribed format with strict word limits Focus on technological obstacle(s), work performed to achieve a technological advancement Must select a field of science or technology from prescribed list Evidence is now prescribed information Must identify the person who wrote the project description Will need to disclose preparer information, fee arrangements and fee amounts for claims filed after 2013 New T661 expected in October 2013 K - 5

247 K - New Forms and Guides The entire library of SR&ED reference material posted on the CRA website has been updated with new policy documents posted on December 12, The list of new policy documents is included in Appendix II. Two key new guides: The SR&ED Technical Review: A Guide for Claimants posted July 25, 2011 A Guide for Claimants is a new guidance document that sets out review procedures and expectations for both RTAs and claimants Claim Review Manual (CRM) for Research and Technology Advisors The CRM is an internal operations manual for CRA reviewers Clarifies the responsibilities of taxpayers to support their SR&ED claims with evidence including contemporaneous documentation Public severed version available on CRA website K - 6

248 K – SR&ED Review Process
Many claims are assessed without review at Taxation Centre If moved to SR&ED Directorate, risk assessment performed by Science Officer If further review required: Claim is assigned to a Financial Reviewer (FR) and a Research and Technology Advisor (RTA) CRA works with tax payer to evaluate claim, issue a proposal then an assessment If the taxpayer disagrees with the CRA, the appeal procedures are: Administrative second review Written technical rebuttal Appeal to the Regional Technical Co-coordinator After assessment, formal appeal via Notice of Objection K - 7

249 K – Role of the Research and Technology Advisor (RTA)
Assemble, organize and analyze all information submitted with the SR&ED claim to ensure completeness and to become familiar with the circumstances of the work Determine the scope of the technical SR&ED review Request additional information (if necessary) Perform site visit/interviews (if required) Prepare and submit additional requests for information should new issues arise Prepare the SR&ED review report setting out conclusions and reasons K – 8a

250 K – Role of the Research and Technology Advisor (RTA)
Specifically as set out in CRA’s Application Policy R, Guidelines for Resolving Claimants’ SR&ED Concerns, the roles and responsibilities of the RTA are the following: Explain the SR&ED review process to the claimant, including the options for resolving any concerns Examine the technical documentation and other relevant information to perform a review; Evaluate the eligibility of the work claimed Request additional information in a clear manner Discuss with the claimant any concerns regarding the eligibility of the work claimed Provide a report to the claimant which includes the eligibility decision of the work claimed and the reasons for the decision Invite feedback from the claimant about the report K – 8b

251 TCC - Role of the “expert witness”
RIS Christie : role of the scientists in determining SR&ED eligibility “What constitutes scientific research for the purposes of the Act is either a question of law or a question of mixed law and fact to be determined by the Tax Court of Canada, not expert witnesses, as is too frequently assumed by counsel for both taxpayers and the Minister. An expert may assist the court in evaluating technical evidence and seek to persuade it that the research objective did or could not lead to a technological advancement. But, at the end of the day, the expert’s role is limited to providing the court with a set of prescription glasses through which technical information can be viewed before being analyzed and weighed by the trial judge.” Before we look at the specific components of an SR&ED project let’s examine the role the TCC in determining SR&ED eligibility: In the case of RIS Christie the judge stated : “What constitutes scientific research for the purposes of the Act is a question of law to be determined by the Tax Court of Canada, not expert witnesses. the expert’s role is limited to providing the court with a set of prescription glasses through which technical information can be viewed before being analyzed and weighed by the trial judge.” The RDBASE SR&ED Consortium© 2013

252 K – Role of the Financial Reviewer (FR)
Financial Reviewer conducts review in parallel to the technical review Determines whether the costs claimed are eligible SR&ED expenditures and qualified expenditures for ITC purposes Reviewer will generally apply risk management guidelines in setting the scope of the financial review - dollar-materiality according to size of company and size of the SR&ED claim The company's prior history with the program may also be considered K - 9

253 [New CRA Request for information (RFI) procedures]
Since approximately January 2013 the CRA has been sending “requests for information” (RFI’s) to a large % of claimants. These RFI’s tend to include questions which can be divided into 3 categories:  Standard questions asked nationally of all claimants Questions specific to a district office & Questions specific to an individual reviewer The RDBASE SR&ED Consortium© 2013

254 New CRA Request for information (RFI) procedures
[Request for 5+ pages of sample technical documents ] Please send this information up to maximum of five (5) letter-sized (8.5" x 11") pages for each project claimed which you feel best demonstrates that the work meets the definition of SR&ED in Subsection 248(1) of the Income Tax Act. In addition, if not included in the above sample, please send us copies of the contemporaneous evidence that: • recorded your initial due diligence activities and that shows that available technology could not overcome the technological problem or obstacle that you faced; • recorded the plan you subsequently devised to overcome the technological problem or obstacle; •Preserved the new technological knowledge gained by the company. The RDBASE SR&ED Consortium© 2013

255 U.5 CRA - Recent Request for Information (RFI) procedures
The RDBASE SR&ED Consortium© Practitioner Workshop Sept 25, 2013

256 [New CRA Request for information (RFI) procedures]
[New focus on “weekly” timesheet details] SR&ED Wages & Contractor labour For salaries, wages and contract labour, please provide: An organization chart with job descriptions/duties for each person claimed. Details of activities for each SR&ED Project claimed, including number of hours claimed for each individual per activity, per month. Contractors For each contractor, we require a copy of the contract(s) & statement(s) of work. The RDBASE SR&ED Consortium© 2013

257 The RDBASE SR&ED Consortium© 2013 Practitioner Workshop Sept 25, 2013

258 K – Responding to the CRA Proposal
If the claimant accepts the proposal this should be indicated in writing or alternately CRA will process the proposal as written after 30 days 2. If the taxpayer disagrees with the conclusions reached by the RTA, the appeal procedures are: Administrative second review Written technical rebuttal Appeal to the Regional Technical Coordinator After assessment, formal appeal via Notice of Objection and/or Appeal to the Courts K - 10

259 K – Claim Issues from CRA’s Perspective
Improper project descriptions Lack of documentation Claimed costs exceed eligible activities K - 11

260 K – CRA Service Standards
The service standards for reviews are: For refundable claims filed with the initial filing of the T2 return, claims should be assessed within 120 days of receiving a complete claim For refundable claims filed as amendments to original T2 filings, claims should be assessed within 240 days of receiving a complete claim For non-refundable claims, including amended returns, the assessment should be issued within 365 days K - 12

261 K – CRA Services to Taxpayers
Pre-claim project review (PCPR) Account executive service First-time SR&ED claimant service Public information and industry specific seminars SR&ED Eligibility Self-Assessment Tool (ESAT) Clickable T661 K - 13

262 U.10 Budget 2013 – new reporting on SR&ED preparer fees
According to the Department of Finance, “Budget 2013 introduces measures to provide the Canada Revenue Agency with new resources and administrative tools to better respond to the minority of SR&ED program tax preparers and SR&ED performers who participate in claims where the risk of non-compliance is perceived to be high and eligibility for the SR&ED program unlikely.” Maximum Efficient Use of Knowledge Corporation © 2013

263 New reporting on SR&ED preparer fees – starts Jan 1, 2014
In particular, in instances where one or more third parties have assisted with the preparation of a claim, the Business Number of each third party details about the billing arrangements including whether contingency fees were used & the amount of the fees payable. In instances where no third party was involved, the claimant will be required to certify that no third party assisted in any aspect of the preparation of the SR&ED program claim. Maximum Efficient Use of Knowledge Corporation © 2013

264 SR&ED – dispute resolution
The normal “negotiation process” could include: Maximum Efficient Use of Knowledge Corporation © 2013

265 Legal Timeframes for tax appeals
Maximum Efficient Use of Knowledge Corporation © 2013

266 Maximum Efficient Use of Knowledge Corporation © 2013

267 Tax Court of Canada informal appeal levels to rise
Overview Currently all judgments that allow appeals under the informal procedure are limited to Taxes payable of $12,000, or Taxable income of $24,000. Those amounts, $12,000 and $24,000, are increased to $25,000 and $50,000, respectively. The RDBASE SR&ED Consortium© 2013

268 Module K – Exercise #1 Turn to HCL case study in Appendix I. What is the deadline for filing of the T2 Corporate income tax return? Corporate tax returns are due 6 months after the year end. The year-end is June 30, 2013, therefore, the deadline for filing the 2013 T2 will be December 31, 2013. K – 14

269 Module K – Exercise #2 What is the deadline for filing of the SR&ED claim for the current year? SR&ED claims are due 12 months after the filing deadline for the tax return. The tax return is due on December 31, 2013; therefore the deadline for filing the 2013 claim will be December 31, 2014. K – 15

270 Module K – Exercise #3 What prescribed forms are required for a complete claim? T661 including prescribed information T2 Sch. 31 for corporations Prescribed provincial forms May also require: Form T1145 – Agreement to Allocate Assistance Form T1146 – Agreement to Transfer Qualified Expenditures Form T1147 – Agreement to Allocate Salary or Wages of Specified Employees Form T1263 – Third Party Payments K – 16

271 Module K – Exercise #4 Provide an outline of the CRA review process. What questions might they ask? What documents might they request? Refer to pages K-9 and K-12 and discuss K – 17

272 The RDBASE SR&ED Consortium© 2013
IV) OTHER NEW ISSUES - Complete claims & filing deadline – 15/18 months CRA – prior position (on claims filed within 15 months of year end) If an SR&ED claim is filed within 90 days before the reporting deadline, the CRA should have sufficient time to conduct a review to determine whether or not the claim meets the filing requirements and to advise the claimant of any deficiencies in the claim. The new Dec policy paper reads, “If the forms are reviewed by the CRA before the SR&ED reporting deadline, the CRA will advise the claimant of any deficiencies and the claimant will be allowed, up to the SR&ED reporting deadline, to provide any missing information.” The RDBASE SR&ED Consortium© 2013

273 The RDBASE SR&ED Consortium© 2013
IV) OTHER NEW ISSUES - Complete claims & filing deadline – 15/18 months The new policy paper adds to the list of “prescribed forms” to include: Prescribed forms for SR&ED expenditures Forms T661 & Schedule T2SCH31 are the prescribed forms for SR&ED expenditures & tax credits respectively. Prescribed information for SR&ED forms include Form T661, including, if applicable, forms - T1145 (non-arm’s length costs), - T1146 (non-arm’s length credits), - T1174 (specified employees / assoc. co’s), & - T1263 (third party payments) Schedule T2SCH31, - Schedule T2SCH49 (exp. limit assoc. co’s). The RDBASE SR&ED Consortium© 2013

274 The RDBASE SR&ED Consortium© 2013
IV) OTHER NEW ISSUES - Complete claims & filing deadline – 15/18 months Author’s comment There is no longer any mention of what might happen if the CRA identifies deficiencies beyond the 90 day limit. In the authors opinion the risk of omitting a related schedule is very high and poses a major concern to claimants & preparers alike. The RDBASE SR&ED Consortium© 2013

275 L - LEARNING OBJECTIVES
To introduce key decisions of the Courts regarding SR&ED eligibility, financial issues, administrative issues and structural issues L - 1

276 L - SR&ED Tax Cases SR&ED legislation is shaped by policy and tested in the Courts There is a large body of tax cases relating to various SR&ED issues: Technological eligibility Financial Issues Administrative issues Structural issues – Partnerships, CCPCs L - 2

277 L – Cases Regarding Technological Systems Uncertainties
Northwest Hydraulic Consultants Limited. 98 DTC 1839 Company performed hydraulic model studies and claimed 17 projects related to physical models of rivers, dams and spillways Question was whether the work was SR&ED CRA viewed the work as routine engineering with no technological advance Company submitted that the work created new knowledge of the engineering structures and the impact on water flow L - 3

278 L – Cases Regarding Technological Systems Uncertainties
Northwest Hydraulic Consultants Limited. 98 DTC 1839 5 projects were selected for review by the court Both sides presented expert witnesses Court found that 4 of the 5 projects qualified Technological uncertainty existed in the minds of the specialist and they applied methods to remove that uncertainty The expertise of the company does not preclude them from claiming SR&ED and indeed sets unrealistic standards Court also commented on importance of IC 86-4 as a guide to SR&ED based on the fact that industry was involved in creation of the document L - 4

279 TECHNOLOGICAL ADVANCEMENT - Northwest Hydraulic
The CRA science officer & expert witness, A detailed review of the 17 projects, shows that no real new or improved devices or processes were developed. The devices and processes developed by NHC in the course of the modelling work for these 17 projects may have been "new" in the sense of a new location (i.e. a hydraulic structure that was not there before, or the implementation of a river improvement scheme), but all of the work described in the NHC project reports refers to standard devices and processes, which are routinely used in similar design situations all over the world. After reviewing the 17 projects that issue, I have concluded that none of the projects led to generic or specific technological advancements, with the possibility of creating new or improving existing devices or processes, which could also have been used in other engineering design situations. A test of such an advancement would be the possibility of a patent. Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge

280 TECHNOLOGICAL UNCERTAINTY & ADVANCEMENT- Northwest Hydraulic
SR&ED is defined for income tax purposes[1], as follows: “scientific research and experimental development means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is (a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view, (b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or (c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, and, in applying this definition to a taxpayer, [1] in subsection 248(1) of the Act 280 280 280

281 TECHNOLOGICAL ADVACNMENT - Northwest Hydraulic
SR&ED is defined for income tax purposes[1], as follows: “scientific research and experimental development means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is (a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view, (b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or (c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, and, in applying this definition to a taxpayer, [1] in subsection 248(1) of the Act 281 281 281

282 TECHNOLOGICAL ADVANCEMENT - Northwest Hydraulic
The Canada Revenue Agency was willing to accept the existence of technical uncertainty and systematic investigation but held fast that no technical advancements were achieved. Based on the evidence examined the judge concluded: "The respondent's position, ably articulated by Mr. Yaskowich [The Canada Revenue Agency's expert witness], was essentially that the appellant, admittedly a world leader in the field of hydraulic model testing, by its own excellence sets the standard for what represents routine engineering or standard practice. With respect I think that this sets an unrealistically high standard - indeed a standard of perfection that would discourage scientific research in Canada." Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge

283 TECHNOLOGICAL ADVANCEMENT - Northwest Hydraulic
Judge’s comment "The addition of these words ["including incremental improvements thereto" ] in 1995 applicable to taxation years ending after December 2, 1992 appears to have been in response to a concern that the achievement or attempted achievement of slight improvements was not covered. I should not have thought it was necessary to say so. Most scientific research involves gradual, indeed infinitesimal, progress. Spectacular breakthroughs are rare and make up a very small part of the results of SR&ED in Canada." Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge

284 L – Cases Regarding Technological Advancement
Rainbow Pipe Line Co. 99 DTC 1081 Company operated an oil pipeline Investigation of stress corrosion cracking Developed and tested a hypothesis Research failed to identify cause of cracking Question was whether the work was SR&ED L - 5

285 L – Cases Regarding Technological Advancement
Rainbow Pipe Line Co. 99 DTC 1081 Company provided independent third party evidence that there was little existing research on SCC issues when the work was done The Courts agreed that the failure of the research did not indicate absence of a technological advance and supported technological uncertainties Court found in favour of the company – work was eligible SR&ED L - 6

286 TECHNOLOGICAL ADVANCEMENT – Rainbow Pipeline
ISSUE: definition of "technological advancement" WIN/LOSE: Win RULING /RATIONALE: rejection of an hypothesis is an advance IMPLICATIONS: Significant precedent on definition of "technological advancement" SIGNIFICANCE: moderate SR&ED is defined for income tax purposes[1], as follows: “scientific research and experimental development means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is (a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view, (b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or (c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, and, in applying this definition to a taxpayer, [1] in subsection 248(1) of the Act 286

287 TECHNOLOGICAL ADVANCEMENT – Rainbow Pipeline
In particular with respect to Stress Corrosion Cracking, Rainbow claimed: • “We needed to know what caused it. • What caused the cracks to form. • What caused them to grow. • What parameters caused the formation -- both the initiation and the growth. • We needed to know more about growth rates. • We needed to know how to identify the SCC that was existing in the pipeline. • We needed to know how to predict where it might occur.” SR&ED is defined for income tax purposes[1], as follows: “scientific research and experimental development means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is (a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view, (b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or (c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, and, in applying this definition to a taxpayer, [1] in subsection 248(1) of the Act 287 287 287

288 TECHNOLOGICAL ADVANCEMENT – Rainbow Pipeline
Judge’s comment: “The rejection after testing of an hypothesis is nonetheless an advance in that it eliminates one hitherto untested hypothesis. Much scientific research involves doing just that. The fact that the initial objective is not achieved invalidates neither the hypothesis formed nor the methods used. On the contrary it is possible that the very failure reinforces the measure of the technological uncertainty.” SR&ED is defined for income tax purposes[1], as follows: “scientific research and experimental development means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is (a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view, (b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or (c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, and, in applying this definition to a taxpayer, [1] in subsection 248(1) of the Act 288 288 288

289 L – Cases Regarding Technological Advancement and Uncertainty
Jentel Manufacturing 2011 TCC 261, 2011 FCA 355 Jentel developed and manufactured engineered thermoformed plastic products for consumer and industrial uses In 2005, SR&ED expenditures were claimed by Jentel Manufacturing The issue is whether the work performed constituted SR&ED: Five criteria used by the Courts to assist in determining whether a particular activity constitutes SR&ED, as summarized by the Federal Court of Appeal in C.W. Agencies Inc. v. The Queen, 2001 FCA 393, 2002 DTC 6740 Court’s decision to disallow claim was based on Jentel’s inability to convince the reviewers that the work performed was anything more than “routine engineering and standard procedures” There must be a “technological advancement” attended by “technological obstacle/uncertainty”, which was not evident L - 7

290 Jentel “Technological Advancement” - lose
Table 1 - Jentel “What if?” = eligibility

291 Jentel - revisited using the RDBASE
Jentel - revisited using the RDBASE.NET suggested SR&ED project description structure ELIGIBILITY: WHAT IF:? Negative indicators Positive indicators of eligibility I PROJECT OBJECTIVE BEYOND STANDARD PRACTICE: (THINKING OUTSIDE THE BOX) i) Benchmarking Existing technology: sources Relied on verbal representations of the company's owner regarding the state of existing technology. Provided specific evidence of known technology limits via: articles, competive products, expert opinions, patent searches, prior in house failures, blogs, etc. ii) Objective(s) Testing of known plastic characteristics vs. known production techniques Ideally we would provide quantified objectives such as cost, strength, weight, tolerances, failure rates,... which "stack up" to require "experimentation" in areas beyond "standard practice" (such as); 1) different configurations on measured structural integrity, 2) effects of plastic melting process conditions, 3) additive reagents &/or 4) modifying extrusion/forming techniques on produced plastic physico-chemical characteristics. II TECHNOLOGICAL UNCERTAINTIES No alteration of process or formulations = comparative assessment of knowns a "matrix" of variables (parameters) were identified for testing under different described conditions. HYPOTHESES = can we improve the existing predictive model for effects re: altered temperature of melt, mix time, order of reagent addition, type of reagents, rate of cooling, etc. influence on measured final plastic characteristics/parameters. 291

292 292 III EXPERIMENTATION (SYSTEMATIC INVESTIGATION)
Focus on RESULTS (What happended?) INSTEAD of CONCLUSIONS (Why it happened?) Provide evidence of "testing or analysis" to resolve ANY of the stated VARIABLES of "technological uncertainty." Jentel grouped the work into four SR&ED “activities”: we have reproduced the first 2 1) Bin Front and Back Panels No alternate designs contemplated Analyzed or tested effects of differing part geometries and structures on overall performance a. Tested “various” molding conditions Tried the 3 methods used on other similar parts without understanding WHY they performed differently 178 samples tested to examine how the plastic melting process could be modified to optimize the combination of backpressure, altered max temperature, temperature profile in relation to mix time, mix speed, uniformity of the resin, melt & fibre distributions, order of reagent addition, etc. then CONCLUDED why one better (e.g. hi temp melt fibres proved optimal but only if we held max. temp to 300 Deg C and increased mix time by 40% to ensure adequate fibre distribution) b. using 8 different plastic materials then Used 8 different sheets without understanding WHY each performed differently Identified, analyzed or tested expected causes of performance differences: e.g.. Viscosity, rheology, …etc. A CONCLUSION would also help but it is NOT necessary to have on EVERY activity. c. tested 2 plastics re. thickness vs. strength Testing to provide a "result" (e.g.. Plastic 1 is better) vs. a conclusion (i.e. why it's better) Analyzed or tested thickness vs. strength vs. variables in the part design above for example: extrusion temperature, cooling time, humidity effects on embrittlement, flex or other characteristics (system uncertainty). CONCLUDED why one better (e.g. HDPE sample proved effective but required 17% more cooling time in order to maintain flex. We attribute this to a combination of the molding pressure and chemical effects of a new resin.) 292

293 L – Cases Regarding Technological Advancement and Uncertainty
Ontario Inc. v R., 2012 TCC 376, [2013] 1 CTC 2170, 2013 DTC 1008 o/a Airmax installed HVAC systems for residential homes In 2007 and 2008, SR&ED expenditures were claimed by the company The issue is whether the work performed constituted SR&ED: Court’s decision to allow claim was based on the company’s record-keeping and documentation of problems, solutions, testing, modification CRA was not able to sustain argument that work was “routine engineering and standard procedures” The company established evidence of “technological advancement” attended by “technological obstacle/uncertainty” L - 8

294 I) Recent SR&ED tax cases & related issue(s)
Airmax Issue 1)  SR&ED eligibility of HVAC improvements - win Issue 2) informal appeal $12K limit / result in year Cal Amp – bonuses linked to SR&ED - loss Lyrtek – CCPC status & defacto control - loss Immunovaccine – if SR&ED loan “government assistance” - loss The RDBASE SR&ED Consortium© Practitioner Workshop Sept 25, 2013

295 Airmax - issue 1- SR&ED eligibility
ELIGIBLE WORK: During the 2007 taxation year SR&ED activities focused on the design of a quieter air diffuser. The Minister accepted that this work was eligible SR&ED. INELIGIBLE WORK: To reduce noise levels further, the appellant undertook testing of the flexible duct used as the conduit to move the hot air generated at the heating source. The appellant put holes in the core of the flexible duct for that purpose, experimented with the size, number and position of the holes, and adopted those variables which reduced noise levels the most WIN/LOSE: Win The RDBASE SR&ED Consortium© Practitioner Workshop Sept 25, 2013

296 Airmax - issue 1- SR&ED eligibility
RULING /RATIONALE: The judge commented: “The evidence shows that the system was unique in the market insofar as it utilized: - Higher than usual pressure in response to narrower duct work used in narrow multi-storey townhouses & - an unconventional heat source unlike more commonly used indirect-fired furnaces & - there was technological uncertainty with respect not only to noise, but also to space & efficiency with those types of systems.” IMPLICATIONS: Basis for project example in HVAC industry SIGNIFICANCE: High The RDBASE SR&ED Consortium© Practitioner Workshop Sept 25, 2013

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300 Airmax - issue 2 – informal appeal limits
ISSUE: informal appeal $12K limit / result in year IMPLICATIONS: strategy to deal with multi year or small issues – discussed later in this presentation SIGNIFICANCE: High Recommendation: Until a better method is developed perhaps the threshold amounts could be raised for SR&ED related claims? The RDBASE SR&ED Consortium© Practitioner Workshop Sept 25, 2013

301 L – Cases Regarding Technological Uncertainty
Soneil International Ltd., 2011 TCC 391, 2011 DTC 1282 Soneil claimed that they conducted scientific research and development in designing inhibitor and power optimization for motorized wheelchairs, virtual battery system, and multi-voltage output charger CRA assessed the 2002 claim and disallowed SR&ED credits Appeal by Soneil dismissed: Insufficient evidence to show that work in these areas was scientific research and development No technological risk or uncertainty seen to exist Did not provide sufficient evidence to show that their work with respect to the application of the existing parts and components required more than routine engineering or standard procedures L - 9

302 L – Cases Regarding Technological Uncertainty
Murray Arlin Dentistry Professional Corporation, TCC 133 Dr. Arlin made claims for investment tax credits in respect of scientific research expenditures in the amount of $103,950 for each of the 2007 and 2008 taxation years Following an audit by the Canada Revenue Agency, the claims were disallowed There was insufficient evidence to support the occurrence of “systematic investigation”, of which Northwest Hydraulic is the seminal judicial decision Evidence was brief and vague in the support of reasonable allocation of Dr. Arlin’s time. Appeal was dismissed L - 10

303 Murray Arlin Dentistry PC
Tritan program to log dental implants 200 variables 50 used 12,000 patient records Sole evidence for 2007 & 2008 was 2007 article Whether hypotheses required vs. Evidence of experimentation or analysis “performed.” Hamilton Region SR&ED Practitioners Group 2012

304 What is a “hypotheses” for SR&ED
Null hypothesis – life sciences Principle Testing for differences Example Directionality Sample size The testing process Common test statistics Arlin case – apply null hypotheses Hamilton Region SR&ED Practitioners Group 2012

305 L – Cases Regarding Technological Uncertainty
Hun-Medipharma Research Inc 99 DTC 407 Question whether certain analysis performed by the corporate taxpayer in respect of anti-stress tablets and medical skin care products were eligible SR&ED CRA disallowed on the basis that there was no experiment, no clinical trials Review of literature in preparation for drug submission not eligible Company submitted that they performed eligible scientific and medical analysis and conclusion of technical, preclinical and clinical data Experimentation not required L - 11

306 L – Cases Regarding Technological Uncertainty
Hun-Medipharma Research Inc 99 DTC 407 Courts agreed that the company conducted eligible analysis for advancement of scientific knowledge with a specific practical application in view IC 86-4R4 does not require clinical experiments The definition of SR&ED does not require both experiment and analysis. It can be either/or provided there is systematic investigation L - 12

307 L – Cases Regarding Systematic Investigation
RIS-Christie Ltd. 97 DTC 99 Company carried on SR&ED into a new onsite concrete forming medium for use in construction industry Some evidence that engineering uncertainty existed, that hypothesis was formulated and taxpayer conducted testing to resolve a technological problem CRA disallowed claim on the basis that there was insufficient evidence to support the claim L - 13

308 L – Cases Regarding Systematic Investigation
RIS-Christie Ltd. 97 DTC 99 CRA produced an expert witness who reviewed the documentation and identified preliminary design calculations that do not involve new knowledge or methodologies Company’s expert testified that methodology of research and development was followed The company identified a problem dealing with concrete forming and temperature variations, and came to technical resolution of the problem L - 14

309 L – Cases Regarding Systematic Investigation
RIS-Christie Ltd. 97 DTC 99 The tax court agreed with the Minister The taxpayer did undertake a project that led to a patent but the evidence does not establish that they engaged in SR&ED Essential element of repeatability was not established Expert witness was unable to support testimony with documentation Decision was overturned on appeal to the Federal Court On balance of probabilities, SR&ED was undertaken Current emphasis on documentation makes this case particularly relevant L - 15

310 EVIDENCE OF INVESTIGATION – RIS Christie
ISSUE: "lack of documentation“ WIN/LOSE: lose round 1 - win round 2 RULING/RATIONALE ineligible - lack of any experimentation or analysis – APPEAL - engineer died prior to trial - court sympathetic IMPLICATIONS:1 ineligible - lack of any experimentation or analysis 2 engineer died prior to trial - court sympathetic SIGNIFICANCE: Moderate SR&ED is defined for income tax purposes[1], as follows: “scientific research and experimental development means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is (a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view, (b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or (c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, and, in applying this definition to a taxpayer, [1] in subsection 248(1) of the Act 310

311 EVIDENCE OF INVESTIGATION – RIS Christie
CRA Queries to client (unable to answer any of them): (a) What was the experimental set-up? (b) What test specimens were used? (c) How many specimens were tested? (d) What were the test parameters? (e) What temperature ranges were used? (f) What loading procedure was used? (g) Was foam injected and then temperature measures taken? (h) What device was used to measure the temperature? (i) At what location were the temperatures measured? (j) As it was a composite system, even thermal rise would produce substantial stresses in the various components. Was any attempt made to model the problem analytically and then measure the thermal deformations. SR&ED is defined for income tax purposes[1], as follows: “scientific research and experimental development means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is (a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view, (b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or (c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, and, in applying this definition to a taxpayer, [1] in subsection 248(1) of the Act 311 311 311

312 L – Cases Regarding Technological Evidence
R.J. Miller 2001 CTC 2657 (TCC) and CTC 120 (FCA) Taxpayer developed a custom shotgun and an advanced receiver-trigger and recoil system CRA denied as no technological advancement or uncertainty Taxpayer declared that auditor was not qualified to review the claim L - 16

313 L – Cases Regarding Technological Evidence
R.J. Miller 2001 CTC 2657 (TCC) and CTC 120 (FCA) Courts referred to Northwest Hydraulics Dismissed evidence of “experts” Concluded that there was no evidence of Technological Uncertainty and claim was denied at the tax court Decision upheld on appeal L - 17

314 L – Cases Regarding Technological Evidence
Global Enviro Inc. and Ian George McIntyre, 2011 ABQB 32 Between 2001 and 2003, Global made SR&ED claims, which the CRA assessed as not valid Global convicted of providing false/misleading evidence to support the claim after the assessment: Attempted to use supporting document (e.g. invoices) to show work was performed in the claim period Supporting document determined to be misleading Fined $250,000, pursuant to ITA Section 239(1.1)(g)(ii) Global’s appeal on the conviction dismissed L - 18

315 L – Cases Regarding Salaries and Wages
Alcatel Canada Inc DTC 387 (TCC) Taxpayer claimed stock option benefits as eligible salaries and wages CRA disallowed on the basis that the stock option benefits were not expenditures incurred Courts allowed the stock option benefits as expense incurred in the year and therefore qualified expenditures for ITC purposes Law was changed effective November 14, 2005 to disallow stock option benefits L - 19

316 L – Cases Regarding Salaries and Wages
CDD-REM Process Vacuum Technology Corp. 2001 1 CTC 2312 Company made payments to other corporations owned by shareholders Claimed portion of the payments as SR&ED Minister disallowed due to lack of evidence of liability, no paper trail L - 20

317 L – Cases Regarding Salaries and Wages
CDD-REM Process Vacuum Technology Corp CTC 2312 Court was satisfied that the payments were paid and were on account of SR&ED Claim was allowed Legislation regarding Non Arm’s Length contract payments were introduced in 1995 to exclude such payments as qualified expenditures The claim would now be made by the performer based on their costs of performing SR&ED on behalf of the payer L - 21

318 L – Cases Regarding Salaries and Wages
Synchrosat Ltd. – 2000 DTC 2468 Taxpayer was involved in the development of a turbine Only revenue was R&D investment tax credits Minister disallowed the 1988 claim on basis that the taxpayer was not carrying on a business to which the SR&ED was related L - 22

319 L – Cases Regarding Salaries and Wages
Synchrosat Ltd. – 2000 DTC 2468 Court found that the taxpayer was involved in an “adventure in the nature of trade” which is considered a business The Court should not second guess the wisdom of business judgment with the benefit of hindsight and the Court cannot foretell the failure of an invention Absence of revenue during the development phase is expected as revenues can only be realized at the end of the adventure Appeal by taxpayer was allowed L - 23

320 L – Cases Regarding Salaries and Wages
Synchrosat Ltd. – 2003 DTC 940 Company claimed again in 2001 for 4 projects related to the turbine The shareholder was the only employee working on the project and the company paid him a reduced salary CRA allowed 25% of the total salary as eligible Taxpayer countered that the salary was paid only for SR&ED and should be allowed as SR&ED in full The Courts did not accept that the salary related only to the one eligible SR&ED activity and reduced the claim to 25% of salary CPP contributions relating to the prior year were allowed in part Confirmed on judicial review L - 24

321 L – Cases Regarding Salaries and Wages
Ergorecherche & Conseils Inc. 98 DTC 1710 Company carried on SR&ED and paid salaries to 2 shareholders Salaries were based on available cash to pay, not hours worked Company had 6 projects: 3 in house and 3 for other parties They received contract payments for the 3 contract projects and allocated all salaries and wages to the in house projects CRA reassessed by allocating labour costs for specified shareholders to the projects based on actual time spent L - 25

322 L – Cases Regarding Salaries and Wages
Ergorecherche & Conseils Inc. 98 DTC 1710 Court considered the method of allocation, including using an hourly rate to charge against the in house projects Did not accept that there were no salaries paid for other projects Agreed with the CRA’s allocation of salaries to all projects based on time Brief discussion of salaries vs. bonus but amounts were not based on profits and no other amounts were paid as salaries L - 26

323 L – Cases Regarding Materials Consumed
Consoltex Inc. 97 DTC 724 Company carried on SR&ED developing new fabrics Substantial amounts of yarn were claimed as SR&ED materials The cloth produced in the course of the experiment was sold CRA attempted to offset the sale proceeds against the SR&ED expenditures claimed The parties agreed on eligibility but disagreed on the expenditures in the claim L - 27

324 L – Cases Regarding Materials Consumed
Consoltex Inc. 97 DTC 724 The Court determined that the project was SR&ED even though some product was sold. Also accepted that the yarn was required for the project. They examined whether the Act required sale proceeds to reduce SR&ED claims and whether the costs should be inventory or cost of sales rather than SR&ED Determined that the proceeds did not need to reduce the claim The costs could be both SR&ED and cost of sales; the company was entitled to a deduction in any event and could choose to claim as SR&ED The ITC should be awarded on the project expenditures in accordance with the philosophy of fiscal incentives Recapture rules now address ITC on materials transformed into experimental production and sold L - 28

325 L – Cases Regarding Materials Consumed
Consoltex Inc. 97 DTC 724 The Court determined that the project was SR&ED even though some product was sold. Also accepted that the yarn was required for the project. They examined whether the Act required sale proceeds to reduce SR&ED claims and whether the costs should be inventory or cost of sales rather than SR&ED This case is similar to a 1984 case – Les Cultures Laflamme. Both cases predate the recapture rules which were introduced in 1988; now the sale of the product would result in recapture of the ITCs claimed on “materials transformed” L - 29

326 MATERIALS – Consoltex (TCC)
ISSUE: materials used in SR&ED then sold WIN/LOSE: Win (then law changed) RULING /RATIONALE: CRA took all or nothing approach – new rules on subsequent disposition IMPLICATIONS: Clarification: labour eligible - materials "sold" excluded SIGNIFICANCE: High SR&ED is defined for income tax purposes[1], as follows: “scientific research and experimental development means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is (a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view, (b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or (c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto, and, in applying this definition to a taxpayer, [1] in subsection 248(1) of the Act 326

327 L – Cases Regarding Buildings vs. Structure
Dew Engineering & Development Ltd. 96 DTC 1765 Taxpayer constructed a portable lab for SR&ED purposes Claimed the costs as SR&ED CRA denied the cost as cost of a building which, along with land, is excluded from SR&ED Courts analyzed the characteristics of the lab and found that it did not meet the definition of a building Taxpayer was entitled to include the cost in their SR&ED claim L - 30

328 L – Cases Regarding Contract Revenue
ComDev Ltd. 99 DTC 775 Taxpayer manufactured parts for sale to an arm’s length taxpayer which received government funding Taxpayer performed SR&ED to develop new components and claimed the expenditures as SR&ED CRA attempted to reduce the claim for the contract payments received from the third party CRA held that the government funding received by the other company should be treated as non-government assistance to the taxpayer L - 31

329 L – Cases Regarding Contract Revenue
ComDev Ltd. 99 DTC 775 Courts held that the parties dealt at arm’s length and hence there was no flow through of the government assistance Furthermore, the taxpayer was not performing SR&ED on behalf of the Canadian government and was not performing SR&ED on behalf of the third party Amounts received for components were not SR&ED contract payments Com Dev was entitled to ITC without reduction for government assistance or contract payment L - 32

330 Maximum Efficient Use of Knowledge Corporation © 2013
CRA "Assistance & Contract Payments Policy" Dec. 19,  Definition of "contract payment" in subsection 127(9) Maximum Efficient Use of Knowledge Corporation © 2013

331 L – Cases Regarding Government Assistance
CCLC Technologies Inc. v. Canada, [1996] F.C.J. No (QL) (FCA), 1996 CarswellNat 1652 Taxpayer received funds from the Alberta government under a Coal Research Agreement Taxpayer performed SR&ED and claimed the expenditures as SR&ED with no reduction for funds received on the basis that it represented an equity investment CRA attempted to reduce the claim for the amounts received CRA held that the funding received by CCLC should be treated as government assistance to the taxpayer The Tax Court held that the funding received was not government assistance. The agreement was an ordinary business arrangement for the Province to acquire an equity interest in the company Federal Court of appeal held that amounts were government assistance as indicators of a commercial investment in a business were not established L - 33

332 L – Cases Regarding Government Assistance
Immunovaccine Technologies Inc. v H.M.Q. (Tax Court Canada docket ITG, 10-Apr-2013) Taxpayer received funds from the Atlantic Canada for Opportunities Agency (ACOA) Taxpayer performed SR&ED and claimed the expenditures as SR&ED with no reduction for funds received on the basis that it represented a commercial loan CRA attempted to reduce the claim for the amounts received CRA held that the funding received by CCLC should be treated as government assistance to the taxpayer The Tax Court agreed. The intent of the parties was to consider the contribution as government assistance. In the funding agreement, the company confirmed that it would not claim any assistance other than the funds received from ACOA L - 34

333 L – Cases Regarding Foreign R&D
Data Kinetics 1988 DTC 1877 Taxpayer carried on SR&ED related to software development Taxpayer carried on all SR&ED in Canada Taxpayer leased time on a mainframe computer to test code CRA denied the costs as SR&ED carried on outside Canada L - 35

334 L – Cases Regarding Foreign R&D
Data Kinetics 1988 DTC 1877 The Courts examined whether the payments related to SR&ED carried on in Canada or outside Canada Determined that the mainframe computer was a tool used to perform SR&ED in Canada and allowed the costs and ITCs L - 36

335 L – Cases Regarding Foreign R&D
LGL Ltd DTC 6108 The taxpayer carried on research which involved tracking whale pods in Canada and Alaska All analysis of data was performed in Canada The taxpayer claimed all project expenditures under s.37(1) The CRA disallowed costs related to the work outside Canada Taxpayer claimed that the project was carried out in Canada and the only work outside Canada was data collection in support of the Canadian project L - 37

336 L – Cases Regarding Foreign R&D
LGL Ltd DTC 6108 The Courts examined whether the payments related to SR&ED carried on in Canada or outside Canada Determined that the project could not be characterized as wholly Canadian Costs were allocated to the Canadian project or the US project depending upon where the work was done This is consistent with current policy – SR&ED must be done in Canada and qualified expenditures include only payments to Canadian taxable suppliers (other than purchases of capital assets or materials) L - 38

337 L – Cases Regarding Directly Attributable Expenditures
Aurora Marine Industries Inc CTC 2183 Corporate taxpayer was engaged in developing marine products Shareholder provided the company with the exclusive use of a boat to test various marine products Company claimed various costs related to the boat including commissioning, insurance, moorage The CRA attempted to disallow the costs on the basis of unstated assumptions L - 39

338 L – Cases Regarding Directly Attributable Expenditures
Aurora Marine Industries Inc CTC 2183 The Courts accepted the testimony of the witness as credible The Courts considered that the company was carrying on eligible SR&ED and that the taxpayer had exclusive use of the boat for purposes of testing in the course of SR&ED; it was not used for anything else Reasonable expenses related to upkeep and maintenance were allowed for the year L - 40

339 L – Cases Regarding Filing Deadline
Alex Parallel Computers Research Inc. 99 DTC 5283 Company missed the filing deadline for its 1994 SRED claims by 3 months The minister refused to waive the deadline or provide an extension The company applied to the Courts to require the Minister to exercise discretion pursuant to subsection 220(2.1). Appeal was allowed Legislation was introduced in July 2010 which removed Ministerial discretion L - 41

340 L – Cases Regarding CCPC Status
Price WaterhouseCoopers Inc. c R., 2012 CarswellNat 5313, 2012 DTC 1048, 2 CTC 2097 Majority of Class A shares owned by a foreign corporation Claimed SR&ED as a CCPC CRA disallowed the refundable credits and the 35% rate on the basis that the company was controlled by the foreign corporation L - 42

341 CCPC status with > 50% foreign shareholders – Bagtech (PWC)
Issue: Can USA create CCPC status Ruling & rationale: WIN - Unanimous Shareholders Agreement breaks control Implications: See other similar cases (Perfect Fry) ITA 256 SIGNIFICANCE: High 341

342 L – Cases Regarding CCPC Status
Lyrtech RD Inc. v. The Queen 2013 TCC 12, Docket (IT)G Company owned by a discretionary trust; trustees were directors of a public corporation Claimed SR&ED as a CCPC CRA disallowed the refundable credits and the 35% rate on the basis that the company was controlled by a public corporation Where the majority of the shares are held by a trust, control is in the hands of the trustees who can bind the trust L - 43

343 Lyrtek - CCPC status & defacto control - LOSS
FACTS: A public corporation, Lyrtech restructured its business in order to transfer its R&D activities to a new corporation, the appellant (Lyrtek RD Inc.) The majority of voting shares for Lyrtek RD Inc. were held in a trust. The trustees also controlled Lyrtek. Lyrtech determined what research work the appellant was to conduct The intellectual property resulting from this research work belonged to Lyrtech. For its research work, the appellant was entitled to receive only 10% of the royalties on sale of products from research work & 25% of the proceeds from licenses. The RDBASE SR&ED Consortium© Practitioner Workshop Sept 25, 2013

344 Lyrtek - CCPC status & defacto control - LOSS
RULING /RATIONALE: “Lyrtech exercised a dominant economic influence over the appellant.” IMPLICATIONS: Need to reduce factors leading to “control” One key step would be to provide a cost plus basis which allowed the SR&ED performer to illustrate a “reasonable expectation of profit.” See cases of “Mimetex” & “Bagtech” for ideas SIGNIFICANCE: High The RDBASE SR&ED Consortium© Practitioner Workshop Sept 25, 2013

345 L – Cases Regarding CCPC Status
Mimetix Pharmaceuticals Inc DTC 1026 (TCC) and 2003 DTC 5194 (FCA) Company owned 50% by a US corporation Claimed SR&ED as a CCPC CRA disallowed the refundable credits and the 35% rate on the basis that the company was controlled by the US corporation L - 44

346 L – Cases Regarding CCPC Status
Mimetix Pharmaceuticals Inc DTC 1026 (TCC) and 2003 DTC 5194 (FCA) Courts considered the degree of voting control exercised by the US corporation and found no one had voting control However they found that the only director that exercised control was the US non-resident director. De facto control was not in Canada Company was not a CCPC and not a qualifying CCPC Claims at the 35% refundable rate were disallowed and the ITC was reduced to the 20% non-refundable rate Decision was upheld on appeal L - 45

347 L – Cases Regarding Partnerships
Ouellet 2004 TCC 308 (TCC), McKeown 2001 DTC 511 (TCC), Canadian Solifuels Inc DTC 5565 (FCA) There are a number of partners that have claimed SR&ED for activities carried on by a partnership Where the CRA believes that the partners are passive investors, they will apply the specified member rules to disallow the credits L - 46

348 L – Cases Law in SR&ED Case law provides guidance and interpretation
There is a large number of cases dealing directly with SR&ED issues – this is only a sample Other tax cases are also relevant as most provisions of the ITA apply to taxpayers that are conducting SR&ED Case law often drives legislative changes Ensure that the decisions you rely upon apply to the period in question L - 47

349 Module L – Exercise #1 Why are court decisions important to understanding the SR&ED program? The SR&ED legislation is open to interpretation by taxpayers and the CRA. In the event of a dispute, the courts will make the final decision. These decisions create precedents that provide guidance to claimants on issues such as eligibility, evidence, expenditures and filing deadlines. L - 48

350 Module L – Exercise #2 How do court decisions influence the SR&ED program? - The CRA may challenge issues in Court that are decided in favour of the taxpayer due to the wording in the Income Tax Act. In some cases, the CRA may approach the Department of Finance to amend the legislation in order to resolve the issue going forward. Provide 2 examples of legislative changes that have resulted from court decisions. - The treatment of sales proceeds in Les Cultures Laflammes and Consoltex resulted in the introduction of the recapture rules. - The treatment of stock options as salaries and wages in the Alcatel case resulted in the legislation that denies stock options as expenditures. L - 49

351 COMMON DOCUMENTATION PROBLEMS
Optimal implementation: Willing contributions of “investigators” Ability to identify and rank the relative significance of technical uncertainties Ability to provide “conciseness and brevity” by focusing on significant technical issues Call for support The next series of slides will try to illustrate some of the common documentation problems for the R&D industry in general and software in particular. Maximum Efficient Use of Knowledge Corporation © 2013 351

352 Need closest benchmark
Common SR&ED documentation problems The first of the most common SR&ED documentation problems is the failure to define standard practice. An example of this might be seen where description starts, “This product will be the first of it’s kind in the world …..” While this may be indicative of an advancement at least from a business perspective, it generally requires some benchmark of similar technology or method to clarify: ·       1) that the anticipated results are not readily apparent, and ·       2) what is to be learned, which basically = the ability to illustrate valid technical uncertainties. In summary, the researchers goal is to identify issues that are “routine engineering.” This would typically be any technical thrusts whose results are readily predictable within a proper definition of the company’s knowledge base. Need closest benchmark Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge Maximum Efficent Use of Knowledge Corporation ME + U = Knowledge 352

353 Work must correlate with uncertainties
Common SR&ED documentation problems Work must correlate with uncertainties Maximum Efficent Use of Knowledge Corporation ME + U = Knowledge Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge

354 Need experience in EACH field of science
Common SR&ED documentation problems Given the state of change of technology in most industries there is an ongoing requirement for research personnel to continually stay abreast of new developments which will impact their ongoing research activities. Often there is considerable amount of judgment required to determine whether a particular individual is qualified to be dealing with the specific technologies in question, particularly where the project contemplates a variety of technologies. Perhaps the best evidence as to “when” someone becomes qualified to perform the experimentation in question, is the point where he or she can formulate relevant technical hypothesis with respect to this work. Need experience in EACH field of science Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge Maximum Efficent Use of Knowledge Corporation ME + U = Knowledge 354

355 “Random” investigation Need to keep evidence of experiments
Common SR&ED documentation problems In the author’s opinion, “Trial and error” (which, according to the CRA’s definitions, is NOT an eligible form of experimentation) generally examines potential solutions to a problem without the ongoing evaluation of why these results occurred. The major difference between “Trial and error” and “systematic investigation” is the existence of : specific technical hypotheses and related technical conclusions. Recommendation: There is nothing wrong with “quick & dirty experiments” however, we should keep adequate evidence of the work performed as well as explanations for (product) failures as well as successes. In this way a technical advancement can be made even if the project itself becomes a “business” failure. Need to keep evidence of experiments Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge Maximum Efficent Use of Knowledge Corporation ME + U = Knowledge 355

356 Notable quote “I couldn't repair your brakes, so I made your horn louder.” - Steven Wright Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge

357 Edison Phonograph = Scientific Uncertainty
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358 Edison Light Bulb = System Uncertainty
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359 SR&ED “light bulb” lessons
American inventor Thomas Edison is credited for “inventing” the lightbulb Reality = story of “incremental innovation” In 1810, British chemist Humphry Davy invented the “electric arc,” a precursor to the light bulb. A series of innovations followed Maximum Efficient Use of Knowledge Corporation © 2013

360 SR&ED“light bulb” lessons
1860s, race for “commercially viable” light bulb Canadians, Woodward & Evans patented nitrogen-filled light bulb lasted longer than others BUT no financing Thomas Edison - successful in obtaining major financial backers continued experiments & bought patents Woodward & Evans + others Maximum Efficient Use of Knowledge Corporation © 2013

361 Key criteria summary Technical/financial summary ensuring:
a) technology benchmarked b) activities correlate to uncertainties c) conclusions (advancements) cited See examples per Maximum Efficient Use of Knowledge Corporation © ME + U = Knowledge

362 Maximum Efficient Use of Knowledge Corporation © 2013
Notable quote “Innovation is the ability to convert ideas into invoices.” - L. Duncan Maximum Efficient Use of Knowledge Corporation © 2013

363 CRA DRAFT project examples released Sep 2013
1301 Pump redesign 1302 Oil seed extraction process 1303 HVAC - How cost constraints affect a project 1304 Greenhouse management strategy - INELIGIBLE 1305 Glue development - Hypotheses formulation example 1306 Food development - INELIGIBLE TRIAL & ERROR 1307 Potato peeler - WHAT IF SCENARIOS 1308 Hockey stick design - SAMPLE SIZE 1309 Chemical formulation - DATA COLLECTION SCENARIOS 1310 Electronics – SR&ED vs. business portion of the project Maximum Efficient Use of Knowledge Corporation © 2013

364 C – CRA draft projects Sep 18, 2013 Example #1: 1301 Pump redesign
Case 1 – Technical problem A chemical company is developing a new process for producing one of their chemical products. One of the components of the process is a series of pumps. However, the pumps started corroding after six months rather than after the expected life of 10 years. The pump supplier was contacted about the problem. They carried out an investigation and traced the problem to an intermittent leak in a filter that allowed corrosive liquid into the unit. The problem was corrected by replacing the filters in the pumps. In this scenario, the problem with the pumps in the new process was technical and not technological. The technical problem was resolved using standard practice (the company’s trouble-shooting procedures) to find the cause of the corrosion and the problem was solved by replacing the filters. Maximum Efficient Use of Knowledge Corporation © 2013

365 Case 2 – Technological uncertainty – pump redesign
Consider a different scenario where a set of pumps fails after six months rather than after the expected life of 10 years. The pump supplier was contacted about the problem. They investigated by following their trouble-shooting guide and found that the failure was due to a leak in the seal on the shaft of the pump, which allowed corrosive liquid into the unit. They replaced the seals in all the pumps, but the pumps failed again after six months. Again, the pump supplier found that the cause of the failure was the same. They investigated further and discovered that the temperature of the shaft after a prolonged period of operation exceeded the maximum recommended operating temperature of the seal material. They also found that the failure of the seal was partly caused by the design of the seal on the shaft as well as the material used for the seal. Under prolonged operation, the seal failed and allowed the corrosive liquid into the unit. Once the cause of the problem was discovered, the supplier began an experimental development project to find out which of several redesigns of the seal and seal materials would be compatible for the operating environment of the pump. Maximum Efficient Use of Knowledge Corporation © 2013

366 Case 2 – Technological uncertainty – pump redesign (ctnd.)
Data on the behaviour and physical properties of the seal materials at much lower temperature ranges were available from the manufacturers. However, there was no information or data available on the corrosive behaviour of materials or their physical properties at the elevated temperatures in the environment that the pump is operating. The supplier undertook a series of experiments to investigate the material behaviour and seal design. In this scenario, the pump supplier faces technological uncertainties (design of the seal and material behaviour at operating conditions) and undertook experimental development work to resolve them. Conclusion This example illustrates the difference between a technical problem that can be resolved by applying practices, techniques, or methodologies that the company knows about or that are available in the public domain, and a technological uncertainty that requires experimental development. Maximum Efficient Use of Knowledge Corporation © 2013

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368 1302 Oil seed extraction process - TU
This example shows that technological uncertainties may arise from limitations in current technology, and technological uncertainty exists when it is not known whether a given result or objective can be achieved or how to achieve it based on generally available scientific or technological knowledge or experience. Example The current technology of extracting oil from oilseeds is based on a batch process, in which seeds are crushed, conditioned, and flaked. The residue after removing the oil consists mainly of protein-rich flour and seed coats with some trapped oil. This residue (or meal) is then ground and the remaining trapped oil is extracted with a solvent. The solvent is recovered from both the meal and the extracted oil by toasting and distillation. The meal is generally sold as an animal feed product. The main limitation of the current technology is that the meal is a mixture of the protein-rich flour and seed coats. Seed coats have no nutritional value, and are visually undesirable as a potential ingredient in foods for human consumption. Also, the conditioning and flaking at °C harms the nutritional value of the oil and the flour. Therefore, there is a need to develop a low-temperature oil-extraction process, including separating protein-rich flour from seed coats, to produce a protein-rich product suitable for human consumption. The specific technological problem is how to separate the seed coats from the protein flour at low temperature. It is difficult to physically separate seed coats and protein flour because they have very similar physical properties and the protein flour is firmly bonded to the seed coats. Maximum Efficient Use of Knowledge Corporation © 2013

369 Maximum Efficient Use of Knowledge Corporation © 2013
1302 Oil separation (ctnd.) Conclusion Though there were several technologies available to separate solid particles with different physical properties, no effective low temperature technologies were available to separate solid particles with very similar physical properties where the particles themselves were bonded together. One technology which had been tried at a small scale was ultrasonic maceration. However, since there was no publicly available information on the use of ultrasonic maceration for this particular type of oilseed, the operating parameters needed to test the technology were not in the public domain. Also, it was not known whether the continuous process needed on a large scale, including the ultrasonic maceration and simultaneous solvent extraction, could be developed. There was technological uncertainty in developing a continuous method to process oilseeds at low temperatures because no one knew whether the objective could be achieved and how to achieve it. Maximum Efficient Use of Knowledge Corporation © 2013

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371 1303 HVAC - How cost constraints affect a project
This example shows that cost targets are not technological uncertainties, but a technological uncertainty may arise by trying technologically uncertain paths to solve a problem to meet the cost targets. Example A company wants to develop an air recirculation system for energy-efficient homes that will permanently remove carbon monoxide. A key component of this system is a module in which carbon monoxide (CO) is converted to relatively harmless carbon dioxide (CO2) at room temperature. A process is available that uses a tin oxide and platinum catalyst to convert CO to CO2 at room temperature, and the company could develop a product based on this process. However, the high cost of using this process will make the selling price of the product out of reach for consumers. There are other methods to convert carbon monoxide, but they are not effective at room temperature. A key requirement is that the module must operate at room temperature. To achieve the project objective (a room-temperature carbon monoxide remover), the company has to develop an inexpensive process that operates effectively at room temperature. The technological uncertainty relates to how to convert CO to CO2 at room temperature that does not use the costly process with tin oxide and platinum. Maximum Efficient Use of Knowledge Corporation © 2013

372 Maximum Efficient Use of Knowledge Corporation © 2013
1303 HVAC – cntd. Conclusion Although the cost target by itself is not a technological uncertainty, a technological uncertainty may arise from the need to avoid using a costly process, even though that process is known to work. The required cost target is also the motivation or reason for the company to undertake work to remove this uncertainty. Maximum Efficient Use of Knowledge Corporation © 2013

373 Maximum Efficient Use of Knowledge Corporation © 2013

374 1304 Greenhouse management strategy - INELIGIBLE
This example shows standard practice, which means applying known techniques to a new situation where it is reasonably certain that the technique will achieve the desired result. Example After testing a newly developed plant variety, a greenhouse grower feels that there is a chance for commercial success and attempts to find the optimum conditions to maximize production. Depending on the zone size that can be controlled in the greenhouse, anywhere from 2 to 10 acres is planted with the promising variety. The grower monitors the growth of the crop and, depending on its performance, makes adjustments to guide the crop to optimal production. These adjustments are often called the “development of cultural management strategies or crop husbandry strategies.” However, greenhouse growers are aware of optimization techniques for factors such as lighting, temperature, CO2 and humidity. Also, developing and implementing management protocols for controlling nutrient levels, de-leafing, thinning, and other operational practices are familiar to them. Maximum Efficient Use of Knowledge Corporation © 2013

375 1304 Greenhouse management strategy (cntd.)
Conclusion These well-known and practiced techniques are standard in this industry, as growers are reasonably certain that the techniques, data, and procedures, when applied in this case, would work. So, although the grower may not be certain of the specific parameters, determining them using these approaches is part of the standard practice of this industry. In this case, there is no scientific or technological uncertainty in determining the optimum conditions to maximize production of a new plant variety. Maximum Efficient Use of Knowledge Corporation © 2013

376 Maximum Efficient Use of Knowledge Corporation © 2013

377 1305 Glue development - Hypotheses formulation
This example illustrates the concept of formulation of a hypothesis to resolve a problem. Example The research and development (R&D) department of a company was asked to come up with a solution to improve the bond strength of their premier glue product to compete with another product. The R&D chemist who was assigned to the project recently came across a published research paper whose authors had used an additive (acting as bonding agent) to increase the bonding strength of two chemicals that belong to the same class of materials as used in the company’s premier glue product. However, the conditions (temperature, pressure, humidity) under which the authors used the additive were quite different than those used by the company in manufacturing the glue. The chemist carried out further searches in both scientific and technical publications on the use of this additive but found nothing more. There was no way of predicting whether the additive would work in enhancing the bond strength of the glue considering the conditions under which the glue was manufactured. The chemist hypothesized that, based on the similarity of the chemical properties of the glue ingredients and the two chemicals used in the research paper, the use of the new bonding agent in the manufacture of the glue under the right conditions should increase the bond strength of the glue. Maximum Efficient Use of Knowledge Corporation © 2013

378 1305 Glue development - Hypotheses formulation
Conclusion This example simply illustrates the concept of a hypothesis—an idea, consistent with known facts, that serves as a starting point for further investigation to prove or disprove that idea. Maximum Efficient Use of Knowledge Corporation © 2013

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380 1306 Food development - INELIGIBLE TRIAL & ERROR
This example shows that when a series of tests are executed without any systematic plan and no attempt is made to analyze the results from each test, it is considered trial and error. Such work is not scientific research and experimental development (SR&ED). Example A company that has been involved in preparing food products for several years wanted to develop a low-calorie pocket pizza product. They proceeded by attempting to create the low-calorie pizza based on their knowledge of preparing standard pizza products. In their first attempt, they used different amounts of sauce, reduced the amount of cheese, and replaced the regular pepperoni with low-fat turkey pepperoni, without changing the layer structure of the pizza. This attempt was considered a failure because the low-fat pepperoni burned during cooking. The next series of attempts involved preparing and testing a different order of layering the ingredients. This attempt also failed because the large size of the pieces of pepperoni led to undercooking. The third attempt reduced the size of the pepperoni pieces by half. This attempt was somewhat successful, but still not good enough. The fourth attempt reduced the thickness of the low-fat pepperoni pieces. This fourth attempt was considered a success and the company proceeded to commercialize the product. Maximum Efficient Use of Knowledge Corporation © 2013

381 1306 Food development - INELIGIBLE TRIAL & ERROR
Conclusion The only lesson learned from each attempt was that it failed. There was no work at any stage to analyze the results from each trial and take corrective action based on the results. In other words, there was no planned approach, including identifying a technological uncertainty, formulating a hypothesis to eliminate that uncertainty, testing the hypothesis, analyzing the results to draw conclusions, and carrying out more experimentation, if needed. The work described in this example is trial and error. Maximum Efficient Use of Knowledge Corporation © 2013

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383 Maximum Efficient Use of Knowledge Corporation © 2013
Notable quote “Everyone has a photographic memory; some just don't have film” - Steven Wright Maximum Efficient Use of Knowledge Corporation © 2013

384 1307 Potato peeler – WHAT IF SCENARIOS
The following example shows how creating new materials, devices, products, or processes, or improving existing ones, can be achieved with or without technological advancement. Examples Case 1 The basic design of the potato peeler has not changed for more than 100 years. A company decided to develop a novel peeler by adding a phosphorescent substance to the plastic handle so that it would be easier to find in a dark kitchen drawer. There was no change to the shape of the handle or to the blade. Adding the phosphorescent substance did not entail any change to the molding process and did not affect the physical properties of the handle or the performance of the peeler. While this was a new product, there was no technological advancement in creating this “glow-in-the-dark” peeler. Case 2 The same company wanted to develop a new potato peeler with the same blade but wanted to modify the handle to make it easier to use. The new handle would be larger, easier to grip, and less likely to slip in the hand of the user. This would be achieved by making it softer yet rigid enough to retain its shape, and its surface would have to be rough enough to prevent it from slipping in a wet hand. It would also have to be dishwasher safe. The company found that their requirements could not be satisfied with any plastic that was available at the time. They decided to try to use a new polymer. Maximum Efficient Use of Knowledge Corporation © 2013